**UNITEDSTATES OF AMERICA**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 
| **x**                                                    | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|----------------------------------------------------------|---------------------------------------------------------------------------------------------------------|
|                                                     |                                                                                                    |
| **FOR  THE QUARTERLY PERIOD ENDED: MARCH 31, 2008** |
|                                                     |                                                                                                    |
| **o**                                                    | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For thetransition period from        to       **

 

**CommissionFile Number: 001-32255**

 

**ANSWERSCORPORATION**

(Exact name of Registrantas specified in its charter)

 

| **Delaware**                                                                |       | **98-0202855**                        |
|-----------------------------------------------------------------------------|------------|---------------------------------------|
| (State or Other  Jurisdiction of Incorporation or Organization)             |       | (I.R.S. Employer  Identification No.) |
|                                                                        |       |                                  |
| **237  West 35****th**** Street, Suite 1101, New York, New York** | ** ** | **10001**                             |
| (Address of  principal executive offices)                                   |       | (Zip Code)                            |

 

**(646)502-4777**

(Registrant’stelephone number)

 

 

(Former Name,Former Address and Former Fiscal Year, if changed since last report)

 

Indicate by check mark whether the registrant: (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.

 

Yes     x                     No      o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seedefinitions of “large accelerated filer,” “accelerated filer,” and “smallerreporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large accelerated filer  o                     |   | Accelerated filer x          |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated filer o                        |   | Smaller reporting  company o |
| (Do not check if a  smaller reporting company) |   |                              |

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes     o                     No      x

 

The number of the registrant’s shares of common stockoutstanding was 7,859,890 as of May 9, 2008.

 

 

----

** **

**ANSWERS CORPORATION**

 

**FORM 10-Q**

 

**CONTENTS**

 
| PART I  — FINANCIAL INFORMATION |                                                                                                        |
|-------------------------------------------|-------------------------------------------------------------------------------------------------------------|
|                                      |                                                                                                        |   |
| Item 1.                                   | Financial Statements                                                                                        | 4 |
|                                      |                                                                                                        |   |
|                                      | Consolidated  Balance Sheets as of March 31, 2008 (unaudited) and December 31,  2007              | 4 |
|                                      |                                                                                                        |   |
|                                      | Consolidated  Statements of Operations (unaudited) for the three months ended  March 31, 2008 and 2007 | 5 |
|                                      |                                                                                                        |   |
|                                      | Consolidated  Statements of Cash Flows (unaudited) for the three months ended  March 31, 2008 and 2007 | 6 |
|                                      |                                                                                                        |   |
|                                      | Notes to Unaudited Consolidated Financial Statements                                                        | 7 |
|                                      |                                                                                                        |   |
| Item 2.                                   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                 | 13 |
|                                      |                                                                                                        |   |
| Item 3.                                   | Quantitative  and Qualitative Disclosures About Market Risk                                                 | 27 |
|                                      |                                                                                                        |   |
| Item 4.                                   | Controls and  Procedures                                                                                    | 27 |
|                                      |                                                                                                        |   |
| PART II — OTHER INFORMATION     |                                                                                                        |
|                                      |                                                                                                        |   |
| Item 1.                                   | Legal Proceedings                                                                                           | 28 |
|                                      |                                                                                                        |   |
| Item 1A.                                  | Risk Factors                                                                                                | 28 |
|                                      |                                                                                                        |   |
| Item 2.                                   | Unregistered  Sales of Equity Securities and Use of Proceeds                                                | 28 |
|                                      |                                                                                                        |   |
| Item 3.                                   | Defaults  Upon Senior Securities                                                                            | 28 |
|                                      |                                                                                                        |   |
| Item 4.                                   | Submission  of Matters to a Vote of Security Holders                                                        | 28 |
|                                      |                                                                                                        |   |
| Item 5.                                   | Other Information                                                                                           | 28 |
|                                      |                                                                                                        |   |
| Item 6.                                   | Exhibits                                                                                                    | 28 |
|                                      |                                                                                                        |   |
| Signatures                                |                                                                                                        | 29 |

 

2

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**INTRODUCTORYNOTE**

 

**This Report on Form 10-Q forAnswers Corporation (“Answers” or the “Company”) may containforward-looking statements. You can identify these statements byforward-looking words such as “may,” “will,” “expect,” “intend,” “anticipate,”believe,” “estimate” and “continue” or similar words. Forward-lookingstatements include information concerning possible or assumed future businesssuccess or financial results. You should read statements that contain thesewords carefully because they discuss future expectations and plans, whichcontain projections of future results of operations or financial condition orstate other forward-looking information.  We believe that it is importantto communicate future expectations to investors. The forward-looking statementsincluded herein are based on current expectations that involve a number ofrisks and uncertainties, which are discussed in Part II, Item 1A, “RiskFactors” and in other sections of this Form 10-Q and in our other filingswith the Securities and Exchange Commission. These risks and uncertainties could cause actual results or events todiffer materially from the forward-looking statements that we make**.

 

**Although, there may be events inthe future that we are not able to accurately predict or control, we do notundertake any obligation to update any forward-looking statements for anyreason, even if new information becomes available or other events occur in thefuture.**  **Accordingly, to the extent that this Form 10-Qcontains forward-looking statements regarding the financial condition,operating results, business prospects or any other aspect of the Company,please be advised that Answers’ actual financial condition, operating resultsand business performance may differ materially from that projected or estimatedby the Company in forward-looking statements.**

 

3

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**PART I - FINANCIAL INFORMATION**

 

**ITEM 1.  FINANCIAL STATEMENTS.**

 

Answers Corporation and Subsidiary

 

**Consolidated Balance Sheets(unaudited, in thousands except share and per share data)**

 
| ** **                                                                                                                                                  | ** ** | **March 31** | ** ** | **December 31** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|----------------------|------------|
| ** **                                                                                                                                                  | ** ** | **2008**          | ** ** | **2007**             | ** ** |
| ** **                                                                                                                                                  | ** ** | **$**             | ** ** | **$**                | ** ** |
| **Assets**                                                                                                                                                  |       |              | ** ** |                 |       |
|                                                                                                                                                        |       |              | ** ** |                 |       |
| **Current assets:**                                                                                                                                         |       |              | ** ** |                 |       |
| Cash and cash equivalents                                                                                                                                   | ** ** | **5,462**         | ** ** | 6,778                |       |
| Investment securities                                                                                                                                       | ** ** | **—**        | ** ** | 700                  |       |
| Accounts receivable                                                                                                                                         | ** ** | **1,272**         | ** ** | 1,448                |       |
| Prepaid expenses and other current assets                                                                                                                   | ** ** | **681**           | ** ** | 487                  |       |
| **Total current assets**                                                                                                                                    | ** ** | **7,415**         | ** ** | 9,413                |       |
|                                                                                                                                                        |       |              | ** ** |                 |       |
| **Long-term deposits (restricted)**                                                                                                                         | ** ** | **209**           | ** ** | 196                  |       |
|                                                                                                                                                        |       |              | ** ** |                 |       |
| **Deposits in respect of employee  severance obligations**                                                                                                  | ** ** | **1,411**         | ** ** | 1,232                |       |
|                                                                                                                                                        |       |              | ** ** |                 |       |
| **Property and equipment, net of  $1,577 and $1,615 accumulated depreciation as of********March 31, 2008 and December 31, 2007,  respectively**   | ** ** | **1,087**         | ** ** | 1,012                |       |
|                                                                                                                                                        |       |              | ** ** |                 |       |
| **Other assets:**                                                                                                                                           |       |              | ** ** |                 |       |
| Intangible assets, net of $2,649 and $2,352  accumulated amortization as of March 31, 2008and December 31, 2007, respectively                     | ** ** | **4,470**         | ** ** | 4,766                |       |
| Goodwill                                                                                                                                                    | ** ** | **437**           | ** ** | 437                  |       |
| Prepaid expenses, long-term, and other assets                                                                                                               | ** ** | **231**           | ** ** | 275                  |       |
| Deferred charges (Lexico acquisition and  public offering)                                                                                                  | ** ** | **—**        | ** ** | 1,267                |       |
| **Total other assets**                                                                                                                                      | ** ** | **5,138**         | ** ** | 6,745                |       |
|                                                                                                                                                        |       |              | ** ** |                 |       |
| **Total assets**                                                                                                                                            | ** ** | **15,260**        | ** ** | 18,598               |       |
|                                                                                                                                                        |       |              | ** ** |                 |       |
| **Liabilities and stockholders’  equity**                                                                                                              |       |              | ** ** |                 |       |
|                                                                                                                                                        |       |              | ** ** |                 |       |
| **Current liabilities:**                                                                                                                                    |       |              | ** ** |                 |       |
| Accounts payable                                                                                                                                            | ** ** | **444**           | ** ** | 968                  |       |
| Accrued expenses                                                                                                                                            | ** ** | **882**           | ** ** | 1,045                |       |
| Accrued compensation                                                                                                                                        | ** ** | **754**           | ** ** | 551                  |       |
| Deferred revenues                                                                                                                                           | ** ** | **10**            | ** ** | 16                   |       |
| **Total current liabilities**                                                                                                                               | ** ** | **2,090**         | ** ** | 2,580                |       |
|                                                                                                                                                        |       |              | ** ** |                 |       |
| **Long-term liabilities:**                                                                                                                                  |       |              | ** ** |                 |       |
| Liability in respect of employee severance  obligations                                                                                                     | ** ** | **1,548**         | ** ** | 1,233                |       |
| Deferred tax liability                                                                                                                                      | ** ** | **17**            | ** ** | 14                   |       |
| **Total long-term liabilities**                                                                                                                             | ** ** | **1,565**         | ** ** | 1,247                |       |
|                                                                                                                                                        |       |              | ** ** |                 |       |
| **Commitments and contingencies**                                                                                                                           |       |              | ** ** |                 |       |
|                                                                                                                                                        |       |              | ** ** |                 |       |
| **Stockholders’ equity:**                                                                                                                              |       |              | ** ** |                 |       |
| Preferred stock: $0.01 par value; 1,000,000  shares authorized, none issued                                                                                 | ** ** | **—**        | ** ** | —               |       |
| Common stock; $0.001 par value; 30,000,000  shares authorized; 7,859,890 sharesissued and outstanding as of March 31, 2008 and December 31,  2007 | ** ** | **8**             | ** ** | 8                    |       |
| Additional paid-in capital                                                                                                                                  | ** ** | **74,393**        | ** ** | 73,893               |       |
| Accumulated other comprehensive loss                                                                                                                        | ** ** | **(27**           | **)**      | (28                  | )          |
| Accumulated deficit                                                                                                                                         | ** ** | **(62,769**       | **)**      | (59,102              | )          |
| **Total stockholders’ equity**                                                                                                                         | ** ** | **11,605**        | ** ** | 14,771               |       |
|                                                                                                                                                        |       |              | ** ** |                 |       |
| **Total liabilities and  stockholders’ equity**                                                                                                        | ** ** | **15,260**        | ** ** | 18,598               |       |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

4

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AnswersCorporation and Subsidiary

 

**Consolidated Statements of Operations(unaudited, in thousands except share and per share data)**

 
| ** **                                                                                                              | ** ** | **Three months ended March 31** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                              | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| ** **                                                                                                              | ** ** | **$**                                               | ** ** | **$** | ** ** |
|                                                                                                                    |       |                                                | ** ** |   |   |
| **Revenues:**                                                                                                           |       |                                                | ** ** |   |   |
| Advertising revenue                                                                                                     | ** ** | **3,013**                                           | ** ** | 2,884 |   |
| Answers service licensing                                                                                               | ** ** | **18**                                              | ** ** | 77 |   |
| Subscriptions                                                                                                           | ** ** | **—**                                          | ** ** | 425 |   |
| ** **                                                                                                              |       | **3,031**                                           | ** ** | 3,386 |   |
|                                                                                                                    |       |                                                | ** ** |   |   |
| **Costs and expenses:**                                                                                                 |       |                                                | ** ** |   |   |
| Cost of revenue                                                                                                         | ** ** | **1,393**                                           | ** ** | 1,144 |   |
| Research and development                                                                                                | ** ** | **875**                                             | ** ** | 722 |   |
| Sales and marketing                                                                                                     | ** ** | **762**                                             | ** ** | 982 |   |
| General and administrative                                                                                              | ** ** | **1,131**                                           | ** ** | 926 |   |
| Termination fees and write-off of costs  relating to the terminatedLexico  acquisition and abandoned follow-on offering | ** ** | **2,543**                                           | ** ** | — |   |
| **Total operating expenses**                                                                                            | ** ** | **6,704**                                           | ** ** | 3,774 |   |
|                                                                                                                    |       |                                                | ** ** |   |   |
| **Operating loss**                                                                                                      | ** ** | **(3,673**                                          | **)**      | (388 | ) |
|                                                                                                                    |       |                                                | ** ** |   |   |
| Interest income, net                                                                                                    | ** ** | **55**                                              | ** ** | 100 |   |
| Other expense, net                                                                                                      | ** ** | **(38**                                             | **)**      | (15 | ) |
|                                                                                                                    |       |                                                | ** ** |   |   |
| **Loss before income taxes**                                                                                            | ** ** | **(3,656**                                          | **)**      | (303 | ) |
|                                                                                                                    |       |                                                | ** ** |   |   |
| Income taxes                                                                                                            | ** ** | **(11**                                             | **)**      | — |   |
|                                                                                                                    |       |                                                | ** ** |   |   |
| **Net loss**                                                                                                            | ** ** | **(3,667**                                          | **)**      | (303 | ) |
|                                                                                                                    |       |                                                | ** ** |   |   |
| **Basic and diluted net loss per  common share**                                                                        | ** ** | **(0.47**                                           | **)**      | (0.04 | ) |
|                                                                                                                    |       |                                                | ** ** |   |   |
| **Weighted average shares used in  computing basic and diluted********net loss per common share**                       | ** ** | **7,859,890**                                       | ** ** | 7,826,584 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

5

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Answers Corporation and Subsidiary

 

**Consolidated Statements of Cash Flows****(unaudited, in thousands)**

 
| ** **                                                                                                                 | ** ** | **Three months ended March 31** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                                 | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| ** **                                                                                                                 | ** ** | **$**                                               | ** ** | **$** | ** ** |
| **Cash flows from operating  activities:**                                                                                 |       |                                                |       |   |   |
| **Net loss**                                                                                                               | ** ** | **(3,667**                                          | **)**      | (303 | ) |
| **Adjustments to reconcile net  loss to net cash (used in) provided by operating activities:**                             |       |                                                | ** ** |   |   |
| Depreciation and amortization                                                                                              | ** ** | **448**                                             | ** ** | 448 |   |
| Deposits in respect of employee severance  obligations                                                                     | ** ** | **(179**                                            | **)**      | (62 | ) |
| Increase in liability in respect of employee  severance obligations                                                        | ** ** | **311**                                             | ** ** | 179 |   |
| Stock-based compensation to employees and  directors                                                                       | ** ** | **501**                                             | ** ** | 525 |   |
| Write-off of amounts relating to the  terminated Lexico acquisition and abandonedfollow-on offering, paid in prior periods | ** ** | **663**                                             | ** ** | — |   |
| Loss on disposal of property and equipment                                                                                 | ** ** | **3**                                               | ** ** | — |   |
| Decrease in deferred tax asset                                                                                             | ** ** | **3**                                               | ** ** | — |   |
| Gains from exchange rates forward contracts,  net                                                                          | ** ** | **(38**                                             | **)**      | — |   |
| Exchange rate losses                                                                                                       | ** ** | **38**                                              | ** ** | 15 |   |
| **Changes in operating assets and  liabilities:**                                                                          | ** ** | **—**                                          | ** ** | — |   |
| Increase in accounts receivable and other  current assets                                                                  | ** ** | **(22**                                             | **)**      | (58 | ) |
| Decrease (increase) in prepaid expenses and  other assets                                                                  | ** ** | **33**                                              | ** ** | (201 | ) |
| Decrease in accounts payable                                                                                               | ** ** | **(176**                                            | **)**      | (122 | ) |
| Increase (decrease) in accrued expenses and  other current liabilities                                                     | ** ** | **280**                                             | ** ** | 83 |   |
| Decrease in deferred revenues                                                                                              | ** ** | **(6**                                              | **)**      | (441 | ) |
| **Net cash provided by (used in)  operating activities**                                                                   | ** ** | **(1,808**                                          | **)**      | 63 |   |
|                                                                                                                       |       |                                                | ** ** |   |   |
| **Cash flows from investing  activities:**                                                                                 |       |                                                | ** ** |   |   |
| Capital expenditures                                                                                                       | ** ** | **(231**                                            | **)**      | (298 | ) |
| Decrease (increase) in long-term deposits                                                                                  | ** ** | **(13**                                             | **)**      | 1 |   |
| Purchases of investment securities                                                                                         | ** ** | **—**                                          | ** ** | (3,203 | ) |
| Proceeds from sales of investment securities                                                                               | ** ** | **700**                                             | ** ** | 2,517 |   |
| **Net cash provided by (used in)  investing activities**                                                                   | ** ** | **456**                                             | ** ** | (983 | ) |
|                                                                                                                       |       |                                                | ** ** |   |   |
| **Cash flows from financing  activities:**                                                                                 |       |                                                | ** ** |   |   |
| Exercise of common stock options                                                                                           | ** ** | **—**                                          | ** ** | 142 |   |
| **Net cash provided by financing  activities**                                                                             | ** ** | **—**                                          | ** ** | 142 |   |
|                                                                                                                       |       |                                                | ** ** |   |   |
| Effect of exchange rate changes on cash and  cash equivalents                                                              | ** ** | **36**                                              | ** ** | (12 | ) |
| **Net decrease in cash and cash  equivalents**                                                                             | ** ** | **(1,316**                                          | **)**      | (790 | ) |
|                                                                                                                       |       |                                                | ** ** |   |   |
| Cash and cash equivalents at beginning of  period                                                                          | ** ** | **6,778**                                           | ** ** | 4,976 |   |
| ** **                                                                                                                 |       |                                                | ** ** |   |   |
| **Cash and cash equivalents at end of period**                                                                             | ** ** | **5,462**                                           | ** ** | 4,186 |   |
| ** **                                                                                                                 | ** ** | ** **                                          | ** ** |   |   |
| **Supplemental disclosures of cash flow  information:**                                                                    |       |                                                | ** ** |   |   |
| **Income taxes paid**                                                                                                      | ** ** | **2**                                               | ** ** | 1 |   |
| ** **                                                                                                                 |       |                                                | ** ** |   |   |
| **Non-cash investing activities:**                                                                                         |       |                                                | ** ** |   |   |
| **Unrealized net loss from securities**                                                                                    | ** ** | **—**                                          | ** ** | 1 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

6

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**ANSWERSCORPORATION**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**(UNAUDITED)**

 

**Note 1 -Business**

 

Answers Corporation (the “Parent”)was founded as a Texas corporation on December 22, 1998, and reorganizedas a Delaware corporation in April 1999. On December 27, 1998, theParent formed a subsidiary based in Israel (the “Subsidiary”), primarily forthe purpose of providing research and development services to the Parent. TheParent and its wholly owned Subsidiary are collectively referred to as the “Company.”The Parent is a public company and trades on the Nasdaq Global Market under thesymbol “ANSW”.

 

As of March 31,2008, approximately $376 thousand of the Company’s net assets were locatedoutside of the United States.

 

TheCompany provides answer-based search services to users primarily through itswebsites, Answers.com and WikiAnswers.com.

 

In the first quarter of2008, the Company’s planned acquisition of Lexico Publishing Group LLC and therelated planned offering of securities were terminated due to unfavorablemarket conditions. As a result, the Company recorded a charge to its statementof operations, amounting to approximately $2.54 million. See note 4 (f) forfurther details.

 

**Note 2 - Summaryof Significant Accounting Policies**

 

**Basis ofPresentation**

 

Theaccompanying consolidated financial statements include the accounts of AnswersCorporation and its Subsidiary and are presented in accordance with accountingprinciples generally accepted in the United States. All significantintercompany balances and transactions have been eliminated in consolidation.

 

Theaccompanying unaudited consolidated financial statements were prepared inaccordance with the instructions for Form 10-Q and, therefore, do not includeall disclosures necessary for a complete presentation of financial condition,results of operations, and cash flows in conformity with generally acceptedaccounting principles. All adjustments, which are, in the opinion ofmanagement, of a normal recurring nature and are necessary for a fair presentationof the interim financial statements, have been included. Nevertheless, thesefinancial statements should be read in conjunction with the consolidatedfinancial statements and related notes included in the Company’s Annual Reporton Form 10-K for the year ended December 31, 2007. The results ofoperations for the three months ended March 31, 2008 are not necessarilyindicative of the results that may be expected for the entire fiscal year orany other interim period.

 

**Use of Estimates**

 

Thepreparation of consolidated financial statements in conformity with generallyaccepted accounting principles in the United States of America requiresmanagement to make certain estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the consolidated financial statements and thereported results of operations during the reporting periods. Actual resultscould differ from those estimates.

 

7

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**ANSWERSCORPORATION**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(UNAUDITED)**

 

**Note 2 - Summaryof Significant Accounting Policies****(cont’d)**

 

**Revenue Recognition**

 

TheCompany, through its websites Answers.com and WikiAnswers.com, generatesrevenues via advertising in the form of sponsored links and image ads. Thisincludes both pay-per-performance ads and paid-for-impression advertising. Inthe pay-per-performance model, the Company earns revenue based on the number ofclicks associated with such ads. In the paid-for-impression model, the Company’srevenue is derived from the display of ads.

 

Todate, the majority of the Company’s advertising revenue has been obtainedthrough the efforts of third parties and has not been the result of directcontracts with advertisers. The third party is obligated to pay the Company aportion of the revenue it receives from advertisers, as compensation for theCompany’s sale of promotional space on its Internet properties. Amountsreceived from such third parties are reflected as revenue in the period inwhich such advertising services are provided.

 

The Company also earns revenuesfrom partners that pay the Company for providing them with answer-basedservices that they then use in their own products, via co-branded web pages.

 

In2003, the Company sold lifetime subscriptions to its GuruNet product, which hadno defined termination date. Cash received from such lifetime subscriptions wasrecorded as deferred revenues and amounted to $425,000. In February 2007,in accordance with the Company’s rights under the agreements it previouslyentered into with such lifetime subscribers, the Company terminated its GuruNetservice and thereby extinguished its service obligation to such subscribers.Thus, the Company recognized the $425,000 previously deferred, as revenue inthe first quarter of 2007.

 

Duringthe three months ended March 31, 2008, the Answers.com and WikiAnswers.comWeb properties accounted for $1,828 thousand and $1,185 thousand of the Company’sadvertising revenue, respectively. During the three months ended March 31,2007, the Answers.com and WikiAnswers.com Web properties accounted for $2,768thousand and $116 thousand of the Company’s advertising revenue, respectively.

 

**Accounting for Stock-Based Compensation**

 

The fair value of stockoptions granted to employees and directors, is estimated at the date of grantusing the Black-Scholes option-pricing model, which takes into considerationthe share price at the date of grant, the exercise price of the option, theexpected life of the option, expected interest rates and the expectedvolatility.

 

Through December 31, 2006,due to the lack of adequate history of its own stock volatility, the Companyestimated its own expected stock volatility based on the historical stockvolatility of three other comparable publicly held companies. During 2007, asthe Company accumulated its own volatility history over longer periods of time,the Company’s assumptions about its stock price volatility were based on a ratethat has been derived by taking into consideration the volatility rates of theaforesaid comparable publicly held companies as well as its own historicalvolatility rates. Beginning in 2008, the Company estimates its expected stockvolatility based on its own historical stock volatility rates only.

 

8

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**ANSWERSCORPORATION**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(UNAUDITED)**

 

**Note 2 - Summaryof Significant Accounting Policies****(cont’d)**

 

**Derivatives and hedging**

 

The Company accounts forderivatives and hedging based on Statement of Financial Accounting Standards133,*“Accounting for Derivative Instrumentsand Hedging Activities”* (SFAS 133). SFAS 133 requires the Company torecognize all derivatives on the balance sheet at fair value. If thederivatives meet the definition of a hedge and are so designated, depending onthe nature of the hedge, changes in the fair value of derivatives will eitherbe offset against the change in fair value of the hedged assets, liabilities,or firm commitments through earnings, or recognized in other comprehensiveincome until the hedged item is recognized in earnings. The ineffective portionof a derivative’s change in fair value is recognized in earnings.

 

During the first quarter of 2008,the Subsidiary entered into option contracts to hedge certain foreign currencydenominated expenses. These derivatives were not designated as hedginginstruments under the rules of SFAS 133 and, therefore, the net gains(losses) are recognized in earnings as they occur. Such gains amounted to $38thousand, and are included in operating expenses as follows:

 
| ** **                 | ** ** | **$ (in thousands)** | ** ** |
|----------------------------|------------|--------------------------------|------------|
|                       |       |                           |       |
| Cost of revenue            |       | 5                              |       |
| Research and development   |       | 20                             |       |
| Sales and marketing        |       | 2                              |       |
| General and administrative |       | 11                             |       |
|                       |       |                           |       |
|                       |       | 38                             |       |

 

**Recently Issued Accounting Standards**

 

In March 2008, theFASB issued Statement of Financial Accounting Standards 161, *“Disclosures about Derivative Instruments and HedgingActivities-an amendment of FASB Statement No. 133”* (SFAS 161).SFAS 161 gives financial statement users better information about the reportingentity’s hedges by providing for qualitative disclosures about the objectivesand strategies for using derivatives, quantitative data about the fair value ofand gains and losses on derivative contracts, and details ofcredit-risk-related contingent features in their hedged positions. SFAS 161 iseffective for financial statements issued for fiscal years beginning after November 15,2008 and interim periods within those years. The Company does not expect theadoption of SFAS 161 to have a material effect on its consolidated financialstatements.

 

9

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**ANSWERSCORPORATION****NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(UNAUDITED)**

 

**Note 3 – Stockholders’ Equity**

 

**General**

 

Thefollowing table summarizes the changes in the Company’s stockholders’ equityduring the three-month period ending March 31, 2008:

 
| ** **                 | ** ** | **$ (in thousands)** | ** ** |
|----------------------------|------------|--------------------------------|------------|
|                       |       |                           |       |
| **December 31, 2007** | ** ** | **14,771**                     | ** ** |
|                       |       |                           |       |
| Stock-based compensation   |       | 501                            |       |
| Net loss for the period    |       | (3,667                         | )          |
| ** **                 | ** ** | ** **                     | ** ** |
| **March 31, 2008**    | ** ** | **11,605**                     | ** ** |

 

**Stock Warrants**

 

As of March 31, 2008, therewere 1,157,763 outstanding stock warrants with a weighted average exerciseprice of $16.21. All warrants are exercisable immediately. No warrants wereexercised during the three months ended March 31, 2008.

 

**Stock Options**

 

During the three months ended March 31, 2008, theCompany granted a total of 18,300 stock options to its employees and officersat an exercise price of $5.22 per option. All such options were granted underthe Company’s 2005 Plan. Additionally, during the same period, 7,706 stockoptions were forfeited.

 

As of March 31, 2008,104,784 and 109,158 options were available for grant under the 2005 Plan andthe 2004 Stock Plan, respectively. All Prior Option Plans are closed for futuregrants.

 

Thetotal fair value of stock options vested during the first quarter of 2008,amounted to $501 thousand and was recorded as stock-based compensation expense.No stock options wereexercised during the three months ended March 31, 2008.

 

10

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**ANSWERSCORPORATION****NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(UNAUDITED)**

 

**Note 4 -Commitments and Contingencies**

 

(a)          Future minimum leasepayments under non-cancelable operating leases for office space and cars, as ofMarch 31, 2008, are as follows:

 
| **Year ending December 31**        | ** ** | **$ (in thousands)** | ** ** |
|---------------------------------------------------|------------|--------------------------------|------------|
|                                              |       |                           |       |
| 2008 (nine months ending December 31,  2008) |       | 337                            |       |
| 2009                                              |       | 403                            |       |
| 2010                                              |       | 240                            |       |
| 2011                                              |       | 1                              |       |
| ** **                                        | ** ** | ** **                     | ** ** |
|                                              | ** ** | 981                            | ** ** |

 

Rental expense for operating leases for the quarter endedMarch 31, 2008, and March 31, 2007 was approximately $133,000, and$122,000, respectively.

 

(b)         A bankguarantee given to the Subsidiary’s landlord, is secured by a restrictedlong-term deposit of $113,000 and collateralized by some of the Subsidiary’sbank deposits (as of March 31, 2008, such deposits amounted to $645,000).

 

(c)          In the ordinarycourse of business, the Company enters into various arrangements with vendors andother business partners, principally for content, property leases, web-hosting,marketing and investor relations arrangements. As of March 31, 2008, thetotal future commitments under these arrangements amount to approximately$1,128,000.

 

(d)         In the ordinarycourse of business, the Company may provide indemnifications of varying scopeand terms to customers, vendors, lessors, business partners, and other partieswith respect to certain matters, including, but not limited to, losses arisingout of its breach of agreements, services to be provided by it, or fromintellectual property infringement claims made by third parties. Additionally,the Company, through its operating agreement, has indemnified its members,officers, employees, and agents serving at the request of the Company to thefullest extent permitted by applicable law. It is not possible to determine themaximum potential amount of liability under these indemnification agreementsdue to the limited history of prior indemnification claims and the unique factsand circumstances involved in each particular agreement. Such indemnificationagreements may not be subject to maximum loss clauses. To date, the Company hasnot incurred costs as a result of obligations under these agreements and hasnot accrued any liabilities related to such indemnification obligations in itsaccompanying financial statements.

 

(e)          From time totime, the Company receives various legal claims incidental to its normalbusiness activities, such as intellectual property infringement claims andclaims of defamation and invasion of privacy. Although the results of claimscannot be predicted with certainty, the Company believes the final outcome ofsuch matters will not have a material adverse effect on its financial position,results of operations, or cash flows.

 

11

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**ANSWERSCORPORATION****NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**(UNAUDITED)**

 

**Note 4 -Commitments and Contingencies (cont’d)**

 

(f)            On July 13, 2007, the Companyentered into a Purchase Agreement to acquire all of the outstanding limitedliability interests of Lexico Publishing Group, LLC for an aggregate purchaseprice of $100 million in cash, subject to adjustments for closing net workingcapital. Consummation of the acquisition of Lexico was subject to the Company’sability to secure financing for the acquisition.

 

On July 17,2007, the Company filed a universal shelf registration statement on Form S-3with the Securities and Exchange Commission which was declared effective on August 6,2007. The registration statement covers up to an aggregate of $140,000,000 ofcommon stock, preferred stock, warrants, debt securities, units or anycombination thereof. The Company filed various prospectus supplements for a proposedpublic offering, the latest of which was filed on February 8, 2008. On February 13,2008 the Company canceled its proposed public offering due to unfavorablemarket conditions.

 

On March 1,2008, the members of Lexico terminated the purchase agreement, due to theCompany’s inability to finance the acquisition. As a result of the terminationof the purchase agreement, the Company reimbursed $500,000 of the sellers’transaction-related legal and accounting expenses, as provided for in thePurchase Agreement.

 

Additionally,in connection with the Lexico transaction, on January 15, 2008, theCompany entered into a Securities Purchase Agreement with an institutionalinvestor, or the senior notes investor, for the optional purchase and sale of$8.5 million aggregate principal amount of its senior secured convertible notesdue 2010, or the senior secured convertible notes. The Company’s intent was toclose the senior secured convertible notes financing in conjunction with itsfollow-on offering, if it needed such funds to close the Lexico acquisition.Since the Company’s purchase agreement with Lexico was terminated, theSecurities Purchase Agreement has also been terminated and the Company paid thesenior secured convertible notes investor a termination fee of $425,000, asprovided for in the Securities Purchase Agreement.

 

Inaddition to the payments to Lexico and the senior notes investor, aggregating$925,000, the Company incurred approximately $1,270,000 and $348,000 of costs,including legal, accounting, banking, consulting and travel costs, in 2007 andin the first quarter of 2008, respectively, in connection with the proposedacquisition of Lexico and follow-on offering. The payments to Lexico, to thesenior notes investor, and the additional costs, collectively $2,543,000, areincluded in the operating expenses on the Company’s statement of operations forthe three months ended March 31, 2008.

 

**Note5 – Major Customer**

 

During the first quarterof 2008, the vast majority of the Company’s advertising revenue was generatedthrough the efforts of third party suppliers (the “Monetization Partners”).Additionally, during the three months ending March 31, 2008 and 2007, theCompany earned approximately 76% and 66% of its advertising revenue,respectively, through one of its Monetization Partners.

 

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**ITEM 2. MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*The following discussion and analysis should beread in conjunction with, and is qualified in its entirety by, our financialstatements (and notes related thereto) and other more detailed financialinformation appearing elsewhere in this report. Consequently*, y*oushould read the following discussion and analysis of our financial conditionand results of operations together with such financial statements and otherfinancial data included elsewhere in this report. Some of the informationcontained in this discussion and analysis or set forth elsewhere in thisreport, including information with respect to our plans and strategy for ourbusiness, includes forward-looking statements that involve risks anduncertainties. You should review the “Risk Factors” section of this report andin our annual report on Form 10-K for a discussion of important factorsthat could cause actual results to differ materially from the results describedin or implied by the forward-looking statements contained in the followingdiscussion and analysis. Additionally, for a description of our Web propertyusage measurements, you should refer to our annual report on Form 10-K. Seealso “Forward-Looking Statements” in Part II, Item 1A. of thisreport.*

 

**Overview**

 

We are a leading online answer engine. Our Webproperties currently consist of Answers.com and WikiAnswers.com. We offerinformation related to over 5 million topics based on content frombrand-name publishers, and our WikiAnswers community answers.  Answers.com combines and presents targetedinformation from disparate sources and delivers answers to users’ questions ina single consolidated view. WikiAnswers.com is a user-generated content, orUGC, community-based question and answer site. According to comScore, a globalInternet information provider, our Web properties had approximately 17.2million unique visitors in March 2008, which ranks Answers Corporationnumber 53 in the top U.S. Web properties. Our goal is to become thepremier online provider of, and leading destination for, answers on any topic.

 

Prior to January 2005, we sold subscriptions to ourreference-based product, GuruNet. After the launch of Answers.com in January 2005,we ceased offering new subscriptions to GuruNet. In February 2007, weterminated the GuruNet service.

 

***Termination ofLexico Acquisition***

 

On July 13, 2007, we entered into a PurchaseAgreement that we subsequently amended on July 31, 2007 and November 12,2007, and on January 15, 2008 we entered into an Amended and RestatedPurchase Agreement, which we subsequently amended on February 8, 2008, toacquire all of the outstanding limited liability interests of Lexico PublishingGroup, LLC for an aggregate purchase price of $100 million in cash,subject to adjustments for closing net working capital.  Consummation of the acquisition of Lexico wassubject to our ability to secure financing for the acquisition.

 

On July 17, 2007, we filed a universal shelfregistration statement on Form S-3 with the Securities and ExchangeCommission which was declared effective on August 6, 2007.  The registration statement covers up to anaggregate of $140 million of common stock, preferred stock, warrants, debtsecurities, units or any combination thereof. On January 16, 2008, wefiled a prospectus supplement for a proposed public offering which we lateramended on February 8, 2008.  On February 13,2008 we canceled our proposed public offering due to unfavorable marketconditions.

 

On March 1, 2008, the members of Lexicoterminated the purchase agreement, due to our inability to finance theacquisition.  As a result of thetermination of the purchase agreement and in accordance therewith, wereimbursed $500,000 of the sellers’ transaction-related legal and accountingexpenses.

 

Additionally, in connection with the Lexicotransaction, on January 15, 2008, we entered into a Securities PurchaseAgreement with an institutional investor, or the senior notes investor, for theoptional purchase and sale of $8.5 million aggregate principal amount ofour senior secured convertible notes due 2010, or the senior securedconvertible notes. Our intent was to close the senior secured convertible notesfinancing in conjunction with our follow-on offering, if we needed such fundsto close the Lexico acquisition. Since our purchase agreement with Lexico wasterminated, the Securities Purchase Agreement also terminated and pursuant tothe Securities Purchase Agreement we have paid the senior notes investor atermination fee of $425,000.

 

In addition to the payments to Lexico and the seniornotes investor noted above, aggregating $925,000, we incurred approximately $1,270,000of costs, in 2007, which were reflected as deferred costs on our December 31,2007 balance sheet, for various matters including legal, accounting, banking,consulting and travel in connection with the proposed acquisition of Lexico andfollow-on offering. Further, we incurred an additional $348,000 of such costsin the first quarter of 2008. Those additional costs and the aforesaid paymentsto Lexico and the senior notes investor, which, in aggregate, amount to$2,543,000, were charged to operations in the first quarter of 2008.

 

**Acquisitions**

 

***WikiAnswers***

 

On November 2, 2006, we acquired WikiAnswers andcertain other assets for an aggregate of $2 million in cash. In connectionwith the allocation of the purchase price, we recorded goodwill of approximately$437 thousand and intangible assets, with estimated useful lives of 

 

13

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three to ten years, of approximately $1,563 thousand.Since the date of the acquisition the revenues and operating expenses ofWikiAnswers have been included in our results of operations.

 

***Brainboost***

 

On December 1, 2005, we acquired Brainboost,developer of the Brainboost Answer Engine which we have integrated into ourAnswers from the Web technology, an artificial intelligence technology enablingnatural language search on the Web. As consideration for the acquisition, wepaid $4.0 million in cash and issued 439,000 shares of our commonstock, valued at approximately $5.6 million at the time of theacquisition. In connection with the allocation of the purchase price, werecorded an intangible asset related to the Brainboost technology, ofapproximately $5.4 million, with an estimated useful life of six years,and recognized compensation expense of approximately $4.2 million.

 

In June 2006, we completed our initial betaintegration of the Brainboost technology into Answers.com as Answers from theWeb. We plan to evaluate further developing this technology throughenhancements to its accuracy, range and speed.

 

**Revenue**

 

***Traffic***

 

Our revenue is primarily driven by the trafficgenerated by our Web properties and our ability to effectively monetize thattraffic. Our current sources of traffic include the following:

 

·             *Search engines:*  Users submit queries and algorithm searchengines respond by generating a list of Web pages that they deem likely tooffer the most relevant content. When our pages rank high in thealgorithmic systems of search engines, our results are more likely to beaccessed by users. For the first quarter of 2008, according to our internalestimates, this source of traffic represented approximately 70% of our traffic.

 

·             *Google’s definition link:*  We have an informal,non-contractual relationship with Google under which Google links certainsearch results related to definitional queries to Answers.com. For the firstquarter of 2008, according to our internal estimates, this source of trafficrepresented approximately 10% of our traffic.

 

·             *Direct users:*  Users visiting and returning to our homepages, and to a far lesser extent, arriving from Web properties that send ustraffic, or via 1-Click Answers and AnswerTips. For the first quarter of 2008,according to our internal estimates, direct users represented approximately 20%of our traffic.

 

Since most of our traffic originates from searchengines, we expend considerable resources improving the volume and optimizingthe monetization of this traffic. The industry commonly refers to such effortsas search engine optimization, or SEO. Our Web properties have at timesexperienced decreases in traffic, and consequently decreases in revenue, due tosearch engine actions, including actions by Google and Yahoo! that took placein 2007. In July 2007, a search engine algorithm adjustment by Google ledto a drop in Google directed traffic to Answers.com. This adjustment reducedour overall traffic by approximately 28% based on the average traffic directedto Answers.com from Google for the week prior to the adjustment as compared tothe week after. As a result, our revenue also declined proportionately. We havenot been able to reverse the impact of this adjustment, and we do notanticipate that we will recover the lost traffic and revenue. In response tothe Google algorithm adjustment, we reduced our headcount and relatedcompensation costs, reducing our base payroll expenses by approximately 12%. InSeptember 2007, Yahoo! briefly dropped our content from its search index.This action was reversed within a week, and we have recovered all of our Yahoo!directed traffic.

 

We continuously seek to improve the user experience ofvisitors to our Web properties, which we believe leads to increased pages pervisit, or stickiness, and return visits, or user-retention. We seek to increasestickiness and user-retention by adding new features, enhancing user interfacesand adding new content to our Web properties.

 

***Monetization***

 

*Advertising Revenue.*  We earn almost all of ourrevenue from advertising. There are two primary categories of Internetadvertising: pay-per-performance, or most commonly cost per click, or CPC, andpay-per-impression, or cost per 1,000 impressions, or CPM. In thepay-for-performance model we earn revenue based on the number of clicksassociated with an ad; in the paid-for-impression model we derive revenue fromthe display of ads. We work with third party ad networks that we believeoptimize the average amount of revenue we earn per page view. Third partyad networks generally compensate us by paying us a portion of the revenue theyearn from advertisers for our provision of promotional space on our Webproperties. Additionally, in the fourth quarter of 2006, we began marketingdirectly to advertisers and generating direct advertising revenue. While our directadvertising efforts has the potential to be a driver of future monetizationimprovements, the results of our direct ad sales team have not yet reacheddesired levels.

 

We gauge the effectiveness of our monetization effortsand trends by measuring our revenue per thousand page views, or RPM. Inour 

 

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Management’s Discussion and Analysis of FinancialCondition and Results of Operations prior to our quarterly report on Form 10-Qfor the quarterly period ended June 30, 2007, we reported RPM based onwebsite queries, or traffic, directly to one of our Answers.com topic pages.Beginning with the Management’s Discussion and Analysis of Financial Conditionand Results of Operations contained in our quarterly report on Form 10-Qfor the quarterly period ended June 30, 2007, we refer to RPM based on page views.Page views include traffic directly to the Answers.com home page, butexclude lookups conducted through 1-Click Answers, AnswerTips and traffic frompartners who pay us for providing them our answer-based services. Page viewsare the more widely recognized industry standard traffic metric. Based upon ourinternal analysis, we estimate the number of Answers.com page views to beapproximately 13% higher than the number of our previously reported Answers.comqueries. This difference is primarily attributable to home page visits inthe page view traffic estimates. RPM in the first quarter of 2007 reportedin this quarterly report, have been modified to conform to the new methodologyand are approximately 13% lower than the amount reported prior to our quarterlyreport on Form 10-Q for the quarterly period ended June 30, 2007. Ourmethodology for reporting the WikiAnswers RPM has remained the same since wehave begun reporting such information.

 

We believe that the primary factor that has thepotential of improving our Web properties’ RPM, is selling ads directly throughour own sales force. While our direct advertising efforts have the potential tobecome a driver of future monetization improvements, the results of our directad sales team have not yet reached desired levels.

 

Two of our third party ad networks, Google andShopping.com, accounted for approximately 76% and 5%, respectively, of ourtotal revenue in the first quarter of 2008 and approximately 66% and 9%,respectively, of our total revenue in the first quarter of 2007. In addition toGoogle and Shopping.com, we utilize the services of other third party adnetworks that provide us with ads. Although there are many companies thatprovide third party ad networks, the loss of Google as a third party ad networkcould have a material adverse impact on our financial condition, as we may notsucceed in receiving terms and ad services as favorable as those provided underour Google Services Agreement (GSA). While the drop in traffic due to the July 2007Google search engine algorithm adjustment impacted our aggregate advertisingrevenue, it did not affect our contractual relationship with Google under theGSA, which was last renewed for an additional two years, through January 31,2010.

 

*Licensing Revenue.*  We also earn revenues frompartners that pay us for providing them with our answer-based services thatthey then use in their own products, via co-branded Web pages. Revenue fromthese arrangements are based on various formulas, including fees based on thenumber of user queries and fixed periodic fees.

 

*Subscription Revenue.*  Prior to December 2003,we sold lifetime subscriptions to GuruNet, generally for $40 per subscription.In December 2003, we decided to alter our pricing model and moved to anannual subscription model, for which we generally charged our subscribers $30per year. We have not sold subscriptions since our launch of Answers.com in January 2005.As of February 2007, we terminated the GuruNet service.

 

**Costs and Expenses**

 

***Cost of Revenue***

 

Cost of revenue consists of fees to third partyproviders of content, Web search service fees, ad serving fees, amortization ofthe cost of acquired software used in our products, data center costs includingdepreciation of information technology assets, contractual revenue sharing feesto various Web property operators for visitors directed to our Web properties,or traffic acquisition costs, as well as the compensation, travel and overheadcosts relating to personnel who are responsible for content editing andintegration, production operations and customer support. As a result of ourmigration to a collocation facility for hosting our Web properties, from our currentmanaged hosting facility, we anticipate operating both facilities during thetransition period, in the second and third quarters of 2008, which will causecost of revenues to rise during those quarters. Notwithstanding, generally, asrevenues increase, we expect our cost of revenue as a percentage of revenue todecrease, since many of its components, such as content licensing, are notdirectly tied to revenue.

 

***Research andDevelopment Expenses***

 

Research and development expenses consist ofcompensation, travel and overhead costs of personnel conducting research anddevelopment of our products and services, and consulting costs. Our researchand development team works primarily on projects to improve and enhance userinterface, product functionality, monetization, disambiguation, scalability andperformance. We generally expect that our research and development expenseswill decline as a percentage of revenue as we grow our revenue.

 

***Sales and MarketingExpenses***

 

Sales and marketing expenses consist of compensation,travel and overhead costs of personnel in-charge of sales and marketing,WikiAnswers community management, and product management, public relations,marketing and market information services, and advertising and promotionalcosts. We generally expect that our sales and marketing expenses will declineas a percentage of revenue as we grow our revenue.

 

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***General andAdministrative Expenses***

 

General and administrative expenses consist primarilyof compensation, travel and overhead costs for financial, legal andadministrative personnel, insurance fees, fees for professional services,including investor relations, legal, accounting and other consulting fees,amortization of domain names, and other general corporate expenses. Overheadcosts consist primarily of rent, telecommunications, utilities and depreciationexpenses. We generally expect that our general and administrative expenses willdecline as a percentage of revenue as we grow our revenue.

 

***Termination fees and write-off of cost relating to theterminated Lexico acquisition and abandoned follow-on offering***

 

In the first quarter of 2008, we recorded a charge of$2,543 thousand consisting of $1,618 thousand of accounting, legal, banking,consulting and travel costs we incurred in 2007 and in the first quarter of2008, in connectionwith the abandoned acquisition of Lexico and follow-on offering of securities,and $925 thousand relating to termination fees we paid as a result of thetermination of the acquisition and follow-on offering.

 

***Stock-BasedCompensation***

 

New employees typically receive stock option awardswithin three months of their start date. We also grant additional stock optionawards to existing employees and directors, usually once a year. We account forstock-based awards under SFAS No. 123 (revised 2004), *“Share-Based Payments”,*or SFAS 123R,which requires measurement of compensation cost for all stock-based awards atfair value on date of grant and recognition of compensation over the serviceperiod awards are expected to vest. Prior to January 1, 2006, we accountedfor stock-based awards to employees and directors under the intrinsic valuemethod, which followed the recognition and measurement principles of AccountingPrinciples Board (APB) Opinion No. 25, “*Accountingfor Stock Issued to Employees”*(APB 25). The intrinsic value method of accounting resulted incompensation expense for stock options to employees and directors to the extentoption exercise prices were set below the market value of our stock on the dateof grant. Costs resulting from stock-based compensation are part of ourcompensation expense and are included in the operating expense categories inour Statement of Operations.

 

***Interest Income Net***

 

Interest income, net primarily consists of interestincome earned on cash, cash equivalent and investment securities balances.

 

***Other Expenses***

 

Other expenses consist primarily of foreign currencyexchange gains and losses.

 

***Income Tax Expense***

 

Our effective tax rate differs from the statutoryfederal rate due to differences between income and expense recognitionprescribed by income tax regulations and Generally Accepted AccountingPrinciples. We utilize different methods and useful lives for depreciating andamortizing property, equipment and intangible assets and different methods andtiming for calculating and recording stock compensation expense and otheraccruals. Furthermore, permanent differences arise from certain income andexpense items recorded for financial reporting purposes but not recognizablefor income tax purposes. In addition, our income tax expense has been adjustedfor the effect of state and local taxes and foreign income from our whollyowned subsidiary. Our deferred tax assets are primarily offset by a valuationallowance because realization depends on generating future taxable income,which, in our estimation, is not more likely than not to transpire.

 

Our Israeli subsidiaryhad income in the three months ended March 31, 2008 and 2007, resultingfrom the services agreement we entered into with such Israeli subsidiary.Pursuant to this agreement, the Israeli subsidiary charges us for research anddevelopment services it provides us, plus 12.5%. However, the subsidiary is an “approvedenterprise” under Israeli law, which means that income arising from thesubsidiary’s approved activities, is subject to zero tax under the “alternativebenefit” path for a period of ten years. Currently, the subsidiary operatesunder two separate “approved enterprise” plans, ending December 31, 2009and December 31, 2014, respectively. In the event of distributions by thesubsidiary to the parent, the subsidiary would have to pay a 10% corporate taxon the amount distributed, and the recipient would have to pay a 15% tax to bewithheld at source on the amounts of such distribution received. At present, wedo not plan on having the subsidiary distribute a dividend to AnswersCorporation.

 

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***Three Months Ended March 31, 2008 Compared to the Three MonthsEnded March 31, 2007***

* *

*Revenue*

 
| ** **                         | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------|------------|------------------------------------------------------|------------|
| ** **                         | ** ** | **2008**                                             | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **                         | ** ** | **(in thousands)**                              | ** ** |
|                               |       |                                                 |       |   |   |   |   |
| Answers.com advertising revenue    |       | $                                                    | 1,828      |   | $ | 2,768 |   | $ | (940 | ) |
| WikiAnswers advertising revenue    |       | 1,185                                                |       | 116 |   | 1,069 |   |
| Answers services licensing revenue |       | 18                                                   |       | 77 |   | (59 | ) |
| Subscription revenue               |       |                                                 |       | 425 |   | (425 | ) |
|                               |       | $                                                    | 3,031      |   | $ | 3,386 |   | $ | (355 | ) |

 

Revenue decreased $355 thousand, or 10%, to $3,031thousand for the three months ended March 31, 2008 from $3,386 thousandfor the three months ended March 31, 2007, which included $425 thousand ofsubscription revenue.

 

Answers.com advertising revenue for the three monthsended March 31, 2008 decreased $940 thousand compared to the three monthsended March 31, 2007, almost entirely due to decreases in traffic.  Answers.com average daily page views inthe three months ended March 31, 2008 were 3,641,000, a decline of 33%compared to the average daily page views of 5,470,000 in the three monthsended March 31, 2007. The Answers.com RPM during those periods were almostidentical. The decline in traffic is primarily due to the July 2007 Googlealgorithm change that significantly impacted Answers.com traffic, reducing ouroverall traffic by approximately 28% based on the average traffic directed toAnswers.com from Google for the week prior to the adjustment as compared to theweek after. As a result, our revenue also declined proportionately. We have notyet been able to reverse the impact of this adjustment, and we do notanticipate that we will recover the lost traffic and revenue. Since the Googleadjustment, we suspended our strategy of licensing new content , and,consequently, we are not experiencing growth in Answers.com traffic. Historically,we operated on the premise that adding rich unique content to Answers.compositively impacted the site’s traffic growth, guided by the principle thatrich unique content was not only appreciated by the human user, rather, it wasalso highly valued by the search engines and their content indexing programs.While Answers.com still receives significant SEO traffic to its rich contentpages, it is not clear whether licensing additional content would yield apositive return. We continue to explore different initiatives to overcome thedecline in Answers.com traffic, but there is no assurance we will succeed inachieving renewed growth for Answers.com.

 

WikiAnswers.com advertising revenue for the threemonths ended March 31, 2008 increased $1,069 thousand compared to thethree months ended March 31, 2007, due to increases in traffic, and to alesser extent, due to improvement in RPM. WikiAnswers.com average daily page views in the three months ended March 31,2008 were 1,885,000, an increase of 543% compared to the average daily page viewsof 293,000 in the three months ended March 31, 2007. We believe that thedramatic growth that WikiAnswers has experienced since we acquired it, in November 2006,is primarily due to the unique dynamics of the site. As our database ofquestions and answers grows, we draw new traffic, primarily from SEO, which inturn results in the creation of new questions and answers, or new content,which in turn drives additional growth. This is a self-perpetuating growthmodel. The WikiAnswers.com RPM during those periods rose from $4.40 to $6.98,primarily due to the inclusion of WikiAnswers under our Google ServicesAgreement, replacing the standard Adsense agreement that was entered into priorto our acquisition of WikiAnswers.

 

Approximately $231thousand and $94 thousand of our advertising revenue in the three months ended March 31,2008 and 2007, respectively, resulted from the efforts of our direct ad salesforce. Our direct ad sales efforts, to date, have not yet delivered the levelof sales that we originally anticipated when we embarked on this effort. Webelieve this is because direct ad sales are less suited to the Answers.comproperty than we had previously projected, due to the reference nature of thesite. Additionally, the slow growth that the Answers.com property hasexperienced has hampered direct ad sales efforts. Notwithstanding, we believethat the different characteristics of WikiAnswers may interest the advertisingcommunity, since users asking questions may be more interested in a product orservice. For example, a user asking, “how do I fix a carburetor on a 2006 ChevyImpala?” is more likely to click on an advertisement for carburetor repairservices than users searching for reference information on Answers.com.

 

Subscription revenue in the three months ended March 31,2007 of $425 thousand resulted from the recognition of revenue from the sale oflifetime subscriptions to our GuruNet service prior to December 2003. Asof December 31, 2006, we had approximately $425 thousand of deferredrevenue relating to these subscriptions. Prior to 2007, we did not recognizeany revenue from the lifetime subscriptions to our GuruNet service because thesubscriptions had no defined term. On February 2, 2007, in accordance withour rights under the agreements we entered into with such subscribers, weterminated the GuruNet service and thereby extinguished our service obligationsto our subscribers. As a result, we recognized the entire $425 thousandpreviously deferred, as revenue, in the first quarter of 2007.

 

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***Revenue Trends byWeb Property***

 

The following table illustrates the historical trendsof our two Web properties’ traffic, revenues and RPMs, by quarter, beginningthe first quarter of 2007:

 
| ** **                             | ** ** | **2007**      | ** ** | **2008**      | ** ** |
|----------------------------------------|------------|---------------|------------|---------------|------------|
| ** **                             | ** ** | **Q1**        | ** ** | **Q2**        | ** ** | **Q3** | ** ** | **Q4** | ** ** | **Q1** | ** ** |
|                                   |       |          |       |          |       |   |   |   |   |   |   |
| **Ad Revenue ($ - in thousands)** |       |          |       |          |       |   |   |   |   |   |   |
|                                   |       |          |       |          |       |   |   |   |   |   |   |
| Answers.com                            |       | 2,768         |       | 2,551         |       | 1,861 |   | 2,270 |   | 1,828 |   |
| WikiAnswers                            |       | 116           |       | 177           |       | 304 |   | 704 |   | 1,185 |   |
| **Total**                              | ** ** | **2,884**     | ** ** | **2,728**     | ** ** | **2,165** | ** ** | **2,974** | ** ** | **3,013** | ** ** |
|                                   |       |          |       |          |       |   |   |   |   |   |   |
| Answers.com                            |       | 96            | %          | 94            | %          | 86 | % | 76 | % | 61 | % |
| WikiAnswers                            |       | 4             | %          | 6             | %          | 14 | % | 24 | % | 39 | % |
| **Total**                              | ** ** | **100**       | **%**      | **100**       | **%**      | **100** | **%** | **100** | **%** | **100** | **%** |
|                                   |       |          |       |          |       |   |   |   |   |   |   |
| **Traffic**                            |       |          |       |          |       |   |   |   |   |   |   |
|                                   |       |          |       |          |       |   |   |   |   |   |   |
| Answers.com                            |       | 5,470,000     |       | 4,890,000     |       | 3,730,000 |   | 3,924,000 |   | 3,641,000 |   |
| WikiAnswers                            |       | 293,000       |       | 440,000       |       | 639,000 |   | 1,152,000 |   | 1,885,000 |   |
| **Total**                              | ** ** | **5,763,000** | ** ** | **5,330,000** | ** ** | **4,369,000** | ** ** | **5,076,000** | ** ** | **5,526,000** | ** ** |
|                                   |       |          |       |          |       |   |   |   |   |   |   |
| Answers.com                            |       | 95            | %          | 92            | %          | 85 | % | 77 | % | 66 | % |
| WikiAnswers                            |       | 5             | %          | 8             | %          | 15 | % | 23 | % | 34 | % |
| **Total**                              | ** ** | **100**       | **%**      | **100**       | **%**      | **100** | **%** | **100** | **%** | **100** | **%** |
|                                   |       |          |       |          |       |   |   |   |   |   |   |
| **RPM**                                |       |          |       |          |       |   |   |   |   |   |   |
| Answers.com                            |       | $             | 5.62       |          | $          | 5.73 |   | $ | 5.42 |   | $ | 6.29 |   | $ | 5.56 |   |
| WikiAnswers                            |       | $             | 4.40       |          | $          | 4.42 |   | $ | 5.17 |   | $ | 6.64 |   | $ | 6.95 |   |

 

Since we purchased WikiAnswers in November 2006,the website has grown dramatically each quarter, both in terms of traffic andrevenue. Conversely, beginning the second quarter of 2007, Answers.com’squarterly traffic has generally declined. In 2008, we expect that Answers.comtraffic will grow very moderately, or in fact decline, while we expectWikiAnswers will continue to grow rapidly. In the second half of 2008, weexpect that WikiAnswers’ ad revenue will exceed that of Answers.com.

 

**Costs and Expenses**

 

***Cost of Revenue***

 
| ** **      | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------|------------|------------------------------------------------------|------------|
| ** **      | ** ** | **2008**                                             | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **      | ** ** | **(in thousands)**                              | ** ** |
|            |       |                                                 |       |   |   |   |   |
| Cost of revenue |       | $                                                    | 1,393      |   | $ | 1,144 |   | $ | 249 |   |
|                 |            |                                                      |            |  |  |  |  |  |  |  |

 

Cost of revenue increased $249 thousand, or 22%, to$1,393, in the three months ended March 31, 2008 from $1,144 in the threemonths ended March 31, 2007. The increase in cost of revenue was dueprimarily to increases in data center costs of $78 thousand, includingdepreciation of information technology assets, increases in compensation costs,excluding stock-based compensation, of $61 thousand as a result of staffingadditions and salary increases, increased stock-based compensation of $10thousand, increases in content licensing costs of $14 thousand, increases infees we pay to Google for web search of $11 thousand, increases in trafficacquisition costs of $12 thousand, and increases in ad serving fees of $14thousand. Additionally, recruitment fees in the first quarter of 2008 were $29thousand, where no such 

 

18

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expense was incurred in the first quarter of 2007.Finally, the amortization expenses relating to intangible assets we purchasedin connection with the WikiAnswers acquisition that took place in November 2006,decreased by $15 thousand to $16 thousand in the first quarter of 2008,compared to $31 thousand in the first quarter of 2007, due to the differentuseful lives of the assets we purchased.

 

***Research andDevelopment Expenses***

 
| ** **               | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------|------------|------------------------------------------------------|------------|
| ** **               | ** ** | **2008**                                             | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **               | ** ** | **(in thousands)**                              | ** ** |
|                     |       |                                                 |       |   |   |   |   |
| Research and development |       | $                                                    | 875        |   | $ | 722 |   | $ | 153 |   |
|                          |            |                                                      |            |  |  |  |  |  |  |  |

 

Research and development expenses increased $153thousand, or 21%, to $875 thousand in the three months ended March 31,2008 from $722 thousand in the three months ended March 31, 2007. Theincrease in research and development expenses was due primarily to an increaseof $143 thousand in compensation-related expenses, and increased stock-basedcompensation of $28 thousand. Those increases were partially offset by areduction of $42 thousand in outside consulting services.

 

***Sales and MarketingExpenses***

 
| ** **          | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------|------------|------------------------------------------------------|------------|
| ** **          | ** ** | **2008**                                             | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **          | ** ** | **(in thousands)**                              | ** ** |
|                |       |                                                 |       |   |   |   |   |
| Sales and marketing |       | $                                                    | 762        |   | $ | 982 |   | $ | (220 | ) |
|                     |            |                                                      |            |  |  |  |  |  |  |  |

 

Sales and marketing expenses decreased $220 thousandor 22%, to $762 thousand during the three months ended March 31, 2008 from$982 thousand during the three months ended March 31, 2007. The decreasein sales and marketing expenses is due primarily to a decrease in compensationrelated expenses, excluding stock-based compensation, of $51 thousand, and a decreasein stock-based compensation of $135 thousand. These decreases resulted mostlyfrom the termination of employment of our Chief Revenue Officer in the thirdquarter of 2007.

 

***General andAdministrative Expenses***

 
| ** **                 | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------|------------|------------------------------------------------------|------------|
| ** **                 | ** ** | **2008**                                             | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **                 | ** ** | **(in thousands)**                              | ** ** |
|                       |       |                                                 |       |   |   |   |   |
| General and administrative |       | $                                                    | 1,131      |   | $ | 926 |   | $ | 205 |   |
|                            |            |                                                      |            |  |  |  |  |  |  |  |

 

General and administrative expenses increased $205thousand, or 22%, to $1,131 thousand during the three months ended March 31,2008 from $926 thousand during the three months ended March 31, 2007. Theincrease in general and administrative expenses was due primarily to increasesin compensation costs, excluding stock-based compensation, of $63 thousand,increases in stock-based compensation of $72 thousand,  increases in insurance costs of $20 thousand,and increases in accounting and legal fees of $29 thousand.

 

***Termination fees and write-off of costs relating to theterminated Lexico acquisition and abandoned follow-on offering***

 
| ** **                                                                                                             | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                                             | ** ** | **2008**                                             | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **                                                                                                             | ** ** | **(in thousands)**                              | ** ** |
|                                                                                                                   |       |                                                 |       |   |   |   |   |
| Termination fees and write-off of cost relating to the terminated  Lexico acquisition and abandoned follow-on offering |       | $                                                    | 2,543      |   | $ | 0 |   | $ | 2,543 |   |
|                                                                                                                        |            |                                                      |            |  |  |  |  |  |  |  |

 

During the three months ended March 31, 2008, werecorded a charge of $2,543 thousand for various costs and fees we incurred inconnection with the terminated acquisition of Lexico and the follow-on offeringof securities. There was no similar event in the three months ended March 31,2007.

 

19

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***Interest Income,Net***

 
| ** **           | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------|------------|------------------------------------------------------|------------|
| ** **           | ** ** | **2008**                                             | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **           | ** ** | **(in thousands)**                              | ** ** |
|                 |       |                                                 |       |   |   |   |   |
| Interest income, net |       | $                                                    | 55         |   | $ | 100 |   | $ | (45 | ) |
|                      |            |                                                      |            |  |  |  |  |  |  |  |

 

Interest income, net decreased $45 thousand, or 45%,to $55 thousand for the three months ended March 31, 2008 from $100thousand for the three months ended March 31, 2007. The decrease ininterest income resulted from lower average cash and investment securitiesbalances, and lower short-term interest rates, during the three months ended March 31,2008, as compared to the three months ended March 31, 2007.

 

***Other Expense, Net***

 
| ** **         | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------|------------|------------------------------------------------------|------------|
| ** **         | ** ** | **2007**                                             | ** ** | **2006** | ** ** | **Change** | ** ** |
| ** **         | ** ** | **(in thousands)**                              | ** ** |
|               |       |                                                 |       |   |   |   |   |
| Other expense, net |       | $                                                    | (38        | ) | $ | (15 | ) | $ | (23 | ) |
|                    |            |                                                      |            |  |  |  |  |  |  |  |

 

Other expense, net increased $23 thousand, or 153%, to$38 thousand during the three months ended March 31, 2008, from $15thousand during the three months ended March 31, 2007. Other expenses inboth periods resulted from foreign currency exchange net losses.

 

***Income Tax(Expense) Benefit***

 

We had net operating loss carryforwards, or NOLs, forfederal income tax purposes of approximately $54 million at December 31,2007, and approximately $49 million at December 31, 2006. The federal netoperating losses will expire if not utilized on various dates from 2019 through2027. Because we have experienced one or more ownership changes, within themeaning of Section 382 of the Internal Revenue Code of 1986, as amended,an annual limitation is imposed on our ability to use $32 million of thesecarryforwards. Our best estimate at this time is that the annual limitation onthe use of $32 million of our NOLs is approximately $1.8 million peryear. Any unused portion of the $1.8 million annual limitation applicableto our restricted NOLs is available for use in future years until such NOLs arescheduled to expire. Our remaining NOLs are not currently subject to suchlimitations. Our Israeli subsidiary has capital loss carryforwards ofapproximately $800 thousand that can be applied to future capital gainsfor an unlimited period of time under current tax rules.

 

**Liquidity and Capital Resources**

 

Our principal sources of liquidity are cash, cashequivalents, and investment securities, which were $5,462 thousand as of March 31,2008. In the three months ended March 31, 2008, our cash used inoperations was $1,808 thousand. We have used cash in our operations invirtually every quarter since our inception. Our ability to generate cash fromoperations in the future will depend primarily on our ability to produce netincome before non-cash expenses such as depreciation and amortization andstock-based compensation.

 
| ** **                                           | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                           | ** ** | **2008**                                             | ** ** | **2007** | ** ** | ** ** | ** ** |
| Net cash provided by (used  in) operating activities |       | $                                                    | (1,808     | ) | $ | 63 |   |   |   |
| Net cash provided by (used in) investing activities  |       | 456                                                  |       | (983 | ) |   |   |
| Net cash provided by financing activities            |       |                                                 | —     |   |   | 142 |   |   |   |   |
|                                                      |            |                                                      |            |  |  |  |  |  |  |  |  |  |

 

***OperatingActivities***

 

Despite a net loss of $3,667 thousand in the firstquarter of 2008, net cash used in operations was $1,808 thousand. Theadjustments to reconcile the two amounts, including changes to the balances ofour various operating assets and liabilities, are noted in detail on theaccompanying statement of cash flows. The largest reconciling items are thewrite-off of amounts relating to the terminated Lexico acquisition andabandoned follow-on offering, paid in prior periods of $663 thousand, $501thousand of operating expenses that were the result of non-cash, stock-basedcompensation to employees and directors, and depreciation and amortization of$448 thousand.

 

20

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Despite a net loss of $303 thousand in the firstquarter of 2007, we had net cash provided by operations of $63 thousand. Theadjustments to reconcile the two amounts, including changes to the balances ofour various operating assets and liabilities, are noted in detail on theaccompanying statement of cash flows. The largest reconciling items are the$525 thousand of operating expenses that were the result of non-cash,stock-based compensation to employees and directors, depreciation andamortization of $448 thousand, and the recognition of $441 thousand ofpreviously deferred revenue, $425 thousand of which, relates to the lifetimesubscriptions we sold in 2003.

 

***InvestingActivities***

 

Net cash provided by (used in) investing activities inthe three months ended March 31, 2008 and 2007, is attributable almostentirely to the proceeds from the sale of investment securities, less cash usedfor purchases of investment securities, and cash used for capital expenditures,as delineated in our Consolidated Statement of Cash Flows.

 

***FinancingActivities***

 

Cash flow from financing activities in the threemonths ended March 31, 2007 resulted from the exercise of stock options.

 

***Future Operations***

 

In connection with the abandoned proposed publicoffering and the terminated Lexico purchase agreement, we had to make cashpayments of $1,878 thousand in the first quarter of 2008, in addition to the$665 thousand we already expended in 2007, for termination fees and costsrelating to the terminated Lexico acquisition and abandoned follow-on offering.These payments had a material impact on the balance of our cash and cashequivalents and investment securities. Additionally, we expect that thecollocation hosting facility we are establishing in 2008 will require an outlayof approximately $700 thousand in capital expenditures in 2008, above andbeyond the $200 thousand we expended in the first quarter of 2008.Notwithstanding, we believe we have sufficient cash to meet our plannedoperating needs for the next twelve months, based on our current cash levelsand expected cash flow from operations in 2008. However, our business strategyincludes growth through additional business combinations and licensing oracquiring products and technologies complementary to our business, which couldrequire use of a significant amount of our available cash. We are consideringraising additional capital through future debt or equity financing to financesuch initiatives. However, we cannot be certain that additional financing willbe available on acceptable terms, or at all.

 

To the extent that we raise additional funds byissuing equity securities, our stockholders may experience significant dilution.

 

**Contractual Obligations andCommitments**

 

As of March 31, 2008, we had the following knowncontractual obligations and commitments (in thousands):

 
| ** **                                        | ** ** | **Purchase   Contracts** | ** ** | **Operating   Leases** | ** ** | **Total****(1)** | ** ** |
|---------------------------------------------------|------------|-------------------------------|------------|-----------------------------|------------|------------------|------------|
| 2008 (nine months ending  December 31, 2008) |       | 541                           |       | 337                         |       | 878              |       |
| 2009                                              |       | 435                           |       | 403                         |       | 838              |       |
| 2010                                              |       | 130                           |       | 240                         |       | 370              |       |
| 2011                                              |       | 21                            |       | 1                           |       | 22               |       |
|                                              |       |                          |       |                        |       |             |       |
|                                              |       | 1,127                         |       | 981                         |       | 2,108            |       |

 

----

(1)           The above table does not includeunrecognized tax benefits of $302 thousand.

 

**Off-Balance Sheet Arrangements**

 

We have not entered into any transactions withunconsolidated entities in which we have financial guarantees, subordinatedretained interests, derivative instruments or other contingent arrangementsthat expose us to material continuing risks, contingent liabilities or anyother obligations under a variable interest in an unconsolidated entity thatprovides us with financing, liquidity, market risk or credit risk support.

 

**Quantitative and qualitativedisclosures about market risk**

 

*Currency Risk.*  Our revenue is denominatedsolely in U.S. dollars. Most of our expenses are also based inU.S. dollars, however, a very significant portion of our expenses aredenominated in New Israel Shekels, or NIS. We expect this level ofNIS expenses to continue for the foreseeable future. In 2007, the value of theU.S. dollar weakened against the value of NIS by 9%, and by an additional8% during the first quarter of 2008. If the value of the U.S. dollarfurther weakens against the value of NIS, there will be a negative impact onour results of operations. In addition, to the extent we hold cash and cashequivalents that are denominated in currencies other than the U.S. dollar,we are subject to the risk of exchange rate fluctuations. We use varioushedging tools, including forward contracts and options, to minimize the effectof currency fluctuations on our income.

 

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*Other Market Risk.*  As of March 31, 2008, all of our excess cash was invested in money market accounts that we believe have no material exposure to theprincipal amount nor to interest rate risk. Historically, we did invest much of our excess cash in various highly liquidinvestments including auction rate, investment grade, corporate and municipaldebt instruments, and auction rate preferred shares of closed-end investmentfunds that invest in long-term fixed income securities, with auction resetperiods (“ARS’s”) of 28 days. Recently, many holders of ARS instrumentshave experienced liquidity difficulties due to the lack of sufficient demandfor the securities on the reset dates. While we did hold some ARS’s as of December 31,2007, we did not experience a loss upon the sale of those securities in thefirst quarter of 2008. Currently, we do not own any ARS’s, and we have ceasedmaking any investments in ARS’s.

 

**Critical Accounting Estimates**

** **

While our significant accounting policies are morefully described in the notes to our audited consolidated financial statementsfor the years ended December 31, 2007 and 2006, and our consolidatedfinancial statements for the three months ended March 31, 2008 and 2007,we believe the following accounting policies to be the most critical inunderstanding the judgments and estimates we use in preparing our consolidatedfinancial statements.

 

***Goodwill,Intangibles and Other Long-Lived Assets***

 

We account for our purchases of acquired companies inaccordance with SFAS No. 141, “Business Combinations,” or SFAS 141, andfor goodwill and other identifiable definite and indefinite-lived acquiredintangible assets in accordance with SFAS No. 142, “Goodwill andOther Intangible Assets,” or SFAS 142. Additionally, we review ourlong-lived assets for recoverability in accordance with SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets,” orSFAS 144.

 

The identification and valuation of intangible assetsand the determination of the estimated useful lives at the time of acquisitionare based on various valuation methodologies including reviews of projectedfuture cash flows. The use of alternative estimates and assumptions couldincrease or decrease the estimated fair value of our goodwill and otherintangible assets, and potentially result in a different impact to our resultsof operations. Further, changes in business strategy and/or market conditionsmay significantly impact these judgments thereby impacting the fair value ofthese assets, which could result in an impairment of the goodwill and acquiredintangible assets.

 

We evaluate our long-lived tangible and intangibleassets for impairment in accordance with SFAS 142, “Goodwill and OtherIntangible Assets,” with theannual impairment testing date set at September 30, and in accordance with SFAS 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets,” whenever events orchanges in circumstances indicate that the carrying amount of an asset may notbe recoverable. If such assets are considered to be impaired, the impairment tobe recognized is measured by the amount by which the carrying amount of theassets exceeds the fair value of the assets. While we use available informationto prepare our estimates and to perform impairment evaluations, the completionof annual impairment tests requires significant management judgments andestimates.

 

In response to the search engine algorithm adjustmentby Google in July 2007, we examined what impact this event might have onthe recoverability of our long-lived assets in accordance with the guidancecontained in SFAS 142 and 144. As a result of our analysis, we concludedthat the carrying value of our assets has not been impaired. However, while weuse available information to prepare our estimates and to perform impairmentevaluations, our recoverability calculations and impairment tests requiresignificant management judgment and estimates. These estimates include ourprojections of undiscounted cash flows and assumptions used in calculatingprojected RPM, page-views, and expenses. In addition, a certain degree ofjudgment was exercised in determining asset groups in accordance with generallyaccepted accounting principles. Had our estimates and assumptions differed, theaccounting treatment might have resulted differently. Future actual resultscould differ significantly from the anticipated results as reflected in ouranalysis.

 

***Accounting forStock-based Compensation***

 

We account for stock-based awards under SFAS No. 123Rwhich requires measurement of compensation cost for all stock-based awards atfair value on date of grant and recognition of compensation over the serviceperiod for awards expected to vest, using the modified prospective method. Theestimation of stock awards that will ultimately vest requires judgment, and tothe extent actual results differ from our estimates, such amounts will berecorded as a cumulative adjustment in the period estimates are revised. Weconsider various factors when estimating expected forfeitures, includinghistorical experience. Actual results may differ substantially from theseestimates.

 

With the exception of stock options granted to employeesprior to May 12, 2004, the date of our first filing with theU.S. Securities and Exchange Commission in connection with our initialpublic offering, or IPO, we determine the fair value of stock options grantedto employees and directors using the Black-Scholes valuation model, whichconsiders the exercise price relative to the market value of the underlyingstock, the expected stock price volatility, the risk-free interest rate and thedividend yield, and the estimated period of time option grants will beoutstanding before they are ultimately exercised. We also determine the fairvalue of stock options and warrants granted to non-employees, for accountingpurposes, using the Black-Scholes valuation model. Prior to our IPO, in October 2004,the market value of the underlying stock was based on estimates, includingvolatility estimates that are inherently highly uncertain and subjective, sinceprior to our IPO there had been no public market for our stock. Subsequent toour IPO, through 2006, we did not have sufficient history to actually predictour volatility, therefore, our assumptions about stock price volatility werebased on the volatility rates of comparable publicly held companies. Theserates may or may not reflect our actual stock price volatility. During 2007, as weaccumulated our own volatility history over longer periods of time, our 

 

22

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assumptions about our stock pricevolatility were based on a rate that was derived by taking into considerationthe volatility rates of the aforesaid comparable publicly held companies aswell as our own historical volatility rates. Beginning 2008, we are estimatingour expected stock volatility based solely on our own historical stockvolatility rates. Hadwe made different assumptions about the market value of our stock, stock pricevolatility or the estimated time option and warrant grants will be outstandingbefore they are ultimately exercised, the related stock based compensationexpense and our net loss and net loss per share amounts could have beensignificantly different, in the three months ended March 31, 2008 and2007.

 

***Accounting forIncome Taxes***

 

As part of the process of preparing our consolidatedfinancial statements, we are required to estimate our income taxes in each ofthe jurisdictions in which we operate. This process involves managementestimating our actual current tax exposure together with assessing temporarydifferences resulting from differing treatment of items for tax and accounting purposes.These differences result in deferred tax assets and liabilities, which areincluded within our consolidated balance sheet. We must then assess thelikelihood that our deferred tax assets will be recovered from future taxableincome and, to the extent we believe that recovery is not more likely than not,we must establish a valuation allowance. Significant management judgment isrequired in determining our provision for income taxes, our deferred tax assetsand liabilities and any valuation allowance recorded against our net deferredtax assets. We have almost fully offset our U.S. net deferred tax assetwith a valuation allowance. Our lack of earnings history and the uncertaintysurrounding our ability to generate US taxable income prior to the expirationof such deferred tax assets were the primary factors considered by managementin establishing the valuation allowance.

 

In July 2006, FASB released FASB Interpretation No. 48,“Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement109,” or FIN 48, effective for fiscal years beginning after December 15,2006. FIN 48 prescribes how a company should recognize, measure, presentand disclose in its financial statements uncertain tax positions that thecompany has taken or expects to take on a tax return. Additionally, for taxpositions to qualify for deferred tax benefit recognition under FIN 48,the position must have at least a “more likely than not” chance of beingsustained upon challenge by the respective taxing authorities. We adopted theprovisions of FIN 48 as of January 1, 2007 and it has not had amaterial impact on our financial statements.

 

**Recently Issued AccountingPronouncements**

 

In March 2008, the FASB issued Statement ofFinancial Accounting Standards 161, “*Disclosuresabout Derivative Instruments and Hedging Activities-an amendment of FASBStatement No. 133”* (SFAS 161). SFAS 161 gives financialstatement users better information about the reporting entity’s hedges byproviding for qualitative disclosures about the objectives and strategies forusing derivatives, quantitative data about the fair value of and gains andlosses on derivative contracts, and details of credit-risk-related contingentfeatures in their hedged positions. SFAS 161 is effective for financial statementsissued for fiscal years beginning after November 15, 2008 and interimperiods within those years. We do not expect the adoption of SFAS 161 to have amaterial effect on its financial statements.

 

**Quarterly Results**

 

The following table sets forth our historicalunaudited quarterly consolidated statement of operations data for 2006, 2007and the first quarter of 2008. You should read this information together withour unaudited consolidated financial statements and the related notes appearingelsewhere in our filings. The results of historical periods are not necessarilyindicative of the results of operations for a full year or any future period.

 

23

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| ** **                                                                                                              | ** ** | **Quarter Ended**                                                               | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|
| ** **                                                                                                              | ** ** | **Mar. 31,   2006**                                                        | ** ** | **Jun. 30,   2006** | ** ** | **Sep. 30,   2006** | ** ** | **Dec. 31,   2006** | ** ** | **Mar. 31,   2007** | ** ** | **Jun. 30,   2007** | ** ** | **Sep. 30,   2007** | ** ** | **Dec. 31,   2007** | ** ** | **Mar. 31,   2008** | ** ** |
| ** **                                                                                                              | ** ** | **(in thousands, except page view and RPM data)** | ** ** |
| Revenues:                                                                                                               |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Advertising  revenue                                                                                                    |       | $                                                                                    | 1,090      |   | $ | 1,457 |   | $ | 1,810 |   | $ | 2,461 |   | $ | 2,884 |   | $ | 2,728 |   | $ | 2,165 |   | $ | 2,974 |   | $ | 3,013 |   |
| Answers services  licensing                                                                                             |       | 53                                                                                   |       | 46 |   | 44 |   | 43 |   | 77 |   | 82 |   | 43 |   | 17 |   | 18 |   |
| Subscriptions                                                                                                           |       | 11                                                                                   |       | 8 |   | 4 |   | 2 |   | 425 |   | — |   | — |   | — |   | — |   |
|                                                                                                                    |       | 1,154                                                                                |       | 1,511 |   | 1,858 |   | 2,506 |   | 3,386 |   | 2,810 |   | 2,208 |   | 2,991 |   | 3,031 |   |
| Costs and  expenses:                                                                                                    |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of revenue                                                                                                         |       | 684                                                                                  |       | 808 |   | 844 |   | 1,071 |   | 1,144 |   | 1,320 |   | 1,179 |   | 1,247 |   | 1,393 |   |
| Research and  development                                                                                               |       | 2,637                                                                                |       | 1,951 |   | 621 |   | 656 |   | 722 |   | 748 |   | 769 |   | 739 |   | 875 |   |
| Sales and  marketing                                                                                                    |       | 642                                                                                  |       | 678 |   | 924 |   | 1,009 |   | 982 |   | 1,072 |   | 1,221 |   | 676 |   | 762 |   |
| General and  administrative                                                                                             |       | 800                                                                                  |       | 965 |   | 765 |   | 854 |   | 926 |   | 1,019 |   | 1,058 |   | 1,017 |   | 1,131 |   |
| Termination fees and write-off of costs relating to the terminated Lexico  acquisition and abandoned follow-on offering |       | —                                                                               |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | 2,543 |   |
|                                                                                                                    |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total operating  expenses                                                                                               |       | 4,763                                                                                |       | 4,402 |   | 3,154 |   | 3,590 |   | 3,774 |   | 4,159 |   | 4,227 |   | 3,679 |   | 6,704 |   |
|                                                                                                                    |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Operating loss                                                                                                          |       | (3,609                                                                               | )          | (2,891 | ) | (1,296 | ) | (1,084 | ) | (388 | ) | (1,349 | ) | (2,019 | ) | (688 | ) | (3,673 | ) |
| Interest income,  net                                                                                                   |       | 141                                                                                  |       | 145 |   | 144 |   | 123 |   | 100 |   | 112 |   | 88 |   | 85 |   | 55 |   |
| Other income  (expense), net                                                                                            |       | (3                                                                                   | )          | (201 | ) | (17 | ) | 44 |   | (15 | ) | 4 |   | — |   | — |   | (38 | ) |
|                                                                                                                    |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss before  income taxes                                                                                               |       | (3,471                                                                               | )          | (2,947 | ) | (1,169 | ) | (917 | ) | (303 | ) | (1,233 | ) | (1,931 | ) | (603 | ) | (3,656 | ) |
| Income taxes(1)                                                                                                         |       | (2                                                                                   | )          | 5 |   | (12 | ) | (59 | ) | — |   | (14 | ) | (19 | ) | (15 | ) | (11 | ) |
|                                                                                                                    |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                                                                                |       | $                                                                                    | (3,473     | ) | $ | (2,942 | ) | $ | (1,181 | ) | $ | (976 | ) | $ | (303 | ) | $ | (1,247 | ) | $ | (1,950 | ) | $ | (618 | ) | $ | (3,667 | ) |
|                                                                                                                    |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other Data:                                                                                                             |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Adjusted EBITDA(2)                                                                                                      |       | $                                                                                    | (823       | ) | $ | (737 | ) | $ | (522 | ) | $ | (207 | ) | $ | 160 |   | $ | (306 | ) | $ | (727 | ) | $ | 180 |   | $ | (181 | ) |
| Answers.com  page views                                                                                            |       | 2,920,000                                                                            |       | 3,030,000 |   | 3,400,000 |   | 4,340,000 |   | 5,470,000 |   | 4,890,000 |   | 3,730,000 |   | 3,924,000 |   | 3,641,000 |   |
| WikiAnswers  page views                                                                                            |       | —                                                                               |       | — |   | — |   | — |   | 293,000 |   | 440,000 |   | 639,000 |   | 1,152,000 |   | 1,885,000 |   |
| Answers.com RPM                                                                                                         |       | $                                                                                    | 4.15       |   | $ | 5.29 |   | $ | 5.79 |   | $ | 6.02 |   | $ | 5.62 |   | $ | 5.73 |   | $ | 5.41 |   | $ | 6.29 |   | $ | 5.56 |   |
| WikiAnswers RPM                                                                                                         |       | —                                                                               |       | — |   | — |   | — |   | $ | 4.40 |   | $ | 4.42 |   | $ | 5.17 |   | $ | 6.64 |   | $ | 6.95 |   |

 

24

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| (1)  | The 2006 quarterly financial results as previously  presented by us in reports and SEC filings, have been modified to account for  an immaterial error in income tax expense involving an over-accrual of  deferred income taxes relating to our subsidiary’s accumulated earnings, as a  result of applying the distributed tax rate as opposed to the undistributed  tax rate.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
|-----------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| (2)  | We define Adjusted EBITDA as net earnings before  interest, taxes, depreciation, amortization, stock-based compensation,  foreign currency exchange rate differences and certain non-recurring revenues  and expenses.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|      | We believe that the presentation of Adjusted EBITDA  provides useful information to investors because these measures enhance their  overall understanding of the financial performance and prospects of our  ongoing business operations. By reporting Adjusted EBITDA, we provide a basis  for comparison of our business operations between current, past and future  periods. Adjusted EBITDA is used by our management team to plan and forecast  our business because it removes the impact of our capital structure (interest  expense), asset base (amortization and depreciation), stock-based  compensation expenses, taxes, foreign currency exchange rate differences and  certain non-recurring revenues and expenses from our results of operations.  More specifically, we believe that removing these impacts is important for  several reasons:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|      | ·    Adjusted  EBITDA disregards amortization of intangible assets and other specified costs  resulting from acquisitions. Specifically, we exclude (a) amortization  of acquired technology from our acquisition of Brainboost Technology, LLC, or  Brainboost, developer of the Brainboost Answer Engine, which has been  integrated into our Answers from the Web technology; (b) compensation  expense resulting from the portion of the stock component of the Brainboost  purchase price that was deemed compensation expense; (c) penalty  payments to the sellers of Brainboost resulting from failure to timely  register the common stock they received in connection with the  acquisition;  (d) amortization of  intangible assets relating to our acquisition of WikiAnswers; and (e) various  costs and fees we incurred in connection with the terminated acquisition of  Lexico and the abandoned follow-on offering of securities. We believe that  excluding these expenses is helpful to investors, due to the fact that they  relate to prior acquisitions and are not necessarily indicative of future  operating expenses. While we exclude these expenses from Adjusted EBITDA we  do not exclude the revenue derived from the acquisitions. The revenue  attributable to WikiAnswers.com in 2007 and 2006 was $1,302 thousand and $62  thousand, respectively. The revenue attributable to our acquisition of the  Brainboost technology is not quantifiable due to the nature of its  integration. |
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|      | ·    We  believe that, because of the variety of equity awards used by companies, the  varying methodologies for determining stock-based compensation expense, and  the subjective assumptions involved in those determinations, excluding  stock-based compensation from Adjusted EBITDA enhances the ability of  management and investors to compare financial results over multiple periods.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|      | ·    We  believe that, excluding depreciation, interest, foreign currency exchange  rate differences and taxes from Adjusted EBITDA provides investors with  additional information to measure our performance, by excluding potential  differences caused by variations in capital structures (affecting interest  expense), asset composition, and tax positions.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|      | ·    Prior  to December 2003, we sold lifetime subscriptions to our GuruNet service,  generally for $40 per subscription. In December 2003, we decided to  alter our pricing model and moved to an annual subscription model, for which  we generally charged our subscribers $30 per year. We have not sold  subscriptions since our launch of Answers.com in January 2005. In February 2007,  we terminated the GuruNet service and recognized $425 thousand of deferred  revenue as revenue during the quarter ended March 31, 2007. We believe  that the recognition of the $425 thousand of revenue is a one-time, non-cash  event and is not reflective of our core business and core operating results,  and we have therefore excluded this amount from Adjusted EBITDA.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|      | Adjusted EBITDA is not a measure of liquidity or  financial performance under generally accepted accounting principles and  should not be considered in isolation from, or as a substitute for, a measure  of financial performance prepared in accordance with GAAP. Investors are  cautioned that there are inherent limitations associated with the use of  Adjusted EBITDA as an analytical tool. Some of these limitations are:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|      | ·    Non-GAAP  financial measures are not based on a comprehensive set of accounting rules or  principles;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|      | ·    Many  of the adjustments to Adjusted EBITDA reflect the exclusion of items that are  recurring and will be reflected in our financial results for the foreseeable  future;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|      | ·    Other  companies, including other companies in our industry, may calculate Adjusted  EBITDA differently than us, thus limiting its usefulness as a comparative  tool;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|      | ·    Adjusted  EBITDA does not reflect the periodic costs of certain tangible and intangible  assets used in generating revenues in our business;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |

 

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|   | ·    Adjusted  EBITDA does not reflect changes in our cash and investment securities and the  results of our investments;                                                                                            |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                     |
|   | ·    Adjusted  EBITDA excludes taxes, which is an integral cost to most businesses; and                                                                                                                         |
|   |                                                                                                                                                                                                                                     |
|   | ·    Because  Adjusted EBITDA does not include stock-based compensation, it does not  reflect the cost of granting employees equity awards, a key factor in management’s  ability to hire and retain employees. |
|   |                                                                                                                                                                                                                                     |
|   | We compensate for these limitations by providing  specific information in the reconciliation to the GAAP amounts excluded from  Adjusted EBITDA. A reconciliation of Adjusted EBITDA to net loss is as follows:                          |

 
| ** **                                                                                                              | ** ** | **Quarter Ended**        | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                                                              | ** ** | **Mar. 31,   2006** | ** ** | **Jun. 30,   2006** | ** ** | **Sep. 30,   2006** | ** ** | **Dec. 31,  2006** | ** ** | **Mar. 31,  2007** | ** ** | **Jun. 30,   2007** | ** ** | **Sep. 30,   2007** | ** ** | **Dec. 31,   2007** | ** ** | **Mar. 31,   2008** | ** ** |
| ** **                                                                                                              | ** ** | **(In thousands)**       | ** ** |
| Net loss                                                                                                                |       | $                             | (3,473     | ) | $ | (2,942 | ) | $ | (1,181 | ) | $ | (976 | ) | $ | (303 | ) | $ | (1,247 | ) | $ | (1,950 | ) | $ | (618 | ) | $ | (3,667 | ) |
| Interest income,  net                                                                                                   |       | (141                          | )          | (145 | ) | (144 | ) | (123 | ) | (100 | ) | (112 | ) | (88 | ) | (85 | ) | (55 | ) |
| Foreign currency  exchange rate differences                                                                             |       | 3                             |       | (26 | ) | 17 |   | (44 | ) | 15 |   | (4 | ) | — |   | — |   | 38 |   |
| Income taxes                                                                                                            |       | 2                             |       | (5 | ) | 12 |   | 59 |   | — |   | 14 |   | 19 |   | 15 |   | 11 |   |
| Depreciation and  amortization                                                                                          |       | 285                           |       | 310 |   | 315 |   | 382 |   | 448 |   | 444 |   | 464 |   | 442 |   | 448 |   |
| Stock-based  compensation                                                                                               |       | 2,501                         |       | 1,844 |   | 459 |   | 495 |   | 525 |   | 599 |   | 574 |   | 426 |   | 501 |   |
| Termination fees and write-off of costs relating to the terminated Lexico  acquisition and abandoned follow-on offering |       | —                        |       | — |   | — |   | — |   | — |   | — |   | — |   | — |   | 2,543 |   |
| Cost related to  August 2007 layoffs                                                                               |       | —                        |       | — |   | — |   | — |   | — |   | — |   | 254 |   | — |   | — |   |
| Subscription  revenue from lifetime subscriptions                                                                       |       | —                        |       | — |   | — |   | — |   | (425 | )(1) | — |   | — |   | — |   | — |   |
| Non recurring  penalty payment in connection with registration of shares                                                |       | —                        |       | 227 | (2) | — |   | — |   | — |   | — |   | — |   | — |   | — |   |
| Adjusted EBITDA                                                                                                         |       | $                             | (823       | ) | $ | (737 | ) | $ | (522 | ) | $ | (207 | ) | $ | 160 |   | $ | (306 | ) | $ | (727 | ) | $ | 180 |   | $ | (181 | ) |

 

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| (1)  | Recognition of previously deferred revenue,  following the termination of the GuruNet service in February 2007. |
|-----------|----------------------------------------------------------------------------------------------------------------------|
|      |                                                                                                                 |
| (2)  | Non-recurring penalty payments that were paid to the  sellers of Brainboost.                                         |

 

26

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**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

*Currency Risk.*Our revenue is denominated solely in U.S. dollars.Most of our expenses are also based in U.S. dollars; however, we are subject toa significant amount of expenses that are denominated in New Israel Shekels(NIS). We expect this level of NIS expenses to continue in the foreseeablefuture. If the value of the U.S. dollar weakens against the value of NIS, therewill be a negative impact on our results of operations. In addition, to theextent we hold cash and cash equivalents that are denominated in currenciesother than the U.S. dollar; we are subject to the risk of exchange ratefluctuations. We often hedge a portion of our foreign currency commitments. Ourderivative transactions are mainly designed to hedge short term cash flowsrelated to anticipated expenses.

 

*Other Market Risk.*We invest most of our excess cash in highly liquidinvestments with an original maturity of three months or less.  Due to the short-term nature of theseinvestments, we believe that there is no material exposure to interest raterisk arising from our investments. Based on our investment policy, suchinstruments are highly rated by rating agencies and therefore we believe thatthere is no material exposure to the principal amount from our investments.

 

**ITEM 4.CONTROLS AND PROCEDURES**

 

Based on an evaluation ofour disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) of the Securities Exchange Act of 1934, as amended) required byparagraph (b) of Rule 13a-15 or Rule 15d-15, as of March 31,2008, our Chief Executive Officer and Principal Financial Officer haveconcluded that our disclosure controls and procedures were effective inensuring that information required to be disclosed by us in the reports that wefile or submit under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the Commission’s rules andforms. Our Chief Executive Officer and Principal Financial Officer also concludedthat, as of March 31, 2008, our disclosure controls and procedures wereeffective in ensuring that information required to be disclosed by us in thereports that we file or submit under the Exchange Act is accumulated andcommunicated to our management, including our Chief Executive Officer andPrincipal Financial Officer, to allow timely decisions regarding requireddisclosure.

 

During the three months ended March 31, 2008,there were no changes in our internal control over financial reporting identifiedin connection with the evaluation required by paragraph (d) of Rule 13a-15or Rule 15d-15 that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting, except asdetailed below: 

 

·      We removed our controller as the informationtechnology administrator for our enterprise resource management system in March2008.

 

·      Our Board of Directors has adopted an approval policy,thus limiting the authority of certain officers to obligate us. Based on thenew policy adopted by the Board in March 2008, no officer of ours has theauthority to make payments, create obligations and take on commitments onbehalf of Answers Corporation above a certain threshold amount without seekingprior Board approval.

 

27

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**PART II.OTHER INFORMATION**

 

**ITEM 1.LEGAL PROCEEDINGS**

** **

From time to time, we receive various legal claims incidental to our normal business activities, such as intellectual property infringement claims and claims of defamation and invasion of privacy. Although the results of claims cannot be predicted with certainty, we believe the final outcome of such matters will not have a material adverse effect on our financial position, results of operations, or cash flows.

 

**ITEM 1A.RISK FACTORS**

 

There have been nomaterial changes to our risk factors previously disclosed in our annual reporton Form 10-K for the period ended December 31, 2007.

 

**ITEM 2.   UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

** **

None.

 

**ITEM3.    DEFAULTS UPON SENIOR SECURITIES**

** **

None.

 

**ITEM 4.* *SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

*** ***

None.

 

**ITEM 5. OTHER INFORMATION**

** **

None.

 

**ITEM 6. EXHIBITS**

 
| 10.1   |   | Amended and  Restated Employment Agreement between GuruNet Israel, Ltd. and Caleb Chill  dated as of March 1, 2008                                           |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                              |
| 31.1   |   | Certification of  Chief Executive Officer required under  Rule 13a-14(a)/15d-14(a) under the Exchange Act.                                              |
|   |   |                                                                                                                                                              |
| 31.2   |   | Certification of  Principal Financial Officer required under Rule 13a-14(a)/15d-14(a) under  the Exchange Act.                                          |
|   |   |                                                                                                                                                              |
| 32.1   |   | Certification of  Chief Executive Officer pursuant to 18 U.S.C Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.     |
|   |   |                                                                                                                                                              |
| 32.2   |   | Certification of  Principal Financial Officer pursuant to 18 U.S.C Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

28

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.

 

 
|                    | **ANSWERS CORPORATION** |
|-------------------------|-------------------------|
|                    | (Registrant)            |
|                    |                    |
|                    |                    |
| Date: May 12, 2008 | By:                     | /s/ Robert S. Rosenschein |
|                    |                    |   |
|                    |                    | Robert S. Rosenschein |
|                    |                    | Chief Executive Officer |
|                    |                    |
|                    |                    |
| Date: May 12, 2008 | By:                     | /s/ Steven Steinberg |
|                    |                    |   |
|                    |                    | Steven Steinberg |
|                    |                    | Chief Financial Officer |
|                    |                    | (Principal Financial Officer) |

 

29

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