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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.
20549

FORM 10-Q

 For the Quarterly Period Ended September 30, 2002

OR

For the Transition Period from _______ to ________ .

Commission File Number: 000-26357

           Check whether the registrant: (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

          As of October 31, 2002, there were 98,118,854 shares of the registrant’s common stock outstanding.

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FORM 10-Q

INDEX

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PART I — FINANCIAL INFORMATION

ITEM 1.   FINANCIAL STATEMENTS

LOOKSMART, LTD. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In Thousands, except per share amounts)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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LOOKSMART, LTD. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(Unaudited)
(In Thousands, except per share amounts)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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LOOKSMART, LTD. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In Thousands)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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LOOKSMART, LTD. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.    Summary of Significant Accounting Policies

Nature of Business and Principles of Consolidation

       LookSmart (“LookSmart” or the “Company”)is a leader in search marketing, helping online and offline businesses acquire qualified leads from the Internet through search. LookSmart provides search results through its network of leading Internet portals, ISPs and Internet media companies. The acquisition of WiseNut in April 2002 has enhanced LookSmart’s ability to provide highly relevant and valuable search results to portals and Internet search providers (“ISPs”) using the WiseNut technology and our proprietary directories. By providing its search results through a network of partners, LookSmart enables businesses to gain access to qualified consumers at the moment that they are searching for relevant products, services and information.

       The consolidated financial statements include the accounts of the Company and its subsidiaries: LookSmart International Pty Ltd., LookSmart Holdings (Delaware), Ltd., LookSmart Netherlands B.V., LookSmart (Barbados), Inc. and LookSmart Germany GmbH. All significant intercompany balances and transactions have been eliminated in consolidation. Investments in 20% to 50% owned partnerships and affiliates are accounted for by the equity method and investments in less than 20% owned affiliates, over which the Company does not exert any significant influence, are accounted for by the cost method.

Revenue Recognition

       The Company generates revenues from listings, advertising, licensing and in prior periods, ecommerce activities. Revenues associated with listings products generally are recognized once collectibility is established, as delivery of services occurs, once all performance obligations have been satisfied and when no refund obligations exist. Listings revenue is recognized as clicks are delivered. Upfront fees are recognized ratably over the longer of the term of the contract or the expected relationship with the customer, which is currently twelve months.

       Advertising revenues are recognized as impressions or clicks are delivered over the period in which the advertisement is displayed, provided that no significant Company obligations remain at the end of a period and collection of the resulting receivable is reasonably assured. Company obligations typically include guarantees of a minimum number of “impressions,” or times that an advertisement appears in pages viewed by users of the Company’s or its partners’ online properties.

       Revenue associated with the Company’s licensing contract is recognized as delivery occurs as specified under the contract, all performance obligations have been satisfied, and no refund obligations exist. Payments from customers received in advance of delivery are recorded as deferred revenues.

       The Company’s ecommerce revenues were generated by the sale of merchandise. Revenue is recognized at the time goods are shipped. In April 2002, the Company exited the ecommerce business.

       For the purpose of determining when to recognize revenue in any of our segments, the time of delivery of the applicable services or merchandise is readily determinable. However, determination of collectibility of payments requires significant judgment on the part of management and includes performing initial and ongoing credit evaluations of customers. The Company recognizes revenues once collectibility is established

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and maintains a reserve for doubtful accounts receivable based upon expected collectibility, which reflects management’s judgment based on this ongoing credit evaluation. In addition, the Company provides a reserve against revenue for estimated credits resulting from billing adjustments.

Expense Recognition

       Generally, all costs are expensed as incurred.  However, product development costs have been capitalized to the extent that costs for internal use software are required to be capitalized and amortized under American Institute of Certified Public Accountants Statement of Position No. 98-1, “Accounting for the Cost of Computer Software Developed or Obtained for Internal Use” (“SOP 98-1”). The Company had capitalized software, net of accumulated depreciation, of $0.7 million and $2.5 million as of December 31, 2001 and September 30, 2002, respectively. These amounts are included in other long-term assets on the balance sheet.

Recently Issued Accounting Pronouncements

BUSINESS COMBINATIONS AND GOODWILL AND OTHER INTANGIBLE ASSETS

       On January 1, 2002, the Company adopted Statement No. 141, “Business Combinations” (“SFAS No. 141”), and Statement No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”). SFAS No. 141 revises the accounting treatment for business combinations, requiring the use of purchase accounting and prohibiting the use of the pooling-of-interests method for all business combinations initiated after June 30, 2001, and broadens the criteria for recording intangible assets separate from goodwill for all business combinations completed after June 30, 2001. SFAS No. 142 revises the accounting for goodwill and other intangible assets by not allowing the amortization of goodwill and establishing accounting for the impairment of goodwill and other intangible assets.  Under SFAS No. 142, the Company ceased amortizing goodwill. All of the Company’s goodwill is attributed to the Listings segment of the business.

The Company’s intangible assets are comprised primarily of purchased technology and have estimated useful lives of 3 to 7 years. The Company has reassessed the expected useful lives of existing intangible assets. This reassessment did not result in any significant changes to the useful lives. The Company reported the following (in thousands):

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       Intangible asset amortization expense was $0.4 million and $1.0 million for the three and nine months ended September 30, 2002, respectively, and $0.8 million and $1.3 million for the three and nine months ended September 30, 2001, respectively. Estimated intangible amortization expense for each of the years ending December 31 is as follows (in thousands):

       SFAS No. 142 requires the Company to test goodwill for impairment using a two-step process. The first step is a screen for potential impairment, while the second step measures the amount of impairment. The first step of the impairment test required a comparison of the fair value of each reporting unit to its carrying value to determine whether there was an indication that impairment existed. If there had been an indication of impairment, the Company would have allocated the fair value of the reporting unit to its assets and liabilities as if the reporting unit had been acquired in a business combination. The Company completed the impairment test as of January 1, 2002 using a fair value approach in accordance with SFAS No. 142. No impairment losses were recorded upon the initial adoption of SFAS No. 142.

       The reconciliation of net income to adjusted net income as if there had been no goodwill amortization in any period presented is as follows for the three and nine months ended September 30, 2001. There was no goodwill amortization for the three and nine months ended September 30, 2002 (in thousands, except per share amounts):

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ACCOUNTING FOR CONSIDERATION GIVEN BY A VENDOR TO A CUSTOMER

       In November 2001, the Financial Accounting Standards Board (“FASB”) Emerging Issues Task Force (“EITF”) reached consensus on Issue 01-9, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products)” (EITF 01-9). The issue provides guidance on accounting for certain payments made by a vendor of goods and services to a customer. Under certain conditions, amounts paid to customers are required to be shown as a reduction in the corresponding revenues recorded from those customers, rather than be shown as expenses in the income statement. EITF 01-9 is generally effective for fiscal years or interim periods beginning after December 15, 2001. Effective January 1, 2002, the Company has adopted the provisions of EITF 01-09, which has had no material impact on the consolidated financial statements.

ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS

       On January 1, 2002, the Company adopted Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“Statement 144”). Statement 144 supersedes Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, and the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business. Statement 144 also amends ARB No. 51, Consolidated Financial Statements, to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. The Company’s disposal of FutureCorp is presented as a discontinued operation in compliance with Statement 144.

RESCISSION OF FASB STATEMENTS NO. 4, 44, AND 64, AMENDMENT OF FASB STATEMENT NO. 13, AND TECHNICAL CORRECTIONS

             In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections (“Statement 145”). Statement 145 rescinds FASB Statement No. 4, Reporting Gains and Losses from Extinguishment of Debt, and an amendment of that Statement, and FASB Statement No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. Statement 145 also rescinds FASB Statement No. 44, Accounting for Leases, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. Statement 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. Statement 145 shall be applied in fiscal years beginning after May 15, 2002. Early adoption of Statement 145 is encouraged and may be as of the beginning of the fiscal year or as of the beginning of the interim period in which the statement was issued.

ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES

             In July 2002, the FASB issued Statement No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”. This statement requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Examples of costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity. Management does not believe adoption of this statement will materially impact the Company’s financial position or results of operations.

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Reclassifications

             Certain reclassifications have been made to prior period consolidated financial statements to conform to the current presentation.

2.          Unaudited Interim Financial Information

             The accompanying unaudited condensed consolidated financial statements reflect all adjustments which are normal and recurring in nature, and, in the opinion of management, are necessary for a fair statement of the results of operations for the periods shown. The results of operations for such periods are not necessarily indicative of the results expected for any full fiscal year or for any future period.

             Certain information and note disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the Securities and Exchange Commission’s rules and regulations. These unaudited interim condensed consolidated financial statements should be read in conjunction with LookSmart’s audited consolidated financial statements and notes for the year ended December 31, 2001, as included in LookSmart’s Annual Report to Shareholders on Form 10-K, as filed with the Securities and Exchange Commission.

3.          Loss from Discontinued Operations

             In the first quarter of 2002, the Company transferred its 52.8% ownership interest in its consolidated subsidiary, Futurecorp, to the minority shareholders. The Company paid Futurecorp AU$90,000 (approximately US$47,000) and issued 16,437 shares of LookSmart common stock in connection with the transfer. As required by SFAS No. 144, the Company reported the results of operations of this component as a loss from discontinued operations of $972,000, which included a $1,035,000 loss on disposal. Revenue and pretax net income reported in discontinued operations for the nine months ended September 30, 2002 were $642,000 and $63,000, respectively.

4.          Asset Impairment and Restructuring Charges

             In January 2001, the Company announced a restructuring of its management and operations. The costs associated with these activities resulted in an impairment and restructuring charge related to LookSmart’s exit from non-core businesses, such as Inside The Web and LookSmart Live!, the amendment of certain marketing agreements, and a reduction in staff of 172 employees.  The restructuring resulted in a one-time charge of $9.4 million during the first quarter of 2001. In April 2001, the Company recognized an impairment charge of $2.4 million related to goodwill from the 1999 Guthy-Renker Internet asset purchase. The Company had no asset impairment and restructuring charges in the first nine months of 2002 and all payments were made in the period the expense was recorded.

5.           Business Concentration

             The Company has a number of agreements with distribution partners that generate traffic, increasing the Company’s revenues from listings products. The Company derives the majority of its outside traffic from one distribution partner.  The Company could replace this partner with other suppliers, however the loss of this distribution partner would have a significantly adverse effect on the Company’s operations, at least in the short term.

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6.          Net Loss Per Share

             In accordance with the requirements of SFAS No. 128, a reconciliation of the numerator and denominator of basic and diluted loss per share is provided as follows (in thousands, except per share amounts):

             Options and warrants to purchase common shares are not included in the diluted loss per share calculations as their effect is antidilutive for all periods. The antidilutive securities included common stock equivalents relating to stock options and warrants to purchase common shares and were as follows (in thousands):

7.          Related Party Transactions

             The Company had a distribution agreement with Guthy-Renker Corporation (“GRC”), one of the Company’s stockholders. The distribution agreement with GRC terminated pursuant to its terms on April 2, 2002. During the first nine months of 2002, the Company earned $940,000 in revenue from GRC and paid GRC $18,000 for marketing and administrative support. During the three and nine months ended September 30, 2001, the Company earned  $791,000 and $9,246,000, respectively, in revenue from GRC. During the three and nine months ended September 30, 2001, the Company paid GRC $8,000 and $100,000, respectively, for marketing and administrative support.

             In April 2002, the Company loaned an executive officer of the Company $250,000. The loan is interest free and may be forgiven ratably over a period of four years, subject to certain performance measures being met. In addition, the Company has agreed to pay taxes due related to forgiveness of the loan and imputed interest. In the event that the officer’s employment terminates during the four year period, the outstanding unforgiven balance is due upon the next anniversary date of the loan. The amount being forgiven, plus imputed interest and payments to cover taxes, are charged to operations ratably over the life of the loan.

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             In October 2001, the Company entered into a license agreement with Viator Ventures, Inc., a technology company wholly owned by an executive officer of the Company. In February 2002, the Company exercised its contractual option to make the license exclusive.  In connection with the license, the Company paid $400,000 and issued 300,000 shares of Company common stock valued at $660,000 to Viator Ventures. The license is classified as property and equipment on the balance sheet and has an estimated useful life of three years.

8.          Segment Information

             Until April 2002, when the Company exited the ecommerce business, the Company operated in four segments: listings, advertising, licensing and ecommerce. Since the discontinuance of its ecommerce business, the Company has operated in three segments: listings, advertising and licensing. In the Condensed Consolidated Statements of Operations and Comprehensive Loss, the Company reports revenue and cost of revenues for these four segments based on the services currently provided by each. With the exception of accounts receivable and deferred revenue, information available to the chief operating decision makers of the Company does not include allocations of assets and liabilities or operating costs to the Company’s segments. As of December 31, 2001 and September 30, 2002, accounts receivable by segment were as follows (in thousands):

           As of December 31, 2001 and September 30, 2002 deferred revenue by segment was as follows (in thousands):

9.        Stock Option Plan

           During the nine months ended September 30, 2002, the Company granted 6,448,744 stock options at the then current fair market value of its underlying common stock. During such period, employees exercised an aggregate of 2,042,544 options, and 2,465,384 options were cancelled. Total outstanding stock options were 17,956,812 as of September 30, 2002.

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10.     Acquisition

           On April 2, 2002, the Company completed the acquisition of WiseNut, Inc. (“WiseNut”), a patent pending next generation search engine technology that combines link popularity with contextual analysis. Management believes the acquisition will enhance the Company’s search technology.

          The Company issued 2,646,000 million shares of common stock at a price per share of $2.47, assumed 293,000 stock options with a fair value of $659,000, incurred direct costs of the transaction in the amount of $474,000 and recorded a liability in the amount of $859,000 for all the outstanding capital stock of WiseNut. Of the total assumed stock options, approximately 132,000 stock options with an intrinsic value of $378,000 were unvested. In accordance with FASB Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation,” these unvested options were accounted for as deferred stock-based compensation and are being recognized over their related vesting periods.

          The common stock issued was valued in accordance with EITF Issue No. 99-12, “Determination of the Measurement Date for the Market Price of Acquirer Securities Issued in a Purchase Business Combination,” using the average of the closing prices of the Company’s common stock for the two days prior to, the date of and the two days after the announcement date of March 12, 2002. The assumed stock options were valued using the Black-Scholes valuation model using a volatility rate of 130%, a risk-free interest rate of 4.3% and an estimated life of four years.

          The preliminary allocation of the purchase price was to tangible and intangible assets, unearned compensation and liabilities assumed. Approximately $6.5 million was allocated to existing search technology and $0.1 million was allocated to an existing customer contract. These amounts were determined through established valuation techniques in the technology industry. Technology acquired will be amortized over a seven-year period and the acquired customer contract will be amortized through November 2002, when the contract is due to expire.

          Under the terms of the acquisition agreement, 1.2 million shares of common stock were placed in an escrow account for a period of 12-18 months. The shares are held in escrow pending the outcome of certain seller representations and warranties. If and when these contingently issuable shares are released from escrow, their fair value at that time will be recorded as goodwill and will be assigned to the Company’s Listings segment.

          The Company’s consolidated financial statements include the operating results of WiseNut from the date of acquisition. Pro forma results of operations have not been presented because the effects were not material.

          The following table presents details of WiseNut’s assets and liabilities acquired by the Company as of the acquisition date (in thousands):

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

Cautionary Note Regarding Forward-Looking Statements

          The following discussion contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  These forward-looking statements reflect our plans, estimates and beliefs, including without limitation forward-looking statements regarding anticipated revenue growth, trends in costs of revenues and operating expenses, international expansion, introduction of additional services, the extent of our distribution network, the adequacy of our capital reserves and our future need for additional capital. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below and elsewhere in this report, particularly in “Factors Affecting Operating Results”. Except as may be required by applicable law, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.  The following discussion should be read in conjunction with the condensed consolidated financial statements and the notes to those statements, which appear elsewhere in this Form 10-Q.

Overview

     LookSmart is a leader in search marketing, helping online and offline businesses obtain qualified leads on the Internet through search. LookSmart provides search results through its network of leading Internet portals, ISPs and Internet media companies. The acquisition of WiseNut in April 2002 has enhanced LookSmart’s ability to provide highly relevant and valuable search results to portals and ISP’s using the WiseNut technology and our proprietary directories By providing its search results through a network of partners, LookSmart enables businesses to gain access to qualified consumers at the moment that they are searching for relevant products, services and information.

Revenues and Cost of Revenues

     Listings. The Company’s listings revenues are derived from LookListings and affiliate partner commissions. LookListings fees are charged on a “cost per click” basis, and are recognized as the clicks are delivered. We expect listings revenues to continue to grow in total and as a proportion of our overall revenues as search marketing continues to be recognized as a highly effective direct marketing tool.  However, as described in the Factors Affecting Operating Results, listings revenues may fluctuate due to a variety of factors.

     Prior to April 9, 2002, the Company charged small businesses a fee to perform an accelerated review of their web sites for possible inclusion in the Company’s directory. Revenue was recognized when the review was completed. On April 9, 2002, LookSmart released Small Business Listings as part of the LookListings Small Business product suite and discontinued the “pay-for-review” service.  This new product offers small businesses inclusion in our search results for continuing fees which are charged on a “cost per click” basis, and are recognized as the clicks are delivered.  In addition, there is a small one-time review fee, which is recognized ratably over the client’s estimated life in the directory, currently estimated to be twelve months.

     The Company’s costs of listings revenues include the distribution fees paid to partners based on LookListings “cost-per-click” revenues when there is no LookSmart branding or other direct sales and marketing efforts associated with the generation of these clicks and revenues. Amortization of certain intangible assets is also included in costs of listings revenues for the three and nine months ended September 30, 2002. We expect distribution costs as a percentage of revenue to increase slightly over the next several quarters as our listings revenues increase and higher contractual revenue sharing obligations apply.

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     Advertising. The Company’s graphical advertising revenues are typically derived from two to four month agreements requiring the Company to serve a minimum number of advertising impressions or clicks over the term of the agreement. We offer advertisers the ability to specify the category of traffic for their advertisements, and we are able to charge premiums on some categories based on advertisers’ perceptions of the associated economic value. This value is derived from the location of the advertisement on the page, the targeting by category or keyword and the size of the audience requesting the page.

     The principal components of cost of advertising revenues are personnel costs of our in-house advertising employees, equipment depreciation, other expenses relating to hosting advertising operations and agency commissions paid to outside advertising agencies. Our costs of advertising revenues are generally fixed, at least in the short term, and cannot be expected to follow short-term fluctuations in advertising revenues. To the extent that advertising costs do not coincide with changes in advertising revenues, fluctuations from this revenue source will have a disproportionate impact on net income or loss.

     Advertising revenues, both in absolute terms and as a percent of total revenues, have declined over the past year. We expect this trend to continue as we de-emphasize this segment of our business.

     Licensing. We license our database content to Microsoft. We expect revenues from licensing to fluctuate from period to period because these revenues are dependent upon the timing of delivery of new non-commercial links to the database under the licensing agreement with Microsoft and the expiration, renewal and addition of agreements with current and future partners.

     Ecommerce. The Company’s ecommerce revenues were generated primarily by the sale of merchandise through online stores such as BuyItOnTheWeb (a wholly-owned business unit of LookSmart). Associated direct product costs are reported as cost of revenues. The Company expects no further ecommerce revenue or expenses due to the decision to exit this segment of the business effective April 2002.

Operating Expenses

     We do not track operating expenses by reportable segment, but treat these as shared overhead of our four reportable segments.

     Sales and Marketing. Sales and marketing expenses include salaries and associated costs of employment for the Company’s sales force, sales administration and customer service staff, payments to distribution partners for directing online users to LookSmart search results and referring Small Business customers, overhead, facilities, allocation of depreciation, amortization of unearned compensation, the impact of variable stock option compensation, and provisions for doubtful trade receivables.  Sales and marketing expenses also include the costs of advertising, trade shows and public relations activities.  We expect that sales and marketing headcount related expenses will remain stable with increases in strategic areas.

     Product Development. Product development costs include all costs related to development and engineering of new products and continued development of our search databases. These costs include salaries and associated costs of employment, overhead, facilities and amortization of intangible assets, amortization of unearned stock-based compensation and the impact of variable stock option compensation. Costs related to the development of software for internal use in the business, including salaries and associated costs of employment, are capitalized as required by generally accepted accounting principles.  Software licensing and computer equipment depreciation related to supporting product development functions are also included in product development expenses. Product development costs are relatively stable in the short term, but are expected to increase in the future as the Company continues to invest selectively in this area.

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     General and Administrative. General and administrative expenses include overhead costs such as executive management, human resources, finance, legal and facilities personnel. These costs include salaries and associated costs of employment, overhead, facilities, allocation of depreciation, amortization of unearned compensation and the impact of variable stock option compensation. General and administrative expenses include related consulting and professional service fees that will vary significantly over time.

     Amortization of Goodwill. In accordance with SFAS No. 142 (See Note 1—Recently Issued Accounting Pronouncements in the Notes to Consolidated Financial Statements which appear in Item 1 in this Form 10-Q), commencing January 1, 2002, the Company ceased amortizing goodwill.

     Asset Impairment and Restructuring Charges.   In January 2001, LookSmart announced a restructuring of its management and operations. The costs associated with these activities resulted in an impairment and restructuring charge related to LookSmart’s exit from non-core businesses, such as Inside The Web and LookSmart Live!, the amendment of certain marketing agreements, and a reduction of staff by 172 employees. In April 2001, the Company recognized an impairment charge of $2.4 million related to goodwill from the 1999 Guthy-Renker Internet asset purchase. The Company had no asset impairment and restructuring charges in the nine months ended September 30, 2002.

     Income Taxes.  Although we are not yet profitable on a consolidated tax basis, tax charges are incurred in connection with our operations in foreign jurisdictions.

Critical Accounting Policies

     The financial condition and results of operations of the Company are based upon certain critical accounting policies, which include estimates, assumptions, and judgments on the part of management. The following discussion highlights those policies and the underlying estimates and assumptions, which management considers critical to an understanding of the financial information in this report. See Note 1—Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements which appear in Item 1 in this Form 10-Q for additional information about these and other accounting policies used in the preparation of the consolidated financial statements included in this Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2001.

     Allowance for Doubtful Accounts. The Company records allowances for doubtful accounts based on a customer-specific analysis, and general matters such as current assessments of past due balances and economic conditions. Additional allowances for doubtful accounts may be required if there is deterioration in past due balances, if economic conditions are less favorable than the Company has anticipated or for customer-specific circumstances, such as bankruptcy.

     Internal Use Software and Web Site Development Costs.    The Company accounts for internal use software in accordance with American Institute of Certified Public Accountants (“AICPA”) Statement of Position No. 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use” (SOP 98-1). In accordance with the capitalization criteria of SOP 98-1, the Company has capitalized external direct costs of materials and services consumed in developing and obtaining internal-use computer software and the payroll and payroll-related costs for employees who are directly associated with and who devote time to the internal-use computer software project.

     The Company capitalizes certain costs incurred in the development of its web sites in accordance with Emerging Issues Task Force (EITF) Issue No. 00-02 Consensus, “Accounting for Web Site Development Costs.” These are costs incurred during the infrastructure, graphics and content development stages.

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     Management judgment is required in determining the point at which various projects enter the stages at which costs may be capitalized, in assessing the ongoing value of the capitalized costs, and determining the estimated useful lives over which the costs are amortized.

     Goodwill and Intangible Assets.    We have recorded goodwill and intangible assets in connection with our business acquisitions. Management judgment is required in the assessment of the related useful lives, and the fair value and recoverability of these assets. Historically, there have been no circumstances that resulted in revised assumptions or impairment charges. The majority of intangible assets are amortized over three to seven years, the period of expected benefit. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” valuation of intangible assets is reassessed periodically to conform to changes in management’s estimates of future performance giving consideration to existing and anticipated competitive and economic conditions. Goodwill is reviewed for impairment at least annually. The Company did not record a goodwill impairment charge in the current year as a result of the initial review. Cash flow forecasts used in evaluation of goodwill and intangibles are based on trends of historical performance and management’s estimate of future performance.

     Stock-Based Compensation.    The Company accounts for stock-based employee compensation arrangements in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB No. 25”) and related interpretations and complies with the disclosure provisions of SFAS No. 123, “Accounting for Stock-based Compensation.” The disclosure provisions of SFAS No. 123 require judgments made by management as to the expected lives of the outstanding options. Management has based the estimated useful life of the options on historical option exercise patterns. If the estimated life of the options increases, the valuation of the options will increase as well. As a result of the repricing of stock options, the Company will incur compensation expense or negative expense in connection with variable accounting for outstanding stock options that have been repriced as the market price of the Company’s common stock increases or decreases.

     Revenue Recognition.    The Company generates revenues from listings, advertising and licensing and until April 2002, generated revenues from ecommerce activities. Revenues associated with listings products generally are recognized once collectibility is established, as delivery of services occurs, once all performance obligations have been satisfied and when no refund obligations exist. In some cases there is also an upfront fee, which is recognized ratably over the longer of the term of the contract or the expected relationship with the customer, which is currently twelve months.

     On April 9, 2002, LookSmart released its Small Business Listings product as part of the LookListings Small Business product suite.  This new product is based on continuing “cost per click” fees, which are recognized as revenue when clicks are delivered.  In addition, there is a small one-time review fee, which is recognized as revenue ratably over the client’s estimated life in the directory, which is currently estimated to be twelve months.

     Advertising revenues are recognized as impressions or clicks are delivered over the period in which the advertisement is displayed, provided that no significant Company obligations remain at the end of a period and collection of the resulting receivable is reasonably assured. Company obligations typically include guarantees of a minimum number of “impressions,” or times that an advertisement appears in pages viewed by users of the Company’s or its partners’ online properties.

     Revenues associated with our licensing contract is recognized as delivery of directory links occurs as specified under the contract, all performance obligations have been satisfied, and no refund obligations exist. Payments from customer received in advance of delivery are recorded as deferred revenues.

     For the purpose of determining when to recognize revenue in any of our segments, the time of delivery of the services is readily determinable. However, determination of collectibility of payments requires

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significant judgment on the part of management and includes performing initial and ongoing credit evaluations of customers. The Company recognizes revenues once collectibility is established and provides a reserve for doubtful accounts receivable based upon expected collectibility, which reflects management’s judgment based on this ongoing credit evaluation. In addition, the Company establishes a revenue reserve for estimated billing adjustments based on historical trends.

Results of Operations

Revenues

     Paid clicks, which include both advertising clicks and listings clicks, increased to 120 million and 277 million for the three and nine months ended September 30, 2002, respectively. This represents increases of 135% and 90% compared to 51 million and 146 million in the corresponding periods in 2001. The increase over the prior year resulted from a refocus of the Company’s business emphasis to the listings business and away from the advertising business, due to the emergence of listings as a strong direct marketing channel for advertisers.

     Revenue per click decreased from $0.20 per click in the third quarter of 2001 to $0.17 per click in the third quarter of 2002. This decrease was primarily the result of declining rates for graphical advertising clicks from the previous year and increased volumes from lower-than-average value clicks in the third quarter of 2002.

     Listings.   Listings revenues were $18.7 million and $47.4 million for the three and nine months ended September 30, 2002, respectively, representing 105% and 100% increase over revenue of $9.1 million and $23.7 million for the three and nine months ended September 30, 2001, respectively. The growth is due to the successful enhancement of our LookListings suite of products, including products for both large and small businesses, an increase in the number of paid listings included in our database, improved relevance of our search results, and our sales and marketing efforts to promote these new products. Listings revenue accounted for 79% and 73% of total revenues in the three and nine months ended September 30, 2002, respectively, an increase from 52% and 37% in the corresponding periods in 2001. Listings revenues represented the largest revenue segment for LookSmart for the last six consecutive quarters.

     Advertising.   Graphical advertising revenues were $1.4 million for the quarter ended September 30, 2002, and $5.7 million in the first nine months of 2002, representing decreases of 69% and 71%, respectively, from revenue of $4.5 million and $19.8 million in the corresponding periods in 2001. The decreases in advertising revenues are attributable to the downturn in the online advertising market, reduced demand and prices for these products and the Company’s de-emphasis of this segment of our business.

     Licensing.   Licensing revenue was $3.6 million for the quarter ended September 30, 2002 and $11.1 million in the first nine months of 2002, representing an increase of 6% from revenue of $3.4 million in the third quarter of 2001 and a 3% decrease from revenue of $11.5 million for the first nine months of 2001. The decrease in licensing revenue is attributable primarily to an unusually high number of expedited non-commercial directory links ordered by Microsoft in the first quarter of 2001. In late 2001, deliveries to Microsoft returned to customary levels. The year-to-date decline was also caused by the timing of delivery of URLs under our agreement with Microsoft.

     Ecommerce.   The Company had no ecommerce revenue during the third quarter of 2002. Ecommerce revenue was $0.6 million for the first nine months of 2002, representing a decrease of 94% from the first nine months of 2001. The decrease is the result of the Company’s decision to exit the ecommerce line of business in April of 2002.

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Cost of Revenues

     Distribution costs as a percentage of revenue, which includes costs for both advertising and listing distribution, increased from 29% in the third quarter of 2001 to 43% in the third quarter of 2002. This increase is due to the impact of the new small business revenue sharing arrangements with our portal partners and the shift in mix of our clicks, as we now receive more clicks from higher cost distribution. We expect distribution costs as a percent of revenue to increase slightly over the next several quarters as our listings revenues increase and higher contractual revenue sharing obligations apply. We expect further increases if we enter into agreements with additional significant distribution partners.

     Listings.   Listings costs of revenues were $8.4 million for the quarter ended September 30, 2002 and $18.7 million for the first nine months of 2002. This represents increases of 262% and 237% over costs of revenue of $2.3 million and $5.5 million for the third quarter of 2001 and first nine months of 2001, respectively. The increase in listings cost of revenues is primarily attributable to the growth in revenue and increased partner distribution expenses for the listings products. The costs have increased as the listings business matures and becomes a principal segment of our business and because we are now sharing revenue on Small Business Listings clicks with our partners. Listings costs of revenues are generally variable as a result of variations in the amount of revenue shared with distribution partners under each agreement.

     Advertising.   Advertising costs of revenues remained relatively flat at $1.5 million for the quarter ended September 30, 2002, and $4.3 million for the first nine months of 2002, compared to costs of revenue of $1.3 million for the third quarter of 2001 and $3.9 million for the first nine months of 2001. Because most of our costs of advertising revenues are generally fixed in the short-term, they cannot be expected to follow declines in advertising revenue.

     Ecommerce.   We had no Ecommerce cost of revenues for the quarter ended September 30, 2002, and $0.1 million for the first nine months of 2002, compared to costs of revenues of $0.2 million and $5.6 million in the corresponding periods in 2001. The decrease is the result of the Company’s decision to exit the ecommerce line of business in the second quarter of 2002.

Operating Expenses

     Sales and Marketing.   Including charges for amortization of unearned compensation and depreciation, sales and marketing expenses changed as follows (dollar figures are in thousands):