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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

Commission file number 000-26357

LOOKSMART, LTD.

(Exact name of Registrant as specified in its charter)

625 Second Street, San Francisco, CA 94107

(415) 348-7000

(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $.001 per share

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 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. Yes x No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes x No ¨

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, based upon the closing price of common stock on the last business day of the most recently completed second fiscal quarter, June 30, 2003, was approximately $225,900,245.70. Shares of voting stock held by each executive officer, director and person who owns 5% or more of the outstanding voting stock have been excluded from this calculation. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of March 1, 2004, 108,592,428 shares of the registrant’s common stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

The information called for by Part III of this Form 10-K is incorporated by reference to the definitive proxy statement for the annual meeting of stockholders of the company which will be filed no later than 120 days after December 31, 2003.

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TABLE OF CONTENTS

PART I

Table of Contents

PART I

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We use words such as “believes”, “intends”, “expects”, “anticipates”, “plans”, “may”, “will” and similar expressions to identify forward-looking statements. Discussions containing forward-looking statements may be found in the material set forth under “Business,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in other sections of the report. All forward-looking statements, including, but not limited to, projections or estimates concerning our business, including demand for our products and services, mix of revenue streams, ability to control and/or reduce operating expenses, anticipated gross margins and operating results, cost savings, product development efforts, general outlook of our business and industry, international businesses, competitive position, stock compensation, adequate liquidity to fund our operations and meet our other cash requirements, are inherently uncertain as they are based on our expectations and assumptions concerning future events. These forward-looking statements are subject to numerous known and unknown risks and uncertainties. You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including our ability to regain profitability in future quarters, our ability to expand our network of distribution partners, the success of our listings business, and all other risks described below in the section entitled “Risk Factors” and elsewhere in this report. All forward-looking statements in this document are made as of the date hereof, based on information available to us as of the date hereof, and we assume no obligation to update any forward-looking statement.

ITEM 1.    BUSINESS

Overview

LookSmart is a provider of products for advertisers who wish to pay to be included in relevant web search results. Our LookListings suite of products provides businesses of all sizes the opportunity to have listings for their company and products included in our distributed web search results, so that their listings are available to Internet users at the moment when they are searching for relevant information. By enabling advertisers to reach users in a highly targeted search context, we provide a proven method of acquiring customers, converting advertising leads into sales and generating useful marketing information for individual customer campaigns. Our campaign reporting technology enables advertisers to monitor the performance of their search marketing campaigns and make changes to their listings through the use of password-protected online accounts.

We distribute our products for advertisers on a network of portals, Internet service providers (ISPs), media companies and search engines. These companies have increasingly recognized the valuable nature of search services for their web sites. We develop custom search services for our distribution partners, in some cases providing full-web search and in other cases providing search results only for a commercial segment of searches. We offer distribution partners a search solution with two important benefits. First, our search solution provides highly relevant search results for their users, which can help to maintain the users’ satisfaction and increase repeat visits of those users. Second, we share with our distribution partners a portion of the listings revenues that we generate from clicks on paid listings in those search results.

In 2003, we delivered 852 million paid clicks for our advertising customers from our distribution network. Microsoft’s MSN accounted for 68% of our revenues in 2003. In October 2003, we were informed by Microsoft that it would not renew the distribution and licensing agreement after its expiration in January 2004. MSN remained our primary source of click traffic through the expiration of our distribution agreement in January 2004. One of our greatest challenges for 2004 is to rebuild and diversify our distribution network and develop alternative sources of click traffic to replace the MSN relationship. Going forward, we intend to identify and target under-served and profitable segments of the search market. Once identified, we intend to build both distribution and proprietary traffic and leverage our existing technologies to provide high-quality search services for these segments, and to generate revenue in these segments by providing paid listings and potentially other revenue-generating products.

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Industry Background

The emergence and wide acceptance of the Internet has fundamentally changed how millions of people and businesses find information and purchase goods and services. Search engines are one of the most popular and useful services on the Internet for people seeking to find information about businesses, goods and services. We believe that search engines will continue to play an important role in helping consumers and businesses find one another and facilitating online commerce.

Search engines provide two critical functions. First, they gather, index and store information about companies’ web sites in a database. Second, they provide Internet users with access to the databases by presenting search results in an easy-to-read format with links directly to companies’ web sites. Businesses that want to increase the number of visitors to their web sites have increasingly recognized the value of being included in search results in response to relevant words or phrases. Search marketing has experienced rapid growth in recent years, and we believe that businesses’ demand for paid placement and paid inclusion in relevant search results will continue to grow as this form of direct marketing gains broader acceptance and as Internet users increasingly rely on search engines to find relevant information.

The types of products offered by search firms can be divided into two main types: “paid inclusion” and “pay-for-placement”. Paid inclusion listings typically appear along with unpaid listings in general search results, which are ordered according to their relevance to a user’s keyword query. Pay-for-placement listings, in contrast, typically appear at or near the top of search results, often in a separate section of search results, and are ordered according to the amount paid by each advertiser to appear in response to a user’s keyword query.

Products and Services

LookListings in 2003

Our LookListings products provide businesses of all sizes the opportunity to include listings for their company and product pages in relevant search results, which are distributed across our network of distribution partners. LookSmart delivered a total of 852 million paid clicks, or clicks to a customer’s web site for which LookSmart receives payment, for its customers in 2003.

In 2003, we introduced several improvements to LookListings. In July 2003, we introduced a new LookListings platform that allows both large and small LookListings account holders access to the LookSmart Reporting Center. This easy-to-use online resource enables businesses to monitor the performance of their LookSmart listings, making campaign analysis, management and optimization simpler and more effective. In October 2003, we introduced a bid-for-placement search listings product, which enables advertisers to precisely target their campaigns by bidding for the search terms that are core to their business.

Our LookListings products include both inclusion-targeted listings and keyword-targeted listings. For maximum convenience, our customers may include both inclusion-targeted listings and keyword-targeted listings in a single, unified campaign. Keyword-targeted listings allow advertisers to select specific keywords, or search terms that are relevant to their specific web pages. Upon selecting relevant keywords, advertisers can choose a maximum price they are willing to pay for clicks, thereby controlling the position of their listings in the Sponsored Search section of the search results page. Placement of keyword-targeted listings within the Sponsored Search results depends on the click-through-rate and the maximum CPC, or cost-per-click, the advertiser is willing to pay for the listing’s campaign. We ensure that an advertiser never pays more than it needs to for its keyword-targeted listings by automatically discounting the CPC paid to the minimum value necessary to maintain the advertiser’s position in search results.

Inclusion-targeted listings provide relevant search traffic with the submission of only a URL, title, and description. These listings are displayed in the main body of search results for searches of relevant terms on LookSmart.com and some of our partners’ sites. Each click to an inclusion-targeted listing is billed at a simple,

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pre-set CPC determined by the advertiser’s business category. Inclusion-targeted listings are occasionally boosted into the Sponsored Search section of the search results page when space is available.

Large LookListings accounts are generally sold directly to advertisers by our sales force or indirectly by advertising agencies, search engine marketing services or other third parties. Our large customers generally purchase tens, hundreds or thousands of listings. Smaller LookListings accounts are primarily sold through an online interface on our web site and involve the payment of monthly fees on a per-click basis. Smaller LookListing account holders may add search listings for multiple pages on their Web sites, including home page, category-level and product-level pages.

Affiliate programs

Our listings business also generates revenues through our participation in affiliate programs. Affiliate programs are programs operated by affiliate network services or online merchants, in which merchants pay traffic providers on a cost-per-acquisition basis. By participating in affiliate programs, we generate revenues when Internet users make a purchase from a participating merchant’s web site after clicking on the merchant’s listing in our search results.

FindArticles

In November 2003, we re-launched our FindArticles service, which allows consumers to search a large database of high-quality content from articles and publications. This service is now accessible to consumers from a tab on the LookSmart.com main search page. With little additional capital contribution or operating investment, we have seen a rapid increase in consumer traffic to, and revenue from, this service. We generate revenue from this service by display of our own LookListings paid listings results, and by display of paid listings provided by Google, Inc.

Listings Products 2000-2002

Prior to the changes to LookListings implemented in 2003, all clicks were billed to advertisers at pre-set rates, without reference to the advertiser’s business category and without bidding. LookListings products were divided into large and small business listings.

We launched our large business listings program in the third quarter of 2000 under the name “Subsite Listings”. This product involved the payment by web site owners of a one-time review fee and periodic “pay-per-click” and maintenance payments for the editorial review and inclusion of multiple subsites in LookSmart’s database of search results. “Pay-per-click” payments were payments based on the number of clicks to a customer’s web site from a listing in the LookSmart directory. In 2001, as a result of customer feedback and marketing information, we expanded Subsite Listings into several products, each directed at the needs of a particular segment of our customer base. LookListings for medium and large businesses consisted primarily of Directory Listings, in which LookSmart editors prepared titles and descriptions for multiple pages within the customer’s web site and included the listings in general web search results that were distributed by our distribution partners. LookListings also included Sponsored Listings, in which businesses paid for placement in a separate section of search results entitled “Sponsored Listings” in response to specific keywords, and Index Listings, in which businesses prepared their own site descriptions for inclusion in Inktomi Corporation’s search index.

Small business listings consisted of a paid inclusion product for small and medium-sized businesses launched in April 2002. LookListings Small Business listings were primarily sold through an online interface on our web site and involved the payment of a small listings set-up fee and payment by customers of monthly fees on a per-click basis. Customers then had their listings included in general search results. Small business listings were also occasionally boosted to the Sponsored Listings section of search results in some parts of our

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distribution network, when their listing was relevant and space was available. We also offered “Add a Category”, in which customers pay a fee to include their listings in an additional relevant category within the LookSmart directories, and “Update Description”, in which customers paid a fee to update their listings to reflect changes to their business or web site. Unlike the Large Business Listings customers, Small Business listings Customers were not able to add multiple listings for one website, such as home page, category- and product-pages.

Our first products directed at small businesses, Express Submit and Basic Submit, were launched in early 2000. With these listings products, businesses paid a fee for review of their web site by LookSmart editors for potential inclusion in the LookSmart directories. We subsequently added additional products to supplement this product line, including “Site Promote”, in which customers were eligible to have listings boosted to the Sponsored Listings section, as well as “Add a Category” and “Update Description” services.

Licensing

Until the licensing portion of our agreement with Microsoft expired on January 15, 2004, we received revenue from licensing and customizing our directories based on Microsoft’s specifications and needs. We provided custom-tailored Internet directory content according to Microsoft’s requests in six-month increments. We do not expect to receive other licensing revenues related to our directories in 2004.

Technology

Our principal assets include our software and systems for creating, building and maintaining the LookSmart index of web sites and directory, and for tracking, analyzing and reporting on our customer campaigns. In 2003, we made significant improvements to these systems, including the acquisition of Grub distributed computing system for crawling and indexing, several improvements to our LookListings product platform, and the roll-out of a bid-for-placement platform. We rely on a combination of trade secret, copyright and trademark laws and contractual provisions to protect our intellectual property and proprietary rights. Our trademarks include, but are not limited to, LookSmart, LookListings, Zeal and WiseNut. We also have four patents pending on various aspects of our WiseNut technology.

LookSmart is uniquely positioned in the search industry because it offers an algorithmic search index, an editorial search directory, and a platform for paid search listings, both via paid inclusion and pay-for-placement.

Our crawler-generated search index, which currently consists of approximately 1.2 billion web pages, is based on our WiseNut technology and assets acquired in April 2002 and Grub technology acquired in January 2003. Our WiseNut technology consists of the search index and a proprietary algorithm that searches through the index and compiles the most relevant search results. We have increased the number of listings in the WiseNut index, increased the frequency of updates to the index and improved the relevancy of search results produced by the algorithm.

The LookSmart directory consists of high-quality web pages that have been editorially reviewed and categorized by human editors using our proprietary technology. As of December 31, 2003, our United States directory had approximately 2.6 million high-quality listings and our international directories had approximately 2.1 million high-quality listings. We exclude listings we believe to be pornographic or promote hatred of people based on color, nationality, religion, gender, sexual orientation or any other basis. Internet users can search our directories from the LookSmart web site or the web sites of some of our distribution partners by searching by keyword or browsing through categories and sub-categories.

Our LookListings suite of paid listings products is based on proprietary technology developed over the last three years. In 2003, we delivered 852 million paid clicks to advertisers, and we have increased the options available to advertisers to gain maximum value from their paid listings campaigns with LookSmart.

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WiseNut Search Engine

Our WiseNut technology includes software for crawling the web and updating our index of approximately 1.2 billion web pages and a proprietary algorithm that searches the index and compiles relevant search results. Since our acquisition of WiseNut in April 2002, we have increased the number of documents in the index, increased the frequency of updates to the index, increased the flexibility and scalability of the technical architecture, and improved the relevance of search results produced by the algorithm. Our current efforts include continuing to improve the size and coverage of the WiseNut index and the speed and relevance of the WiseNut search engine.

Grub Crawling Technology

Our Grub technology includes a distributed computing platform for crawling and indexing the web by harnessing the unused processing capacity of multiple volunteer’s personal computers. The Grub client software is downloadable from our web site and easily installed on a participant’s personal computer. The client software then reviews a pre-set series of web sites and relays key data back to LookSmart’s servers for compilation into LookSmart’s search index. We have successfully used the software to identify dead links in the WiseNut index, thereby allowing us to remove them from the index. We believe that by automating this removal process, we may be able to achieve substantial gains in the freshness of the index and cost savings over the long term.

Campaign Tracking, Reporting and Service

We have developed a proprietary system to track, analyze, report and optimize customer campaigns. This system collects click data for each listing that we manage for our customers. The system also features proprietary algorithms that seek to discover fraudulent or robotic clicks and ensure accurate customer billing. In addition, we provide each of our LookListings customers with a password-protected online account that enables them to track and analyze their search marketing campaigns using online reports. In 2003, we made significant changes to this proprietary system, implementing bid-for-placement for keyword-targeted listings and allowing advertisers to manage both inclusion-targeted listings and keyword-targeted listings in a single account.

Community Participation

We permit certain Internet users to add non-commercial listings to our English-language directory through our Zeal.com web site. In order to create or edit listings, Internet users must pass tests to determine their qualifications with respect to particular subject matter categories and editorial guidelines. Once these users have demonstrated proficiency in their category and achieved certain quality ratings from other users, we deem them “Zealots” and provide them with access to more advanced tools to add listings and manage categories. To date, Zeal’s community of volunteers has contributed more than 250,000 high quality, non-commercial listings to the directories.

Unified Editorial Model

We have developed a proprietary software application, the Unified Editorial Model, or UEM, used by our editors to create, edit, categorize and place listings in LookSmart’s directories. The UEM also allows Zealots to contribute non-commercial listings in their area of expertise to the LookSmart database. This system has undergone frequent revision and upgrade and multiple editors can use the application simultaneously. In addition to the UEM, we have developed or licensed several algorithms which enable us to extract data from the database, publish this data in various editions of the directory and perform routine maintenance on the database, such as dead link checking.

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Distribution Network

We actively pursue relationships with portals, ISPs, media companies, search services and other web sites in order to maintain and increase the distribution of our listings. These relationships are key drivers of our growth because more distribution generally results in more clicks and listings revenues. We develop custom search services for our distribution partners, in some cases providing full-web search and in other cases providing search results only for a commercial segment of searches. In 2003, we delivered 852 million paid clicks for our advertising customers from our distribution network. Microsoft’s MSN accounted for 64% of our listings revenues and remained our primary source of click traffic through the expiration of our distribution agreement in January 2004. One of our greatest challenges for 2004 is to rebuild and diversify our distribution network and develop alternative sources of click traffic to replace the MSN relationship.

International Operations

In 2003, we restructured our international business operations, including both our joint venture with British Telecommunications (BT), BT LookSmart, and our business in Australia. From 2000 through 2002, our international operations in Europe and Asia were conducted by the joint venture, while since 1996 we have operated a wholly-owned subsidiary in Australia. All of these businesses generated the majority of their revenues from listings products, often with slight variations on the versions sold in the United States. For example, in Australia we offered our small business listings product for an annual subscription fee rather than on a pay-per-click basis.

In December 2002, we and BT decided to dissolve the joint venture. In the first quarter of 2003, we assumed ownership of the joint venture’s business operations in the United Kingdom and Japan. As a result, in 2003 revenues from our international businesses constituted 14% of our total revenues. However, following the termination of the MSN contract, we concluded that our ownership of international operations was no longer strategically or financially viable, and we have therefore moved to close or sell these operations. We therefore expect that revenues from our international business will play a much smaller role in 2004 as we continue the process of closing or selling our foreign businesses.

In January 2004 we sold the assets of our Australian business to our yellow pages business partner, Sensis, a division of Telstra Ltd., Australia’s leading telecommunications company. We are in the process of selling or closing, respectively, our Japanese and United Kingdom operations. Following the closure of these offices, we expect that an immaterial portion of our business will be outside of the United States and Canada.

Competition

The search engine field is competitive and rapidly changing. The types of products offered by search firms can be divided into two main types: “paid inclusion” and “pay-for-placement”. LookSmart offers both paid inclusion and pay-for-placement products.

We compete for advertisers on the basis of several factors, including:

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We face competition from companies that provide one or both types of search marketing services, including About.com, AOL Time Warner, Ask Jeeves, Yahoo!, FindWhat, Google, Microsoft’s MSN, and Terra Lycos. In addition, we compete with traditional media such as television, radio and print, as well as online advertisers and high-traffic web sites, for a share of our customers’ total advertising expenditures. Many of our competitors have greater capital or technical resources, larger distribution networks or user bases, longer operating histories and greater brand recognition than we have.

The search industry has recently experienced rapid consolidation. In March 2003, Yahoo! acquired Inktomi, a provider of paid inclusion products and algorithmic search. In October 2003, Yahoo! acquired Overture, a provider of pay-for-placement products, paid inclusion products and algorithmic search. In October 2003, Google announced its intention to acquire Sprinks, a provider of pay-for-placement products. In March 2004, Ask Jeeves announced its intention to acquire Interactive Search Holdings, which operates iWon, Excite, and other search sites. This industry consolidation has resulted in a smaller number of competitors, each of which offers a broader range of pay-for-placement and paid inclusion products. It is difficult to predict whether these industry trends will continue and what impact they may have on our competitive position in the search industry.

Marketing

Marketing activities are important in our efforts to attract additional customers and distribution partners. Our marketing strategy is primarily targeted at the following groups:

Employees

As of December 31, 2003, we had 408 employees worldwide, including 266 in our San Francisco headquarters and 142 in offices elsewhere. As of March 1, 2004, we had 242 employees worldwide, including 195 in our San Francisco headquarters and 47 in offices elsewhere. We have never had a work stoppage, and none of our United States employees is currently represented by a labor union. We consider our relations with our employees to be good.

Web Site

Our web site, www.looksmart.com, provides access, without charge, to our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with the Securities and Exchange Commission.

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RISK FACTORS

You should carefully consider the risks described below before making an investment decision regarding our common stock. If any of the following risks actually occurs, our business, financial condition and results of operations could be harmed. In that case, the trading price of our common stock could decline and you could lose all or part of your investment.

We likely will not be able to regain profitability in 2004, which could result in a decline in our stock price

We likely will not be able to regain profitability in 2004. Our distribution and licensing agreement with Microsoft expired in January 2004, and the expiration of this agreement had a material and adverse effect on our business and financial results. Microsoft accounted for approximately 64% of our listings revenues and all of our licensing revenue in 2003. Accordingly, we likely will be unable to maintain profitability in future quarters.

We reached profitability for the first time in the fourth quarter of 2002. Prior to that time, we incurred net losses in every quarter since inception, including net losses of approximately $6.6 million in the first three quarters of 2002, $59.6 million in 2001, $62.6 million in 2000 and $64.7 million in 1999. As of December 31, 2003, we had an accumulated deficit of $176.4 million.

The extent of our net losses in 2004 will depend on our ability to generate revenues, develop our distribution network and sources of proprietary traffic, restructure our business, and contain our expenses. We expect to spend significant amounts to:

Because of the foregoing factors, and others outlined in this report, we will likely be unable to maintain profitability on a quarterly or annual basis in 2004.

We may lose customers and our revenue per click may fall as a result of the expiration of the Microsoft agreement in January 2004, which would cause a decline in our revenues

We may lose additional advertisers from our advertiser base and our average revenue per click may fall as a result of the loss of Microsoft as a distribution partner in January 2004. Advertisers may decide that their return on investment has decreased as a result of the loss of paid clicks from MSN and the shift toward other, less well-known distribution partners. Most of our advertising contracts are short-term in nature and are terminable on short notice. It is difficult to predict whether, and to what extent, we will lose advertisers or advertisers will pay reduced revenues per click because we are no longer a principal source of MSN’s search results. If enough of our advertisers terminate their advertising contracts with us, or if our revenue per click falls significantly, then our listings revenues and results of operations would be materially and adversely affected.

We rely primarily on our network of distribution partners to generate paid clicks; if we were unable to maintain or expand this network, our ability to generate revenues would be seriously harmed

Because our revenues depend on clicks on our paid listings, our listings business depends on the volume of traffic on our distribution network. Microsoft accounted for approximately 64% of our listings revenues in 2003. Our distribution agreement with Microsoft expired in January 2004. In addition, our distribution agreements with About.com’s Sprinks and Yahoo’s Inktomi, which collectively accounted for approximately 9.5% of our listings revenues in 2003, expired in December 2003 and February 2004, respectively. As a result of the loss of these partners, our volume of clicks is likely to decline significantly in 2004 compared to 2003.

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Our listings revenues are concentrated and substantially dependent on a small number of distribution partners. The loss of any of these partners would likely have a material and adverse effect on our financial results. If any of our key distribution contracts are not renewed, or if they are terminated, we would need to find alternative sources of click traffic or otherwise replace the lost paid clicks. Although alternate sources of click traffic are currently available in the market, the search market is consolidating and there is fierce competition among search providers to sign agreements with traffic providers. We face the risk that we might be unable to negotiate and sign agreements with such providers on favorable terms, if at all. If we are unsuccessful in maintaining and expanding our distribution network, then our ability to generate revenues would be seriously harmed.

Our revenues are highly concentrated in the listings business; if we were unable to grow listings revenues, find alternative sources of revenue, and contain our costs, then our results of operations and financial conditions would suffer

To regain profitability, we will need to continue expanding our listings business or significantly reduce our operating costs. Listings accounted for $140.9 million or 90.2% of our total revenues in 2003 and is likely to account for substantially all of our revenues in 2004. Our success will depend upon the extent to which advertisers choose to use and partners choose to distribute our listings products. Some of our products will require both modification of existing software and systems and the creation or acquisition of new software and systems. We may lack the managerial, editorial and technical resources necessary to expand our product offerings in a timely manner. Even if we expand our product offerings, customers and partners may not adopt our products at projected rates. For these and other reasons, these initiatives may not generate sufficient revenues to reach our profitability goals. If we are unable to generate significant additional revenues from our listings business or significantly reduce our operating costs, our results of operations and financial condition will suffer.

We may incur unexpected costs or delays in restructuring our operations and reducing our costs, which could materially and adversely affect our financial results

In the fourth quarter of 2003, we began to restructure our operations and reduce our costs in light of the loss of the Microsoft relationship. However, we will likely be unable to adjust spending quickly enough to compensate for the expected reduction in revenues in 2004. Also, we may incur unexpected costs, such as the possibility of litigation stemming from workforce reductions, in connection with the restructuring. Our costs are based in part on expectations of future revenues and, to a large extent, are fixed. We may incur restructuring charges and our operating results may vary in future quarters as a result of changes in our expenses and costs.

Our quarterly revenues and operating results may fluctuate for many reasons, each of which may negatively affect our stock price

Our revenues and operating results will likely fluctuate significantly from quarter to quarter as a result of a variety of factors, including:

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Due to the above factors, we believe that period-to-period comparisons of our financial results are not necessarily meaningful, and you should not rely on them as indicators of our future performance. If our financial results in any future period fall below the expectations of securities analysts and investors, the market price of our securities would likely decline.

Any failure in the performance of our operating systems could harm our business and reputation, which could materially adversely affect our revenues

Any system failure, whether caused by software failure, power interruptions, unauthorized intruders and hackers, or natural disasters, that causes an interruption in our service or our ability to serve search results and track clicks, could result in reduced clicks and revenues. If we lose key technical personnel or we are unable to scale our system for tracking paid clicks, we may experience an interruption of our listings revenues. A system failure that prevents us from tracking paid clicks or reporting accurate information to our customers’ online accounts could adversely affect our financial results and business reputation.

The occurrence of a natural disaster or unanticipated problems at our principal headquarters or at a third-party facility could cause interruptions or delays in our business, loss of data or could render us unable to provide some services. Our California facilities exist on or near known earthquake fault zones and a significant earthquake could cause an interruption in our services. We do not have back-up sites for our main customer operations center and editorial department, which are both located at our San Francisco, California office. An interruption in our ability to track paid clicks and provide customer support would materially and adversely affect our financial results.

We may face liability for claims related to our listings business, and these claims may be costly to resolve

We make Internet search services available to our users through the use of our proprietary algorithms and databases. This creates the potential for claims to be made against us, either directly or through indemnification provisions in contracts with partners and customers. We are obligated under some agreements to indemnify our partners in the event that they are subject to claims that our listings or services infringe on the rights of others. These claims might, for example, be made for trademark, copyright or patent infringement, defamation, negligence, personal injury, breach of contract, unfair advertising, unfair competition, invasion of privacy or other claims. Allegations are made against us from time to time concerning these types of matters, and we have been subject to purported class action lawsuits in connection with our listings services.

Litigating these claims could consume significant amounts of time and money, divert management’s attention and resources, cause delays in integrating acquired technology or releasing new products, or require us to enter into royalty or licensing agreements. Royalty or licensing agreements, if required, may not be available on acceptable terms, if at all. Our insurance may not adequately cover claims of this type, if at all. If a court were to determine that some aspect of our search services or listings infringed upon or violated the rights of others, we could be prevented from offering some or all of our services, which would negatively impact our revenues and business. There can be no assurance that our services do not infringe the intellectual property rights of third parties. A successful claim of infringement against us and our failure or inability to license the infringed or similar technology could have a material adverse effect on our business, operating results and financial condition.

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We face growing competitive pressures in the search marketing industry, which could materially and adversely affect our financial results

We compete in the relatively new and rapidly evolving paid listings industry, which presents many uncertainties that could require us to further refine our business model. Our success will depend on many factors, including our ability to:

We compete with companies that provide paid placement products, paid inclusion products, and other forms of search marketing, including AOL Time Warner, Ask Jeeves, FindWhat, Google (and its AdWords and Sprinks services), Microsoft’s MSN, Terra Lycos and Yahoo (and its Overture service). In the paid inclusion field, we compete for advertisers on the basis of the relevance of our search results, the price per click charged to advertisers, the volume of clicks that we can deliver to advertisers, tracking and reporting of campaign results, customer service and other factors. Some of our competitors have greater capital or technical resources, larger distribution networks or proprietary user bases, longer operating histories and greater brand recognition than we have.

The search industry has recently experienced rapid consolidation, particularly with the acquisitions of companies offering algorithmic search indices and paid inclusion programs. In March 2003, Yahoo acquired Inktomi, which offers a paid inclusion program for its algorithmic search index. In April 2003, Overture Services acquired AltaVista and the web search unit of FAST Search & Transfer, each of which also offers a paid inclusion program and algorithmic search indices. In October 2003, Yahoo acquired Overture Services and Google announced its intention to acquire Sprinks from About.com. Industry consolidation may result in larger competitors with a greater focus on algorithmic search, sponsored listings or paid inclusion products. If these industry trends continue, or if we are unable to compete in the sponsored listings and paid inclusion industries, our financial results may suffer.

We may experience downward pressure on our revenue per click, which could have a material and adverse effect on our financial results

We have experienced, and may in the future experience, downward pressure on advertising prices in the industry due to cost-cutting efforts by businesses and the increasing amount of advertising inventory becoming available on the Internet. We compete with other web search services, online publishers and high-traffic web sites, as well as traditional media such as television, radio and print, for a share of our customers’ total advertising expenditures. Many potential advertisers and advertising agencies have only limited experience advertising on the Internet and have not devoted a significant portion of their advertising expenditures to search marketing. Acceptance of the search marketing among advertisers will depend, to a large extent, on its perceived effectiveness and the continued growth of commercial usage of the Internet. If we experience downward pricing pressure for our products in the future, our financial results may suffer.

Our stock price is extremely volatile, and such volatility may hinder investors’ ability to resell their shares for a profit

The stock market has experienced significant price and volume fluctuations in recent years, and the stock prices of Internet companies have been extremely volatile. Because of our limited operating history and the changes necessary in light of the loss of the Microsoft contract, it is extremely difficult to evaluate our business

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and prospects. You should evaluate our business in light of the risks, uncertainties, expenses, delays and difficulties associated with managing and growing a relatively new business, many of which are beyond our control. Our stock price may decline, and you may not be able to sell your shares for a profit, as a result of a number of factors including:

In the past, securities class action litigation has often been instituted after periods of volatility in the market price of a company’s securities. A securities class action suit against us could result in substantial costs and the diversion of management’s attention and resources, regardless of the merits or outcome of the case.

We may need additional capital in the future to support our operations and, if such additional financing is not available to us, our business, liquidity and results of operations will be materially and adversely impacted

Although we believe that our working capital will provide adequate liquidity to fund our operations and meet our other cash requirements for the foreseeable future, unanticipated developments in the short term, such as the entry into agreements which require large cash payments or the acquisition of businesses with negative cash flows, may necessitate additional financing. We may seek to raise additional capital through public or private debt or equity financings in order to:

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The capital markets, and in particular the public equity market for Internet companies, have historically been volatile. It is difficult to predict when, if at all, it will be possible for Internet companies to raise capital through these markets. We cannot assure you that the additional financing will be available on terms favorable to us, or at all. If we issue additional equity or convertible debt securities, our existing stockholders may experience substantial dilution.

We face capacity constraints on our software and infrastructure systems that may be costly and time-consuming to resolve

We use proprietary and licensed software to crawl the web and index web pages, create and edit directory listings, search the database, distribute our search results and serve associated web pages. Any of these software systems may contain undetected errors, defects or bugs or may fail to operate with other software applications. The following developments may strain our capacity and result in technical difficulties with our web site or the web sites of our distribution partners:

If we fail to address these issues in a timely manner, we may lose the confidence of advertisers and partners, our revenues may decline and our business could suffer. In addition, as we expand our service offerings and enter into new business areas, we may be required to significantly modify and expand our software and infrastructure systems. If we fail to accomplish these tasks in a timely manner, our business will likely suffer.

Our business depends on Internet service providers, and any failure or system downtime experienced by these companies could materially and adversely affect our revenues

Our users, partners and customers depend on ISPs, online service providers and other third parties for access to the LookSmart search results. These service providers have experienced significant outages in the past and could experience outages, delays and other operating difficulties in the future. The occurrence of any or all of these events could adversely affect our reputation, brand and business, which could have a material adverse effect on our financial results.

We have an agreement with Savvis Communications, Inc. to house equipment for web serving and networking and to provide network connectivity services. We also have an agreement with AboveNet Communications, Inc. to provide network connectivity services. Our network connectivity and network hardware infrastructure are fully redundant using equipment and connectivity at our Savvis data center and our San Francisco offices. However, we do not presently maintain fully redundant click tracking, customer account and web serving systems at separate locations. Accordingly, our operations depend on Savvis and AboveNet to protect the systems in its data center from system failures, earthquake, fire, power loss, water damage, telecommunications failure, hackers, vandalism and similar events. Neither Savvis nor AboveNet guarantees that our Internet access will be uninterrupted, error-free or secure. We have deployed firewall hardware at each facility to thwart hacker attacks. We have not developed a disaster recovery plan to respond in the event of a catastrophic loss of our primary systems. Although we maintain property insurance and business interruption insurance, we cannot guarantee that our insurance will be adequate to compensate us for all losses that may occur as a result of a catastrophic system failure.

Our success depends on our ability to attract and retain key personnel; if we were unable to continue to attract and retain key personnel in the future, our business could be materially and adversely impacted

Our success depends, in part, on the continued service of our key management personnel. The loss of the services of any of our key employees could adversely affect our business. Our success depends on our ability to

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identify, attract, retain and motivate a highly skilled chief executive officer and search development, technical, marketing and other management personnel. We cannot assure you that we will be able to retain our key employees or that we can identify, attract and retain highly skilled personnel in the future.

If we become subject to employment claims, we could incur liability for damages and incur substantial costs in defending ourselves

Companies in our industry whose employees accept positions with competitors frequently claim that these competitors have engaged in unfair hiring practices or that the employment of these persons would involve the disclosure or use of trade secrets. These claims could prevent us from hiring personnel or cause us to incur liability for damages. We may also be sued in connection with our restructuring and workforce reductions by employees claiming wrongful termination or similar causes of action. We could also incur substantial costs in defending ourselves or our employees against these claims, regardless of their merits. Defending ourselves from these claims could also divert the attention of our management away from our operations.

We may incur unforeseen expenses and liabilities in connection with the dissolution of BT LookSmart and closure of our international offices

In the fourth quarter of 2002, we and BT agreed to close our joint venture, BT LookSmart. We are still in the process of dissolving the joint venture, and we have subsequently commenced closing or selling our offices in the United Kingdom and Japan. In January 2004, we sold our Australian business to Sensis, a subsidiary of Telstra. Withdrawal from foreign markets and closure or dissolution of foreign offices may be more time-consuming and costly than we anticipated, and we may incur costs in excess of the amounts we forecasted in connection with these activities.

Our acquisition of businesses and technologies may be costly and time-consuming; acquisitions will likely also dilute our existing stockholders

Although we currently have no plans, proposals or agreements to make acquisitions, if we are presented with appropriate opportunities, we intend to make acquisitions of, or significant investments in, complementary companies or technologies to increase our technological capabilities and expand our service offerings. Acquisitions may divert the attention of management from the day-to-day operations of LookSmart. It may be difficult to retain key management and technical personnel of the acquired company during the transition period following an acquisition. Acquisitions or other strategic transactions may also result in dilution to our existing stockholders if we issue additional equity securities and may increase our debt. We may also be required to amortize significant amounts of intangible assets or record impairment of goodwill in connection with future acquisitions, which would adversely affect our operating results.

We have acquired businesses and technologies in recent years, including the acquisition of the intellectual property assets of Grub, Inc. in the first quarter of 2003. Integration of acquired companies and technologies into LookSmart is likely to be expensive, time-consuming and strain our managerial resources. We may not be successful in integrating any acquired businesses or technologies and these transactions may not achieve anticipated business benefits.

Our business prospects depend on the continued growth in the use of the Internet; if such growth in usage were to subside or stop completely, our business could be materially and adversely impacted

Our business is dependent upon continued growth in the use of the Internet as a medium for search marketing and commercial transactions. Internet usage for these purposes may not grow at projected rates for various reasons, such as:

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