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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. ¨

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, 2004, was approximately $211,996,761. 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, 2005, 113,750,931 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, 2004.

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PART I

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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, future profits or losses, international businesses, competitive position, stock compensation and 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. 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 listings products 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.

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

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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.

Products and Services

LookListings

Our LookListings products provide advertisers the opportunity to include listings for their company and product pages on relevant search results pages, which are distributed across our network of distribution partners. We delivered a total of 482 million paid clicks, or clicks to a customer’s web site for which we received payment, for our customers in 2004.

In 2004, we launched the LookListings application programming interface, or API. The API allows advertisers to tie their systems into our LookListings advertiser portal, the Advertiser Center, so that they can easily and automatically manage a large numbers of listings with us. We also increased the timeliness of our click tracking and advertiser reporting system, so that advertisers are now able to access their spend information as quickly as one hour after clicks occur. Finally, we rolled out a keyword pricing tool to enable our customers to have greater visibility into the keyword bidding process.

Our LookListings products include both keyword-targeted listings and paid inclusion listings. For maximum convenience, our customers may include both paid inclusion listings and keyword listings in a single, unified campaign. Keyword 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 influencing 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. For keyword listings, we ensure that an advertiser never pays more than needed by automatically discounting the CPC paid to the minimum value necessary to maintain the advertiser’s position in search results.

Paid inclusion 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 a paid inclusion listing is billed at a simple, pre-set CPC. Paid inclusion listings are 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 thousands of listings and pay fees on a monthly per-click basis. Smaller LookListings accounts are primarily sold through an automated online interface on our web site and involve the payment of monthly fees on a per-click basis. Smaller LookListings account holders may add search listings for multiple pages on their Web sites, including home page, category-level and product-level pages.

Affiliate programs

We generate revenues through our participation in online affiliate programs, which are programs operated by affiliate network services (such as LinkShare or Commission Junction) or online merchants in which we are paid a fee for a participating merchant’s acquisition of new customer orders. By participating in affiliate programs, we generate revenues when users make a purchase from a participating merchant’s web site after clicking on the merchant’s listing in our search results.

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FindArticles

Our FindArticles service allows consumers to search a large database of high-quality content from articles and publications. This service is accessible to consumers from www.findarticles.com and consumers often find FindArticles content through other search engines. We generate revenue from this service in the form of commissions for purchases of premium content, per-click fees on our own paid listings, and revenue sharing from clicks on paid listings provided by Google, Inc.

Net Nanny

In April 2004, we acquired Net Nanny, a software product for family-friendly web surfing, from BioNet Systems, LLC. This software enables consumers to set web access parameters for specific family members. In September 2004, we released Net Nanny 5.1, which includes family-safe filtered search, an Internet monitor, web site filtering, time limits, chat recording, newsgroup blocking and privacy controls. We currently sell Net Nanny software through our web site at www.netnanny.com and through our network of authorized distributors.

Furl.net

In July 2004, we acquired the Furl.net service, an online bookmarking service, from Furl, LLC. The Furl service, available at www.furl.net and through a downloadable toolbar, allows members to simply and securely save copies of any web page. Users can instantly find what they need by searching their online personalized categories and archives from any computer. In addition, Furl users can publicly share their bookmarked web pages and help other users find those web pages.

Evolution of LookListings: 2000-2003

In 2000, we launched our first paid listings products, Express Submit and Basic Submit, and our first per-click listings product, Subsite Listings. With Express Submit and Basic Submit, 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. Subsite Listings involved the payment by web site owners of a one-time review fee and periodic per-click and maintenance payments for the review and inclusion of multiple subsites in our search results.

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. For medium and large businesses, LookSmart editors prepared titles and descriptions for multiple pages within the customer’s web site and included the listings in search results. 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 a distribution partner’s search index.

In 2002, we launched LookListings Small Business listings, a paid inclusion product available through an online interface for a small set-up fee and monthly per-click fees. 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 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.

In 2003, we introduced several improvements to LookListings. In July 2003, we introduced the LookSmart Reporting Center, an easy-to-use online resource that enables businesses to monitor the performance of their

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LookSmart listings, making campaign analysis, management and optimization simpler and more effective. In October 2003, we introduced our first bid-for-placement listings service, which enables advertisers to precisely target their campaigns by bidding for the search terms that are core to their business.

Licensing

Our licensing agreement with Microsoft expired in the first quarter of 2004. Prior to that time, we received revenue from licensing and customizing our directories based on Microsoft’s specifications and needs. We received no other licensing revenues related to our directories in 2004.

Technology

Our principal assets include our software and systems for crawling the web, storing and indexing web page information, updating the index, handling search queries, serving search results, and for tracking, analyzing and reporting on customer campaigns. 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 LookListings^®, LookSmart^®, Net Nanny^®, WiseNut^® and Zeal^®. We also have patents pending on various aspects of our WiseNut search technology.

Advertiser Center

We have developed a proprietary system, the Advertiser Center, to track, analyze, report and optimize customer campaigns. The Advertiser Center collects click data for each listing that we manage for our customers, filters out fraudulent clicks through our TrueLead fraud detection system, and provides accurate customer billing. In addition, we provide each of our LookListings customers with a password-protected online account that enables them to track, analyze and optimize their search marketing campaigns using online reports.

Search Technology

Our commercial search technology includes software for providing high-volume search results, building and updating indexes, and incorporating maximum CPC and click-through-rate in the placement of listings in search results, updated throughout the day.

Our WiseNut search technology includes software for crawling the web and updating our index of approximately one billion web pages and a proprietary algorithm that searches the index and compiles relevant search results. Since our acquisition of WiseNut in 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. In 2004, we made core engineering improvements to greatly expand the capacity of the system and reduce the cost of delivering search results to less than one-tenth of what it had been previously.

We also developed new search technology using our Furl.net personal bookmarking service following our acquisition of the Furl.net business in July 2004. If a Furl user archives a web page, our servers automatically crawl that web page and include it in our updated web search index. Our unique ranking algorithm also makes use of proprietary WiseNut and Furl data to improve the relevance of these web search results.

Crawling Technology

Our Grub crawling technology includes a distributed computing platform for crawling and indexing the web by harnessing the unused processing capacity of multiple volunteers’ personal computers. The Grub client software is downloadable from our web site and easily installed on a volunteer’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

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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.

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 2004, we delivered 482 million paid clicks for our advertising customers from our distribution network.

One of the biggest challenges for our business development team has been to rebuild the distribution network after the end of our contractual relationship with Microsoft’s MSN in the first quarter of 2004. Prior to the expiration of the agreement, MSN accounted for approximately two-thirds of our listings revenues and was our largest source of click traffic. Since that time, we have added dozens of smaller distribution partners to our network in an effort to rebuild and diversify our sources of distribution. As a result, in 2004 only three distribution partners were responsible for more than 10% of our listings revenues: ePilot, Mamma.com and Search123. One of our greatest challenges for 2005 is to continue to diversify our distribution network and develop new sources of click traffic.

Competition

The search engine industry is competitive and rapidly changing. The types of advertising services offered by search engines include paid placement listings, paid inclusion listings, locally-relevant listings, contextual listings and wireless listings. 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. Our competitors include Amazon’s A9, AOL Time Warner, Ask Jeeves, FindWhat, Google, Microsoft’s MSN and Yahoo!, all of whom have greater capital or technical resources, larger distribution networks or user bases, longer operating histories and/or greater brand recognition than we have.

We compete on two main fronts: the advertising market and the distribution market. We compete for advertisers against other search engines, Internet companies, and other media and publishers on the basis of several factors, including:

We compete for distribution partners against other search engines on the basis of several factors, including:

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International Operations

In 2004, we largely completed the closure of our international businesses. From 2000 through 2002, our international operations in Europe and Asia were conducted by our joint venture with British Telecommunications, BTLookSmart. We also operated a subsidiary in Australia from 1996 until early 2004. 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. 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. Following the termination of the MSN contract in the first quarter of 2004, we concluded that our international businesses were no longer strategically or financially viable. As a result, we closed our foreign offices and sold the remaining assets of these businesses in the first half of 2004.

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, 2004, we had 144 employees, including 140 in our San Francisco headquarters and four elsewhere. We have never had a work stoppage, and none of our 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 may be unable to achieve operating profitability in the foreseeable future, and if we achieve operating profitability, we may be unable to maintain it, which could result in a decline in our stock price

We had a net loss of $9.6 million in 2004 and as of December 31, 2004, our accumulated deficit was $186 million. We may be unable to achieve operating profitability in the foreseeable future and, if we regain operating profitability, we may be unable to maintain it. Our ability to achieve and maintain operating profitability will depend on our ability to generate additional revenues and contain our expenses. In order to generate additional revenues, we will need to expand our network of distribution partners, expand our proprietary traffic sources, and expand our advertiser base. We may be unable to do so because of the risks identified in this report or for unforeseen reasons. Also, we may be unable to contain our costs due to the need to make revenue sharing payments to our distribution partners, to invest in product development, marketing and search technologies, and enhance our search services. Because of the foregoing factors, and others outlined in this report, we may be unable to achieve and maintain operating profitability in the future.

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

In 2004, substantially all of our revenues came from search traffic on our distribution network. We have in the past, and may in the future, be unable to maintain key partners in our distribution network. For example, in early 2004 we lost Microsoft’s MSN, Inktomi and About.com’s Sprinks as partners, which was the primary cause of the decrease in paid clicks from 2003 to 2004. Our distribution network is still concentrated, with our five largest network partners accounting for approximately 51% of our revenues in 2004. If we lose any significant portion of our distribution network, we would need to find alternative sources of click traffic to 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 traffic 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 financial results are highly concentrated in the listings business; if we were unable to grow listings revenues and find alternative sources of revenue, our financial results would suffer

Listings accounted for 100% of our revenues in 2004 and will likely account for substantially all of our revenues in 2005. 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, capital 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, financial condition and/or liquidity will suffer.

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If we experience downward pressure on our revenue per click and/or match rate, or we are unable to rebuild our revenue per click and/or match rate, our financial results will suffer

We have experienced, and may in the future experience, downward pressure on our average revenue per click and match rate, or rate at which paid listings are matched against search queries, due to various factors. In the fourth quarter of 2004, for example, our average revenue per click and match rate decreased due to the loss of a few large advertisers and a reduction in average spend per advertiser. We may experience decreases in revenue per click or match rate in the future for many reasons, including the erosion of our advertiser base, the reduction in average advertiser spend, the reduction in the number of listings purchased by advertisers, or for other reasons. If our revenue per click or match rate fall for any reason, or if we are unable to grow our revenue per click and match rate, then we may be unable to achieve our financial projections and our stock price would likely suffer.

Our growth depends on our ability to retain and grow our advertiser base; if our advertiser base and average advertiser spend continues to fall, our financial results would suffer

In 2004, our distribution network shifted from being predominantly dependent on MSN to being a more diversified network of smaller distribution sources. As a result of the change in distribution, a number of larger advertisers in our advertiser base either stopped purchasing LookListings or reduced their average spend. In the fourth quarter of 2004, this resulted in a decrease in our average revenue per click and match rate. Our future growth depends on our ability to build an advertiser base that corresponds with the characteristics of our distribution network. If our sales and marketing efforts are insufficient, or if we are unable to build an advertiser base at projected rates, we may be unable to meet our financial guidance, and our stock price would likely suffer.

Any failure in the performance of our key operating systems could materially and adversely affect our revenues

Any system failure that interrupts our search service, whether caused by computer viruses, software failure, power interruptions, unauthorized intruders and hackers, or other causes, could harm our financial results. For example, our system for tracking and invoicing clicks is dependent upon a proprietary software platform. If we lose key personnel or experience a failure of software, this system may fail. In such event, we may be unable to track paid clicks and invoice our customers, which would materially and adversely affect our financial results and business reputation.

If we fail to detect and remove fraudulent clicks, we could lose the confidence of our advertisers, thereby causing our business to suffer

Click fraud is an increasing problem for the Internet advertising industry, and we are exposed to the risk of fraudulent clicks on our paid listings. Click fraud occurs when a person or robotic software clicks on a paid listing for some reason other than to view the underlying content. We have from time to time credited invoices or refunded revenue to our customers due to click fraud, and we expect to continue to do so in the future. The perpetrators of click fraud have developed sophisticated methods to evade detection, and we are unlikely to detect and remove all fraudulent clicks from our search network. If our fraud detection systems are insufficient, or if we find new evidence of past fraudulent clicks, we may have to issue credits or refunds retroactively to our advertisers, yet we may still have to pay revenue share to our network partners. This would negatively affect our profitability and hurt our brand. If fraudulent clicks are not detected and removed from our search network, the affected advertisers may experience a reduced return on their investment in our listings because the fraudulent clicks will not lead to actual sales for the advertisers. This could lead the advertisers to become dissatisfied with our listings, which could lead to loss of advertisers and revenue and could materially and adversely affect our financial results.

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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:

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 past financial results as an indicator 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.

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 on our ability to identify, attract, retain and motivate highly skilled software development, technical, sales, and management personnel. The loss of the services of any of our key employees could adversely affect our business. 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.

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 listings, compile and distribute our search results, track paid clicks, and detect click fraud. 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

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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.

Accounting for employee stock options using the fair value method could significantly reduce our net income

The Company is required to adopt SFAS 123R (accounting for stock options using the fair value method of accounting) in the third quarter of 2005, which will likely increase our compensation expenses related to stock options. The adoption of SFAS 123R will likely have a significant adverse impact on our financial statements and net income per share.

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

Companies in the Internet, technology and media industries own large numbers of patents, copyrights, trademarks and trade secrets and frequently enter into litigation based on allegations of infringement or other violations of intellectual property rights. As we face increasing competition, the possibility of intellectual property rights claims against us grows. 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 are currently subject to two purported class action lawsuits in connection with our listings services. Our technologies may not be able to withstand any third-party claims or rights against their use. In addition, we are obligated under some agreements to indemnify our partners in the event that they are subject to claims that our services infringe on the rights of others.

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 will 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.

We face growing competitive pressures, which could materially and adversely affect our financial results

We compete in the relatively new and rapidly evolving paid search industry, which presents many uncertainties that could require us to further refine our business model. 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, 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 larger distribution networks and proprietary traffic bases, longer operating histories and greater brand recognition than we have.

If we do not introduce new products and services and successfully adapt to our rapidly changing industry, our financial condition may suffer

The Internet search industry is rapidly evolving and very turbulent, and we will need to develop new products and services and adapt to new business environments and competition in order to reach our profitability goals. New search and advertising technologies could emerge that make our services comparatively less useful or new business methods could otherwise emerge that divert Web traffic away from our search network. Also, we

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may inaccurately predict the direction of search technologies or the advertising market, which could lead us to make investments in technologies and products that do not generate sufficient returns. Rapid industry change makes it difficult for us to forecast our results accurately, particularly over longer periods, and might cause our profitability to decline significantly. We face the risk that we may be unable to adapt to new developments in the search industry, or that our new products and services may not be broadly adopted by customers, in which case we would eventually need to obtain additional financing or cease operations.

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 operational changes required by the reduction of the Microsoft distribution channel resulting from the expiration of our contractual relationship with Microsoft’s MSN in the first quarter of 2004, it is extremely difficult to evaluate our business 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.

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We may need additional capital in the future to support our operations and, if such additional financing is not available to us, our 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:

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.

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. 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 their data centers 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 developed a 30-day disaster recovery plan to respond in the event of a catastrophic loss of our critical, revenue-generating systems. We have an agreement with Raging Wire, Inc. in Sacramento, California to provide co-location and networking services for our critical systems in such an event. 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.

We rely on insurance to mitigate some risks and, to the extent the cost of insurance increases or we are unable to maintain sufficient insurance to mitigate the risks, our operating results may be diminished

We purchase insurance to cover potential risks and liabilities. In the current environment, insurance companies are increasingly specific about what they will and will not insure. It is possible that we may not be able to get enough insurance to meet our needs, may have to pay very high prices for the coverage we do get or

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may not be able to acquire any insurance for certain types of business risk. This could leave us exposed to potential claims or unexpected events. If we were found liable for a significant claim in the future, our operating results could be negatively impacted. Also, to the extent the cost of insurance increases, our operating results will be negatively affected.

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 located at our San Francisco, California office. An interruption in our ability to serve search results, track paid clicks, and provide customer support would materially and adversely affect our financial results.

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

From time to time we evaluate corporate development opportunities, and when appropriate, 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 certain assets from BioNet Systems, LLC in the second quarter of 2004 and from Furl, LLC in the third quarter of 2004. 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. We intend to license to end users certain software we acquired from BioNet Systems, LLC, but we may lack the managerial and technical resources necessary to implement a software licensing business model in a timely manner. Unlicensed copying and use of such software in the United Sates and abroad will represent a loss of revenue to us. Furthermore, end users may not license our products at projected rates.

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 be unable to collect invoiced amounts from some of our customers, which could materially and adversely impact our business

We derive a portion of our revenues from the sale of listings to companies that represent credit risks. Some of our customers have gone out of business, have limited operating histories or are operating at a loss. Moreover, many of these companies have limited cash reserves and limited access to additional capital. We have in some

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cases experienced difficulties collecting outstanding accounts receivable. Our allowance for doubtful accounts receivable as of December 31, 2004 was $1.5 million, or 27% of our gross accounts receivable. We may continue to have these difficulties in the future, and if a significant part of our customer base experiences financial difficulties or is unable or unwilling to pay our search marketing fees for any reason, our business will suffer.

New litigation or regulation of search engines may adversely affect the commercial use of our search service and our financial results

New laws and regulations applicable to the search engine industry may limit the delivery, appearance and content of our advertising. If such laws are enacted, or if existing laws are interpreted to limit our ability to place advertisements for certain kinds of advertisers, it could and have a material and adverse effect on our financial results. For example, in 2002, the Federal Trade Commission, in response to a petition from a private organization, reviewed the way in which search engines disclose paid placement or paid inclusion practices to Internet users and issued guidance on what disclosures are necessary to avoid misleading users about the possible effects of paid placement or paid inclusion listings on the search results. In 2003, the United States Department of Justice issued statements indicating its belief that displaying advertisements for online gambling might be construed as aiding and abetting an illegal activity under federal law. In 2004, the United States Congress considered new laws regarding sale of pharmaceutical products over the Internet, which could affect our sales of advertisements for such products. If any new law or government agency were to require changes in the labeling, delivery or content of our listings, or if we are subject to legal proceedings regarding these issues, it may reduce the desirability of our services or the types of advertisements that we can run, and our business could be materially and adversely harmed.

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

We are still in the process of dissolving our joint venture, BT LookSmart, and our other international offices. Withdrawal from foreign markets and closure or dissolution of foreign offices may be more costly than we anticipated, possibly involving employment-related litigation or tax audits. If we incur costs in excess of the amounts we forecasted in connection with these activities, our financial results would be materially and adversely affected.

Privacy-related regulation of the Internet could limit the ways we currently collect and use personal information which could decrease our advertising revenues or increase our costs

Internet user privacy has become an issue both in the United States and abroad. The United States Congress is considering new legislation to regulate Internet privacy, and the Federal Trade Commission and government agencies in some states and countries have investigated some Internet companies, and lawsuits have been filed against some Internet companies, regarding their handling or use of personal information. Any laws imposed to protect the privacy of Internet users may affect the way in which we collect and use personal information. We could incur additional expenses if new laws or court judgments, in the United States or abroad, regarding the use of personal information are introduced or if any agency chooses to investigate our privacy practices.

Our search engine places information, known as cookies, on a user’s hard drive, generally without the user’s knowledge or consent. This technology enables web site operators to target specific users with a particular advertisement and to limit the number of times a user is shown a particular advertisement. Although some Internet browsers allow users to modify their browser settings to remove cookies at any time or to prevent cookies from being stored on their hard drives, many consumers are not aware of this option or are not knowledgeable enough to use this option. Some privacy advocates and governmental bodies have suggested limiting or eliminating the use of cookies. If this technology is reduced or limited, the Internet may become less attractive to advertisers and sponsors, which could result in a decline in our revenues.

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We and some of our partners or advertisers retain information about our users. If others were able to penetrate the network security of these user databases and access or misappropriate this information, we and our partners or advertisers could be subject to liability. These claims may result in litigation, our involvement in which, regardless of the outcome, could require us to expend significant time and financial resources.