UNITED STATES OF AMERICA

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

For the transition period from            to

Commission File Number: 001-32255

ANSWERS CORPORATION

(Exact name of Registrant as specified in its charter)

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      o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 Large accelerated Filer   o          Accelerated filer         o            Non-accelerated filer           x

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

Yes      o                       No       x

The number of the registrant’s shares of common stock outstanding was 7,854,890 as of November 8, 2007.

ANSWERS CORPORATION

FORM 10-Q

CONTENTS

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INTRODUCTORY NOTE

This Report on Form 10-Q for Answers Corporation (“Answers” or the “Company”) may contain forward-looking statements. You can identify these statements by forward-looking words such as “may,” “will,” “expect,” “intend,” “anticipate,” believe,” “estimate” and “continue” or similar words. Forward-looking statements include information concerning possible or assumed future business success or financial results. You should read statements that contain these words carefully because they discuss future expectations and plans, which contain projections of future results of operations or financial condition or state other forward-looking information.  We believe that it is important to communicate future expectations to investors. The forward-looking statements included herein are based on current expectations that involve a number of risks and uncertainties, which are discussed in Item 1A, “Risk Factors” and in other sections of this Form 10-Q and in our other filings with the Securities and Exchange Commission. These risks and uncertainties could cause actual results or events to differ materially from the forward-looking statements that we make.

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

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PART I - FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Answers Corporation and Subsidiary

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

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

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Answers Corporation and Subsidiary

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

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

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Answers Corporation and Subsidiary

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

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

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Answers Corporation and Subsidiary

Notes to the Consolidated Financial Statements as of September 30, 2007 (unaudited)

Note 1 — Business and Summary of Significant Accounting Policies

The Company

Answers Corporation (“the Parent”), formerly GuruNet Corporation, was founded as a Texas corporation on December 22, 1998, and reorganized as a Delaware corporation in April 1999. On December 27, 1998, the Parent formed a subsidiary based in Israel (“the Subsidiary”), primarily for the purpose of providing research and development services to the Parent. The Parent and its wholly owned Subsidiary are collectively referred to as “the Company.”

As of September 30, 2007, approximately $985,000 of the Company’s net assets were located outside of the United States.

The Company is an online answer engine.  Its web properties currently consist of Answers.com and WikiAnswers.com.

Basis of Presentation

The accompanying consolidated financial statements include the accounts of Answers Corporation and its Subsidiary and are presented in accordance with accounting principles generally accepted in the United States. All significant intercompany balances and transactions have been eliminated in consolidation.

According to item 10 of Regulation S-B, commencing January 1, 2007, the Company is no longer considered a “small business issuer”.

The accompanying unaudited interim consolidated financial statements were prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of financial condition, results of operations, and cash flows in conformity with generally accepted accounting principles. All adjustments, which are, in the opinion of management, of a normal recurring nature and are necessary for a fair presentation of the interim financial statements, have been included. Nevertheless, these financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-KSB for the year ended December 31, 2006. The results of operations for the three and nine months ended September 30, 2007 are not necessarily indicative of the results that may be expected for the entire fiscal year or any other interim period.

Use of Estimates

The preparation of consolidated financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported results of operations during the reporting periods. Actual results could differ from those estimates.

Revenue Recognition

The Company, through its websites Answers.com and WikiAnswers.com, generates revenues via advertising in the form of sponsored links and image ads. This includes both pay-per-performance ads and paid-for-impression advertising. In the pay-per-performance model, the Company earns revenue based on the number of clicks associated with such ads; in the paid-for-impression model, the Company’s revenue is derived from the display of ads.

To date, the vast majority of the Company’s advertising revenue has been obtained through the efforts of third party ad networks. Third party ad networks generally compensate the Company by paying the Company a portion of the revenue they earn from adertisers for provision of promotional space on the Company's web properties. Amounts received from such third party ad networks are reflected as revenue in the period in which such advertising services are provided. In the fourth quarter of 2006, the Company begain marketing directly to advertisers and generating direct advertising revenue

In 2003, the Company sold lifetime subscriptions to its GuruNet product, which had no defined termination date. Cash received from such lifetime subscriptions was recorded as deferred revenues and amounted to $425,000 as of December 31, 2006. In February 2007, in accordance with the Company’s rights under the agreements it previously entered into with such lifetime subscribers, the Company terminated its GuruNet service and thereby extinguished its service obligation to such subscribers. Thus, the Company recognized the $425,000 previously deferred, as revenue in the first quarter of 2007.

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

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Derivatives and Hedging

The Company accounts for derivatives and hedging based on Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133). SFAS No. 133 requires the Company to recognize all derivatives on the balance sheet at fair value. If the derivatives meet the definition of a hedge and are so designated, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings, or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative’s change in fair value is recognized in earnings.

In June 2007, and during the third quarter of 2007, the Subsidiary entered into several forward contracts to hedge certain foreign currency denominated expenses. These derivatives were not designated as hedging instruments under the rules of SFAS 133 and therefore the net gains (losses) are recognized in earnings. During the three and nine months ended September 30, 2007, such gains amounted to $69,000, and are included in operating expenses as follows:

Recently Issued Accounting Standards

In September 2006, the Financial Accounting Standards Board issued SFAS No. 157, “Fair Value Measurements,” (SFAS 157). SFAS 157 establishes a framework for measuring fair value and expands disclosures about fair value measurements. The changes in current practice resulting from the application of the Statement relate to the definition of fair value, the methods used to measure fair value, and the expanded disclosures about fair value remeasurement. The statement is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company does not believe that the adoption of the provisions of SFAS 157 will have a material impact on its consolidated financial position and results of operations.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” (SFAS 159), which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS 159 will become effective on January 1, 2008. The Company is currently evaluating the impact of adopting SFAS 159 on its financial position, cash flows, and results of operations.

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Note 2 — Stockholders’ Equity

General

The following table summarizes the changes in the Company’s stockholders’ equity during the nine-month period ending September 30, 2007:

Common Stock

During the nine months ended September 30, 2007, the Company issued a total of 44,659 shares of common stock due to the exercise of 44,659 of the Company’s outstanding stock options, for a total consideration of approximately $145,000.

Stock Warrants

As of September 30, 2007 there were 1,157,763 outstanding stock warrants with a weighted average exercise price of $16.21 per warrant. All warrants are exercisable immediately. No warrants were exercised during the nine months ended September 30, 2007.

Stock Options

During the nine months ended September 30, 2007, the Company granted a total of 384,650 stock options to its employees, officers and directors at an average exercise price of $11.79 per option. All such options were granted under the Company’s 2005 Plan. Additionally, during the same period, 181,331 stock options were forfeited.

As of September 30, 2007, 101,707 and 96,754 options were available for grant under the 2005 Plan and the 2004 Stock Plan, respectively. All prior option plans are closed for future grants.

The total fair value of stock options vesting during the nine months ended September 30, 2007, amounted to $1,698,000 and was recorded as stock-based compensation expense.

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Note 3 — Commitments and Contingencies

(a)                                               Future minimum lease payments under operating leases for office space and cars, as of September 30, 2007, are as follows:

                                                          Rental expense for operating leases for the three months ended September 30, 2007 and 2006 was $126,000 and $83,000, respectively. Rental expense for operating leases for the nine months ended September 30, 2007 and 2006 was $370,000 and $292,000, respectively.

(b)                                           All of the Subsidiary’s obligations to its bank, including the bank guarantee given to the Subsidiary’s landlord, are secured by a lien on all of the Subsidiary’s deposits at such bank. As of September 30, 2007, deposits at such bank amounted to $995,000, including a restricted long-term deposit of $95,000.

(c)                                            In the ordinary course of business, the Company enters into various arrangements with vendors and other business partners, principally for content, web-hosting, marketing and investor relations arrangements. As of September 30, 2007, the total future cash commitments under these arrangements amount to approximately $1,205,000.

(d)                                           On November 2, 2006 (the “Closing Date”), the Parent acquired certain assets of Interesting.com, Inc. including the domain names www.faqfarm.com and www.wikianswers.com in exchange for $2,000,000 in cash (the “Acquisition Costs”). For a period commencing on the Closing Date and ending one year thereafter, the parties to the agreement have agreed to indemnify each other for damages resulting from any breach of their respective representations, warranties and covenants provided under the agreement.

(e)                                            On July 14, 2005, a former marketing employee of the Company (“the Employee”), filed a statement of claim (“the Claim) with the Regional Labor Court in Jerusalem, Israel (“the Court”), against the Parent, the Subsidiary, the Parent’s Chief Executive Officer and its Chief Financial Officer, in the amount of approximately US$50,000, for deferred salary, severance pay and unpaid commissions, as well as 43,441 options to purchase such number of our shares of common stock, with an exercise price of $2.76 per share. On June 27, 2007, the Company and the Employee entered into a settlement agreement. As a result of this settlement agreement, the Company paid the Employee $130,000, including the Employee’s legal fees, and the claim was dismissed without prejudice.

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

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(g)                                             On July 13, 2007, the Company entered into a purchase agreement to acquire all of the outstanding limited liability interests of Lexico Publishing Group, LLC for an aggregate purchase price of $100 million in cash, subject to adjustments for closing net working capital and transaction costs. Transaction costs  incurred in connection with this acquisition are estimated to be approximately $2.2 million. According to the terms of the agreement, $10 million, which is referred to as the Lexico Employee Bonuses, may be paid to the employees of Lexico, subject to certain terms and conditions and a pre-determined payout schedule. In the event that such terms and conditions are not met, the portion of the Lexico Employee Bonuses not paid to employees will be due to the members of Lexico. In addition, $10 million of the purchase price will be placed in escrow for 12 months to secure the indemnification obligations of the members under the agreement, as well as any post-closing purchase price adjustments for net working capital or transaction expenses.

In connection with the initial allocation of the purchase price, Lexico Employee Bonuses paid to Lexico employees will be recorded as compensation expense during the contracted service period, which in most cases is one year.  The remaining purchase price will be recorded as intangible assets, with estimated useful lives of one to ten years, and goodwill.

Consummation of the acquisition of Lexico is subject to the Company's ability to secure financing for the acquisition, as well as customary conditions to closing, including absence of any legal prohibition on consummation of the acquisition, obtaining governmental and third party consents, the accuracy of the representations and warranties, and delivery of customary closing documents. The Company intends to use approximately $100 million of the net proceeds from a public offering to acquire Lexico.

The purchase agreement may be terminated under the following circumstances, subject to the limitations described in the purchase agreement: (i) by mutual written consent; (ii) by either the Company or the sellers if the acquisition is not consummated by January 13, 2008 subject to certain extensions; (iii) by either the Company or the sellers if there is a final, non-appealable order restraining, enjoining or otherwise prohibiting the consummation of the acquisition; or (iv) by either the Company or the sellers upon an incurable material breach of the purchase agreement by the other party, which breach would result in the failure of the terminating party’s closing conditions to be fulfilled.  The purchase agreement provides that, upon termination for an incurable material breach of the purchase agreement by the Company, which breach would result in the failure of the Company's closing conditions to be fulfilled, the Company will be required to pay the sellers a $2.0 million termination fee. Similarly, the purchase agreement provides that, upon termination of the purchase agreement for an incurable material breach by the sellers, which breach would result in the failure of their closing conditions to be fulfilled, they will be required to pay the Company a $2.0 million termination fee. In addition, if the purchase agreement is terminated for failure of the financing condition, the Company will be required to reimburse the out-of-pocket transaction expenses of the sellers up to $400,000.

As of September 30, 2007, the Company incurred approximately $498,000 in legal, accounting and investment banking fees that would have to be charged to operations, rather than capitalized as purchase price, in the event the Company does not close the transaction. Additionally, as of September 30, 2007, the Company incurred approximately $384,000 in financing costs that would have to be charged to operations, rather than charged to shareholders' equity, in the event we do not close the transaction.

Note 4 — Income Tax

(a)                                              In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109” (FIN 48). FIN 48 clarifies the accounting for uncertainties in income taxes recognized in a company’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes”. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Company adopted the provisions of FIN 48 as of January 1, 2007. Interest and penalties related to unrecognized tax benefits are recognized as a component of income tax expense.

Since the date of adoption, as a result of tax positions taken in the current year, including associated estimated interest and penalties which were not material, the Company’s unrecognized tax benefits increased by $50,000, to a total of $230,000. Of the total unrecognized tax benefits at adoption date, approximately $90,000, if recognized, would impact the effective tax rate in 2007.

The Parent or its Subsidiary file income tax returns in the U.S. federal jurisdiction, and various state & local, and foreign jurisdictions. The Parent is no longer subject to U.S. federal, state and local income tax examinations by tax authorities for years prior to 2003, whereas the Subsidiary is no longer subject to foreign examinations by its tax authority for years prior to 2004. The New York State Department of Taxation and Finance commenced an examination of the Company’s New York State income tax returns for 2003 through 2005 but has not yet reached any conclusions. The Company does not anticipate that their examination would result in a material change to the Company’s financial position.

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(b)                                           The 2006 financial statements as previously presented by the Company in reports and SEC filings, have been modified to account for an immaterial error in the income tax expense in the Consolidated Statements of Operations and deferred taxes on the Consolidated Balance Sheets involving an over-accrual of deferred income taxes relating to the Subsidiary’s accumulated earnings, as a result of applying the distributed tax rate as opposed to the undistributed tax rate.

Note 5 — Major Customers

During the nine months ended September 30, 2007, the vast majority of the Company’s advertising revenue was generated through the efforts of third party ad networks. Additionally, during the three months ended September 30, 2007, the Company earned approximately 67% and 8% of its total revenue through two of its third party ad networks, Google and Shopping.com, compared to 70% and 15%, respectively, of the total revenue during the third quarter of 2006. Of the total revenue during the nine months ended September 30, 2007, Google and Shopping.com accounted for approximately 65% and 9%, compared to 67% and 15% of our total revenue during the same period in 2006.

Note 6 — Risks and Uncertainties

In July 2007, a search engine algorithm adjustment by Google led to a drop in Google directed traffic to Answers.com. As a result, overall traffic and revenue on Answers.com dropped by approximately 28% from levels immediately prior to the change. The Company has not been able to reverse the impact of this adjustment, and it does not anticipate that it will recover the lost traffic and revenue.

In response to the Google algorithm adjustment, the Company reduced its headcount and related recurring compensation costs by approximately 12%. As a result, the Company recorded a one-time charge of approximately $250 thousand in the third quarter of 2007.

As a result of the search engine algorithm adjustment by Google, the Company examined what impact the aforesaid event might have on the recoverability of its long-lived assets in accordance with the guidance contained in SFAS 142 and 144. As a result of the analysis, the Company concluded that the carrying value of its assets has not been impaired.  However, while the Company uses available information to prepare its estimates and to perform impairment evaluations, the recoverability calculations and impairment tests require significant management judgment and estimates.  Such estimates include projections of undiscounted cash flows and assumptions used in calculating projected growth of RPM’s, page-views, and expenses.  In addition, a certain degree of judgment was exercised in determining asset groups in accordance with generally accepted accounting principles.  Had the Company's estimates and assumptions differed, the accounting treatment might have resulted differently.  Future actual results could significantly differ from the anticipated results as reflected in the Company's analysis.

The Company continues to rely heavily on search engines for a substantial portion of the users visiting its Web properties. From time to time, search engines change their algorithms that direct search queries to Internet Web sites, including the Company’s Web properties. Search engines may also restrict the flow of users visiting the Company’s Web properties specifically. The Company cannot guarantee that it will successfully react to these actions and recover any lost traffic.  Accordingly, changes in search engine algorithms or a restriction on the flow of users visiting the Company’s Web properties from the search engines, could cause a significant decrease in traffic and revenues.

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

The following discussion and analysis should be read together with our financial statements and the notes to those statements that appear elsewhere in this Quarterly Report. This discussion contains forward-looking statements reflecting our current expectations and involves risks and uncertainties. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “intend,” “potential,” or “continue” or the negative of these terms or other comparable terminology.  For example, statements regarding our expectations as to future financial performance, expense levels and liquidity sources are forward-looking statements.  Actual results and the timing of events could differ materially from those discussed in our forward-looking statements as a result of many factors, including those set forth under “Risk Factors” and elsewhere in this Quarterly Report.

Overview

We are a leading online answer engine. Our Web properties currently consist of Answers.com and WikiAnswers.com. We offer information related to over 4 million topics based on content from brand-name publishers, our WikiAnswers community and our proprietary natural language search technology, which we refer to as Answers from the Web. Answers.com combines and presents targeted information from disparate sources and delivers answers to users’ questions in a single consolidated view.  WikiAnswers.com is a user-generated content, or UGC, community-based question and answer site. According to comScore, a global Internet information provider, our Web properties had approximately 14 million unique visitors in September 2007, which ranks Answers Corporation number 62 in the top U.S. Web properties. Our goal is to become the premier online provider of and leading destination for answers on any topic.

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

Recent Events

In July 2007, a search engine algorithm adjustment by Google led to a drop in Google directed traffic to Answers.com. This adjustment reduced our overall traffic by approximately 28% based on the average traffic directed to Answers.com from Google for the week prior to the adjustment as compared to the week after. As a result, our revenue also declined proportionately. We have not been able to reverse the impact of this adjustment, and we do not anticipate that we will recover the lost traffic and revenue. In response to the Google algorithm adjustment, we reduced our headcount and related compensation costs, reducing our base payroll expenses by approximately 12%. As a result, we recorded a charge of approximately $250 thousand in the third quarter of 2007, related to this restructuring.

In September 2007, Yahoo! dropped our content from its search index, which reduced our Yahoo! directed traffic. This action was reversed within a week, and we have recovered all of our Yahoo! directed traffic.

Planned Lexico Acquisition

On July 13, 2007, we entered into a purchase agreement to acquire all of the outstanding limited liability interests of Lexico Publishing Group, LLC for an aggregate purchase price of $100 million in cash, subject to adjustments for closing net working capital and transaction expenses. Our transaction expenses incurred in connection with this acquisition are estimated to be approximately $2.2 million. According to the terms of our agreement, $10 million, which we refer to as the Lexico Employee Bonuses, may be paid to the employees of Lexico, subject to certain terms and conditions and a pre-determined payout schedule. In the event that such terms and conditions are not met, the portion of the Lexico Employee Bonuses not paid to employees will be due to the members of Lexico. In addition, $10 million of the purchase price will be placed in escrow for 12 months to secure the indemnification obligations of the members under the agreement, as well as any post-closing purchase price adjustments for net working capital or transaction expenses.

In connection with the initial allocation of the purchase price, Lexico Employee Bonuses paid to Lexico employees will be recorded as compensation expense during the contracted service period, which in most cases is one year.  The remaining purchase price will be recorded as intangible assets, with estimated useful lives of one to ten years, and goodwill.

Consummation of the acquisition of Lexico is subject to our ability to secure financing for the acquisition, as well as customary conditions to closing, including absence of any legal prohibition on consummation of the acquisition, obtaining governmental and third party consents, the accuracy of the representations and warranties, and delivery of customary closing documents. We intend to use approximately $100 million of the net proceeds from a public offering to acquire Lexico.

The purchase agreement may be terminated under the following circumstances, subject to the limitations described in the purchase agreement: (i) by mutual written consent; (ii) by either us or the sellers if the acquisition is not consummated by January 13, 2008 subject to certain extensions; (iii) by either us or the sellers if there is a final, non-appealable order restraining, enjoining or otherwise prohibiting the consummation of the acquisition; or (iv) by either us or the sellers upon an incurable material breach of the purchase agreement by the other party, which breach would result in the failure of the terminating party’s closing conditions to be fulfilled.  The purchase agreement provides that, upon termination for an incurable material breach of the purchase agreement by us, which breach would result in the failure of our closing

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conditions to be fulfilled, we will be required to pay the sellers a $2.0 million termination fee. Similarly, the purchase agreement provides that, upon termination of the purchase agreement for an incurable material breach by the sellers, which breach would result in the failure of their closing conditions to be fulfilled, they will be required to pay us a $2.0 million termination fee. In addition, if the purchase agreement is terminated for failure of the financing condition, we will be required to reimburse the out-of-pocket transaction expenses of the sellers up to $400,000.

Shelf Registration Statement

On July 17, 2007, we filed a universal shelf registration statement with the Securities and Exchange Commission (SEC). The registration statement covers up to an aggregate of $140,000,000 of common stock, preferred stock, warrants, debt securities, units or any combination thereof. On August 6, 2007, the universal shelf registration statement was declared effective by the SEC.

Acquisitions

WikiAnswers

On November 2, 2006, we acquired WikiAnswers and certain other assets for an aggregate of $2.0 million in cash. In connection with the allocation of the purchase price, we recorded goodwill of approximately $437 thousand and intangible assets, with estimated useful lives of three to ten years, of approximately $1,563 thousand. Since the date of the acquisition the revenues and operating expenses of WikiAnswers have been included in our results of operations.

Brainboost

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

Under the terms of the acquisition, 50% and 25% of the shares of common stock were held in escrow for 3 and 6 months after the purchase date, respectively. Release from escrow was contingent upon our continued employment of one of the principals of the general partnership that formerly owned Brainboost. The escrowed shares were deemed to be compensation for services to be performed by the principal of the seller over the six-month period ending May 31, 2006. Because the escrow criteria were met, the shares were released from escrow, as scheduled, on March 1, 2006 and June 1, 2006. As a result, we recorded a compensation expense charge of approximately $4.2 million, which represented the value of these shares, on a straight-line basis, over the requisite six-month employment commitment period.

The stock component of the consideration was subject to a registration rights agreement pursuant to which we agreed that if our registration statement was not effective with the Securities and Exchange Commission by April 1, 2006, we would pay the sellers a penalty of $100,000 per month, pro-rated daily.  Our registration statement was declared effective on June 9, 2006; consequently, we paid the sellers $227 thousand in the second quarter of 2006.

In June 2006, we completed our initial beta integration of the Brainboost technology into Answers.com as Answers from the Web. We plan to further develop the technology through enhancements to its accuracy, range and speed.

Revenue

Traffic

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

•                  Search engines: Users submit queries and algorithm search engines respond by generating a list of Web pages that are likely to offer the most relevant content. When our pages rank high in the algorithmic systems of search engines, our results are more likely to be accessed by users. According to our internal estimates, for September 2007, this source of traffic represented approximately 60% of our traffic.

•                  Google’s definition link:  We have an informal, non-contractual relationship with Google under which Google links search results related to certain definitional queries to Answers.com.  According to our internal estimates, for September 2007, this source of traffic represented approximately 15% of our traffic.

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•                  Direct users: Users visiting our Web properties directly.  According to our internal estimates, for September 2007, direct users represented approximately 25% of our traffic.

Since most of our traffic originates from search engines, we expend considerable resources improving the volume and optimizing the monetization of this traffic. The industry commonly refers to such efforts as search engine optimization, or SEO. Our Web properties have at times experienced decreases in traffic, and consequently decreases in revenue, due to search engine actions, including the recent actions by Google and Yahoo!

We continuously seek to improve the user experience of visitors to our Web properties, which we believe leads to increased pages per visit, or stickiness, and return visits, or user-retention. We seek to increase stickiness and user-retention by adding new features, enhancing user interfaces and adding new content to our Web properties.

Our Web properties receive direct traffic to their respective home pages. Answers.com also receives direct traffic through partner Web properties or through software downloads and access tools, 1-Click Answers and AnswerTips. 1-Click Answers and AnswerTips are tools that allow users to click on a word or phrase and gain access to Answers.com’s online content through a pop-up information bubble.

Monetization

Advertising Revenue. We earn most of our revenue from advertising. There are two primary categories of Internet advertising, pay-per-performance, or most commonly cost per click, or CPC, and pay-per-impression, or cost per 1,000 impressions, or CPM. In the pay-for-performance model we earn revenue based on the number of clicks associated with such ads; in the paid-for-impression model we derive revenue from the display of ads. We also work with third party ad networks that we believe optimize the average amount of revenue we earn per page view. Third party ad networks generally compensate us by paying us a portion of the revenue they earn from advertisers for our provision of promotional space on our Web properties. Additionally, in the fourth quarter of 2006, we began marketing directly to advertisers and generating direct advertising revenue. We expect direct advertising revenue to become a greater part of our overall revenue during the remainder of 2007.

We gauge the effectiveness of our monetization efforts and trends by measuring our revenue per one thousand page views, or RPM. In our Management’s Discussion and Analysis of Financial Condition and Results of Operations prior to our quarterly report on Form 10-Q for the quarterly period ended June 30, 2007, we reported RPM based on website queries, or traffic directly to one of our Answers.com topic pages. Beginning with the Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our quarterly report on Form 10-Q for the quarterly period ended June 30, 2007, we refer to RPM based on page views. Page views include traffic directly to the Answers.com home page, but exclude lookups conducted through 1-Click Answers, AnswerTips and traffic from partners who pay us for providing them our answer-based services. Page views are the more widely recognized industry standard traffic metric. Based upon our internal analysis, we estimate the number of Answers.com page views to be approximately 13% higher than the number of our previously reported Answers.com queries. This difference is primarily attributable to home page visits in the page view traffic estimates. Historical RPM in this Form 10-Q for the quarter ended September 30, 2007 have been modified to conform to the new methodology and are approximately 13% lower than amounts reported prior to our quarterly report on Form 10-Q for the quarterly period ended June 30, 2007. The following table sets forth our Answers.com average daily page views and RPM, since our launch of Answers.com:

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Our Answers.com RPM increased significantly since we launched the Web property through the end of 2006 due to the implementation of various optimization methods, including:

•                  modifying the user interface;

•                  modifying the color, background and placement of ads displayed;

•                  modifying the size of ads;

•                  changing the number of ads per page;

•                  adding or switching third party ad networks;

•                  increasing the revenue-share percentage offered by third party ad networks;

•                  modifying the types of ads introduced;

•                  modifying the content displayed; and

•                  introducing direct advertising sales.

While we plan to continue focusing on optimizing our monetization, utilizing and expanding on many of the techniques we have used in the past, we believe that the primary factor that will improve our Answers.com RPM is selling ads directly through our own sales force. Excluding expected growth in direct ad sales revenue, we anticipate that our Answers.com RPM will fluctuate around current levels. In the second half of 2006, we hired our Vice President of Advertising Sales. During the second quarter of 2007, we hired three additional salespersons. As our direct advertising sales grow and become a more significant part of our revenue, we expect to see additional growth in our Answers.com RPM.

Two of our third party ad networks, Google and Shopping.com, accounted for approximately 67% and 8%, respectively, of our total revenue during the three months ending September 30, 2007, compared to approximately 70% and 15%, respectively, of our total revenue in the same period in 2006.  Google and Shopping.com accounted for approximately 65% and 9%, respectively, of our total revenue during the nine months ending September 30, 2007, compared to approximately 67% and 15%, respectively, of our total revenue in the same period in 2006. In addition to Google and Shopping.com, we utilize the services of other third party ad networks that provide us with ads.  Although there are many companies that provide third party ad networks, the loss of Google as a third party ad network could have a material adverse impact on our financial condition, as we may not succeed in receiving terms and ad services as favorable as those provided under our Google Services Agreement (GSA), the contractual relationship pursuant to which Google serves our Web properties with advertisements. While the drop in traffic due to the July 2007 Google search engine algorithm adjustment impacted our aggregate advertising revenue, it did not impact the GSA.

Licensing Revenue. We also earn revenues from partners that pay us for providing them with our answer-based services that they then use in their own products, via co-branded Web pages. Revenue from these arrangements are based on various formulas, including a percentage of the revenues these parties earn by delivering our services to their users, fees based on the number of user queries and fixed periodic fees.

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

Costs and Expenses

Cost of Revenue

Cost of revenue consists of fees to third party providers of content, Web search service fees, ad serving fees, amortization of the cost of acquired software used in our products, data center costs including depreciation of information technology assets, contractual revenue sharing fees to various Web property operators for visitors directed to our Web properties, or traffic acquisition costs, as well as the compensation, travel and overhead costs relating to personnel who are responsible for content editing and integration, production operations and customer support. As revenue increases, we expect our cost of revenues as a percentage of revenue to decrease, however, we may experience an increase in our cost of revenues as a percentage of revenue, during the transition period in 2008 related to our anticipated shift to a co-location facility for hosting our web properties, rather than our current managed hosting facility.

Research and Development Expenses

Research and development expenses consist of compensation, travel and overhead costs of personnel conducting research and development of our products and services, and consulting costs. Our research and development team works primarily on projects to improve and enhance user interface, product functionality, disambiguation, scalability and performance. We generally expect that our research and development expenses will decline as a percentage of revenue as we grow our revenue.

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Sales and Marketing Expenses

Sales and marketing expenses consist of compensation, travel and overhead costs of sales and marketing and product management personnel, public relations, marketing and market information services, and advertising and promotional costs. We generally expect that our sales and marketing expenses will decline as a percentage of revenue as we grow our revenue.

General and Administrative Expenses

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

Stock-Based Compensation

New employees typically receive stock option awards within three months of their start date. We also grant additional stock option awards to existing employees and directors, usually once a year. As of January 1, 2006, we adopted SFAS No. 123 (revised 2004), “Share-Based Payments”, or SFAS 123R, which requires measurement of compensation cost for all stock-based awards at fair value on date of grant and recognition of compensation over the service period awards are expected to vest. Such costs are part of our compensation expense and are included in the operating expense categories in our Statement of Operations.

Other Compensation Charges

In connection with our purchase of Brainboost, we issued shares of common stock, valued at approximately $4.2 million, which were deemed to be compensation for services.  Accordingly, $4.2 million was charged to compensation expense over the six-month period ending May 31, 2006.

In connection with our pending acquisition of Lexico, we will pay the Lexico Employee Bonuses to the employees of Lexico, subject to certain terms and conditions and a pre-determined payout schedule. In the event that such terms and conditions are not met, the portion of the $10 million not paid to employees will be due to the members.  In connection with the initial allocation of the purchase price, Lexico Employee Bonuses paid to Lexico employees will be recorded as compensation expense during the contracted service period, which in most cases is one year.

Other

Interest Income (Net)

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

Other Expenses

Other expenses consists primarily of foreign currency exchange gains and losses. In the nine months ended September 30, 2006, other expenses included a payment of $227 thousand to the sellers of Brainboost as a result of our delay registering with the SEC shares we issued as consideration in the transaction.

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Income Tax Expense

Our effective tax rate differs from the statutory federal rate due to differences between income and expense recognition prescribed by income tax regulations and Generally Accepted Accounting Principles. We utilize different methods and useful lives for depreciating and amortizing property, equipment and intangible assets and different methods and timing for calculating and recording stock compensation expense. Furthermore, permanent differences arise from certain income and expense items recorded for financial reporting purposes but not recognizable for income tax purposes. In addition, our income tax expense has been adjusted for the effect of state and local taxes and foreign income from our wholly owned subsidiary. Our deferred tax assets are offset by a valuation allowance because realization depends on generating future taxable income, which, in our estimation, is not more likely than not to transpire.

Our Israeli subsidiary had income during the nine months ending September 30, 2007 and 2006, resulting from the services agreement we entered into with such Israeli subsidiary. Pursuant to this agreement, the Israeli subsidiary charges us for research and development services it provides us, plus 12.5%. However, the subsidiary is an “approved enterprise” under Israeli law, which means that income arising from the subsidiary’s approved activities is subject to zero tax under the “alternative benefit” path for a period of ten years. In the event of distributions by the subsidiary to the parent, the subsidiary would have to pay a 10% corporate tax on the amount distributed, and the recipient would have to pay a 15% tax to be withheld at source on the amounts of such distribution received.

                The following table sets forth the historical operating results as a percentage of revenue for the periods indicated:

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Three Months and Nine Months Ended September 30, 2007 and 2006

Revenue

Revenue increased $350 thousand, or 19%, to $2,208 thousand for the three months ended September 30, 2007 from $1,858 thousand for the three months ended September 30, 2006. The increase in our revenue was primarily the result of $304 thousand of advertising revenue generated through WikiAnswers.com, a website we did not own during the same period in 2006, and increases in our Answers.com advertising revenue, of $51 thousand. Average daily page views for Answers.com in the three months ended September 30, 2007 were approximately 3,730,000, compared to approximately 3,400,000 in the same period in 2006. RPM for Answers.com was $5.41 in the three months ended September 30, 2007, compared to $5.79 in the same period in 2006. In future periods we expect that WikiAnswers will comprise a larger percentage of our advertising revenue.

Revenue increased $3,881 thousand, or 86%, to $8,404 thousand for the nine months ended September 30, 2007 from $4,523 thousand for the nine months ended September 30, 2006. The majority of the increase in our revenue was due to an increase in Answers.com advertising revenue of $2,822 thousand, which was the result of increases in our Answers.com traffic and monetization rates. Average daily page views for Answers.com in the nine months ended September 30, 2007 were approximately 4,700,000 compared to approximately 3,120,000 in the same period in 2006. RPM for Answers.com was $5.59 in the nine months ended September 30, 2007, compared to $5.07 in the same period in 2006. In addition, advertising revenues in the nine months ended September 30, 2007 includes $598 thousand generated from WikiAnswers, a website we did not own during the same period in 2006.

In July 2007, a search engine algorithm adjustment by Google led to a drop in Google directed traffic to Answers.com. This adjustment reduced our overall traffic by approximately 28% based on the average traffic directed to Answers.com from Google for the week prior to the adjustment as compared to the week after. As a result, our revenue also declined proportionately. We have not been able to reverse the impact of this adjustment, and we do not anticipate that we will recover the lost traffic and revenue. In response to the Google algorithm adjustment, we reduced our headcount and related compensation costs, reducing our base payroll expenses by approximately 12%.  In September 2007, Yahoo! dropped our content from its search index. This action was reversed within a week, and we have recovered all of our Yahoo! directed traffic.

Approximately $256 thousand and $415 thousand of our advertising revenue in the three and nine months ending September 30, 2007, respectively, resulted from the efforts of our direct ad sales force. We had no direct ad sales during the three and nine months ending September 30, 2006.

Subscription revenue in the nine months ended September 30, 2007 of $425 thousand resulted from the recognition of revenue from the sale of lifetime subscriptions of our GuruNet service prior to December 2003. As of December 31, 2006, we had approximately $425 thousand of deferred revenue relating to these subscriptions.  Prior to the nine months ended September 30, 2007, we did not recognize any revenue from the lifetime subscriptions to our GuruNet service because the subscriptions had no defined term. On February 2, 2007, in accordance with our rights under the agreements we entered into with such subscribers, we terminated the GuruNet service and thereby extinguished our service obligations to our subscribers.  As a result, we recognized the entire $425 thousand previously deferred, as revenue, in the first quarter of 2007. We had no additional subscription revenue in 2007. Subscription revenue of $4 thousand and $23 thousand in the three and nine months ended September 30, 2006, respectively, related to fixed-term subscriptions we sold prior to January 2005, as we recognized the revenue from fixed term subscriptions over the lives of such subscriptions.

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Costs and Expenses

Cost of Revenue

Cost of revenue increased $335 thousand, or 40%, to $1,179 thousand for the three months ended September 30, 2007 from $844 thousand for the three months ended September 30, 2006. The increase in cost of revenue was due primarily to increases in data center costs of $164 thousand, including depreciation of information technology assets, increases in content licensing costs of $118 thousand, and increases in fees we pay to Google for web search and ad serving fees of $34 thousand. Additionally, in the three months ended September 30, 2007 we incurred $32 thousand of amortization expenses relating to intangible assets we purchased in connection with the WikiAnswers acquisition in November 2006.  We did not incur any similar expenses for the three months ended September 30, 2006. These increases were offset, to some extent by decreases in compensation costs of $61 thousand.

Cost of revenue increased $1,307 thousand, or 56%, to $3,643 thousand for the nine months ended September 30, 2007 from $2,336 thousand for the nine months ended September 30, 2006. The increase in cost of revenue was due primarily to increases in data center costs of $503 thousand, including depreciation of information technology assets, increases in content licensing costs of $369 thousand, increases in fees we pay to Google for web search and ad serving fees of $160 thousand, and increases in compensation costs of $77 thousand as a result of staffing additions in our production operations and content departments and salary increases which took effect in March 2007. Additionally, in the nine months ended September 30, 2007 we incurred $97 thousand of amortization expenses relating to intangible assets we purchased in connection with the WikiAnswers acquisition in November 2006.  We did not incur any similar expenses for the nine months ended September 30, 2006.

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Research and Development Expenses

Research and development expenses increased $148 thousand, or 24%, to $769 thousand for the three months ended September 30, 2007 from $621 thousand for the three months ended September 30, 2006. The increase in research and development expenses was due primarily to increases in compensation-related expenses of $119 thousand due to growth in our research and development team and salary increases which took effect in March 2007, and increased overhead of $27 thousand.

Research and development expenses decreased $2,970 thousand, or 57%, to $2,239 thousand for the nine months ended September 30, 2007 from $5,209 thousand for the nine months ended September 30, 2006. The decrease in research and development expenses was due primarily to compensation charges of $3.5 million for the nine months ended September 30, 2006, resulting from the acquisition of Brainboost.  We did not incur any similar charges in the same period of 2007. This decrease was partially offset by increases in compensation-related expenses of $413 thousand due to growth in our research and development team and salary increases which took effect in March 2007, and increases in overhead of $81 thousand.

Sales and Marketing Expenses

Sales and marketing expenses increased $297 thousand, or 32%, to $1,221 thousand for the three months ended September 30, 2007 from $924 thousand for the three months ended September 30, 2006. Compensation related expenses increased $230 thousand, primarily due to growth in our sales and marketing team, including the hiring of three ad sales managers during the second quarter of 2007. We also incurred a one-time severance charge of approximately $220 thousand in the three months ended September 30, 2007, as the result of the termination of employment of our Chief Revenue Officer in August 2007 as part of the reduction in headcount due to the impact on us of the Google search engine adjustment in July 2007. Additionally, expenses relating to Internet and marketing metrics software and information services increased approximately $40 thousand, and overhead rose approximately $26 thousand, in the three months ended September 30, 2007 as compared to the same period in 2006. These increases were offset, in part, by decreases in advertising and promotion expenses of approximately $116 thousand and by a decrease in marketing-related expenses due to an accrual of $75 thousand relating to a lawsuit from a former marketing employee incurred in the three months ended September 30, 2006. There was no such expense in the same period of 2007.

Sales and marketing expenses increased $1,031 thousand, or 46%, to $3,275 thousand for the nine months ended September 30, 2007 from $2,244 thousand for the nine months ended September 30, 2006. Compensation related expenses increased $843 thousand, primarily due to growth in our sales and marketing team, including the hiring of three ad sales managers during the second quarter of 2007. We also incurred a one-time severance charge of approximately $220 thousand in the nine months ended September 30, 2007, as the result of the termination of employment of our Chief Revenue Officer in August 2007 as part of the reduction in headcount due to the impact on us of the Google search engine adjustment in July 2007. Additionally, expenses relating to Internet and marketing metrics software and information services increased approximately $160 thousand, and overhead rose approximately $80 thousand, in the nine months ended September 30, 2007 as compared to the same period in 2006. Finally, in the nine months ended September 30, 2007, we incurred recruiting fees of approximately $50 thousand to fill certain ad sales position openings, fees we did not incur during the same period in 2006. These increases were offset, in part, by a decrease in advertising and promotion expenses of approximately $235 thousand and by a decrease in marketing-related expenses due to an accrual of $75 thousand relating to a lawsuit from a former marketing employee incurred in the nine months ended September 30, 2006. There was no such expense in the same period of 2007.

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General and Administrative Expenses

General and administrative expenses increased $293 thousand, or 38%, to $1,058 thousand for the three months ended September 30, 2007 from $765 thousand for the three months ended September 30, 2006. The increase in general and administration expenses was due primarily to increases in compensation costs of $189 thousand, amortization expenses of $50 thousand relating to the WikiAnswers intangible assets and accounting and legal fees of $32 thousand