LookSmart has signed a deal with Microsoft for MSN to display LookSmart search results at times. The recent agreement, which LookSmart announced yesterday, leaves it up to MSN to decide when to use the listings.

On Jan. 15, MSN officially eliminated the directory layer of its search results, after terminating its agreement with LookSmart to display its paid inclusion listings. In paid inclusion, advertisers pay to have their Web sites included in indexes, though relevancy determines ranking.

“After the end of that relationship, MSN wanted to continue using LookSmart search results as they transition to their new search solution,” said Dakota Sullivan, LookSmart’s vice president of marketing.

Sullivan said the directory listings still appear occasionally, and LookSmart did not know how long MSN would continue to use them.

“Whether that takes them a week, a month or the rest of the year, that’s up to them,” he said.

The loss of Microsoft staggered LookSmart, wiping away the source of two-thirds of its revenue. The San Francisco-based company shut its United Kingdom office and said it planned to cut its staff 50 percent. It also replaced its CEO, Jason Kellerman, with Damian Smith on an interim basis. LookSmart’s board of directors is searching for a permanent replacement.

To cushion the blow from losing Microsoft, LookSmart began a paid search service in October. The company said the new offering is doing better than expected, thanks to offering lower click rates than search providers like Google and Overture.

“Search marketing has become so popular that there’s been such an influx of major advertisers accustomed to paying network TV rates … for many advertisers who have been doing search marketing for a year or two, they can’t get an ROI from that,” Sullivan said.

Following the lead of search companies like FindWhat.com, LookSmart has focused on second- and third-tier search sites to distribute its listings. While the top four search sites handle about 75 to 80 percent of all search queries, hundreds of smaller sites account for the rest. Sullivan said LookSmart sifts these sites to find the ones that have quality traffic.

“We’re trying to bring the same sort of rigor that Overture and Google bring to this tier of traffic,” he said.

LookSmart’s distribution network has 75 sites including SearchFeed, myGeek and Brainfox. Though such sites have smaller audiences, they provide quality leads at a price lower than on Google and Overture, Sullivan said.

“There’s a need in the marketplace for the same high-quality traffic that converts at a lower cost,” he said. In a typical category, Sullivan estimates that LookSmart advertisers can pay 20 to 25 percent less for a lead than the same listing on Google or Overture.

Thanks to paid search growing 25 percent compared with a year ago as well as the fruits of its cost-cutting efforts, LookSmart raised its financial guidance for the first quarter. It now expects $21 million to $23 million in sales, up from $16 million to $18 million. Net loss, not including stock compensation, is forecast at $10 million to $12 million with $4 million to $5 million in restructuring costs. This is down from previous guidance of a $12 million to $14 million net loss and a $5 million to $6 million restructuring charge.

Sullivan said LookSmart had not seen widespread advertiser defections since the end of the MSN deal. The company no longer reports its advertiser base. In October, it said it had 32,000 advertisers.