##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION  FORM 10-QSB x QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 September 30, 2004
 o TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE EXCHANGE ACT 
 Commission File Number: 000-50989 INTERCHANGE CORPORATION  Delaware
    
    33-0849123(State or other jurisdiction of
    
    (IRS Employerincorporation or organization)
    
    Identification No.)
 24422 Avenida de la Carlota, Suite 120
Laguna Hills, CA 92653
(Address of principal executive offices) (949) 784-0800
Issuers telephone number Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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 o  No x Number of shares outstanding at November 15, 2004:
    
    
    
    Common:
    6,981,941Preferred:
    0
 Transitional Small Business Disclosure Format:     Yes   o     No   x 1




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Interchange Corporation
Table of Contents PagePART I  FINANCIAL STATEMENTSItem 1.   Financial StatementsBalance Sheets as of December 31, 2003 and September 30, 2004 (Unaudited)
    
    
    3Statements of Operations for the three and nine month ended September 30, 2004 and 2003 (Unaudited)
    
    
    4Statements of Cash Flows for the nine months ended September 30, 2004 and 2003 (Unaudited)
    
    
    5Notes to Financial Statements (Unaudited)
    
    
    6Item 2.   Managements Discussion and Analysis or Plan of Operation
    
    
    12Item 3.   Controls and Procedures
    
    
    25PART II  OTHER INFORMATIONItem 1.   Legal Proceedings
    
    
    26Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    26Item 3.   Defaults Upon Senior Securities
    
    
    26Item 4.   Submission of Matters to a Vote of Security Holders
    
    
    26Item 5.   Other Information
    
    
    27Item 6.   Exhibits
    
    
    27Signatures
    
    
    28Exhibits Filed with this Report
    
    
    29EXHIBIT 10.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1
  2




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##### Table of Contents



PART I  FINANCIAL INFORMATION 
 Item 1. Financial Statements INTERCHANGE CORPORATION 
 BALANCE SHEET
 September 30,
    
    December 31,2004
    
    2003(Unaudited)ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    1,359
    
    
    $
    699Restricted cash
    
    
    13
    
    
    
    16Accounts receivable, net of allowances of $2 and $25, respectively
    
    
    992
    
    
    
    638Prepaid finance expense, net of accumulated amortization of $652
and $209, respectively
    
    
    695
    
    
    
    448Prepaid expenses and other current assets
    
    
    49
    
    
    
    42Total current assets
    
    
    3,108
    
    
    
    1,843Property and equipment, net
    
    
    518
    
    
    
    481Long-term restricted cash
    
    
    51
    
    
    
    64Deposits
    
    
    37
    
    
    
    33Total assets
    
    $
    3,714
    
    
    $
    2,421LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT)Current liabilities:Accounts payable
    
    $
    1,802
    
    
    $
    1,152Accrued compensation
    
    
    288
    
    
    
    469Payroll taxes payable
    
    
    1,866
    
    
    
    2,071Other accrued liabilities
    
    
    837
    
    
    
    605Deferred revenue
    
    
    524
    
    
    
    391Notes payable
    
    
    10
    
    
    
    Convertible secured promissory notes
    
    
    1,300
    
    
    
    1,300Convertible secured debentures, net of debt discount of $2
and $53, respectively
    
    
    2,380
    
    
    
    2,329Total current liabilities
    
    
    9,007
    
    
    
    8,317Long-term notes payable
    
    
    7
    
    
    
    Total liabilities
    
    
    9,014
    
    
    
    8,317Commitments, contingencies and subsequent eventsStockholders equity (deficit):Convertible preferred stock, $0.00001 par value;
10,000,000 shares authorized; 1,008,125 shares issued and
outstanding; liquidation preference of $5,234,754
    
    
    
    
    
    
    Common stock, $0.00001 par value; 30,000,000 shares authorized;
1,922,964 issued and outstanding
    
    
    
    
    
    
    Additional paid-in capital
    
    
    7,095
    
    
    
    6,884Accumulated deficit
    
    
    (12,395
    )
    
    
    (12,780
    )Total stockholders deficit
    
    
    (5,300
    )
    
    
    (5,896
    )Total liabilities and stockholders deficit
    
    $
    3,714
    
    
    $
    2,421
 See accompanying notes to the financial statements. 3




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INTERCHANGE CORPORATION 
 STATEMENTS OF OPERATIONS
 Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Revenue
    
    $
    5,375
    
    
    $
    2,150
    
    
    $
    13,101
    
    
    $
    6,004Operating expenses:Search serving
    
    
    2,803
    
    
    
    939
    
    
    
    6,627
    
    
    
    2,703Sales and marketing
    
    
    1,058
    
    
    
    456
    
    
    
    2,649
    
    
    
    1,277General and administrative
    
    
    601
    
    
    
    284
    
    
    
    1,713
    
    
    
    1,031Research and development
    
    
    374
    
    
    
    162
    
    
    
    843
    
    
    
    537Non-cash equity based expense
    
    
    2
    
    
    
    91
    
    
    
    11
    
    
    
    212Total operating expenses
    
    
    4,838
    
    
    
    1,932
    
    
    
    11,843
    
    
    
    5,760Operating income
    
    
    537
    
    
    
    218
    
    
    
    1,258
    
    
    
    244Interest and other income (expense)
    
    
    (239
    )
    
    
    (124
    )
    
    
    (843
    )
    
    
    (296
    )Income (loss) before income taxes
    
    
    298
    
    
    
    94
    
    
    
    415
    
    
    
    (52
    )Provision for income taxes
    
    
    10
    
    
    
    1
    
    
    
    29
    
    
    
    2Net income (loss)
    
    $
    288
    
    
    $
    93
    
    
    $
    386
    
    
    $
    (54
    )Per share data:Basic net income (loss) per share
    
    $
    0.15
    
    
    $
    0.05
    
    
    $
    0.20
    
    
    $
    (0.03
    )Diluted net income (loss) per share
    
    $
    0.06
    
    
    $
    0.03
    
    
    $
    0.09
    
    
    $
    (0.03
    )Basic weighted average shares outstanding
    
    
    1,922,964
    
    
    
    1,822,963
    
    
    
    1,922,599
    
    
    
    1,809,923Diluted weighted average shares
outstanding
    
    
    4,444,170
    
    
    
    2,969,166
    
    
    
    4,443,805
    
    
    
    1,809,923
 See accompanying notes to the financial statements. 4




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INTERCHANGE CORPORATION 
 STATEMENTS OF CASH FLOWS
 Nine months endedSeptember 30,2004
    
    2003Cash flows from operating activities:Net income (loss)
    
    $
    386
    
    
    $
    (54
    )Adjustments to reconcile net income (loss) to cash provided by
(used in) operating activities:Depreciation and amortization
    
    
    156
    
    
    
    71Provision for doubtful accounts
    
    
    7
    
    
    
    10Non-cash equity based expense related to stock option and
warrant issuances
    
    
    11
    
    
    
    212Non-cash interest expense
    
    
    73
    
    
    
    Changes in operating assets and liabilities:Accounts receivable
    
    
    (361
    )
    
    
    (299
    )Prepaid expenses and other
    
    
    (259
    )
    
    
    (393
    )Other non-current assets
    
    
    (4
    )
    
    
    Accounts payable and accrued liabilities
    
    
    695
    
    
    
    (507
    )Deferred revenue
    
    
    133
    
    
    
    (197
    )Net cash provided by (used in) operating activities
    
    
    837
    
    
    
    (1,157
    )Cash flows from investing activities:Capital expenditures
    
    
    (173
    )
    
    
    (96
    )Decrease in restricted cash
    
    
    16
    
    
    
    20Net cash used in investing activities
    
    
    (157
    )
    
    
    (76
    )Cash flows from financing activities:Proceeds from issuance of common stock from exercise of options
    
    
    
    
    
    
    2Proceeds from sale of convertible secured debentures
    
    
    
    
    
    
    1,830Proceeds from sale of convertible secured promissory notes
    
    
    
    
    
    
    370Proceeds from notes payable
    
    
    
    
    
    
    9Payment of notes payable
    
    
    (20
    )
    
    
    (59
    )Net cash (used in) provided by financing activities
    
    
    (20
    )
    
    
    2,152Net increase in cash and cash equivalents
    
    
    660
    
    
    
    919Cash and cash equivalents, beginning of period
    
    
    699
    
    
    
    100Cash and cash equivalents, end of period
    
    $
    1,359
    
    
    $
    1,019Supplemental cash flow information:Interest paid
    
    $
    100
    
    
    $
    49Income taxes paid
    
    $
    12
    
    
    $
    2Non-cash investing and financing transactions:Common stock issued in satisfaction of liabilities
    
    $
    200
    
    
    $
    105Insurance financing
    
    $
    17
    
    
    $
    21Capital lease
    
    $
    20
 See accompanying notes to the financial statements. 5




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INTERCHANGE CORPORATION 
 NOTES TO FINANCIAL STATEMENTS
 1. Basis of presentation The unaudited interim financial statements as of September 30, 2004 and for the
three and nine months ended September 30, 2004 and 2003, included herein, have
been prepared by the Company, without audit, pursuant to rules and regulations
of the Securities and Exchange Commission, and, in the opinion of management,
reflect all adjustments (consisting of only normal recurring adjustments) which
are necessary for a fair presentation. The results of operations for the three
and nine months ended September 30, 2004 are not necessarily indicative of the
results for the full year. The accompanying financial statements should be read
in conjunction with the financial statements and notes thereto for the year
ended December 31, 2003 included in the Companys final prospectus dated
October 20, 2004 for its initial public offering filed with the Securities and
Exchange Commission. 2. Significant accounting policies The Companys significant accounting policies are disclosed in the Companys
final prospectus dated October 20, 2004 for its initial public offering filed
with the Securities and Exchange Commission. The Companys significant
accounting policies have not materially changed during the three months ended
September 30, 2004. Stock-based compensation The Company accounts for stock-based employee compensation under the
recognition and measurement principles of Accounting Principles Board Opinion
(APB) No. 25, Accounting for Stock Issued to Employees(APB No. 25). Statement
of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based
Compensation(SFAS No. 123), established accounting and disclosure requirements
using a fair value based method of accounting for stock-based employee
compensation plans. As allowed by SFAS No. 123, the Company has elected to
continue to apply the intrinsic value based method of accounting described
above, and has adopted the disclosure requirements of SFAS No. 123 and related
SFAS No. 148, Accounting for Stock-Based Compensation  Transition and
Disclosure. The following table illustrates the effect on net income (loss) and
earnings (loss) per share if the Company had applied the fair value recognition
provisions of SFAS No. 123 to stock-based compensation (in thousands, except
per share amounts): Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net income (loss), as reported
    
    $
    288
    
    
    $
    93
    
    
    $
    386
    
    
    $
    (54
    )Add: Stock-based compensation expense
recorded in accordance with APB No. 25
    
    
    2
    
    
    
    
    
    
    
    11
    
    
    
    Deduct: Additional stock-based employee
compensation expense determined under
fair value based method for all
award, net
of tax effects
    
    
    (101
    )
    
    
    (115
    )
    
    
    (330
    )
    
    
    (336
    )Pro forma net income (loss)
    
    $
    189
    
    
    $
    (22
    )
    
    $
    67
    
    
    $
    (390
    )Net income (loss) per share:Basic  as reported
    
    $
    0.15
    
    
    $
    0.05
    
    
    $
    0.20
    
    
    $
    (0.03
    )Basic  pro forma
    
    $
    0.10
    
    
    $
    (0.01
    )
    
    $
    0.03
    
    
    $
    (0.22
    )Net income (loss) per share:Diluted  as reported
    
    $
    0.06
    
    
    $
    0.03
    
    
    $
    0.09
    
    
    $
    (0.03
    )Diluted  pro forma
    
    $
    0.04
    
    
    $
    (0.01
    )
    
    $
    0.02
    
    
    $
    (0.22
    )
 6




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The fair value of these options were estimated at the date of grant using a
Black-Scholes option pricing model with the following assumptions: Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Risk-free interest rate
    
    
    4.80
    %
    
    
    5.07
    %
    
    
    4.80
    %
    
    
    5.07
    %Expected lives (in years)
    
    
    10
    
    
    
    10
    
    
    
    10
    
    
    
    10Expected dividend yield
    
    None
    
    None
    
    None
    
    NoneExpected volatility
    
    
    25
    %
    
    
    25
    %
    
    
    25
    %
    
    
    25
    %
 Net income (loss) per share SFAS No. 128, Earnings per Share, establishes standards for computing and
presenting earnings per share. Basic earnings (loss) per share is calculated
using the weighted average shares of common stock outstanding during the
periods. Diluted earnings (loss) per share is calculated using the weighted
average number of common and potentially dilutive common shares outstanding
during the period, using the as-if converted method for convertible preferred
stock, convertible secured debentures and convertible secured promissory notes,
and the treasury stock method for options and warrants. For the three and nine months ended September 30, 2004, potentially dilutive
securities, which consist of warrants to purchase 38,375 shares of common stock
at prices ranging from $8.00 to $20.00 per share, convertible secured
promissory notes including accrued interest that could convert into 734,096
shares of common stock and convertible debentures that could convert into
711,044 shares of common stock were not included in the computation of diluted
net income per share because such inclusion would be antidilutive. For the three months ended September 30, 2003, potentially dilutive securities,
which consist of options to purchase 812,822 shares of common stock at prices
ranging from $2.00 to $4.00 per share, warrants to purchase 1,778,902 shares of
common stock at prices ranging from $2.00 to $20.00 per share, convertible
secured promissory notes including accrued interest that could convert into
733,962 shares of common stock and convertible debentures that could convert
into 546,119 shares of common stock were not included in the computation of
diluted net income per share because such inclusion would be antidilutive. For the nine months ended September 30, 2003, potentially dilutive securities,
which consist of options to purchase 897,322 shares of common stock at prices
ranging from $0.40 to $4.00 per share, warrants to purchase 1,778,902 shares of
common stock at prices ranging from $2.00 to $20.00 per share, convertible
secured promissory notes including accrued interest that could convert into
733,962 shares of common stock, convertible debentures that could convert into
546,119 shares of common stock and convertible preferred stock that could
convert into 1,079,403 shares of common stock were not included in the
computation of diluted net income per share because such inclusion would be
antidilutive. 7




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The following table sets forth the computation of basic and diluted net income
(loss) per share for the periods indicated (in thousands, except per share
amounts): Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Numerator:Net income (loss)
    
    $
    288
    
    
    $
    93
    
    
    $
    386
    
    
    $
    (54
    )Denominator:Denominator for basic calculation weighted
average shares
    
    
    1,923
    
    
    
    1,823
    
    
    
    1,923
    
    
    
    1,810Dilutive common stock equivalents:Options
    
    
    649
    
    
    
    67
    
    
    
    649
    
    
    
    Warrants
    
    
    702
    
    
    
    
    
    
    
    702
    
    
    
    Convertible preferred stock
    
    
    1,170
    
    
    
    1,079
    
    
    
    1,170
    
    
    
    Denominator for diluted calculation weighted
average shares
    
    
    4,444
    
    
    
    2,969
    
    
    
    4,444
    
    
    
    1,810Net income (loss) per share:Basic net income (loss) per share
    
    $
    0.15
    
    
    $
    0.05
    
    
    $
    0.20
    
    
    $
    (0.03
    )Diluted net income (loss) per share
    
    $
    0.06
    
    
    $
    0.03
    
    
    $
    0.09
    
    
    $
    (0.03
    )
 3. Composition of certain balance sheet and statement of operations captions Prepaid financing expense consists of placement fees, legal and accounting
fees, printing costs and other financing related expenses. Prepaid financing
expense at December 31, 2003, consisted of $448,000 of expenses related to the
issuance of the convertible secured debentures, which are being amortized over
the life of the debentures. The remaining balance as of September 30, 2004 was
$6,000. In addition, as of September 30, 2004 prepaid financing expense also
included $689,000 of expenses related to the initial public offering. Property and equipment consisted of the following (in thousands): September 30,
    
    December 31,2004
    
    2003Furniture and fixtures
    
    $
    193
    
    
    $
    193Office equipment
    
    
    69
    
    
    
    64Computer equipment
    
    
    931
    
    
    
    753Computer software
    
    
    187
    
    
    
    177Idle assets (not depreciated)
    
    
    9
    
    
    
    91,389
    
    
    
    1,196Less accumulated depreciation and amortization
    
    
    (871
    )
    
    
    (715
    )Property and equipment, net
    
    $
    518
    
    
    $
    481
 8




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Amounts recorded as non-cash equity based expense represent the fair value
expense, utilizing the Black-Scholes model at the date of grant, of warrants,
and options issued to non-employees of the Company for services and relate to
the following statement of operations categories (in thousands): Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003General and administrative:Non-cash warrant expense
    
    $
    
    
    
    $
    91
    
    
    $
    
    
    
    $
    212Non-cash option expense
    
    
    2
    
    
    
    
    
    
    
    11
    
    
    
    $
    2
    
    
    $
    91
    
    
    $
    11
    
    
    $
    212
 4. Convertible secured debentures Between August 2003 and November 2003, the Company entered into a convertible
debenture and warrant purchase agreement with various investors. Pursuant to
this agreement, the investors purchased an aggregate of $2,382,000 in 8%
convertible debentures and warrants. The convertible debentures are secured by
the Companys assets and are subordinated to the convertible notes payable. The
purchase of the convertible debentures and the warrants took place in seven
tranches. The tranches closed on August 27, 2003, September 5, 2003, September
16, 2003, September 30, 2003, October 15, 2003, October 20, 2003 and November
20, 2003. The convertible debentures are due on the earlier of (i) the first
anniversary from the date of issuance, or (ii) fifteen days following the
Companys consummation of any equity and/or debt financing with aggregate gross
proceeds of at least $10,000,000. Each convertible debentures holder will have
the right, at any time, to convert their debenture into shares of the Companys
common stock at an initial conversion ratio of one share of common stock for
each $3.35 of principal amount of debenture. During August 2004, the Company entered into Extension Agreements with holders
of the Companys convertible secured debentures with maturity dates of August
27, 2004, September 5, 2004, September 16, 2004 and September 30, 2004. These
agreements extended the maturity date of the convertible secured debentures to
the earlier of (i) December 31, 2004, or (ii) 15 days following the completion
of a financing with net proceeds to the Company of at least $10 million. As of
September 30, 2004, the outstanding balance of convertible debentures was
$2,382,000 (See Note 6). 5. Stock option plans 1999 Plan In March 1999, the Company adopted the 1999 Incentive Equity Plan (1999 Plan).
The 1999 Plan provides for the grant of non-qualified and incentive stock
options to employees, directors and consultants of options to purchase share of
the Companys stock. Options are granted at exercise prices equal to the fair
market value of the common stock on the date of grant. Generally, twenty-five
percent of the options are available for exercise at the end of nine months,
while the remainder of the grant is exercisable ratably over the next
twenty-seven month period, provided the optionee remains in service to the
Company. The Company has reserved 500,000 shares for issuance under the 1999
Plan, of which 492,210 were outstanding and 3,415 were available for future
grant at September 30, 2004. 2000 Plan In March 2000, the Company adopted the 2000 Incentive Equity Plan (2000 Plan).
The 2000 Plan provides for the grant of non-qualified and incentive stock
options to employees, directors and consultants of options to purchase share of
the Companys stock. Options are granted at exercise prices equal to the fair
market value of the common stock on the date of grant. Generally, twenty-five
percent of the options are available for exercise at the end of nine months,
while the remainder of the grant is exercisable ratably over the next
twenty-seven month period, provided the optionee remains in service to the
Company. The Company has reserved 500,000 shares for issuance under the 2000
Plan, of which 491,612 were outstanding and 8,388 were available for future
grant at September 30, 2004. 9




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##### Table of Contents



2004 Plan In January 2004, the Company adopted the 2004 Incentive Equity Plan (2004
Plan), in August 2004, the Company amended the 2004 Plan and in September 2004,
the stockholders of the Company approved the 2004 Plan, as amended. The 2004
Plan provides for the grant of non-qualified and incentive stock options to
employees, directors and consultants of options to purchase share of the
Companys stock. Options are granted at exercise prices equal to the fair
market value of the common stock on the date of grant. Generally, twenty-five
percent of the options are available for exercise at the end of nine months,
while the remainder of the grant is exercisable ratably over the next
twenty-seven month period, provided the optionee remains in service to the
Company. The Company has reserved 600,000 shares for issuance under the 2004
Plan, of which 269,125 were outstanding and 330,875 were available for future
grant at September 30, 2004. Stock option activity under the plans during the nine months ended September
30, 2004 is as follows: Weight AverageShares
    
    Exercise PriceOutstanding at December 31, 2003
    
    
    897,322
    
    
    $
    3.06Granted
    
    
    355,625
    
    
    $
    2.47Outstanding at September 30, 2004
    
    
    1,252,947
    
    
    $
    2.90Exercisable at September 30, 2004
    
    
    811,903
    
    
    $
    3.18
 Stock option summary information for the plans at September 30, 2004 is as
follows: Options Outstanding
    
    Options ExercisableWeightedAverage
    
    Weighted
    
    
    
    
    
    WeightedRemaining
    
    Average
    
    
    
    
    
    AverageContractual
    
    Exercise
    
    
    
    
    
    ExerciseRange of Exercise Prices
    
    Shares
    
    Life
    
    Price
    
    Shares
    
    Price$0.40 - $1.00
    
    
    84,500
    
    
    
    5.2
    
    
    $
    0.40
    
    
    
    84,500
    
    
    $
    0.40$1.01 - $2.00
    
    
    262,500
    
    
    
    8.3
    
    
    $
    2.00
    
    
    
    144,097
    
    
    $
    2.00$2.01 - $3.00
    
    
    340,750
    
    
    
    9.3
    
    
    $
    2.25
    
    
    
    40,623
    
    
    $
    2.25$3.01 - $4.00
    
    
    544,072
    
    
    
    6.7
    
    
    $
    4.00
    
    
    
    542,683
    
    
    $
    4.00$4.01 - $6.00
    
    
    21,125
    
    
    
    9.8
    
    
    $
    6.00
    
    
    
    
    
    
    $
    1,252,947
    
    
    
    7.7
    
    
    $
    2.90
    
    
    
    811,903
    
    
    $
    3.18
 6. Subsequent events Initial Public Offering (IPO) The Securities and Exchange Commission declared the Companys registration
statement on Form SB-2 (Registration No. 333-116965) under the Securities Act
of 1933 effective on October 18, 2004. Under this registration statement, in an
initial public offering, the Company registered 3,157,500 shares of its common
stock, including 407,500 shares subject to the underwriters over-allotment
option, with an aggregate public offering price of $25,260,000. On October 22, 2004, the Company completed its IPO in which it sold 2,750,000
shares of its common stock that resulted in gross proceeds of $22,000,000, of
which the Company paid approximately $1,540,000 in underwriting discounts and
commissions, $440,000 as a non-accountable expense allowance to the
underwriters and approximately $1,010,000 in related IPO costs. As a result,
the approximate net cash proceeds from the offering were $19,010,000. In
connection with the IPO, the underwriters were issued warrants to purchase
315,750 shares of the Companys common stock at an exercise price of $10.00 per
share that expire on October 22, 2009. The fair value of these warrants, using
the Black-Scholes model at the date of grant, was $499,333 and was recorded as
an IPO cost. The assumptions used in 10




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##### Table of Contents



the Black-Scholes model were as follows: no dividend yield; 3.31% interest
rate; five years contractual life; and volatility of 25%. Upon the completion of the IPO on October 22, 2004, the Company issued an
aggregate of 1,169,722 shares of its common stock upon the automatic conversion
of its outstanding preferred stock. The preferred stock converted as follows:
497,750 shares of Companys convertible preferred Series A stock automatically
converted into 598,866 shares of the Companys common stock; 68,188 shares of
the Companys convertible preferred Series B stock automatically converted into
102,734 shares of the Companys common stock; 284,188 shares of the Companys
convertible preferred Series C stock automatically converted into 292,711
shares of the Companys common stock; 123,999 shares of the Companys
convertible preferred Series D stock automatically converted into 136,604
shares of the Companys common stock; and 34,000 shares of the Companys
convertible preferred Series E stock automatically converted into 38,807 shares
of the Companys common stock. Subsequent to the IPO, there are no shares of
convertible preferred stock issued or outstanding. On November 1, 2004, the underwriters exercised their over-allotment option. As
a result, the Company sold an additional 407,500 shares of common stock
resulting in gross proceeds of $3,260,000, of which the Company paid
approximately $228,200 in underwriting discounts and commissions and $65,200 as
a non-accountable expense allowance to the underwriters. As a result, the
approximate net cash proceeds were $2,966,600. Convertible Secured Debentures Conversion During October 2004, the Company entered into Extension Agreements with holders
of the Companys convertible secured debentures with maturity dates of October
15, 2004 and October 20, 2004. These agreements extended the maturity date of
the convertible secured debentures to the earlier of (i) December 31, 2004, or
(ii) 15 days following the completion of a financing with net proceeds to the
Company of at least $10 million. As a result of the completion of the IPO on October 22, 2004, the principal
amount and any unpaid accrued interest of the Companys outstanding convertible
secured debentures became due on November 6, 2004. The holders of the
convertible secured debentures had a right to convert all or any portion of the
outstanding principal amount into shares of the Companys common stock at a
conversion price equal to $3.35 per share prior to November 6, 2004. Holders of
the convertible secured debentures converted $2,360,172 of principal amount
into 704,529 shares of the Companys common stock. The remaining principal
amount of $21,828 plus accrued interest of $211,597 was paid in November 2004
and no convertible secured debentures remain outstanding. Convertible Secured Promissory Notes During October 2004, the Company repaid the full outstanding principal amount
of the Companys convertible secured promissory notes of $1,300,000 and the
accrued interest of $176,058 to Frastacky Associates, Inc., a stockholder of
the Company. 11




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##### Table of Contents



Item 2. Managements Discussion and Analysis or Plan of Operation This Quarterly Report on Form 10-QSB contains forward-looking statements that
involve risks, uncertainties and assumptions. Our actual results could differ
materially from those anticipated in the forward-looking statements as a result
of certain factors discussed in Risk Factors and elsewhere in this Report. The following discussion and analysis of financial condition and results of
operations should be read in conjunction with the attached financial statements
and related notes thereto, and with the audited financial statements and
related notes thereto as of December 31, 2003 and for the year ended December
31, 2003 included in our final prospectus dated October 20, 2004 and filed with
the Securities and Exchange Commission. Overview We provide paid-search services that enable businesses to reach consumers
through targeted online advertising. Our services enable businesses to
advertise their products and services by listing them in our distributed
Internet search results. We supply these sponsored listings to our Distribution
Network in response to targeted keyword searches performed by Internet users.
Sponsored listings are generally compiled according to the advertisers bid
price for a click-through in connection with a specific keyword search. Results of Operations The following table sets forth our historical operating results as a percentage
of revenue for the periods indicated and is derived from our unaudited
financial statements, which, in the opinion of our management, reflect all
adjustments that are of normal recurring nature, necessary to present such
information fairly: Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Revenue
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Operating expenses:Search serving
    
    
    52.1
    
    
    
    43.7
    
    
    
    50.6
    
    
    
    45.0Sales and marketing
    
    
    19.7
    
    
    
    21.3
    
    
    
    20.3
    
    
    
    21.3General and administrative
    
    
    11.2
    
    
    
    13.2
    
    
    
    13.1
    
    
    
    17.2Research and development
    
    
    7.0
    
    
    
    7.5
    
    
    
    6.4
    
    
    
    8.9Non-cash equity based expense
    
    
    0.0
    
    
    
    4.2
    
    
    
    0.0
    
    
    
    3.5Total operating expenses
    
    
    90.0
    
    
    
    89.9
    
    
    
    90.4
    
    
    
    95.9Operating income
    
    
    10.0
    
    
    
    10.1
    
    
    
    9.6
    
    
    
    4.1Interest and other income (expense)
    
    
    (4.4
    )
    
    
    (5.8
    )
    
    
    (6.4
    )
    
    
    (5.0
    )Income (loss) before income taxes
    
    
    5.6
    
    
    
    4.3
    
    
    
    3.2
    
    
    
    (0.9
    )Provision for income taxes
    
    
    0.2
    
    
    
    0.0
    
    
    
    0.3
    
    
    
    0.0Net income (loss)
    
    
    5.4
    %
    
    
    4.3
    %
    
    
    2.9
    %
    
    
    (0.9
    )%
 Three months ended September 30, 2004 and 2003 Revenue Revenue was $5.4 million and $2.2 million for the three months ended September
30, 2004 and 2003, respectively, representing an increase of $3.2 million or
150.0%. The increase was primarily due to an increased number of
revenue-generating click-throughs, substantially all of which resulted from an
increase in the number of our Distribution Network partners from 126 at
September 30, 2003 to 256 at September 30, 2004. Click-through revenue from our
largest Distribution Network partner, Okomura Digital Media IBX, represented
20.3% of our revenue for the three months ended September 30, 2003 and no
Distribution Network partner represented greater than 10% of our revenue for
the three months ended September 30, 2004. 12




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We derived 40.0% of our revenue from direct advertisers and 60.0% of our
revenue from our Advertiser Network partners during the three months ended
September 30, 2004, as compared to 48.1% of our revenue from direct advertisers
and 51.9% from Advertiser Network partners during the three months ended
September 30, 2003. Our Advertiser Network partner, LookSmart, represented
32.9% and 32.6% of our revenue for the three months ended September 2004 and
2003, respectively. This increase in revenue resulted primarily from an
increase in search requests resulting in an increase in click-throughs from our
Advertising Network partner, LookSmart. Search Serving Search serving expenses were $2.8 million and $939,000 for the three months
ended September 30, 2004 and 2003, respectively, representing an increase of
$1.9 million or 198.5%. As a percentage of revenue, search serving expenses
were 52.1% and 43.7% for the three months ended September 30, 2004 and 2003,
respectively. Substantially all of this increase represented increased payments
to our Distribution Network partners associated with our higher revenue in the
current period. The increase in percentage of revenue was due to increased
revenue sharing arrangements with our distribution network partners. We expect
search serving expense to continue at the same percentage of revenue. Sales and Marketing Sales and marketing expenses were $1.0 million and $456,000 for the three
months ended September 30, 2004 and 2003, respectively, representing an
increase of $602,000 or 132.0%. As a percentage of revenue, sales and
marketing expenses were 19.7% and 21.3% for the three months ended September
30, 2004 and 2003, respectively. The increase in absolute dollars was primarily
due to an increase in sales commissions associated with higher direct
advertiser deposits and higher revenue, and to a lesser extent, an increase in
the number of sales and marketing personnel. General and Administrative General and administrative expenses were $601,000 and $284,000 for the three
months ended September 30, 2004 and 2003, respectively, representing an
increase of $317,000 or 111.6%. As a percentage of revenue, general and
administrative expenses were 11.2% and 13.2% for the three months ended
September 30, 2004 and 2003, respectively. The increase in absolute dollars was
primarily due to an increase in consulting, legal and accounting fees. Research and Development Research and development expenses were $374,000 and $162,000 for the three
months ended September 30, 2004 and 2003, respectively, representing an
increase of $212,000 or 130.9%. As a percentage of revenue, research and
development expenses were 7.0% and 7.5% for the three months ended September
30, 2004 and 2003, respectively. The increase in absolute dollars was primarily
due to an increase in salaries and related personnel costs as a result of an
increase in research and development headcount. Non-Cash Equity Based Expense Non-cash equity based expense was $2,000 and $91,000 for the three months ended
September 30, 2004 and 2003, respectively, representing a decrease of $89,000
or 97.8%. As a percentage of revenue, non-cash equity based expense was less
than 0.1% and 4.2% for the three months ended September 30, 2004 and 2003,
respectively. The decrease in absolute dollars was a result of fewer warrants
issued to non-employees. Interest and Other Income (Expense) Interest and other income (expense) was $(239,000) and $(124,000) for the three
months ended September 30, 2004 and 2003, respectively, representing an
increase in net interest expense of $115,000 or 92.7%. This increase was
primarily due to interest expense relating to the convertible secured
debentures issued during 2003. Net Income (Loss) We had a net income of $288,000 and $93,000 for the three months ended
September 30, 2004 and 2003, respectively. 13




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Nine months ended September 30, 2004 and 2003 Revenue Revenue was $13.1 million and $6.0 million for the nine months ended September
30, 2004 and 2003, respectively, representing an increase of $7.1 million or
118.2%. The increase was primarily due to an increased number of
revenue-generating click-throughs, substantially all of which resulted from an
increase in the number of our Distribution Network partners from 126 at
September 30, 2003 to 256 at September 30, 2004. Click-through revenue from our
largest Distribution Network partner, Okomura Digital Media IBX, represented
10.8% and 14.7% of our revenue for the nine months ended September 30, 2004 and
2003, respectively. We derived 54.0% of our revenue from direct advertisers and 46.0% of our
revenue from our Advertiser Network partners during the nine months ended
September 30, 2004, as compared to 48.4% of our revenue from direct advertisers
and 51.6% from Advertiser Network partners during the nine months ended
September 30, 2003. Our Advertiser Network partner, LookSmart, represented
36.3% and 34.4% of our revenue for the nine months ended September 2004 and
2003, respectively. This increase in revenue resulted primarily from an
increase in search requests resulting in an increase in click-throughs from our
Advertising Network partner, LookSmart. Search Serving Search serving expenses were $6.6 million and $2.7 million for the nine months
ended September 30, 2004 and 2003, respectively, representing an increase of
$3.9 million or 145.2%. As a percentage of revenue, search serving expenses
were 50.6% and 45.0% for the nine months ended September 30, 2004 and 2003,
respectively. Substantially all of this increase represented increased payments
to our Distribution Network partners associated with our higher revenue in the
current period. The increase in percentage of revenue was due to increased
revenue sharing arrangements with our distribution network partners. We expect
search serving expense to continue at the same percentage of revenue. Sales and Marketing Sales and marketing expenses were $2.6 million and $1.3 million for the nine
months ended September 30, 2004 and 2003, respectively, representing an
increase of $1.3 million or 107.4%. As a percentage of revenue, sales and
marketing expenses were 20.3% and 21.3% for the nine months ended September 30,
2004 and 2003, respectively. The increase in absolute dollars was primarily due
to an increase in sales commissions associated with higher direct advertiser
deposits and higher revenue, and to a lesser extent, an increase in the number
of sales and marketing personnel. General and Administrative General and administrative expenses were $1.7 million and $1.0 million for the
nine months ended September 30, 2004 and 2003, respectively, representing an
increase of $682,000 or 66.1%. As a percentage of revenue, general and
administrative expenses were 13.1% and 17.2% for the nine months ended
September 30, 2004 and 2003, respectively. The increase in absolute dollars was
primarily due to an increase in consulting, legal and accounting fees. Research and Development Research and development expenses were $843,000 and $537,000 for the nine
months ended September 30, 2004 and 2003, respectively, representing an
increase of $306,000 or 57.0%. As a percentage of revenue, research and
development expenses were 6.4% and 8.9% for the nine months ended September 30,
2004 and 2003, respectively. The increase in absolute dollars was primarily due
to an increase in salaries and related personnel costs as a result of an
increase in research and development headcount. Non-Cash Equity Based Expense Non-cash equity based expense was $11,000 and $212,000 for the nine months
ended September 30, 2004 and 2003, respectively, representing a decrease of
$201,000 or 94.8%. As a percentage of revenue, non-cash equity based expense
was less than 0.1% and 3.5% for the nine months ended September 30, 2004 and
2003, respectively. The decrease in absolute dollars was a result of fewer
warrants issued to non-employees. 14




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##### Table of Contents



Interest and Other Income (Expense) Interest and other income (expense) was $(843,000) and $(296,000) for the nine
months ended September 30, 2004 and 2003, respectively, representing an
increase in net interest expense of $547,000 or 184.8%. This increase was
primarily due to interest expense relating to the convertible secured
debentures issued during 2003. Net Income (Loss) We had a net income of $386,000 for the nine months ended September 30, 2004
and a net loss of $54,000 for the nine months ended September 30, 2003. Liquidity and Capital Resources We have funded our business, to date, primarily from issuances of equity and
debt securities. Cash and cash equivalents were $1.4 million as of September
30, 2004 and $699,000 as of December 31, 2003. We had negative working capital
of $5.9 million as of September 30, 2004 and $6.5 million as of December 31,
2003. As a result of our Initial Public Offering, we anticipate having positive
working capital going forward. Net cash provided by (used in) operations was $837,000 and $(1.1 million) for
the nine months ended September 30, 2004 and 2003, respectively. The increase
in cash provided by operations was due to an increase in net income, an
increase in accounts payable and accrued liabilities and an increase in
deferred revenue. Net cash used in investing activities was $157,000 and $76,000 for the nine
months ended September 30, 2004 and 2003, respectively. The increase in cash
used in investing activities was due an increase in capital expenditures,
mostly computer equipment. We intend to continue to grow our business and we
expect our capital expenditures to increase. Net cash provided by (used in) financing activities was $(20,000) and $2.2
million for the nine months ended September 30, 2004 and 2003, respectively.
During the nine months ended September 30, 2003, we raised gross proceeds of
$1.8 million from the sale of convertible secured debentures, $370,000 from the
sale of convertible secured promissory notes and $2,000 from the exercise of
stock options. Initial Public Offering (IPO) The Securities and Exchange Commission declared our registration statement on
Form SB-2 (Registration No. 333-116965) under the Securities Act of 1933
effective on October 18, 2004. Under this registration statement, in an initial
public offering, we registered 3,157,500 shares of our common stock, including
407,500 shares subject to the underwriters over-allotment option, with an
aggregate public offering price of $25,260,000. On October 22, 2004, we completed our IPO in which we sold 2,750,000 shares of
our common stock that resulted in gross proceeds of $22,000,000, of which we
paid approximately $1,540,000 to underwriting discounts and commissions,
$440,000 as a non-accountable expense allowance to the underwriters and
approximately $1,010,000 in related IPO costs. As a result, the approximate net
cash proceeds from the offering were $19,010,000. In connection with the IPO,
the underwriters were issued warrants to purchase 315,750 shares of our common
stock at an exercise price of $10.00 per share that expire on October 22, 2009.
The fair value of these warrants, using the Black-Scholes model at the date of
grant, was $499,333 and was recorded as an IPO cost. The assumptions used in
the Black-Scholes model were as follows: no dividend yield; 3.31% interest
rate; five years contractual life; and volatility of 25%. Upon the completion of our IPO on October 22, 2004, we issued an aggregate of
1,169,722 shares of our common stock upon the automatic conversion of our
outstanding preferred stock. The preferred stock converted as follows: 497,750
shares of our convertible preferred Series A stock automatically converted into
598,866 shares of our common stock; 68,188 shares of our convertible preferred
Series B stock automatically converted into 102,734 shares of our common stock;
284,188 shares of our convertible preferred Series C stock automatically
converted into 292,711 shares of our common stock; 123,999 shares of our
convertible preferred Series D stock automatically converted into 136,604
shares of our common stock; and 34,000 shares of our convertible preferred
Series E stock automatically converted into 38,807 shares of our common stock.
Subsequent to the IPO, there are no shares of convertible preferred stock
issued or outstanding. 15




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##### Table of Contents



On November 1, 2004, the underwriters exercised their over-allotment option. As
a result, we sold an additional 407,500 shares of common stock resulting in
gross proceeds of $3,260,000, of which we paid approximately $228,200 in
underwriting discounts and commissions and $65,200 as a non-accountable expense
allowance to the underwriters. As a result, the approximate net cash proceeds
were $2,966,600. Convertible Secured Debentures Conversion During October 2004, we entered into Extension Agreements with holders of our
convertible secured debentures with maturity dates of October 15, 2004 and
October 20, 2004. These agreements extended the maturity date of the
convertible secured debentures to the earlier of (i) December 31, 2004, or (ii)
15 days following the completion of a financing with net proceeds to us of at
least $10 million. As a result of the completion of the IPO on October 22, 2004, the principal
amount and any unpaid accrued interest of our outstanding convertible secured
debentures became due on November 6, 2004. The holders of the convertible
secured debentures had a right to convert all or any portion of the outstanding
principal amount into shares of our common stock at a conversion price equal to
$3.35 per share prior to November 6, 2004. Holders of the convertible secured
debentures converted $2,360,172 of principal amount into 704,529 shares of our
common stock. The remaining principal amount of $21,828 plus accrued interest
of $211,597 was paid in November 2004 and no convertible debentures remain
outstanding. Convertible Secured Promissory Note During October 2004, we repaid the full outstanding principal amount of our
convertible secured promissory notes of $1,300,000 and the accrued interest of
$176,058 to Frastacky Associates, Inc., one of our stockholders. As a result of our IPO, management believes that our current cash and cash
flows from operations will be sufficient to operate our company for the next
twelve months. We may from time to time decide to access the capital markets
and issue our securities; such issuances may have a dilutive effect on current
stockholders. Quantitative and Qualitative Disclosures About Market Risk Interest Rate Risk Changes in interest rates in the United States would not materially affect the
interest earned on our cash and cash equivalents. Based on our overall interest
rate exposure at September 30, 2004, a near-term change in interest rates,
based on historical movements, would not materially affect the fair value of
interest rate sensitive instruments. Our debt instruments have fixed interest
rates and terms and, therefore, a significant change in interest rates would
not have a material adverse effect on our financial position or results of
operations. Risk Factors We have historically incurred losses and may continue to incur losses in the
future, which may impact our ability to implement our business strategy and
adversely affect our financial condition. We have a history of losses. Although we achieved a net income of $60,000 for
the fiscal year ended December 31, 2003 and a net income of $386,000 for the
nine months ended September 30, 2004, we had an accumulated deficit of $12.4
million at September 30, 2004. We expect to significantly increase our
operating expenses by expanding our marketing operations and increasing our
level of capital expenditures in order to grow our business and further develop
and maintain our services. Such increases in operating expense levels and
capital expenditures may adversely affect our operating results if we are
unable to immediately realize benefits from such expenditures. We also expect
that our operating expenses will significantly increase as a result of becoming
a public company. We cannot assure you that we will be profitable or generate
sufficient profits from operations in the future. If our revenue growth does
not continue, we may experience a loss in one or more future periods. We may
not be able to reduce or maintain our expenses in response to any decrease in
our revenue, which may impact our ability to implement our business strategy
and adversely affect our financial condition. 16




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##### Table of Contents



We face intense competition from larger, more established companies, as well as
our own Advertiser Network partners, and we may not be able to compete
effectively, which could reduce demand for our services. The online paid-search market is intensely competitive. Our primary current
competitors include Yahoo! Inc., Google Inc. and our own Advertiser Network
partners. Although we currently pursue a strategy that allows us to partner
with a broad range of websites and search engines, our current and future
partners may view us as a threat to their own internal paid-search services.
Nearly all of our competitors have longer operating histories, larger customer
bases, greater brand recognition and significantly greater financial, marketing
and other resources than we do. Our competitors may secure more favorable
revenue sharing arrangements with network distributors, devote greater
resources to marketing and promotional campaigns, adopt more aggressive growth
strategies and devote substantially more resources to website and systems
development than we do. In addition, the search industry has recently
experienced consolidation, including the acquisitions of companies offering
paid-search services. Industry consolidation has resulted in larger, more
established and well-financed competitors with a greater focus on paid-search
services. If these industry trends continue, or if we are unable to compete in
the paid-search market, our financial results may suffer. Additionally, larger companies such as Google and Microsoft Corporation may
implement technologies into their search engines or software that make it less
likely that consumers can reach, or execute searches on, our Distribution
Network partners websites and less likely to click-through on our Advertiser
Network partners sponsored listings. The implementation of such technologies
could result in a decline in click-throughs to our advertisers sponsored
listings, which would decrease our revenues. If we are unable to successfully
compete against current and future competitors or if our current Advertising
Network partners choose to rely more heavily on their own distribution networks
in the future, our operating results will be adversely affected. We rely on our Advertiser Network partners to provide us access to their
advertisers, and if they do not, it could have an adverse impact on our
business. We rely on our Advertiser Network partners to provide us with advertiser
listings so that we can distribute these listings to our Distribution Network
partners in order to generate revenue when a consumer click-through occurs on
our Advertiser Network partners sponsored listings. For the nine months ended
September 30, 2004, 46.0% of our revenue was derived from our Advertiser
Network partners. Most of our agreements with our Advertiser Network partners
are short-term, and, as a result, they may discontinue their relationship with
us or negotiate new terms that are less favorable to us, at any time, with
little or no notice. Our success depends, in part, on the maintenance and
growth of our Advertiser Network partners. If we are unable to develop or
maintain relationships with these partners, our operating results and financial
condition will suffer. We are dependent on our Distribution Network partners to provide us with search
traffic, and if they do not, our business could be harmed. We rely on our Distribution Network partners, a network of more than 250
websites and search engines with which we have contracts, to provide us with
consumer search traffic. Historically, nearly all of our search traffic has
come from our Distribution Network partners, and we believe this will continue
in the future. Our Distribution Network partners are very important to our
revenue and results of operations. Any adverse change in our relationships with
key Distribution Network partners could have a material adverse impact on our
revenue and results of operations because our sponsored listings would be
placed on fewer websites and search engines in response to consumer search
requests. Our agreements with these Distribution Network partners are
short-term, and as a result, our Distribution Network partners may discontinue
their relationship with us or negotiate new terms that are less favorable to
us, at any time, with little or no notice. If we are unable to maintain
relationships with our current Distribution Network partners or develop
relationships with prospective Distribution Network partners, our operating
results and financial condition will suffer. In addition, if our Distribution
Network does not grow and improve over time, current and prospective
advertisers may reduce or terminate their business with us. Any decline in the
number of our Distribution Network partners could adversely affect the value of
our services. We released our Local Direct platform in early 2004 and our future success will
depend upon the continued development and enhancement of our services and
technologies. In early 2004, we released Local Direct, which is based upon our Keyword DNA
technology. We intend to invest significant additional amounts of time and
resources to the enhancement and deployment of our Local Direct search and
advertising platform. Although we believe that the majority of our revenue will
continue to come from our own 17




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##### Table of Contents



advertisers and the advertisers of our Advertiser Network partners, we believe
that our newly developed Local Direct platform will contribute a larger
percentage of our revenue as the local paid-search sector grows. The Internet
and online commerce industries are characterized by rapid technological change,
changing market conditions and customer
demands. Our future success will substantially depend on our ability to enhance
our existing services, develop new services and proprietary technology (such as
Local Direct) and respond to technological advances in a timely and
cost-effective manner. The development of our systems and other proprietary
technologies entails significant technical and business risk. If we are unable
to capitalize on our new services and continue to enhance our existing services
in a cost-effective manner, our business could be materially adversely
affected. Our executive officers and certain key personnel are critical to our success,
and the loss of these officers and key personnel could harm our business. Our performance is substantially dependent on the continued services and
performance of our executive officers and other key personnel. We only have
employment agreements with our three executive officers: Heath B. Clarke (Chief
Executive Officer and Chairman of the Board), Michael A. Sawtell (President and
Chief Operations Officer) and Douglas S. Norman (Chief Financial Officer and
Secretary). Each of Messrs. Clarke, Sawtell and Normans employment agreements
may be terminated with 30 days notice by either the executive or us. No keyman
life insurance has been purchased on any of Messrs. Clarke, Sawtell or Norman.
Our performance also depends on our ability to retain and motivate our officers
and key employees. The loss of the services of any of our officers or other key
employees could have a material adverse effect on our business, prospects,
financial condition and results of operations. Our future success also depends
on our ability to identify, attract, hire, train, retain and motivate other
highly skilled technical, managerial and marketing personnel. Competition for
such personnel is intense, and we cannot assure you that we will be successful
in attracting and retaining such personnel. The failure to attract and retain
our officers or the necessary technical, managerial and marketing personnel
could have a material adverse effect on our business, prospects, financial
condition and results of operations. The market for Internet and paid-search advertising services is in the early
stages of development, and if the market for our services decreases it will
have a material adverse effect on our business, prospects, financial condition
and results of operations. Internet marketing and advertising, in general, and paid-search, in particular,
are in the early stages of development. Our future revenue and profits are
substantially dependent upon the continued widespread acceptance, growth, and
use of the Internet and other online services as effective advertising mediums.
Many of the largest advertisers have generally relied upon more traditional
forms of media advertising and have only limited experience advertising on the
Internet. Paid-search, in particular, is still in an early stage of development
and may not be accepted by consumers for many reasons including, among others,
that consumers may conclude that paid-search results are less relevant and
reliable than non-paid-search results, and may view paid-search results less
favorably than search results generated by non-paid-search engines. If
consumers reject our paid-search services, or commercial use of the Internet
generally, and the number of click-throughs on our sponsored listings
decreases, the commercial utility of our search services could be adversely
affected. We expect that our anticipated future growth including through potential
acquisitions, may strain our management, administrative, operational and
financial infrastructure, which could adversely affect our business. We anticipate that significant expansion of our present operations will be
required to capitalize on potential growth in market opportunities. This
expansion has placed, and is expected to continue to place, a significant
strain on our management, operational and financial resources. We expect to add
a significant number of additional key personnel in the future, including key
managerial and technical employees who will have to be fully integrated into
our operations. In order to manage our growth, we will be required to continue
to implement and improve our operational and financial systems, to expand
existing operations, to attract and retain superior management, and to train,
manage and expand our employee base. We cannot assure you that we will be able
to effectively manage the expansion of our operations, that our systems,
procedures or controls will be adequate to support our operations or that our
management will be able to successfully implement our business plan. If we are
unable to manage growth effectively, our business, financial condition and
results of operations could be materially adversely affected. Furthermore, we
may choose to expand our operations or market presence by pursuing acquisitions
of complementary business, services or technologies or engage in other
strategic alliances with third parties. Any such transactions would be
accompanied by the risks commonly encountered in such transactions, including,
among others, the difficulty of assimilating operations, technology and
personnel of the combined companies, the potential disruption of our ongoing
business, the inability to retain key technical and managerial personnel, the
inability of management to maximize our financial and 18




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strategic position through the successful integration of acquired businesses,
additional expenses associated with amortization of acquired intangible assets,
the maintenance of uniform standards, controls and policies and the impairment
of relationships with existing employees and customers. We have limited
experience in these types of acquisitions, and we may not be successful in
overcoming these risks or any other potential problems. As a result, any
acquisition may have a material adverse effect on our business, prospects,
financial condition and results of operations. We may be subject to intellectual property claims that create uncertainty about
ownership of technology essential to our business and divert our managerial and
other resources. There has been a substantial amount of litigation in the technology industry
regarding intellectual property rights. We cannot assure you that third parties
will not, in the future, claim infringement by us with respect to our current
or future services, trademarks or other proprietary rights. Our success
depends, in part, on our ability to protect our intellectual property and to
operate without infringing on the intellectual property rights of others in the
process. There can be no guarantee that any of our intellectual property will
be adequately safeguarded, or that it will not be challenged by third parties.
We may be subject to patent infringement claims or other intellectual property
infringement claims that would be costly to defend and could limit our ability
to use certain critical technologies. For example, Overture Services, Inc., recently acquired by Yahoo!, which
operates in certain competitive areas with us and owns U.S. Patent No.
6,269,361, which purports to give Overture rights to certain bid-for-placement
services and pay-per-performance search technologies. Overture is currently
involved in litigation with FindWhat.com relating to this patent. FindWhat.com
is contesting Overtures patent. Google Inc. recently paid a significant
settlement amount to Yahoo in order to settle multiple pending claims asserted
by Yahoo and its wholly-owned subsidiary, Overture. One of the claims asserted
by Overture was a claim for patent infringement by Google of U.S. Patent No.
6,269,361. As
part of the settlement, Overture dismissed its patent lawsuit against Google
and granted Google a fully-paid, perpetual license to the patent and several
related patent applications held by Overture. As the settlement related to
multiple claims, the settlement amount related directly to U.S. Patent No.
6,269,361 is unclear. The settlement may, however, increase the likelihood that
Overture may further seek to enforce any rights it may have relating to U.S.
Patent No. 6,269,361 and pursue further action against us. We have received correspondence from Overture advising us that it is willing to
license its patent to us and requesting that we provide an explanation if we
are not interested in a license; however, we have not had any discussions with
Overture regarding any license terms or otherwise relating to that matter. If
Overture construes any of our current services or business model as infringing
upon the above-referenced patent, then we could be sued or asked to obtain a
license, re-engineer our services or revise our business model according to
terms that could be expensive and/or unreasonable. Additionally, if we were to
acquire or develop a new service or business model that Overture construes as
infringing upon the above-referenced patent, then we could be sued or asked to
obtain a license, re-engineer our services or revise our business model
according to terms that may be expensive and/or unreasonable. It is also
possible that we may not be permitted to obtain a license from Overture, in
which case we may be required to stop using our technology if it is found to be
infringing. We may also be required to pay damages, including damages for past
infringements and treble damages if we were found to have willfully infringed
Overtures patent. If we cannot develop non-infringing technology or business
models or if we cannot obtain a license, our service offerings may be severely
limited and we may not be able to compete effectively in our industry. Any of
these risks, if they occur, could adversely affect our business and financial
performance. We may also become subject to interference proceedings conducted in the patent
and trademark offices of various countries to determine the priority of
inventions. The defense and prosecution, if necessary, of intellectual property
suits, interference proceedings and related legal and administrative
proceedings is costly and may divert our technical and management personnel
from their normal responsibilities. We may not prevail in any of these suits.
An adverse determination of any litigation or defense proceedings could cause
us to pay substantial damages, including treble damages if we willfully
infringe, and, also, could put our patent applications at risk of not being
issued. Furthermore, because of the substantial amount of discovery required in
connection with intellectual property litigation, there is a risk that some of
our confidential information could be compromised by disclosure during this
type of litigation. In addition, during the course of this kind of litigation,
there could be public announcements of the results of hearings, motions or
other interim proceedings or developments in the litigation. If investors
perceive these results to be negative, it could have an adverse effect on the
trading price of our common stock. Any patent litigation could negatively impact our business by diverting
resources and management attention away from other aspects of our business and
adding uncertainty as to the ownership of technology and services that we view 19




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as proprietary and essential to our business. In addition, a successful claim
of patent infringement against us and our failure or inability to obtain a
license for the infringed or similar technology on reasonable terms, or at all,
could have a material adverse effect on our business. If we expand our operations internationally, we will become susceptible to
risks associated with international operations. Our business strategy includes expanding our operations internationally,
particularly relating to our Local Direct platform. We have very limited prior
experience operating in foreign jurisdictions. Conducting international
operations subjects us to new risks that we have not generally faced in the
United States. These risks and uncertainties include:  
    
    localization of our services, including translation into foreign languages;
    
    unexpected changes in foreign regulatory requirements, including Internet and technology regulations;
    
    longer accounts receivable payment cycles and difficulties in collecting accounts receivable;
    
    difficulties managing and staffing international operations;
    
    potentially adverse tax consequences, including foreign tax systems
and restrictions on the repatriation of earnings;
    
    maintaining and servicing computer hardware in distant locations;
    
    complying with a wide variety of foreign laws and different legal standards; and
    
    reduced or varied protection for intellectual property rights in some countries. The occurrence of any one of these risks could negatively affect our proposed
international business and, consequently, our results of operations. We may be subject to lawsuits for information displayed on our websites and the
websites of our advertisers, which may affect our business. Laws relating to the liability of providers of online services, for activities
of their advertisers and for the content of their advertisers listings are
currently unsettled. It is unclear whether we could be subjected to claims for
defamation, negligence, copyright or trademark infringement or claims based on
other theories relating to the information we
publish on our websites or the information that is published across our
Distribution Network. These types of claims have been brought, sometimes
successfully, against online services as well as other print publications in
the past. We may not successfully avoid civil or criminal liability for
unlawful activities carried out by our advertisers. Our potential liability for
unlawful activities of our advertisers or for the content of our advertisers
listings could require us to implement measures to reduce our exposure to such
liability, which may require us, among other things, to spend substantial
resources or to discontinue certain service offerings. Our insurance may not
adequately protect us against these types of claims and the defense of such
claims may divert the attention of our management from our operations. If we
are subjected to such lawsuits, it may adversely affect our business. Government and legal regulations may damage our business. We are not currently subject to direct regulation by any government agency,
other than regulations generally applicable to Internet businesses, and there
are currently few significant laws or regulations directly applicable to access
to or commerce on the Internet. It is possible, however, that a number of laws
and regulations may be adopted with respect to the Internet, covering issues
such as the positioning of sponsored listings on search results pages. For
example, the Federal Trade Commission, or FTC, has recently reviewed the way in
which search engines disclose
paid-search practices to Internet users. In 2002, the FTC issued guidance
recommending that all search engine companies ensure that all paid-search
results are clearly distinguished from non-paid results, that the use of
paid-search is clearly and conspicuously explained and disclosed and that other
disclosures are made to avoid misleading users about the possible effects of
paid-search listings on search results. The adoption of laws or regulations
relating to placement of paid search advertisements or user privacy, defamation
or taxation may inhibit the growth in use of the 20




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Internet, which in turn, could decrease the demand for our services and
increase our cost of doing business or otherwise have a material adverse effect
on our business, prospects, financial condition and results of operations. Any
new legislation or regulation, or the application of existing laws and
regulations to the Internet or other online services, could have a material
adverse effect on our business, prospects, financial condition and results of
operations. If we fail to detect click-through fraud, we could lose the confidence of our
advertisers, thereby causing our business to suffer. We are exposed to the risk of fraudulent or illegitimate clicks on our
sponsored listings. If fraudulent clicks are not detected, the affected
advertisers may experience a reduced return on their investment in our
advertising programs because the fraudulent clicks will not lead to revenue for
the advertisers. As a result, our advertisers may become dissatisfied with our
advertising programs, which could lead to loss of advertisers and revenue. Failure to adequately protect our intellectual property and proprietary rights
could harm our competitive position. Our success is substantially dependent upon our proprietary technology, which
relates to a variety of business and transactional processes associated with
our paid-search advertising model, our Keyword DNA technology and our Local
Direct search and advertising platform. We rely on a combination of patent,
trademark, copyright and trade secret laws, as well as confidentiality
agreements and technical measures, to protect our proprietary rights. Although
we have filed patent applications and provisional patents on certain parts of
our technology, much of our proprietary information may not be patentable, and
we do not currently possess any patents. We cannot assure you that we will
develop proprietary technologies that are patentable or that any pending patent
applications will be issued or that their scope is broad enough to provide us
with meaningful protection. We have applied for trademark registration of the
ePilot, Assured Response, Network Advantage, Paid Search Plus and Local Direct
trademarks in the United States and may claim trademark rights in, and apply
for trademark registrations in the United States for a number of other marks.
We cannot assure you that we will be able to secure significant protection for
these marks. Despite our efforts to protect our proprietary rights,
unauthorized parties may attempt to copy aspects of our services or to obtain
and use information that we regard as proprietary. We cannot assure you that
our means of protecting our proprietary rights will be adequate or that our
competitors will not independently develop similar technology or duplicate our
services or design around patents issued to us or our other intellectual
property rights. If we are unable to adequately protect our intellectual
property and proprietary rights, our business and our operations could be
adversely affected. We may experience downward pressure on our bid prices if advertisers do not
obtain a competitive return on investment, which could have a material and
adverse effect on our financial results. We may experience downward pressure on our bid prices if advertisers do not
obtain a favorable return on investment from our paid-search services in
comparison to our competitors services or other advertising methods. We
compete with other web search services, online publishers and high-traffic web
sites, as well as traditional media such as television, radio and print, for a
share of our advertisers total advertising expenditures. Many potential
advertisers and advertising agencies have only limited experience advertising
on the Internet and have not devoted a significant portion of their advertising
expenditures to paid-search. Acceptance of paid-search marketing among
advertisers will
depend, to a large extent, on its perceived effectiveness and the continued
growth of commercial usage of the Internet. If we experience downward pricing
pressure for our services in the future, our financial results may suffer. One Advertiser Network partner has provided a substantial portion of our
revenue; the loss of this partner may have a material adverse effect on our
operating results. Our Advertiser Network partner, LookSmart, Ltd., represented 32.9% and 36.3% of
our total revenue for the three and nine months ended September 30, 2004,
respectively. It is difficult to predict whether LookSmart will continue to
represent such a significant portion of our revenue in the future. LookSmart
may choose not to renew our agreement in the future or may choose to reduce the
use of our paid-search services. Although we believe that other advertisers
within our Advertiser Network could replace a substantial portion of
LookSmarts sponsored listings, we cannot assure you that we would receive the
same number of revenue-generating click-throughs or that we could service the
same breadth of search requests, in which case our business and financial
results may be harmed. 21




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One of our customers accounts for a significant portion of our accounts
receivable, and the failure to collect from that customer would harm our
financial condition and results of operations. While most of our customers pay for our services in advance, some do not. One
of our customers that does not pay in advance, LookSmart, has and will likely
continue for the foreseeable future to account for a significant portion of our
accounts receivable. At September 30, 2004, LookSmart represented 60.3%, of our
total accounts receivable. LookSmarts accounts have been, and will likely
continue to be, unsecured and any failure to collect on those accounts would
harm our financial condition and results of operations. Problems with our computer and communication systems may harm our business. A key element of our strategy is to generate a high volume of traffic across
our network infrastructure to and from our Advertiser and Distribution Network
partners. Accordingly, the satisfactory performance, reliability and
availability of our software systems, transaction processing systems and
network infrastructure are critical to our reputation and our ability to
attract and retain advertising customers, as well as maintain adequate customer
service levels. We may experience periodic systems interruptions. Any
substantial increase in the volume of traffic on our software systems or
network infrastructure will require us to expand and upgrade our technology,
transaction-processing systems and network infrastructure. We cannot assure you
that we will be able to accurately project the rate or timing of increases, if
any, in the use of our network infrastructure or timely expand and upgrade our
systems and infrastructure to accommodate such increases. We rely on third party technology, server and hardware providers, and a failure
of service by these providers could adversely affect our business and
reputation. We rely upon third party data center providers to host our main servers and
expect to continue to do so. In the event that these providers experience any
interruption in operations or cease operations for any reason or if we are
unable to agree on satisfactory terms for continued hosting relationships, we
would be forced to enter into a relationship with other service providers or
assume hosting responsibilities ourselves. If we are forced to switch hosting
facilities, we may not be successful in finding an alternative service provider
on acceptable terms or in hosting the computer servers ourselves. We may also
be limited in our remedies against these providers in the event of a failure of
service. In
the past, we have experienced short-term outages in the service maintained by
one of our current co-location providers. We also rely on third party providers
for components of our technology platform, such as hardware and software
providers, credit card processors and domain name registrars. A failure or
limitation of service or available capacity by any of these third party
providers could adversely affect our business and reputation. State and local governments may be able to levy additional taxes on Internet
access and electronic commerce transactions, which could result in a decrease
in the level of usage of our services. Beginning in 1998, the federal government imposed a moratorium on state and
local governments imposition of new taxes on Internet access and eCommerce
transactions, which has now expired. State and local governments may be able to
levy additional taxes on Internet access and eCommerce transactions unless the
moratorium is reinstituted. Any increase in applicable taxes may make eCommerce
transactions less attractive for businesses and consumers, which could result
in a decrease in eCommerce activities and the level of usage of our services. Our business could be substantially harmed if we fail to pay taxes we owe. During 2000 and through 2002, we either failed to pay or failed to pay timely
our federal payroll tax liabilities. As a result, we incurred penalties and
interest on the unpaid balances. The original amount of unpaid taxes was
approximately $1.1 million. In October 2003, we entered into an installment
agreement with the Internal Revenue Service whereby we agreed to pay $30,000
per month through December 2004 and $40,000 per month thereafter until the
liability is paid in full. Our agreement with the Internal Revenue Service was
based on our then current financial condition, and it may be modified or
terminated by the Internal Revenue Service at any time if their information,
including updated financial information that we must provide them upon request,
shows that our ability to pay the amount owed has significantly changed. The
Internal Revenue Service can also terminate our agreement at any time if we do
not make the monthly installment payments as agreed upon, do not pay any other
federal tax debt when due, do not provide financial information if requested or
if they find that collection of the taxes we owe is in jeopardy. If the
Internal Revenue Service terminates our agreement, they may collect the entire
amount we owe by levy on our income, bank accounts or other assets, by seizing
our property or by taking other legal action against us. Penalties and
interest, as provided by law, will continue to accrue until the liability is
paid in full, and as of September 30, 2004, the 22




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outstanding liability was $1.9 million. We are presently in compliance with the
terms of our agreement with the Internal Revenue Service, but our business
could be substantially harmed if in the future we fail to pay the taxes we owe
and the Internal Revenue Service asserts its rights against us. The market price of our common stock is likely to be highly volatile, which
could cause investment losses for our stockholders and result in stockholder
litigation with substantial costs, economic loss and diversion of our
resources. Prior to our recent IPO, there was no public trading market for our common
stock. We cannot predict the extent to which investor interest will support an
active and liquid trading market for our common stock. In addition, the trading price of our common stock is likely to be highly
volatile and could be subject to wide fluctuations as a result of various
factors, many of which are beyond our control, including:  
    
    developments concerning proprietary rights, including patents, by us or a competitor;
    
    market acceptance of our new and existing services and technologies;
    
    announcements by us or our competitors of significant contracts,
acquisitions, commercial relationships, joint ventures or capital
commitments;
    
    actual or anticipated fluctuations in our operating results;
    
    continued growth in the Internet and the infrastructure for
providing Internet access and carrying Internet traffic;
    
    introductions of new services by us or our competitors;
    
    enactment of new government regulations affecting our industry;
    
    changes in the number of our Advertising and Distribution Network partners;
    
    seasonal fluctuations in the level of Internet usage;
    
    loss of key employees;
    
    institution of intellectual property litigation by or against us;
    
    success of our international expansion;
    
    changes in the market valuations of similar companies; and
    
    changes in our industry and the overall economic environment. Due to the short-term nature of our Advertiser Network and Distribution Network
partner agreements and the emerging nature of the paid-search market, we may
not be able to accurately predict our operating results on a quarterly basis,
if at all, which may lead to volatility in the trading price of our common
stock. In addition, the stock market in general, and the Nasdaq SmallCap Market
and the market for online commerce companies in particular, have experienced
extreme price and volume fluctuations that have often been unrelated or
disproportionate to the operating performance of the listed companies. These
broad market and industry factors may seriously harm the market price of our
common stock, regardless of our operating performance. In the past, following
periods of volatility in the market, securities class action litigation has
often been instituted against these companies. Litigation against us, whether
or not a judgment is entered against us, could result in substantial costs, and
potentially, economic loss, and a diversion of our managements attention and
resources. As a result of these and other factors, you may not be able to sell
your shares and may suffer a loss on your investment. 23




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Future sales of shares of our common stock that are eligible for sale by our
stockholders may decrease the price of our common stock. We had 6,981,941 shares of common stock outstanding on November 15, 2004. Of
these shares, 1,976,452 are held by directors, executive officers and other
affiliates and will be subject to volume limitations under Rule 144 under the
Securities Act. In addition, there were outstanding options to purchase
1,292,947 shares of our common stock and warrants to purchase 2,058,794 shares
of our common stock. Actual sales, or the prospect of sales by our present
stockholders or by future stockholders, may have a negative effect on the
market price of our common stock. Anti-takeover provisions may limit the ability of another party to acquire us,
which could cause our stock price to decline. Our amended and restated certificate of incorporation, our amended and restated
bylaws and Delaware law contain provisions that could discourage, delay or
prevent a third party from acquiring us, even if doing so may be beneficial to
our stockholders. In addition, these provisions could limit the price investors
would be willing to pay in the future for shares of our common stock. The
following are examples of such provisions in our amended and restated
certificate of incorporation and in our amended and restated bylaws:  
    
    special meetings of our stockholders may be called only by our
Chief Executive Officer, by a majority of the members of our board of
directors and by the holders of shares entitled to cast not less than
10% of the votes at the meeting;
    
    stockholder proposals to be brought before any meeting of our
stockholders must comply with advance notice procedures;
    
    our board of directors is classified into three classes, as nearly
equal in number as possible;
    
    newly-created directorships and vacancies on our board of directors
may only be filled by a majority of remaining directors, and not by our
stockholders;
    
    a director may be removed from office only for cause by the holders
of at least 75% of the voting power entitled to vote at an election of
directors;
    
    our amended and restated bylaws may be further amended by our
stockholders only upon a vote of at least 75% of the votes entitled to
be cast by the holders of all outstanding shares then entitled to vote
generally in the election of directors, voting together as a single
class; and
    
    our board of directors is authorized to issue, without further
action by our stockholders, up to 10,000,000 shares of undesignated
preferred stock with rights and preferences, including voting rights,
designated from time to time by our board of directors. We are also subject to Section 203 of the Delaware General Corporation Law,
which provides, subject to enumerated exceptions, that if a person acquires 15%
or more of our voting stock, the person is an interested stockholder and may
not engage in business combinations with us for a period of three years from
the time the person acquired 15% or more of our voting stock. Our ability to utilize our net operating loss carryforwards and certain other
tax attributes may be limited. Under Section 382 of the Internal Revenue Code, if a corporation undergoes an
ownership change (generally defined as a greater than 50% change (by value)
in its equity ownership over a three-year period), the corporations ability to
use its pre-change net operating loss carryforwards and other pre-change tax
attributes against its post-change income may be limited. Although no definite
determination can be made at this time, there is a significant possibility that
the offering (along with other ownership changes that have occurred within the
past three years) will cause us to experience an ownership change. Even if the
offering does not cause an ownership change to occur, we may
experience an ownership change after the offering as a result of subsequent
shifts in our stock ownership. As of December 31, 2003 we have net operating
loss carryforwards of approximately $7.0 million and $6.0 million for federal
and state income tax purposes, respectively. Although no precise computation
can be made at this time, if we experience an ownership change as a result of
this offering, the amount of our pre-change net operating loss carryforward
that we could utilize after the ownership change might be limited. 24




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Item 3. Controls and Procedures We maintain disclosure controls and procedures (as such term is defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended, that are designed to ensure that information required to be disclosed
in our Exchange Act reports is recorded, processed, summarized and reported
within the time periods specified in the SECs rules and forms, and that such
information is accumulated and communicated to our management, including our
Chief Executive officer and Chief Financial Officer, as appropriate, to allow
timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, our
management recognized that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving the
desired control objectives, and the our management necessarily was required to
apply its judgment in evaluating the cost-benefit relationship of possible
controls and procedures. As required by Rule 13a-15(b) and 15d-15(b) under the Exchange Act, we carried
out an evaluation, under the supervision and with the participation of our
management, including the Companys Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures as of the end of the fiscal quarter covered by this
report. Based upon the foregoing, the Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures were
effective in reaching a level of reasonable assurance in achieving our desired
control objectives. There have been no significant changes in our internal controls over financial
reporting during the most recent fiscal quarter that has materially affected,
or is reasonably likely to materially affect, our internal controls over
financial reporting. 25




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PART II  OTHER INFORMATION 
 Item 1. Legal Proceedings None 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds None 
 Item 3. Defaults Upon Senior Securities None 
 Item 4. Submission of Matters to a Vote of Security Holders  a)
    
    We held our 2004 annual meeting of stockholders on September 9,
2004. As of the close of business on August 26, 2004, the record date
of the meeting, we had outstanding 1,922,964 shares of our common stock
and 1,008,125 shares of our preferred stock representing 1,169,774
common stock equivalent shares for a total of 3,092,738 shares
outstanding. A total of 2,162,123 shares of common stock were
represented in person or by proxy at the meeting and constituted a
quorum.b)
    
    Managements nominees for election as directors were Heath B.
Clarke, Theodore E. Lavoie, and Philip K. Fricke, each of whom were an
incumbent director. Each of the nominees was elected as a director at
the meeting.c)
    
    (i) Proposal 1: To elect three nominees to the board of directors: Nominee
    
    For
    
    Withheld AuthorityHeath B. Clarke
    
    
    2,161,652
    
    
    
    471Theodore E. Lavoie
    
    
    2,161,652
    
    
    
    471Philip K. Fricke
    
    
    2,161,652
    
    
    
    471
  There were no abstentions.  (ii)
    
    Proposal 2: To approve the 2004 Equity Incentive Plan,
as Amended: For:
    
    
    2,159,771Against:
    
    
    0Abstain:
    
    
    2,352
  (iii)
    
    Proposal 3: To approve the amendment and restatement
of the Companys certificate of incorporation: For:
    
    
    2,161,652Against:
    
    
    0Abstain:
    
    
    471
  (iv)
    
    Proposal 4: To approve the amendment and restatement of
the Companys bylaws: For:
    
    
    2,161,652Against:
    
    
    0Abstain:
    
    
    471
 26




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(v)
    
    Proposal 5: To ratify the appointment of Haskell &
White, LLP as the Companys independent auditors for fiscal year
2004. For:
    
    
    2,161,652Against:
    
    
    0Abstain:
    
    
    471
  d)
    
    Not applicable. 
 Item 5. Other Information Upon the completion of the Companys IPO on October 22, 2004, the Company
issued an aggregate of 1,169,722 shares of its common stock upon the automatic
conversion of its outstanding preferred stock. The preferred stock converted as
follows: 497,750 shares of Companys convertible preferred Series A stock
automatically converted into 598,866 shares of the Companys common stock;
68,188 shares of the Companys convertible preferred Series B stock
automatically converted into 102,734 shares of the Companys common stock;
284,188 shares of the Companys convertible preferred Series C stock
automatically converted into 292,711 shares of the Companys common stock;
123,999 shares of the Companys convertible preferred Series D stock
automatically converted into 136,604 shares of the Companys common stock; and
34,000 shares of the Companys convertible preferred Series E stock
automatically converted into 38,807 shares of the Companys common stock. The
offer and sale of the securities were effected without registration in reliance
on the exemption from registration provided by Section 3(a)(9) of the
Securities Act. From October 25, 2004 to November 6, 2004, the Company issued an aggregate of
704,529 shares of its common stock upon conversion of $2,360,172 principal
amount the Companys convertible secured debentures. The holders of the
convertible secured debentures had a right to convert all or any portion of the
outstanding principal amount into shares of the Companys common stock at a
conversion price equal to $3.35 per share prior to November 6, 2004. The offer
and sale of the securities were effected without registration in reliance on
the exemption from registration provided by Section 3(a)(9) of the Securities
Act. 
 Item 6. Exhibits ExhibitNumber
    
    Description10.1
    
    2004 Incentive Equity Plan as Amended31.1
    
    Certification of Principal Executive Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 200231.2
    
    Certification of Principal Financial Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 200232.1
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 27




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##### Table of Contents



SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized. INTERCHANGE CORPORATIONNovember 19, 2004
    
    /s/ Heath B. ClarkeDateHeath B. ClarkeChief Executive Officer and Chairman/s/ Douglas S. NormanDouglas S. NormanChief Financial Officer and Secretary
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##### Table of Contents



EXHIBITS FILED WITH THIS REPORT ExhibitNumber
    
    Description10.1
    
    2004 Incentive Equity Plan as Amended31.1
    
    Certification of Principal Executive Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 200231.2
    
    Certification of Principal Financial Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 200232.1
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 29