**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**




________________




**FORM
      10-K**




________________




**xANNUAL
      REPORT PURSUANT
      TO SECTION 13 OR 15(d) OF THE** **SECURITIES
      EXCHANGE ACT OF 1934**





**For
      the fiscal year ended December 31, 2005**





**OR**




**o   
      TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE** **SECURITIES
      EXCHANGE ACT OF 1934**





**For
      the transition period from ____________ to ____________ .**





**Commission
      file number 000-27065**





**APTIMUS,
      INC.**


**(Exact
      name of registrant as specified in its charter)**





**Washington**
            **91-1809146****(Jurisdiction
                of incorporation)**
            **(I.R.S.
                Employer Identification
                No.)**





**100
      Spear Street**


**Suite
      1115**


**San
      Francisco, CA 94105**


**(Address
      of principal executive offices)**





**Registrant's
      telephone number: (415) 896-2123**





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





**Title
                of each class**
            
            **Name
                of each exchange****on
                which registered****None**
            
            **N/A**





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





**Common
      Stock, no par value**


**(Title
      of Class)**





Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act.   Yes o No
x







1




Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Exchange Act. Yes oNo
x




Indicate
      by check mark whether the registrant: (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the registrant was required
      to file such reports), and (2) has been subject to such filing requirements
      for
      the past 90 days. Yes x
No
o




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




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


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





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act).  Yes  o  No
x




The
      aggregate market value of the voting and non-voting common equity held by
      non-affiliates computed by reference to the price at which the common equity
      was
      last sold on the Nasdaq National Market as of the last business day of the
      registrant’s most recently completed second fiscal quarter, which was June 30,
      2005: $98,537,563.




The
      number of shares of the registrant's Common Stock outstanding as of February
      28,
      2006 was 6,528,163.




**DOCUMENTS
      INCORPORATED BY REFERENCE**




Portions
      of the definitive Proxy Statement to be delivered to shareholders in connection
      with the Annual Meeting of Shareholders to be held on or about June 9, 2006
      are
      incorporated by reference into Part III.









2


**FORWARD
      LOOKING STATEMENTS**




Certain
      statements in this Annual Report constitute forward-looking statements within
      the meaning of Section 21E of the Securities Exchange Act of 1934.
      Forward-looking statements can often be identified by terminology such as may,
      will, should, expect, plan, intend, expect, anticipate, believe, estimate,
      predict, potential or continue, the negative of such terms or other comparable
      terminology. Such forward-looking statements involve known and unknown risks,
      uncertainties and other factors that may cause the actual results, performance
      or achievements of Aptimus, Inc. ("Aptimus", "we", "us" or the "Company"),
      or
      developments in the Company's industry, to differ materially from the
      anticipated results, performance or achievements expressed or implied by such
      forward-looking statements. Important factors currently known to management
      that
      could cause actual results to differ materially from those in forward-looking
      statements include, without limitation, fluctuation of the Company's operating
      results, the ability of the Company to compete successfully, the ability of
      the
      Company to maintain current client and publisher relationships and attract
      new
      ones, the sufficiency of remaining cash and short-term investments to fund
      ongoing operations and the ability to integrate acquired companies. For
      additional factors that may cause actual results to differ materially from
      those
      contemplated by such forward-looking statements, please see the risks and
      uncertainties described under "Business — Risk Factors" in Part I of this Annual
      Report. Certain of the forward-looking statements contained in this Report
      are
      identified with cross-references to this section and/or to specific risks
      identified under "Business — Risk Factors."




**PART
      I**




**Item
      1:** ***Business***




**Overview**




Aptimus
      operates a results-based advertising network, distributing advertisements for
      direct marketing advertisers across a network of third-party web sites.
      Advertisers pay us only for the results that we deliver through one of four
      pricing models - (i) cost per click, (ii) cost per lead, (iii) cost per
      acquisition or (iv) cost per impression. We then share a portion of the amounts
      we bill to our advertiser clients with publishers on whose web properties we
      distribute the advertisements. In addition, we occasionally pay web site owners
      either a fixed fee for each completed user transaction or a fee for each
      impression of a placement served on the web site.




At
      the
      core of the Aptimus Network is a database configuration and software platform
      used in conjunction with a direct marketing approach for which we have filed
      a
      non-provisional business method patent application called Dynamic Revenue
      OptimizationTM (DRO). DRO determines through computer-based logic, on a real-time
      basis, which advertisements in our system, using the yield of both response
      history and value, should be displayed for prominent promotion on each
      individual web site placement in our network. The outcome of this approach
      is
      that we generate superior user response and revenue potential for each specific
      web site placement and a targeted result for our advertiser
      clients.




**Company
      History**




Aptimus
      began in 1994 as the FreeShop division of Online Interactive, Inc. This division
      was spun-off from Online Interactive, Inc. in 1997 as FreeShop International,
      Inc., and later became FreeShop.com, Inc. FreeShop was an online direct
      marketing web site connecting marketers and consumers in an innovative new
      approach made possible by the Internet. The concept was to take advantage of
      the
      Internet’s ability to quickly link advertisers and individual consumers to
      increase the efficacy of direct marketing campaigns by allowing consumers to
      pick and choose the promotional offers they actually wanted from direct
      marketers. This site-centric approach led to our growth through our initial
      public offering in 1999 and into 2000. The core of our business model was the
      lead generation business, a decades-old two-step marketing process where
      marketers offer a free trial, sample or information as a first step in the
      process of acquiring a new customer. By the year 2000, our lead generation
      business was surrounded by advertising and sponsorship opportunities, which
      eventually grew to 65% of our revenues in the second quarter of 2000.




3


During
      the year 2000, funding for Internet companies slowed and stock prices generally
      declined. Lack of funding, combined with an increased focus among Internet
      companies on profitability over revenue growth objectives, resulted in reduced
      marketing spending by Internet companies, most notably in the second half of
      2000. This drop in spending had significant repercussions throughout the
      industry and materially affected our advertising and sponsorship
      businesses.




While
      we
      faced major challenges in 2000 and our results suffered, we maintained our
      aggressive posture and focused on what we know best - online direct marketing.
      Toward that end, beginning in June 2000, we undertook an evaluation of all
      aspects of how we do business. Through this effort, we made a number of
      determinations and commitments that formed the basis of our strategy going
      forward.




•
              We
                  determined that revenue streams from advertising and sponsorship
                  opportunities were declining quickly and would not likely return
                  to their
                  earlier levels for some time to come. Those revenue streams were
                  critical
                  to making rapid growth via our site-centric approach possible,
                  given the
                  high marketing and infrastructure costs of growing a web site
                  audience.•
              We
                  determined that our response-based advertising business remained
                  viable,
                  since direct marketing in general continued to prosper, most direct
                  marketers recognized the importance of the Internet as a key part
                  of their
                  distribution mix, and the core of our traditional direct marketer
                  client
                  base remained in place.•
              We
                  determined that all major sites throughout the industry would be
                  feeling
                  the same impacts on advertising spending, and thus would be seeking
                  alternative revenue-generation opportunities such as results-based
                  pricing
                  (where fees are paid on a per-lead or other results
                  basis).•
              We
                  determined that our direct marketing clients could be served even
                  better
                  by our placement of their offers in relevant context through other
                  companies’ web sites and email channels, without Aptimus spending the
                  significant resources required to continue to maintain and grow
                  our own
                  web site audiences.




As
      a
      result of these determinations, we made a shift to a network strategy beginning
      in the Summer of 2000, placing direct marketing clients’ offers in contextually
      relevant locations on publisher web sites throughout the Internet. Consistent
      with this new strategy, in October 2000, we renamed our company Aptimus, Inc.,
      and named our network the Aptimus Network.




From
      the
      summer of 2000 to the summer of 2001, we laid the foundation for our new network
      business model, and also reevaluated and changed all aspects of our company
      in
      the process. We exited the web site business and terminated most of the
      contracts that were tied to our web site business. We also reduced our staff
      from a high of 215 to 28 at the end of 2001 primarily through restructuring
      plans implemented in February of 2001 and June of 2001. In addition, in November
      2001, we completed a major issuer tender offer, acquiring 9,230,228 shares
      of
      our outstanding common stock, or approximately 69.87% of our outstanding shares
      as of November 15, 2001, at a price per share of $0.48. The tender offer was
      designed to provide liquidity to shareholders who wished to sell their
      investment in us at a slight premium to market. In addition, management believed
      that the then current share price discounted the long-term value of our stock
      and, therefore, a buy-back would also be beneficial to remaining
      shareholders.




As
      of the
      summer of 2001, we completed our transition to a network business.




4


**Industry
      Background**




*Direct
      Marketing*




Advertising
      expenditures can be broadly defined as either brand or direct marketing. Brand
      advertising is intended to generate brand name awareness and create a specific
      image for a particular company, product or service. Direct marketing involves
      any communication to a consumer intended to generate a specific response or
      action, generally a purchase of a product or service.




*Traditional
      Direct Marketing*




Traditional
      direct marketing media include direct mail, telemarketing, newspaper, magazine,
      radio and television advertising. Although traditional direct marketing is
      effective and widely used, it presents a number of challenges for marketers
      and
      consumers alike. Traditional direct marketers generally lack specific and timely
      information on a particular consumer’s immediate interests. Given the costs
      associated with traditional direct marketing, which typically include printing,
      data processing, postage, assembly, labor, telecommunications, and facilities,
      as well as the recent introduction of the FTC’s “do not call” registry, low
      response rates can make the process inefficient.




*Online
      Direct Marketing*




Online
      direct marketing media include banner advertisements, interstitials,
      advertorials, text-links, pop-ups, targeted email solicitations search and
      web
      site sponsorships. We believe that online direct marketing is more efficient
      than traditional direct marketing because online offers avoid expenses
      associated with physical advertising such as production costs, mailing expenses,
      and personnel expenses associated with individual telemarketing calls, while
      allowing offers to be tailored to the interests of specific demographic groups
      drawn to particular web sites. Further, user data input capabilities enable
      easier and faster customer response. In addition, online direct
      marketing:




·
            facilitates
                instantaneous data and feedback on marketing campaigns;




·
            provides
                direct marketers with multiple performance-based payment models;
                and




·
            enables
                highly customized marketing
                campaigns.




Even
      with
      these advantages, direct marketers face challenges in realizing the full
      potential of the Internet as a marketing medium. With millions of web sites,
      only a fraction of which have significant audiences, it is difficult for
      marketers to decide where to spend their marketing budgets. Even leading brand
      name marketers who build their own web sites must find ways to attract a
      sizeable audience. In addition, financial hurdles presented by rapidly evolving
      technologies such as updating archaic computer and legacy data entry systems,
      may impede conventional direct marketers from successfully extending their
      activities to the Internet. Also, a number of new applications such as programs
      that block pop-up ads, as well as new business practices such as charging
      commercial emailers a fee for every email sent to an email account holder,
      have
      recently emerged and are becoming more widely used. Similarly, there is evolving
      popular dissatisfaction with some of the more intrusive methods of online
      advertising, such as pop-ups and unsolicited email. These technologies, together
      with evolving consumer sentiment, may diminish the value of placing online
      advertisements, particularly in the pop-up and email format, and discourage
      online advertising in general. Finally, federal and state laws have been
      implemented or are being implemented that would limit the use of email
      advertising and the collection of personal data that has previously been used
      to
      help target offers. For example, the Controlling The Assault of Non-Solicited
      Pornography and Marketing Act of 2003, popularly described as the CAN SPAM
      Act,
      has placed strict limitations on how and to whom commercial email solicitations
      can be delivered. As a result, the number of consumers to whom direct marketers
      can legitimately communicate by email has been significantly reduced.




5


In
      addition, efforts by ISPs and private networks to limit or restrict a material
      portion of our emails, our increasingly successful emphasis on the growth and
      development of our Network business, our focus on improving lead quality, the
      steadily shrinking revenue contribution both in real and relative terms from
      our
      email operations, and the unjustifiably significant demand on internal resources
      all contributed to our decision in December 2005 to indefinitely suspend all
      email operations, effective immediately.




**The
      Aptimus Solution**




We
      have
      developed an effective performance-based advertising network. The Aptimus
      Network generates orders for marketers by presenting their offers across a
      network of web site publishers that we believe encompass a broad demographic
      of
      users from sites focused on personal finance, electronics and technology, health
      and fitness to sites devoted to games and trivia, hobbies, news and online
      community. At the same time, the Aptimus Network provides incremental revenue
      benefits to its web site publishers, enabling revenue generation for its key
      formats, while saving the publisher the risk and cost of supporting additional
      internal advertising sales and engineering personnel. Our revenues per thousand
      page impressions or CPM, a standard measurement of value for Internet-based
      companies, for the year ended December 31, 2005 averaged $243.70 for our core
      placements within a transaction process and $17.96 for our other,
      non-transaction related placements. Moreover, our real-time data validation
      capabilities filter the data users input and reject orders with invalid data
      so
      that we only deliver orders to our advertising clients that our systems have
      prescreened for data quality. For the year ended December 31, 2005 and 2004,
      user leads from our top five largest website publishers accounted for 29.4%
      and
      45.7% of our total revenues, respectively. Of the top five publishers in the
      year ended December 31, 2005, one accounted for 10.6% of revenues.




Marketers
      pay only for the results they achieve on a cost per click, cost per lead,
      percentage of revenue, cost per acquisition, or cost per impression basis,
      as
      well as combinations of those models. As a result, marketers can refine their
      offers and payment models to achieve their specific objectives.




The
      Aptimus Network is focused primarily on advertising placements at the points
      of
      various transactional activities on web sites where consumers are more active
      and, thus, more likely to respond to offers from marketers. Key formats include
      cross-marketing promotions at the point of registration, log-in, download or
      other transactional activities on web sites. Heading into 2006, the Aptimus
      Network is also incorporating other online advertising formats, including a
      growing focus on search, banner and RSS (real simple syndication) media, that
      are expanding the solutions Aptimus offers both its advertising clients and
      web
      site publishers alike.




*Dynamic
      Revenue Optimization* *TM*




At
      the
      core of the Aptimus Network is a proprietary database configuration and software
      platform supporting a direct marketing approach for which we have filed a
      non-provisional business method patent application called Dynamic Revenue
      OptimizationTM, which automatically determines through computer-based logic on a
      real-time basis the offers from among the total offers in our rotation, in
      terms
      of response history and value, for promotion on each publisher’s web site and in
      each email sent. The technology is designed to optimize results for our
      advertiser clients by presenting offers that we believe are most likely to
      be of
      interest to specific customers, while maximizing revenues for our publishers
      and
      us. The system can target offers on a real time basis based on any information
      the user has submitted in the transaction process where our offer page is
      located. For example, male users on a particular publisher’s site may have a
      different response history to our offers than the site’s female visitors. Our
      system can tailor the offer mix displayed on the site depending on items such
      as
      the gender of the user to assure the highest response rate possible. Other
      useful targeting variables include age and physical address among others.




Our
      Dynamic Revenue Optimization system measures every offer in every ad position
      on
      a revenue generation basis. Then, the offers that generate the greatest revenues
      for that specific position automatically receive more exposure there, while
      lower performing offers receive less exposure. The analytics are continuously
      updated to quickly identify the performance of new offers and to adjust and
      improve the performance of every placement.




6


Revenues
      for each offer are determined based on response rate to each offer in each
      position multiplied by the fee for that response, whether the advertiser is
      paying a fee per click, a fee per lead, a fee per acquisition or based on any
      other measurable outcome. This approach is more flexible than other
      response-based systems that usually focus on one payment model exclusively,
      such
      as the cost per click approach of paid search networks.




Because
      Dynamic Revenue Optimization depends on consumer response as a central factor,
      the system automatically improves the targeting of each offer based on consumer
      behavior, emphasizing the offers that have generated the highest level of
      response in each location for that category of offer, target consumer and web
      site. This aspect of our algorithm ensures that offers are placed in front
      of a
      receptive audience. But consumer response is only one factor in determining
      offer placement. Dynamic Revenue Optimization also factors in the price per
      result paid by each advertiser. Offers are thus prioritized based on revenue
      received by us in combination with consumer response to the offers. For example,
      if two offers each generate 100 orders per 1,000 impressions and one advertiser
      is paying $1 per order and the other advertiser is paying $2 per order, Dynamic
      Revenue Optimization will emphasize the offer paying $2 per order. Similarly,
      if
      between these two offers, the first receives 30 orders and the second receives
      100 orders each per 1,000 impressions, and the first pays $10.00 per order
      and
      the second $2.00 per order, Dynamic Revenue Optimization will emphasis the
      first, higher paying offer even though it gets a fraction of the orders the
      second offer receives per 1,000 impressions. This is so because the higher
      paying offer generates more total revenue per 1,000 impressions than the lower
      paying offer. This dynamic creates a competitive environment where advertisers
      have an incentive to pay us higher fees and to create the most compelling offer
      in order to ensure priority placement of their offer along with creating offers
      of high interest to consumers.




*Benefits
      to Consumers*




We
      present our offers from leading brands to consumers, allowing consumers to
      easily select and respond to the offers that are of greatest interest to them.
      Because the Aptimus Network prioritizes offers in each location based on actual
      response behavior in that location, consumers are more likely to find offers
      of
      unique interest and value to them since they are likely to have interests in
      common with others who have come to the same location. In addition, we present
      our offers in brief, easy to read text that is accompanied by an HTML image
      of
      the advertised product or service. While we can support the placement of many
      offers on a page, we have found that users prefer and respond best if presented
      with relatively few offers on a page. And consistent with our desire to maintain
      a user-friendly process, our offer pages are intuitive and easy to navigate
      and
      users are not forced or required to order something before proceeding to the
      next step in the transaction process.




*Benefits
      to Advertisers*




We
      benefit advertisers by offering a flexible, cost effective way to acquire new
      customers online. The Aptimus Network presents their offers across a selection
      of web site publishers, and our Dynamic Revenue Optimization approach
      automatically attempts to determine where the most responsive customers are
      likely to be for each offer. Advertisers pay us solely based on the results
      achieved for them, on a cost per click, cost per lead, cost per order, or other
      payment model that makes the most sense for them. Thus, advertisers can test
      new
      marketing programs with us with little to no risk, and with the potential for
      high volume results for the best performing offers.




*Benefits
      to Publishers*




We
      work
      closely with publishers to identify key areas of their web sites that have
      the
      most profit potential, and then dynamically serve targeted offers into those
      placements on an ongoing basis. With our recently expanded capability of
      incorporating search-based ad units, our DRO-optimized placements are now
      available to publishers with high non-US based traffic volumes. Publishers
      share
      in the results achieved, and we do all of the work to manage the placements,
      advertiser sales, order taking, data validation, optimization, billing, and
      so
      forth.




7


The
      transaction-related positions on our publishers’ web sites that we prefer are
      different than the targeted positions of other ad networks. The Aptimus Network
      generates attractive revenues while keeping consumers at the publisher’s web
      site, rather than clicking them away to the web site of a sponsoring advertiser,
      which is disruptive to the consumer’s experience and counter to the publisher’s
      interests.




**Strategy**




Our
      objective is to be the performance-based advertising network on the Internet
      preferred by advertisers and web site publishers alike. We intend to achieve
      this objective by the following key strategies:




*Grow
      Web Site Publisher Base*




We
      intend
      to continue to grow our web site distribution network as our primary emphasis
      in
      2006 and beyond now that we have an established technology platform and a
      growing base of advertiser clients with both continuing and campaign-based
      customer acquisition goals. We believe our Dynamic Revenue Optimization system
      enables us to generate higher revenues than through random placement of offers.
      Our main emphasis is to increase the number of web site publisher impressions
      throughout our network. Our key target distribution publishers are large web
      site properties with significant volumes of transactional activities such as
      registrations, log-ins, downloads, auction bids, and other processes where
      users
      are performing a transactional activity of some form. We are also seeking major
      brand distribution publishers in key vertical interest categories to continue
      to
      attract more and new types of major brand clients. These types of clients have
      products and services that appeal to a broad demographic market, have large
      advertising budgets, have historically relied on traditional print and
      electronic distribution channels to advertise and acquire new customers, and
      are
      interested in extending their customer acquisition efforts to direct, measurable
      online marketing programs.




*Expand
      Client Base*




We
      believe that we provide advertisers with a cost-effective alternative to
      traditional direct marketing and, as a result, we have a significant opportunity
      to increase the number of direct marketing clients we serve. In particular,
      we
      are seeing more national consumer brand companies seeking Internet-based direct
      marketing vehicles, and we plan to initiate new relationships and expand our
      existing relationships with these companies. We continue to focus our sales
      staff on broadening relationships with existing advertiser clients and acquiring
      new advertiser clients. We plan to continue to expand and refine the services
      we
      offer to our clients, including:




·
            enhanced
                marketing programs,




·
            new
                methods of presenting offers, and




·
            expanded
                data-gathering and validation options.




We
      intend
      to achieve these objectives by a combination of inquiry and research to
      determine evolving advertiser and publisher needs, placement opportunities
      and
      user interests and then focusing our development resources and efforts on
      solutions that will support the desired service extensions and enhancements.
      Finally, we also offer our services to advertising and direct marketing agencies
      as a solution for their client companies to access consumers on the
      Internet.




8


*Increase
      Revenues*




Our
      Dynamic Revenue Optimization platform is designed to increase revenues through
      an algorithmic approach. As discussed, the algorithm ranks offers based on
      two
      independent factors: (i) the number of responses (what we call “orders”)
      the offer receives, and (ii) the revenues received by us per response. As
      one or both of these factors increase, the algorithm places the offer
      incrementally more prominently versus offers not ranked as highly by the
      algorithm. Over time, as we continue to add new clients and competitive offers,
      our system should automatically increase our revenues from others based on
      the
      revenue optimizing function of our algorithm. In addition, clients have an
      incentive to make their offers more attractive to consumers and increase the
      fees they pay to us per order, as the revenue results for their offer will
      be a
      key factor in determining the exposure of their offer. We also offer marketers
      tools to dynamically test new offer formats and versions, such as different
      graphics or text, to improve the response rate to their preferred offer in
      the
      Aptimus Network.




**Sales
      and Marketing**




*Client
      Base Development*




We
      sell
      our solutions to advertiser clients primarily through a sales and marketing
      organization comprised of Aptimus employed sales staff based in San Francisco
      and New York. As part of our strategy to increase our client base, we have
      expanded our sales force and client account management teams in 2005 and will
      continue to do so on an as needed basis. In addition, we work extensively with
      advertising agencies, which often act as “offer aggregators” bringing multiple
      new clients and offers to us simultaneously. Relationships with key advertising
      agencies have enabled us to expand our base of clients and offers more rapidly,
      without having to expand our internal sales team as quickly or as much as might
      otherwise be required. We consider our relationships with the agencies we work
      with to be good. However, use of agencies also can mean that we are paid a
      lower
      fee for the leads we generate than if we were to source the offers directly
      from
      the advertisers. This is so because the advertisers pay an agency fee to the
      agencies, which is calculated as a percentage of the total fee payable for
      the
      leads we deliver, and which have the effect of reducing the fee we get paid
      by
      the sum the advertiser must pay the agency. In addition, use of an agency as
      an
      intermediary between the advertiser and us inhibits or prevents the development
      of direct personal relationships with the advertiser. In the absence of direct
      personal relationships the potential for account retention and expansion can
      be
      limited or eliminated entirely. Finally, our policy is to not sign contracts
      with agencies that prohibit or restrict our ability to contract directly with
      the advertisers we source through them or to contract with other agencies to
      source the same offers from the same advertisers as we source through the first
      agency. There are no agency contracts currently in place with such limitations.
      Going forward, we intend to place a greater emphasis on developing direct
      relationships with advertisers and their agencies of record in 2006 and
      beyond.




*Publisher*  *Base
      Development*




We
      have a
      dedicated business development team who target and offer web sites the
      opportunity to participate in the Aptimus Network. Since our preferred
      transaction-oriented placements are not the more traditional banner and
      skyscraper placements sought by other ad networks, we have learned that the
      publisher sales process can take weeks or even months to complete from initial
      contact to the date our offers are live on the publisher’s site. Our business
      development employees work closely with our publishers and potential publishers
      to determine the most advantageous offer placements and presentation formats,
      often monetizing previously untapped content and traffic. Our technology
      platform continually and dynamically analyzes consumer response to offers
      presented on each publisher web site in order to optimize results on each of
      those sites. We also experiment with multiple overall presentation formats
      and
      placements in an attempt to enhance revenues for our publishers.




9


**Operations
      and Technology**




We
      have
      implemented a broad array of offer presentation, dynamic optimization, customer
      service, transaction processing and reporting systems using both proprietary
      and
      licensed technologies. The Aptimus Network resides on a proprietary platform
      that is flexible, reliable and scalable. The proprietary elements of our
      platform we have developed over the past five years include our database
      configurations, our data models and the software code we have written that
      retrieves, analyzes and assigns random values to user, offer and placement
      information, and distributes offers based on that analysis and random
      valuation. **** Together
      we term this combination of proprietary software code, data modeling and
      database architecture our offer rotation engine and the resulting process
      Dynamic Revenue Optimization. We believe that our system can support millions
      of
      consumers and large numbers of advertiser clients and web site distribution
      publishers. Our proprietary network has been developed using both data and
      process engineering approaches to ensure a comprehensive and reliable
      architecture. We have filed a non-provisional patent application with the US
      Patent and Trademark Office that covers our proprietary offer rotation engine
      as
      a whole as well as its various unique component parts. However, the proprietary
      elements of our platform will remain proprietary whether or not the US Patent
      and Trademark Office accepts our application and issues the requested business
      method patent. The Aptimus Network technology has been created with four
      foundation goals in mind:




*Flexibility:* The
      network is built entirely in Java, HTML, and XML, and is intended to run across
      all platforms and networks.




*Compatibility:* To
      support the network, we have designed our offer presentation formats to scale
      easily across publisher web sites with a minimum of technical integration
      required. Since our platform is based on standard open-source code, we have,
      to
      date, not encountered any systems incompatibility issues with our clients or
      publishers. Our offer page is extremely easy for our publishers to implement.
      Our engineers provide them with a line of code, which typically takes less
      than
      an hour for them to fully integrate into their system.




*Reliability:* We
      have
      conducted millions of paid transactions, such as leads, and clicks, across
      our
      network of publisher sites with a negligible failure rate. All our data
      transfers are conducted according to industry-standard security protocols,
      including Secure Sockets Layer (SSL). In the past four years, we have never
      encountered an outage exceeding three hours. However, in the event of a
      longer-term outage in the future, our system is designed to cache incoming
      data,
      which can then be processed when our system functionality is
      restored.




*Scalability:* All
      of
      our technologies are designed for rapid, complete deployment across a large
      number of distribution publishers. With our single point implementation process,
      new offers are built quickly and efficiently and go live simultaneously across
      all our network placements. We have to date not encountered any challenges
      or
      limitations to our ability to scale our technology infrastructure to meet the
      demands of our growing network. We believe that we can support up to five times
      the current traffic.




The
      Aptimus Network technology has been designed to evolve with the business and
      the
      Internet marketplace.




**Competition**




While
      we
      believe that our Dynamic Revenue Optimization technology offers us a significant
      advantage over any potential competition in the transaction-based environments
      we prefer, we nonetheless face competition from other online advertising and
      direct marketing networks for client advertising budgets. Other online
      advertising networks and performance based marketing providers that advertisers
      might work with include ValueClick, Google, Q Interactive (f/k/a/CoolSavings),
      QuinStreet, aZoogle, Adteractive, aQuantive, Ask.com, Miva and Advertising.com.
      The online lead generation space saw increased competition in 2005, particularly
      in respect to “high value” ad inventory paying $10 or more per lead. It also saw
      heightened demand from advertisers, particularly those with high value lead
      inventory, for an increase in the “quality” of the leads delivered to them. In
      this respect, the advertisers’ quality demands included both accuracy in respect
      to the data itself - for example, valid email and postal addresses and telephone
      numbers - as well as the interest level of the user selecting the offer - for
      example, users who have affirmatively selected an offer as opposed to being
      forced by the process to select the offer. We expect these trends to continue
      in
      the future. In response to these challenges, Aptimus terminated several
      relationships with publishers whose site traffic the Company concluded was
      incompatible with the quality requirements of our advertisers. We also added
      several additional automated data validation processes that are both scalable
      and unique to Aptimus that the Company believes differentiates us favorably
      from
      the competition




10


We
      also
      compete indirectly for Internet advertising revenues in general with large
      Web
      publishers and Web portals, such as America Online, Microsoft Network, and
      Yahoo!, all of whom would also be strong distribution publishers for the Aptimus
      Network.




**Seasonality**




We
      are
      subject to seasonal and cyclical fluctuations from both the clients and
      publishers within our network. Web site publishers are less likely to integrate
      our network solution into their transaction-based processes during their busiest
      revenue periods. The fourth quarter of each year will typically be the busiest
      period for most of our targeted publishers. Some publishers also buy media
      to
      drive traffic to their sites. These media buys will often fluctuate with the
      season, resulting in higher traffic volumes during the publishers’ peak media
      buying activities. Additionally, on the client side of our network, many
      advertisers generally increase their customer acquisition efforts in the third
      quarter and early fourth quarter more than at any other time of the year. Other
      clients generally increase their expenditures on advertising in the third and
      fourth quarters of their fiscal year, which typically end either on December
      31
      or June 30 of each calendar year. Further, in the United States Internet user
      traffic typically subsides during the summer months. Expenditures by advertisers
      also tend to reflect overall economic conditions as well as individual budgeting
      and buying patterns of advertisers.




**Significant
      Customers**




For
      the
      years ended December 31, 2005, 2004 and 2003 our ten largest clients accounted
      for 50.0%, 63.9% and 61.7% of our revenues, respectively. For the year ended
      December 31, 2005 one client accounted for more than 10% of our revenues. This
      client, Adteractive accounted for 10.2% of our revenues in 2005. For the year
      ended December 31, 2004 two clients accounted for more than 10% of our revenues.
      These clients, Advertising.com and Quinstreet accounted for 20.2% and 12.3%,
      respectively, of our revenues in 2004. For the year ended December 31, 2003
      two
      clients accounted for more than 10% of our revenues. These clients, Proctor
      & Gamble and Advertising.com accounted for 13.6% and 10.1%, respectively, of
      revenues during 2003.




Over
      the
      past year we have sought to work with larger clients with bigger ad budgets.
      This has resulted in the percentage of our revenues derived from our 10 largest
      clients remaining relatively high. We expect our revenues to be composed of
      a
      similar mix of large and small advertiser clients in the immediate
      future.




**Intellectual
      Property**




We
      regard
      our copyrights, service marks, trademarks, pending patents, trade secrets,
      proprietary technology and similar intellectual property as critical to our
      success, and we rely on trademark, patent and copyright law, trade secret
      protection and confidentiality and license agreements with our employees,
      customers, independent contractors, publishers and others to protect our
      intellectual property rights. We have registrations of the trademark “Aptimus”
and the Centaur design in the United States, both of which will expire in 2013
      if we do not renew them prior to that time. We have registrations for the
      trademark “Aptimus” in Australia, Canada, China, and New Zealand, which will
      respectively expire in 2010, 2019, 2012 and 2007 if we do not renew them prior
      to their respective expiration dates. And we have a pending registration of
      the
      trademark “Aptimus” in the European Union. We also have a pending
      non-provisional business method patent application in the United States and
      under the Patent Cooperation Treaty for protection in the PCT member states
      that
      covers our proprietary offer rotation engine as a whole as well as its various
      unique component parts. Our intellectual property rights have broad application
      across all of our business activities.




11


We
      have
      registered a number of domain names, including aptimus.com among others.
      Internet regulatory bodies regulate domain names. The regulation of domain
      names
      in the United States and in foreign countries is subject to change in the
      future. Regulatory bodies could establish additional top-level domains, appoint
      additional domain name registrars or modify the requirements for holding domain
      names. The relationship between regulations governing domain names and laws
      protecting trademarks and similar intellectual property rights is unclear.
      Therefore, we could be unable to prevent third parties from acquiring domain
      names that infringe on or otherwise decrease the value of our trademarks and
      other proprietary rights.




We
      may be
      required to obtain licenses from others to refine, develop, market and deliver
      new services. We may be unable to obtain any such license on commercially
      reasonable terms, if at all, or guarantee that rights granted by any licenses
      will be valid and enforceable. We currently hold perpetual licenses to “off the
      shelf” software programs developed and distributed by the following vendors:
      Oracle, Veritas, eGain, Embarcadero, Dell, Sun, Hitachi, Cisco, Foundry, Network
      Associates and Microsoft. We will be entitled to periodic updates to such
      programs provided we continue to pay yearly maintenance fees for each. Except
      for our Microsoft Office application where we do not feel paying for annual
      maintenance services is necessary or useful, we are currently paying yearly
      maintenance fees for all of the software programs that we currently use and
      have
      no current plans to cease paying such yearly maintenance fees. However, if
      we do
      elect to cease making such maintenance payments for a particular program, we
      may
      no longer be entitled to receive future updates, if any, to that software issued
      by the copyright holder, nor will we be entitled to free technical support
      service in the event the need for such support arises.




**Financial
      Information About Geographic Areas**




For
      the
      years ended December 31, 2005, 2004, and 2003 revenues attributable to the
      United States have been $15.9 million, $14.0 million, and $4.6 million, or
      100%
      in each year. For the past three fiscal years all long-lived assets of the
      Company have been located in the United States.




**Employees**




As
      of
      February 28, 2006, we had a total of 48 employees. The current employee mix
      includes 33 in sales and marketing, 9 in technology and development, and 6
      in
      finance and administration. Unions represent none of our employees. We consider
      relations with our employees to be good.




**Item
      1A:** ***Risk
      Factors***




**RISKS
      RELATED TO OUR BUSINESS**




***We
      generate substantially all of our revenue from advertising, and the reduction
      in
      spending by or loss of advertisers or publishers could materially reduce our
      revenues.***




We
      derive
      substantially all of our revenues from fees paid by our advertiser clients
      for
      results-based advertisements displayed on our publishers’ web sites. Our
      advertiser clients and publishers can generally terminate their contracts with
      us at any time on thirty (30) days prior notice or less. Advertisers will not
      continue to do business with us if their investment in advertising with us
      does
      not generate sales leads and, ultimately, customers, or if we fail to deliver
      their advertisements in an appropriate and effective manner. Publishers will
      not
      renew their contracts with us if we fail to generate revenue from the
      advertisements we place on their sites. If we are unable to remain competitive
      and provide value to our advertisers and publishers, they may stop placing
      advertisements with us or allowing us to display advertisements on their web
      sites, which would adversely affect our revenues.




12


***A
      limited number of advertisers accounted for a significant percentage of our
      revenues in 2005 and the loss of one or more of these advertisers could cause
      our revenues to decline.***




For
      the
      year ended December 31, 2005, revenues from our two largest advertiser clients
      accounted for 18.2% of our total revenues. For the year ended December 31,
      2005
      our largest client, Adteractive, Inc., accounted for 10.2% of our total revenue.
      We anticipate that a limited number of clients collectively will continue to
      account for a significant portion of our revenues for the foreseeable
      future. **** Key
      factors in maintaining our relationships with these clients include our
      performance on individual campaigns, the quality of the results we generate
      for
      these clients, and the relationships of our sales employees with client
      personnel. To the extent that our performance does not meet client expectations,
      or the reputation of our data quality or relationships with one or more major
      clients are impaired such that they reduce or eliminate use of our services,
      our
      revenues could decline significantly and our operating results could be
      adversely affected.





One
      of
      our clients, Prospective Direct, Inc., is an advertising network with whom
      we
      also compete for advertisers. We maintain short-term, renewable contracts that
      Prospective Direct, Inc. may at some point elect not to renew. In addition
      to
      the factors noted above, circumstances that may cause Prospective Direct, Inc.
      not to renew its contracts with us include a desire by Prospective Direct,
      Inc.
      not to contract directly with a competitor. If Prospective Direct, Inc. elects
      not to renew its contracts with us, our revenues could decline and our operating
      results could be adversely affected.




***A
      limited number of publishers accounted for a significant percentage of our
      user
      leads in 2005 and the loss of one or more of these publishers could cause our
      revenues to decline.***




For
      the
      year ended December 31, 2005, user leads from our five largest website
      publishers accounted for 29.4% of our total revenue, with the top two publishers
      accounting for 10.6% and 5.9% of revenues, respectively. We anticipate that
      a
      limited number of publishers collectively will continue to account for a
      significant portion of our lead volume for the foreseeable future. **** Key
      factors in maintaining our relationships with these distributors include the
      performance of our individual placements on their respective sites, the total
      revenues we generate for each of these publishers, and the relationships of
      our
      business development employees with publisher personnel. Of this group of
      publishers, all but one can terminate its contract with us at any time on thirty
      (30) days prior notice or less. The other publisher has a contract with an
      auto-renewing, one-year term. To the extent that our performance does not meet
      publisher expectations, or that the publishers source alternative, higher paying
      advertising placements from competitive third-party networks or directly from
      advertisers such that they reduce or eliminate use of our services, our lead
      volume and, in turn, our revenues could decline significantly and our operating
      results could be adversely affected.




***We
      face intense and growing competition, which could result in price reductions,
      reduced operating margins and loss of market share.***




The
      market for Internet advertising and related services is highly competitive.
      If
      we fail to compete effectively against other Internet advertising service
      companies, we could lose advertising clients or publishers and our revenues
      could decline **.** We
      expect
      competition to continue to increase because there are no significant barriers
      to
      entry. Our principal competitors include other on-line companies that provide
      advertisers with results-based advertising services, including advertising
      networks such as Google, aQuantive, Q Interactive (f/k/a CoolSavings),
      Advertising.com, QuinStreet and ValueClick. In addition, we compete with large
      interactive media companies with strong brand recognition, such as AOL,
      Microsoft and Yahoo!, that sell advertising inventory directly to advertisers.
      We also compete with traditional advertising media, such as direct mail,
      television, radio, cable and print, for a share of advertisers’ total
      advertising budgets.




13


Many
      current and potential competitors have advantages over us, such as longer
      operating histories, greater name recognition, larger client bases, greater
      access to advertising space on high-traffic web sites, and significantly greater
      financial, technical, marketing and human resources. These companies can use
      their experience and resources against us in a variety of competitive ways,
      including by making acquisitions, investing more aggressively in research and
      development and competing more aggressively for advertisers and publishers
      through increased marketing or other promotions. In addition, existing or future
      competitors may develop or offer services that provide significant performance,
      price, creative or other advantages over those offered by us.




Current
      and potential competitors may merge or establish cooperative relationships
      among
      themselves or with third parties to improve the ability of their products and
      services to address the needs of our clients and publishers and prospective
      clients and publishers. As a result, new competitors may emerge that may rapidly
      acquire significant market share as well as place significant downward pressure
      on the pricing of our services.





In
      addition, current and potential clients and publishers have or may establish
      products and services that are competitive with ours, or that better serve
      their
      own internal needs or the needs of others. For example, a number of our
      competitors for advertisers, including, QuinStreet, Advertising.com and
      ValueClick, are also clients of ours. As a result, current clients and
      publishers may choose to terminate their contracts with us and potential clients
      and publishers may choose not to contract for our products and services or
      to
      contract with one of our competitors.




If
      we
      fail to compete successfully, we could have difficulties attracting and
      retaining advertising clients and publishers, which may decrease our revenues
      and adversely affect our operating results. Increased competition may also
      result in price reductions that cannot be offset by cost reductions resulting
      in
      substantial decreases in operating income.




***Our
      revenues would decline or stagnate if the market for results-based Internet
      marketing services fails to grow.***




Our
      services are offered to advertisers using results-based pricing models. The
      market for results-based Internet advertising remains at a relatively early
      stage, and the viability and profitability of this market is unproven. If
      advertisers conclude that results-based marketing services are not profitable
      or
      fail to achieve their customer acquisition goals, the Internet advertising
      market could move away from these services, and our revenues could decline
      or
      stagnate.




***We
      depend on interactive publishers for inventory to display our clients’
advertising, and any decline in the supply of advertising inventory available
      through our network could cause our revenues to decline.***




Most
      of
      the web sites and search engines on whose pages, and before whose users, our
      advertising is displayed are not bound by long-term contracts that ensure us
      a
      consistent supply of advertising inventory. We generate a significant portion
      of
      our revenues from the advertising inventory provided by a limited number of
      publishers. In many instances, publishers can change the amount of inventory
      they make available to us at any time. In addition, publishers may place
      reasonable restrictions on our use of their advertising inventory. These
      restrictions may prohibit advertisements from specific advertisers or specific
      industries, or restrict the use of certain creative content or format. If a
      publisher decides not to make inventory available to us, or decides to increase
      the cost, or places significant restrictions on the use of such inventory,
      we
      may not be able to replace this with inventory from other publishers that
      satisfy our requirements in a timely and cost-effective manner. As a result,
      we
      may be unable to place advertisements in high value positions and advertisers
      may be dissuaded from using our services. In addition, we may find it necessary
      to pay a substantially larger fee to publishers to maintain advertising
      inventory. If this happens, our revenues could decline or our cost of acquiring
      inventory may increase.




14


***We
      have a short operating history as an advertising network business and a
      relatively new business model in an emerging and rapidly evolving market. This
      makes it difficult to evaluate our future prospects and may increase the risk
      of
      your investment.***




We
      first
      derived revenue from our advertising network business in late 2000. However,
      our
      advertising revenues were not 100% attributable to our results-based advertising
      network model until the second quarter of 2002. We introduced our current
      technology platform on which our model is based in June of 2002. Furthermore,
      the balance between our network publisher and former email distribution channels
      changed significantly in the past years reflecting both the public’s negative
      perception of commercial email solicitation, as well as our concerted efforts
      to
      expand our network of web site publishers during this period. And we suspended
      indefinitely our email business in its entirety in the fourth quarter of 2005.
      As a result, we have relatively little operating history as a results-based
      advertising network business for you to evaluate in assessing our future
      prospects. Also, we derive substantially all of our revenues from online
      advertising, which is an immature industry that that continues to undergo rapid
      and dramatic change. You must consider our business and prospects in light
      of
      the risks and difficulties we will encounter with a relatively immature business
      model in a new and rapidly evolving market. As a result, management may need
      to
      devote substantial time and effort to refining our business model. Such efforts
      may distract it from other aspects of our business such as growing the publisher
      base or attracting more advertising clients. In addition, due to the changes
      in
      our business model, our historic financial statements provide very limited
      guidance as to the current structure of our business, particularly the financial
      statements predating the second half of 2002.




***New
      technologies could block or filter our ads, which could reduce the effectiveness
      of our services and lead to a loss of customers.***




Technologies
      may be developed that can block the display of our ads. We derive substantially
      all of our revenues from fees paid to us by advertisers in connection with
      the
      display of ads on web pages. Any ad-blocking technology could severely restrict
      the number for advertisements that we are able to place before consumers
      resulting in a reduction in the attractiveness of our services to advertisers.
      If advertisers determine that our services are not providing substantial value,
      we may suffer a loss of clients. As a result, ad-blocking technology could,
      in
      the future, substantially decrease the number of ads we place resulting in
      a
      decrease in our revenues.




***We
      have to keep up with rapid technological change to continue offering our
      advertising clients competitive services or we may lose clients and be unable
      to
      compete.***




Our
      future success will depend on our ability to continue delivering our advertising
      clients and publishers competitive results-based Internet marketing services.
      In
      order to do so, we will need to adapt to rapidly changing technologies, to
      adapt
      our services to evolving industry standards and to improve the performance
      of
      our services. Our failure to adapt to such changes would likely lead to a loss
      of clients or a substantial reduction in the fees we are able to charge versus
      competitors who have more rapidly adopted improved technology. Any loss of
      clients or reduction of fees would adversely impact our revenue. In addition,
      the widespread adoption of new Internet technologies or other technological
      changes could require substantial expenditures to modify or adapt our services
      or infrastructure. If we are unable to pass all or part of these costs on to
      our
      clients, our margins and, therefore, profitability will be reduced.




15


***Because
      our advertiser client and publisher contracts generally can be cancelled by
      the
      client or publisher with little or no notice or penalty, the termination of
      one
      or more large contracts could result in an immediate decline in our revenues.***




We
      derive
      substantially all of our revenues from marketing services under short-term
      insertion order contracts with advertising clients and web site publishers,
      approximately 75% of which may be cancelled upon thirty (30) days or less
      notice. In addition, the client contracts generally do not contain penalty
      provisions for cancellation before the end of the contract term. The short
      contract terms in general reflect the limited timelines, budgets and customer
      acquisition goals of specific advertising campaigns and are consistent with
      industry practice. The non-renewal, re-negotiation, cancellation or deferral
      of
      large contracts or a number of contracts that in the aggregate account for
      a
      significant amount of revenues, could cause an immediate and significant decline
      in our revenues and harm our business.




***If
      our advertisers, publishers or we fail to comply with regulations governing
      consumer privacy, we could face substantial liability and incur significant
      litigation and other costs.***




Our
      collection, maintenance and use of information regarding Internet users could
      result in lawsuits or government inquiries. These actions may include those
      related to U.S. federal and state legislation limiting the ability of companies
      like ours to collect, receive and use information regarding Internet users
      and
      to distribute commercial emails. In addition, we cannot assure you that our
      advertiser clients, web site publishers and email list owners are currently
      in
      compliance, or will remain in compliance, with their own privacy policies,
      regulations governing data collection or consumer privacy or other applicable
      legal requirements. We may be held liable if our clients use our technology
      or
      the data we collect on their behalf, or they collect in a process initiated
      by
      us, in a manner that is not in compliance with applicable laws or regulations
      or
      their own stated privacy policies. Litigation and regulatory inquiries are
      often
      expensive and time-consuming and their outcome is uncertain. Any involvement
      by
      us in any of these matters may require us to:




·
            spend
                significant amounts on our legal defense;




·
            divert
                the attention of senior management from other aspects of our business;




·
            defer
                or cancel new product or service launches as a result of these claims
                or
                proceedings; and




·
            make
                changes to our present and planned products or services.




As
      a
      result of any of the foregoing, our revenues may decrease and our expenses
      may
      increase substantially.




***Changes
      in government regulation or industry standards applicable to the Internet could
      decrease the demand for our services and increase our costs of doing business.***




Our
      business is subject to existing laws and regulations that have been applied
      to
      Internet communications, commerce and advertising. New laws and regulations
      may
      restrict specific Internet activities, and existing laws and regulations may
      be
      applied to Internet activities, either of which could increase our costs of
      doing business over the Internet and adversely affect the demand for our
      advertising services. In the United States, federal and state laws already
      apply
      or may be applied in the future to areas, including children’s privacy,
      copyrights, taxation, user privacy, search engines, Internet tracking
      technologies, direct marketing, data security, pricing, sweepstakes, promotions,
      intellectual property ownership and infringement, trade secrets, export of
      encryption technology, acceptable content and quality of goods and services.




The
      European Union has adopted directives that may limit our ability to collect
      and
      use information regarding Internet users in Europe. The effectiveness of our
      Dynamic Revenue Optimization algorithm and database configuration could be
      limited by any regulation restricting the collection or use of information
      regarding Internet users. Furthermore, due to the global nature of the Internet,
      it is possible that although our transmissions originate in particular states,
      governments of other states or foreign countries might attempt to regulate
      our
      transmissions or levy sales or other taxes relating to our activities. In
      addition, the growth and development of the market for Internet commerce may
      prompt calls for more stringent consumer protection laws, both in the United
      States and abroad, that may impose additional burdens on companies conducting
      business over the Internet. Such legislation, if adopted, could hinder the
      growth in the use of the Internet generally and decrease the acceptance of
      the
      Internet as a communications, commercial and advertising medium.




16


In
      addition to government regulation, privacy advocacy groups and the technology
      and direct marketing industries may consider various new, additional or
      different self-regulatory standards applicable to the Internet. Governments,
      trade associations and industry self-regulatory groups may enact more burdensome
      laws, regulations and guidelines, including consumer privacy laws, affecting
      our
      clients, publishers and us, which could harm our business by increasing
      compliance costs or limiting the scope of our business.




***We
      have a history of losses and we have an accumulated deficit of $59.6
      million.***




We
      incurred net losses of $17.9 million, or more than 9.5 times the amount of
      our
      revenues, for the year ended December 31, 2001, $5.5 million, or more than
      1.9
      times the amount of our revenues, for the year ended December 31, 2002, and
      $1.5
      million, or one-third the amount of our revenues for the year ended December
      31,
      2003. As of December 31, 2005, our accumulated deficit was $59.6 million. Even
      though we have achieved profitability for the last two fiscal years, we may
      be
      unable to sustain profitability on a quarterly or annual basis in the future.
      In
      the three months ended December 31, 2005 we incurred net operating losses of
      $288,000. It is possible that our revenues will grow more slowly than we
      anticipate or that operating expenses will exceed our expectations.




***We
      may need additional financing at some point in the future, without which we
      may
      be required to restrict or discontinue our
      operations.***




We
      anticipate that our available cash resources will be sufficient to meet our
      currently anticipated capital expenditures and working capital requirements
      indefinitely. In the event our cash from operations does not meet or exceed
      our
      capital expenditure and working capital requirements, we may need to raise
      additional funds to continue operation. In addition, we may need to raise
      additional funds to develop or enhance our services or products, fund expansion,
      respond to competitive pressures or acquire businesses or technologies.
      Unanticipated expenses, poor financial results or unanticipated opportunities
      that require financial commitments could give rise to earlier financing
      requirements. If we raise additional funds through the issuance of equity or
      convertible debt securities, the percentage ownership of our existing
      shareholders would be reduced, and these securities might have rights,
      preferences or privileges senior to those of our common stock. Additional
      financing may not be available on terms favorable to the Company, or at all.
      If
      adequate funds are not available or are not available on acceptable terms,
      our
      ability to fund our expansion, take advantage of business opportunities, develop
      or enhance services or products or otherwise respond to competitive pressures
      would be significantly limited, and we might need to significantly restrict
      or
      discontinue our operations.




***Our
      quarterly operating results are uncertain and may fluctuate significantly,
      which
      could negatively affect the value of our share price.***




Our
      operating results have varied significantly from quarter to quarter in the
      past
      and may continue to fluctuate. For example, during the year ended December
      31,
      2005, the percentage of annual revenues attributable to the first, second,
      third
      and fourth quarters were 24.2%, 28.2%, 24.4% and 23.2%, respectively and for
      the
      year ended December 31, 2004, the percentage of annual revenues attributable
      to
      the first, second, third and fourth quarters were 12.9%, 21.3%, 31.7% and 34.1%,
      respectively.




17


Our
      limited operating history under our new business model also makes it difficult
      to ascertain the effects of seasonality and cyclicality on our business. You
      should not rely on period-to-period comparisons of our operating results as
      an
      indication of our future performance. Factors that may affect our quarterly
      operating results include the following:




·
            the
                addition of new clients or publishers or the loss of existing clients
                or
                publishers;




·
            the
                addition of new services or the limitation or loss of existing services;




·
            changes
                in demand and pricing for our services;




·
            changes
                in the volume, cost and quality of publisher and email database inventory
                available to us;




·
            the
                timing and amount of sales and marketing expenses incurred to attract
                new
                advertisers and publishers;




·
            changes
                in our pricing policies, the pricing policies of our competitors
                or the
                pricing of Internet advertising generally;




·
            changes
                in governmental regulation of the Internet itself or advertising
                on the
                Internet;




·
            changes
                in the health of the overall economy;




·
            timing
                differences at the end of each quarter between our payments to publishers
                and our collection of related revenues from advertisers; and




·
            predicted
                or unpredicted costs related to operations and corporate activities.




Because
      our business continues to change and evolve, our historical operating results
      may not be useful in predicting our future operating results. In addition,
      advertising spending has historically been cyclical in nature, reflecting
      overall economic conditions as well as budgeting and customer acquisition
      patterns. For example, in 1999 and 2000, advertisers spent heavily on Internet
      advertising. This was followed by a lengthy downturn in Internet ad spending.
      We
      also shifted the focus of our business from being web site-based to
      network-based during this period, which caused our revenues to decline below
      the
      expectations of securities analysts and investors as a web site-based business.
      Furthermore, spending by some advertisers tends to be seasonal, with larger
      portions of their ad budgets dedicated to customer acquisition efforts in the
      third and fourth quarters of the calendar year. We anticipate that cyclicality
      and seasonality of our business will continue in the future causing our
      operating results to fluctuate.





For
      these
      reasons, comparing our operating results on a period-to-period basis may not
      be
      meaningful, and you should not rely on past results as an indication of future
      performance. Quarterly and annual expenses as a percentage of revenues may
      be
      significantly different from historical or projected rates. These lower
      operating results may cause a decrease in our stock price.




***We
      may be liable for content in the advertisements we deliver for our clients
      resulting in unanticipated legal costs.***




We
      may be
      liable to third parties for content in the advertising we deliver if the
      artwork, text or other content involved violates copyrights, trademarks or
      other
      third-party intellectual property rights or if the content is defamatory.
      Although substantially all of our contracts include both warranties from our
      advertisers that they have the right to use and license any copyrights,
      trademarks or other intellectual property included in an advertisement and
      indemnities from our advertisers in the event of a breach of such warranties,
      a
      third party may still file a claim against us. Any claims by third parties
      against us could be time-consuming, could result in costly litigation and
      adverse judgments. Such expenses would increase our costs of doing business
      and
      reduce our net income per share. In addition, we may find it necessary to limit
      our exposure to such risks by accepting fewer or more restricted advertisements
      leading to loss of revenue.




18


***The
      loss of the services of any of our executive officers or key personnel would
      likely cause our business to suffer.***




Our
      future success depends to a significant extent on the efforts and abilities
      of
      our senior management and certain key employees. The loss of the services of
      any
      of these individuals could result in harm to key client or publisher
      relationships, loss of key information, expertise or know-how and unanticipated
      recruitment and training costs. Circumstances that may lead to a loss of such
      individuals include his recruitment and hiring by an entity inside or outside
      the industry, his voluntary termination of employment to pursue alternative
      career or personal opportunities, and the illness or death of the individual
      or
      a member of his immediate family. We may be unable to attract, motivate and
      retain other key employees in the future. We have, in the past, and may in
      the
      future, experienced difficulty in hiring qualified personnel. We do not have
      employment agreements with any of our key personnel, nor do we have key-person
      insurance for any of our employees. The loss of the services of our senior
      management or other key employees could make it more difficult to successfully
      operate our business and pursue our business goals.




***Decreased
      effectiveness of equity compensation could adversely affect our ability to
      attract and retain employees and changes in accounting rules will adversely
      affect our earnings.***




We
      have
      historically used stock options as a key component of our total employee
      compensation program in order to align employees’ interests with the interests
      of our stockholders, encourage employee retention, and provide competitive
      compensation packages. Volatility or lack of positive performance in our stock
      price may adversely affect our ability to retain key employees, all of who
      have
      been granted stock options, or attract additional highly qualified personnel.
      Recently granted outstanding employee stock options have exercise prices in
      excess of our current stock price. To the extent these circumstances continue
      or
      recur, our ability to retain present employees may be adversely affected. In
      addition, the Financial Accounting Standards Board has adopted changes to
      Generally Accepted Accounting Principles that will require an expense to be
      recorded for employee stock option grants and other equity incentives, as of
      January 1, 2006. And applicable Nasdaq stock exchange listing standards require
      stockholder approval of equity compensation plans, which will make amending
      current stock option plans to accommodate equity incentive arrangements with
      reduced expense potential more expensive, time consuming and, ultimately,
      uncertain. As a result, in addition to recording additional compensation
      expense, we may incur increased compensation costs, change our equity
      compensation strategy or find it difficult to attract, retain and motivate
      employees, any of which could materially adversely affect our business.




***Acquisitions
      could result in operating difficulties, dilution and other harmful consequences.***




We
      have
      limited experience acquiring companies. The companies we have acquired have
      been
      small. We have evaluated in the past, and may in the future evaluate, potential
      strategic transactions. Any of these transactions could be material to our
      financial condition and results of operations. In addition, the process of
      integrating an acquired company, business or technology may create unforeseen
      operating difficulties and expenditures and may not provide the benefits
      anticipated. The areas where we may face risks include ***:***





·
            difficulties
                integrating operations, personnel, technologies, products and information
                systems of acquired businesses;




19




·
            potential
                loss of key employees of acquired businesses;




·
            adverse
                effects on our results of operations from acquisition-related charges
                and
                amortization of goodwill and purchased
                technology;




·
            increased
                fixed costs, which could affect profitability;




·
            inability
                to maintain the key business relationships and the reputations of
                acquired
                businesses;




·
            potential
                dilution to current shareholders from the issuance of additional
                equity
                securities;




·
            inability
                to maintain our standards, controls, procedures and
                policies;




·
            responsibility
                for liabilities of companies we acquire; and




·
            diversion
                of management’s attention from other business
                concerns.




Also,
      the
      anticipated benefit of an acquisition may not materialize. Future acquisitions
      could result in the incurrence of debt or write-offs of goodwill. For example,
      our acquisition of XmarksTheSpot.com, Inc. in late 2000 was completed for $1.5
      million in cash, the issuance of 349,202 shares of additional common stock,
      and
      the assumption of $300,000 in outstanding liabilities. The acquisition also
      caused the consumption of our Chief Executive Officer’s, Chief Financial
      Officer’s and General Counsel’s attention at a time of mounting external
      challenges for the company. Subsequently, during 2001, $1.7 million of
      intangible assets recorded related to this acquisition were written
      off.




Incurring
      any of the stated difficulties could result in increased costs and decreased
      revenue. Future acquisitions may require us to obtain additional equity or
      debt
      financing, which may not be available on favorable terms or at all.




***Since
      our stock price is volatile, your ability to sell shares of our stock held
      by
      you at a profit may be impaired, and we may become subject to securities
      litigation that is expensive and could result in a diversion of
      resources.***




The
      market price of our common stock has fluctuated in the past and is likely to
      continue to be highly volatile. Factors affecting the stability of our stock
      price include the limited number of shares held by holders who are not deemed
      company “insiders” (i.e. executive management, directors and holders of in
      excess of 10% of the issued and outstanding shares of common stock), the limited
      trading volume of our common stock on the Nasdaq National Market, the limited
      size of the public market for our common stock, and speculative buying and
      selling of our common stock. In addition, as of December 31, 2005, our employees
      and outside directors held vested options to purchase a total of approximately
      1.6 million shares of our common stock. Significant sales of our common stock
      by
      a significant number of our employees and directors as a result of option
      exercises, could adversely impact the price of our common stock. As a result,
      it
      may be difficult to sell shares of our common stock at a profit. Furthermore,
      securities class action litigation has often been brought against companies
      that
      experience volatility in the market price of their securities. Litigation
      brought against us could result in substantial costs to us in defending against
      the lawsuit and a diversion of management’s attention that could result in
      higher expenses and lower revenue, which may, in turn, further diminish the
      value of your investment.




20


***Our
      chief executive officer holds a substantial portion of our stock, which could
      limit your ability to influence the outcome of key transactions, including
      changes of control.***




As
      of
      December 31, 2005, Mr. Choate beneficially owned approximately 20.1% of our
      issued and outstanding common stock. As a result, the ability of our other
      shareholders to influence matters requiring approval by our shareholders,
      including the election of directors and the approval of mergers or similar
      transactions, could be limited.




***Our
      articles of incorporation, bylaws, change in control agreements and the
      Washington Business Corporation Act contain anti-takeover provisions that could
      discourage or prevent a takeover, even if an acquisition would be beneficial
      to
      our shareholders.***




Provisions
      of our amended and restated articles of incorporation, our bylaws, change in
      control agreements we have entered into with certain of our executive officers,
      and our Shareholder Rights Plan, which provides for the dilutive issuance of
      shares in the event of a hostile takeover bid or similar transaction, could
      make
      it more difficult for a third party to acquire us, even if doing so would be
      beneficial to our shareholders. These provisions include:




·
            authorizing
                the issuance of “blank check” preferred stock that could be issued by our
                board of directors, without shareholder approval, to increase the
                number
                of outstanding shares or change the balance of voting control and
                thwart a
                takeover attempt;




·
            prohibiting
                cumulative voting in the election of directors, which would otherwise
                allow less than a majority of shareholders to elect directors;




·
            declaration
                of a dividend distribution of preferred share purchase rights and
                adoption
                of a Rights Plan in March 2002, which would discourage a change of
                control
                attempt without the approval of the Board of Directors;
                and




·
            under
                change in control agreements between the company and each of Messrs.
                Choate, Wade, Davis, Nelson, Wrubel, Benz and Mayor in the event
                of a sale
                or merger of the company that results in the termination of the
                executive’s employment, the executive will receive a severance payment
                equal to six months of his base salary (Messrs. Benz and Mayor),
                eight
                months of his base salary (Messrs. Wrubel, Wade, Davis and Nelson)
                or
                one-year of his base salary (Mr. Choate). As of December 31, 2005,
                the
                aggregate total of such severance payments equals $856,333. In addition,
                100% of the unvested portion of any stock options held by the individual
                executive at the time of his termination will automatically vest
                and
                become exercisable.




Chapter
      23B.19 of the Washington Business Corporation Act imposes restrictions on
      transactions between corporations and significant shareholders unless such
      transactions are approved by a majority of the corporation’s board of directors
      prior to the time that such shareholders acquire 10% or more of the outstanding
      stock. In addition, under the terms of our stock option plan a change of control
      will trigger accelerated vesting of options unless the acquiring company assumes
      the options or grants comparable options. These factors may discourage, delay
      or
      prevent a change in control, which certain shareholders may favor.




***An
      increase in the number of orders on our network may strain our systems or those
      of our third-party service providers, and we are vulnerable to system
      malfunctions or failures.***




Any
      serious or repeated problems with the performance of our network could lead
      to
      the dissatisfaction of consumers, our clients or our publishers. The order
      volume on our network is expected to increase over time as we seek to expand
      our
      client, consumer and publisher base. The proprietary and third-party systems
      that support our network must be able to accommodate an increased volume of
      traffic. Although we believe our systems and those of our third-party hosting
      service providers in their current configuration can accommodate at least five
      times current order volumes, our network has, in the past, experienced slow
      response times and brief outages. Slow response times and outages can be caused
      by technical problems with our Internet service providers, denial of service
      attacks, network router, firewall or switch failures, database server failures,
      storage area network failures, and natural disasters. Except for a four-hour
      system failure caused by a computer hardware malfunction at our Internet service
      provider in early 2004, we have not experienced any system failures or slow
      downs exceeding two hours in length. We may experience similar problems in
      the
      future that could interrupt traffic on our network and lead to the loss of
      fees.
      In addition, if we experience a high volume of interruptions, advertisers may
      choose to use other providers, leading to a decrease in revenue.




21


Substantially
      all of our contracts specifically exclude liability resulting from computer
      hardware or software failures, third-party systems malfunctions and Internet
      connectivity failure. Furthermore, we do not guarantee system availability
      or
“up time” in any of our contracts. However, a third party may still file a claim
      against us. Any claims by third parties against us could be time-consuming,
      could result in costly litigation and adverse judgments and could require us
      to
      modify or upgrade our operating systems and infrastructure.




***In
      the future we may need to increase the capacity of our operating systems and
      infrastructure to grow our business.***




We
      may
      need in the future to improve and upgrade our operating systems and
      infrastructure in order to support the growth of our operations. Without such
      improvements, our operations might suffer from slow delivery times, unreliable
      service levels or insufficient capacity, any of which could negatively affect
      our reputation and ability to attract and retain advertising clients and
      publishers. We may be unable to expand our systems in a timely fashion, which
      could limit our ability to grow. In addition, the expansion of our systems
      and
      infrastructure will require us to commit financial, operational and technical
      resources before the volume of business the upgraded systems and infrastructure
      are designed to handle materializes. There can be no assurance that the volume
      of business will, in fact, increase. If we improve and upgrade our systems
      and
      the volume of our business does not increase to support the costs, our margins
      may decrease or disappear entirely.




***If
      our users request products and services directly from our clients instead of
      requesting the product or service through us, our revenues may
      decline.***




Our
      advertising clients and/or publishers may offer the same free, trial or
      promotional products or services on their own web sites that we offer via our
      advertising network. Users may choose to request products or services directly
      from our advertising clients and/or publishers instead of requesting the product
      or service through us. Our publisher agreements generally include a
      non-solicitation clause that prohibits our publishers from soliciting the
      business of our advertising clients directly while the publisher is under
      contract with us. However, our client agreements do not contain any restrictions
      on the client’s ability to solicit users directly or through other publishers or
      offer networks. If this happens, our revenues could decline or fail to grow
      and
      our profitability could be adversely affected.




***We
      may need to incur litigation expenses in order to defend our intellectual
      property rights, and might nevertheless be unable to adequately protect these
      rights.***




We
      may
      need to engage in costly litigation to enforce our intellectual property rights,
      to protect our trade secrets or to determine the validity and scope of the
      intellectual property rights of others. We can give no assurance that our
      efforts to prevent misappropriation or infringement of our intellectual property
      will be successful. An adverse determination in any litigation of this type
      could require us to make significant changes to the structure and operation
      of
      our services and features or to license alternative technology from another
      party. Implementation of any of these alternatives could be costly and
      time-consuming and may not be successful. Any intellectual property litigation
      would likely result in substantial costs and diversion of resources and
      management attention.




22


Our
      success largely depends on our trademarks, including “Aptimus,” and internally
      developed technologies, including our opt-in serving business method, which
      includes computer-driven offer rotation and implementation, consumer order
      collection, consumer order processing and lead generation, that we seek to
      protect through a combination of patent, trademark, copyright and trade secret
      laws. Protection of our proprietary business method and trademarks is crucial
      as
      we attempt to build our proprietary advantage, brand name and reputation.
      Despite actions we take to protect our intellectual property rights, it may
      be
      possible for third parties to copy or otherwise obtain and use our intellectual
      property without authorization or to develop similar intellectual property
      independently. In addition, legal standards relating to the validity,
      enforceability and scope of protection of intellectual property rights in
      Internet-related businesses are uncertain and still evolving. In the event
      that
      our pending non-provisional business method patent application is granted,
      we
      may experience difficulty entering this patent. The scope of business method
      patent and the activities that may be deemed to infringe on such patent is
      not
      as clearly defined as device patent rights. As a result, we may face additional
      difficulty enforcing such rights if granted. Although we are not currently
      engaged in any lawsuits for the purpose of defending our intellectual property
      rights, we may need to engage in such litigation in the future. Moreover, we
      may
      be unable to maintain the value of our intellectual property rights in the
      future.




***We
      could become involved in costly and time-consuming disputes regarding the
      validity and enforceability of recently issued or pending
      patents.***




The
      Internet, including the market for e-commerce and online advertising, direct
      marketing and promotion, is characterized by a rapidly evolving legal landscape.
      A variety of patents relating to the market have been recently issued. Other
      patent applications may be pending and yet other patent applications may be
      forthcoming. We have a pending non-provisional business method patent
      application before the United States Patent and Trademark Office and have made
      appropriate filings with certain foreign regulatory bodies preserving our patent
      rights in their jurisdictions, which we intend to prosecute. The patent
      application has been submitted to secure patent rights to our offer serving
      business method, which includes computer-driven, randomized offer rotation
      and
      implementation, consumer order collection, consumer order processing and lead
      generation. We intend to vigorously prosecute the patent application process,
      which may entail substantial expense and management attention.




We
      are
      not presently engaged in any patent-related disputes, nor have we ever been
      accused of infringing another’s patent rights. However, we may incur substantial
      expense and management attention may be diverted if litigation ever does occur.
      Moreover, whether or not claims against us have merit, we may be required to
      enter into license agreements or be subject to injunctive or other equitable
      relief, either of which would result in unexpected expenses that would affect
      our profitability or management distraction that would reduce the time
      management can devote to operational issues.




***We
      may face litigation and liability for information displayed on our network
      or
      that was formerly delivered in an email.***




We
      may be
      subjected to claims for defamation, negligence, copyright or trademark
      infringement and various other claims relating to the nature and content of
      materials we publish on our offer distribution network or distribute by email.
      These types of claims have been brought, sometimes successfully, against online
      services in the past. We could also face claims based on the content that is
      accessible from our network through links to other web sites. In addition,
      we
      may be subject to litigation based on laws and regulations concerning commercial
      email resulting from our discontinued email business. Any litigation arising
      from these claims would likely result in substantial costs and diversion of
      resources and management attention, and an unsuccessful defense to one or more
      such claims could result in material damages and/or injunctive or other
      equitable relief. We have no insurance coverage for these types of claims.




23


***Security
      and privacy breaches could subject us to litigation and liability and deter
      consumers from using our network.***




While
      we
      employ security measures typical of our industry, including encryption
      technology, we could be subject to litigation and liability if third parties
      penetrate our network security or otherwise misappropriate our users’ personal
      or credit card information. This liability could include claims for unauthorized
      purchases with credit card information, impersonation or other similar fraud
      claims. It could also include claims for other misuses of personal information,
      such as for unauthorized marketing purposes. In addition, the Federal Trade
      Commission and other federal and state agencies have investigated various
      Internet companies in connection with their use of personal information. We
      could be subject to investigations and enforcement actions by these or other
      agencies. In addition, we license on a very limited basis customer names and
      street addresses to third parties. Although we provide an opportunity for our
      customers to remove their names from our user list, we nevertheless may receive
      complaints from customers for these license arrangements.




The
      need
      to transmit confidential information securely has been a significant barrier
      to
      electronic commerce and communications over the Internet. Any compromise of
      security could deter people from using the Internet in general or, specifically,
      from using the Internet to conduct transactions that involve transmitting
      confidential information, such as purchases of goods or services. Many marketers
      seek to offer their products and services on our distribution network because
      they want to encourage people to use the Internet to purchase their goods or
      services. Internet security concerns could frustrate these efforts. Also, our
      relationships with consumers may be adversely affected if the security measures
      we use to protect their personal information prove to be ineffective. We cannot
      predict whether events or developments will result in a compromise or breach
      of
      the technology we use to protect customers’ personal information. We have no
      insurance coverage for these types of claims. In addition to direct losses
      from
      claims, if consumers are leery of using our system, we may not be able to
      attract advertisers to our network leading to a decline in
      revenues.




Furthermore,
      our computer servers or those of our third-party service providers, if any,
      may
      be vulnerable to computer viruses, physical or electronic break-ins and similar
      disruptions. We may need to expend significant additional capital and other
      resources to protect against a security breach or to alleviate problems caused
      by any such breaches. We may be unable to prevent or remedy all security
      breaches. If any of these breaches occur, we could lose marketing clients,
      distribution publishers and visitors to our distribution network resulting
      in a
      decline in revenues and, ultimately, profitability.




***Failure
      to timely collect amounts due pursuant to outstanding accounts receivable would
      have a negative impact on our cash position.***




Pursuant
      to our arrangements with our publishers, we make payments for leads generated
      on
      their web sites representing up to 100% of the total amount due prior to
      collecting fees from our advertising clients with respect to such fees. In
      the
      event that we are unable to collect payments due from a substantial number
      of
      our advertising clients in a reasonable time frame, we may be unable to make
      payments when due to our publisher or to other creditors and we may need to
      seek
      short-term financing or other financing means. Any failure to collect amounts
      due in a timely manner would adversely affect our cash position and increase
      our
      costs of operating to the extent we are required to borrow funds to cover any
      shortfalls.




***Consolidation
      among Internet publishers may result in a reduction in available inventory
      for
      ad placement and may increase the pricing power of publishers resulting in
      increased operating expenses.***




While
      we
      believe that the number of websites available for ad placement will continue
      to
      grow, many of the higher traffic sites have experienced consolidation over
      the
      past few years. If significant consolidation of attractive sites continues
      to
      occur, we may face additional difficulties in obtaining high value placements
      for our clients as a result of increased competition for limited space. If
      we
      are unable to provide high value placement to our clients, they may choose
      to
      use the services of a competitor, resulting in lower revenue. In addition,
      large
      publishers may have additional pricing power with respect to ad placement on
      their sites requiring increased expenditures without the guaranty of a
      concomitant increase in revenue. Any such occurrence would negatively impact
      profitability.




24


***We
      may not achieve the levels of revenues anticipated if our Dynamic Revenue
      Optimization system does not function as anticipated.***




Our
      Dynamic Revenue Optimization system is designed to measure every offer in every
      ad position on a revenue generation basis. Then, the offers with greater
      revenues for that specific position should automatically receive more exposure
      there, while lower performing offers receive less exposure. If the Dynamic
      Revenue Optimization system performs as expected, the analytics should be
      continuously updated to quickly identify the performance of new offers and
      to
      adjust and improve the performance of every placement. Revenues per offer are
      determined based on response rate to each offer in each position multiplied
      by
      the fee for that response, whether the advertiser is paying a fee per click,
      a
      fee per lead, a fee per acquisition or based on any other measurable outcome.
      In
      the event that the Dynamic Revenue Optimization system fails to properly place
      advertisements as anticipated or otherwise does not function as anticipated,
      our
      revenue may not achieve anticipated levels and our profitability may
      suffer.




***In
      the event that we suffer a catastrophic data loss, our ability to effectively
      utilize the Dynamic Revenue Optimization system and provide our advertising
      clients user information would be compromised resulting in decreased
      revenue.***




Our
      Dynamic Revenue Optimization system relies on historical data regarding consumer
      response to offers to adjust placement of ads in an attempt to maximize revenue
      generated. In the event that we suffer a catastrophic loss of data due to a
      failure of storage devices, or otherwise, the effectiveness of the Dynamic
      Revenue Optimization system would be substantially reduced until we are able
      to
      recapture the lost data. In addition, if we lose consumer data prior to
      providing it to advertising clients, we will be unable to collect fees with
      respect to such lost leads. Any such event would result in an interruption
      in
      our activities and a loss of revenue.




**RISKS
      RELATED TO OUR INDUSTRY**




***If
      the acceptance of online advertising and online direct marketing does not
      increase, our business will suffer.***




The
      demand for online marketing may not develop to a level sufficient to support
      our
      continued operations or may develop more slowly than we expect. We derive all
      of
      our revenues from contracts with advertiser clients under which we provide
      online marketing services through our offer distribution network. The Internet
      has not existed long enough as a marketing medium to demonstrate its
      effectiveness relative to traditional marketing methods. Advertisers that have
      historically relied on traditional marketing methods may be reluctant or slow
      to
      adopt online marketing. Many advertisers have limited or no experience using
      the
      Internet as a marketing medium. In addition, advertisers that have invested
      substantial resources in traditional methods of marketing may be reluctant
      to
      reallocate these resources to online marketing. Those companies that have
      invested a significant portion of their marketing budgets in online marketing
      may decide after a time to return to more traditional methods if they find
      that
      online marketing is a less effective method of promoting their products and
      services than traditional marketing methods. Moreover, the Internet-based
      companies that have adopted online marketing methods may themselves develop
      more
      slowly than anticipated or not at all. This, in turn, may result in slower
      growth in demand for the online direct marketing services of the type we
      provide.




We
      do not
      know if accepted industry standards for measuring the effectiveness of online
      marketing, particularly of the cost per action model most commonly used by
      us,
      will develop. An absence of accepted standards for measuring effectiveness
      could
      discourage companies from committing significant resources to online marketing.
      Moreover, advertisers may determine that the cost per action pricing model
      is
      less effective in achieving, or entirely fails to achieve, their marketing
      objectives. If the market for Internet advertising fails to continue to develop,
      develops more slowly than we expect, or rejects our primary cost per action
      pricing model, our ability to place offers and generate revenues could be
      harmed.




25


***If
      we are unable to adapt to rapid changes in the online marketing industry, our
      revenues and profitability will suffer.***




Online
      marketing is characterized by rapidly changing technologies, frequent new
      product and service introductions, short development cycles and evolving
      industry standards. We may incur substantial costs to modify our services or
      infrastructure to adapt to these changes and to maintain and improve the
      performance, features and reliability of our services. We may be unable to
      successfully develop new services on a timely basis or achieve and maintain
      market acceptance. In the event our efforts are unsuccessful, we may be unable
      to recover the costs of such upgrades and, as a result, our profitability may
      suffer.




***We
      face risks from potential government regulation and other legal uncertainties
      relating to the Internet.***




Laws
      and
      regulations that apply to Internet communications, commerce and advertising
      are
      becoming more prevalent. The adoption of such laws could create uncertainty
      in
      use of the Internet and reduce the demand for our services, or impair our
      ability to provide our services to clients. Congress has enacted legislation
      regarding children’s privacy on the Internet. In addition, the federal Control
      the Assault of Non-Solicited Pornography and Marketing Act of 2003 (the “CAN
      SPAM Act”), which regulates commercial email practices in the United States, was
      signed into law in December 2003. Additional laws and regulations may be
      proposed or adopted with respect to the Internet covering issues such as user
      privacy, freedom of expression, pricing, content and quality of products and
      services, taxation, advertising, intellectual property rights and information
      security. Passage of the CAN SPAM Act, which preempts state laws regulating
      commercial email, certainly has eliminated some uncertainty in respect to our
      discontinued commercial email practices caused by the various, often conflicting
      state laws. The Act’s effect on our future business will be limited in scope and
      more likely positive than negative to the extent it makes our network business
      more attractive to advertisers and publishers alike, but it may still impact
      any
      legacy claims arising from our former email business. The passage of legislation
      regarding user privacy or direct marketing on the Internet may reduce demand
      for
      our services or limit our ability to provide customer information to marketers.
      Furthermore, the growth of electronic commerce may prompt calls for more
      stringent consumer protection laws. For example, the European Union has adopted
      a directive addressing data privacy that may result in limits on the collection
      and use of consumer information. The adoption of consumer protection laws that
      apply to online marketing could create uncertainty in Internet usage and reduce
      the demand for our services, or impair our ability to provide those services
      to
      clients.




In
      addition, we are not certain how our business may be affected by the application
      of existing laws governing issues such as property ownership, copyrights,
      encryption and other intellectual property issues, taxation, libel, obscenity
      and export or import matters. It is possible that future applications of these
      laws to our business could reduce demand for our services or increase the cost
      of doing business as a result of litigation costs or increased service delivery
      costs.




Our
      services are available on the Internet in many states and foreign countries,
      and
      these states or foreign countries may claim that we are required to qualify
      to
      do business in their jurisdictions. Currently, we are qualified to do business
      only in Washington and California. Our failure to qualify in other jurisdictions
      if we were required to do so could subject us to taxes and penalties and could
      restrict our ability to enforce contracts in those jurisdictions.




**Item
      1B.** ***Unresolved
      Staff Comments***




Not
      applicable




26


**Item
      2:** ***Properties***




We
      currently occupy 4,200 square feet in a leased facility in Seattle, Washington,
      7,653 square feet in a leased facility in San Francisco, California and 1,200
      square feet in a leased facility in Danbury, Connecticut. The current lease
      in
      Seattle expires in May 2009, the current lease in San Francisco expires in
      December 2007 and the current lease in Danbury, Connecticut expires in July
      2006. The leased facilities are adequate for our current needs.




**Item
      3:** ***Legal
      Proceedings***




We
      are
      not engaged in any material litigation at this time.




**Item
      4:** ***Submission
      of Matters to a Vote of Security Holders***




No
      matters were submitted for a vote of our shareholders during the fourth quarter
      of 2005.




27


**PART
      II**




**Item
      5:** ***Market
      For Our Common Equity And Related Stockholder Matters***




**Price
      Range of Common Stock**




Our
      Common Stock was quoted on the Nasdaq National Market under the symbol “FSHP”
from our initial public offering on September 27, 1999 through October 23,
      2000.
      From October 24, 2000 through September 30, 2002, the Common Stock was quoted
      on
      the Nasdaq National Market under the symbol “APTM.” From October 1, 2002 to
      March 6, 2003, the Common Stock was quoted on the Nasdaq Small-Cap Market under
      the symbol “APTM.” From March 7, 2003 through March 16, 2005, the Common Stock
      was traded on the OTCBB under the symbol “APTM.” As of March 17, 2005, the
      Common Stock has traded on the Nasdaq National Market under the symbol “APTM.”
Prior to September 27, 1999, there was no public market for our common stock.
      The following table shows the high and low closing sale prices for our common
      stock as reported on the Nasdaq National Market, the Nasdaq Small-Cap Market
      and
      the OTCBB for the periods indicated:




**High**
            
            **Low****Year
              Ended
              December 31, 2004**First
                quarter
            
            $
            5.88
            
            $
            4.00Second
                quarter
            
            $
            7.50
            
            $
            5.30Third
                quarter
            
            $
            17.68
            
            $
            5.50Fourth
                quarter
            
            $
            27.45
            
            $
            16.76**Year
              Ended
              December 31, 2005**First
                quarter
            
            $
            27.00
            
            $
            16.90****Second
                quarter
            
            $
            22.24
            
            $
            12.96Third
                quarter
            
            $
            20.79
            
            $
            12.30****Fourth
                quarter
            
            $
            14.09
            
            $
            6.15







As
      of
      March 7, 2006 **,** there
      were approximately 211 holders of record of the Common Stock and 6,528,163
      shares of the Common Stock outstanding. The number of holders of record is
      calculated excluding individual participants in securities positions listings.
      The closing price of our shares on March 7, 2006, was $4.96.




We
      have
      never paid cash dividends on the Common Stock and do not intend to pay cash
      dividends on the Common Stock in the foreseeable future. Our board of directors
      intends to retain any earnings to provide funds for the operation and expansion
      of our business.




**Recent
      Sales of Unregistered Securities**




In
      November 2005 41,673 unregistered shares of Common Stock were issued pursuant
      to
      the exercise of warrants to purchase shares of common stock for $0.50 per
      shares, issued in July 2003. The shares were issued in reliance upon the
      exemptions from registration provided by Rule 506 of Regulation D and Section
      4(2) under the Securities Act for sales to accredited investors, as that term
      is
      defined in Rule 501(a) of Regulation D.




Item
      6:
      Selected Financial Data




The
      following selected financial data are qualified in their entirety by reference
      to, and you should read them in conjunction with, our consolidated financial
      statements and the notes thereto and “Management’s Discussion and Analysis of
      Financial Condition and Results of Operations” appearing elsewhere in this
      annual report. The statement of operations data presented below for the years
      ended December 31, 2001, 2002, 2003, 2004 and 2005, and the s elected
      balance sheet data at December 31, 2001, 2002, 2003, 2004 and 2005, are derived
      from Aptimus’ consolidated financial statements that have been audited by Moss
      Adams LLP, independent registered public accounting firm.






28




**Aptimus,
                Inc.****Year
                Ended December 31,****2005**
            
            **2004**
            
            **2003**
            
            **2002**
            
            **2001****Statement
                of Operations Data:**Revenues
            
            $
            15,894
            
            $
            13,993
            
            $
            4,571
            
            $
            2,915
            
            $
            1,874Operating
                expenses:Cost
                of revenues
            
            
            7,316
            
            
            6,262
            
            
            1,436
            
            
            1,013
            
            
            321Sales
                and marketing
            
            
            3,598
            
            
            2,316
            
            
            1,288
            
            
            1,974
            
            
            6,210Connectivity
                and network costs
            
            
            865
            
            
            812
            
            
            1,023
            
            
            1,312
            
            
            1,784Research
                and development
            
            
            658
            
            
            615
            
            
            527
            
            
            559
            
            
            1,640General
                and administrative
            
            
            2,004
            
            
            1,564
            
            
            1,423
            
            
            1,695
            
            
            2,757Depreciation
                and amortization
            
            
            356
            
            
            255
            
            
            315
            
            
            1,305
            
            
            2,268Lease
                renegotiation costs and abandonment of leasehold
                improvements
            
            
            —
            
            
            —
            
            
            —
            
            
            478
            
            
            —Loss
                (gain) on disposal or impairment of long-term assets
            
            
            95
            
            
            1
            
            
            37
            
            
            105
            
            
            142Restructuring
                costs
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            4,998Total
                operating expenses
            
            
            14,892
            
            
            11,825
            
            
            6,049
            
            
            8,441
            
            
            20,120Operating
                income (loss)
            
            
            1,002
            
            
            2,168
            
            
            (1,478
            )
            
            (5,526
            )
            
            (18,246
            )Interest
                expense
            
            
            —
            
            
            35
            
            
            41
            
            
            24
            
            
            155Interest
                income
            
            
            261
            
            
            33
            
            
            8
            
            
            46
            
            
            720Gain
                on warrant liability
            
            
            89
            
            
            —
            
            
            —
            
            
            —
            
            
            —Impairment
                of long-term investment
            
            
            —
            
            
            40
            
            
            —
            
            
            —
            
            
            197Net
                income (loss)
            
            $
            1,352
            
            $
            2,126
            
            $
            (1,511
            )
            $
            (5,504
            )
            $
            (17,878
            )Earnings
                (loss) per share:Basic
            
            $
            0.21
            
            $
            0.38
            
            $
            (0.35
            )
            $
            (1.35
            )
            $
            (1.44
            )Diluted
            
            $
            0.18
            
            $
            0.30
            
            $
            (0.35
            )
            $
            (1.35
            )
            $
            (1.44
            )Weighted
                average shares outstanding:Basic
            
            
            6,351
            
            
            5,630
            
            
            4,333
            
            
            4,073
            
            
            12,400Diluted
            
            
            7,578
            
            
            7,182
            
            
            4,333
            
            
            4,073
            
            
            12,400




29





**As
                of December 31,****2005**
            
            **2004**
            
            **2003**
            
            **2002**
            
            **2001****Balance
                Sheet Data:**Cash
                and cash equivalents
            
            $
            4,349
            
            $
            3,610
            
            $
            2,368
            
            $
            667
            
            $
            3,651Working
                capital (deficiency)
            
            
            11,737
            
            
            4,591
            
            
            2,457
            
            
            698
            
            
            4,387Total
                assets
            
            
            13,827
            
            
            7,206
            
            
            3,975
            
            
            1,941
            
            
            7,510Current
                Liabilities
            
            
            1,341
            
            
            2,006
            
            
            996
            
            
            709
            
            
            798Long-term
                obligations, less current portion
            
            
            —
            
            
            —
            
            
            267
            
            
            —
            
            
            68Total
                shareholders’ equity
            
            
            12,486
            
            
            5,200
            
            
            2,712
            
            
            1,232
            
            
            6,644





30


**Item
      7:** ***Management’s
      Discussion And Analysis Of Financial Conditions And Results Of
      Operations***




**Overview**




We
      are a
      results-based advertising network that distributes advertisements for direct
      marketing advertisers across a network of third-party web sites. For
      advertisers, the Aptimus Network offers an Internet-based distribution channel
      to present their advertisements to users on web sites. Advertisers pay us only
      for the results that we deliver. We then share a portion of the amounts we
      bill
      our advertiser clients with the third-party web site owners or “publishers” on
      whose web properties we distribute the advertisements.




At
      the
      core of the Aptimus Network is a database configuration and software platform
      and direct marketing approach for which we have filed a non-provisional business
      method patent application called Dynamic Revenue OptimizationTM. This system is
      designed to determine the advertisements in our system for promotion on each
      individual web site that the system estimates may generate the greatest user
      response and revenue potential for that specific web site. This estimation
      is
      made using computer-based logic on a real-time basis incorporating response
      history and value of the advertisements in our system. The purpose of the system
      is to enhance results for our advertiser clients by presenting the offers in
      our
      database that are more likely to be of interest to specific customers, which
      enhancing revenues for our publishers and us.




Our
      primary offer presentation format includes cross-marketing promotions at the
      point of registration or other transactional activity on web sites. We believe
      that users are more inclined to respond to our clients’ advertisements in an
      environment where they are engaged in some form of transaction, the logic being
      a consumer is more likely to take the additional action of responding to an
      ad
      when he or she is in a transaction frame of mind. We thus strive to have our
      offers displayed in environments on our publishers’ web sites where consumers
      are taking some form of action. Actions can include when a user registers to
      be
      included in a web site community or to receive a newsletter, when a user logs
      in
      to a site where he or she is already registered, when a user downloads a
      software program or other product, and when a user completes an online survey.
      In identifying potential publisher sites to include in our network, a key
      consideration for us is the number of registrations, log ins, downloads or
      other
      form of user transactions taking place on the site. The more user transactions,
      the more desirable that publisher is for inclusion in our network.




Over
      the
      past three years, a key focus of ours has been expanding the number of
      publishers in our network. To this end, we have added six employees to our
      business development team since early December 2003, whose job is to focus
      exclusively on adding new publishers to our network and expanding our
      relationships with current publishers. In 2005, we hired two senior-level
      employees to head the business development team and expect to continue hiring
      business development personnel in the future as necessary. Our lead volumes
      remain concentrated among a limited number of top performing publishers. While
      our goal is to expand the number of publishers and reduce the concentration
      of
      revenue from any one publisher, we anticipate that a limited number of
      publishers collectively will continue to account for a significant portion
      of
      our lead volume for the foreseeable future.




In
      late
      2005, we indefinitely suspended our email operations, which had been in decline
      in recent years. While this business was historically high margin and
      contributed nearly 9% and 18% of the company’s revenues in 2005 and 2004,
      respectively, increasing resistance from ISPs and resulting deliverability
      challenges made growth and stability in this area uncertain. Marketplace trends
      also indicated further challenges ahead for the email business as a whole.
      We
      thus elected to suspend our email marketing activities indefinitely to focus
      on
      more stable and predictable network-based offer distribution solutions that
      we
      believe best serve our clients’ needs.




31


Our
      most
      effective placement on publishers’ websites is at the point of a transaction
      where we host an offer page that is included as an intermediate step in the
      user-initiated transaction process. We define a transaction as a registration,
      download or other active participation point on a publisher website. We consider
      these transaction-oriented web site placements our core placements, and they
      are
      thus the focus of our model and are referred to in this Financial Report as
      our
“core placements”. Our offers also appear in other formats where we either do
      not host the offer page or the page that we do host is not included as an
      intermediate step in a transaction process. These other formats, which are
      collectively referred to in this Financial Report as “other placements”, include
      pop-ups and pop-unders, log-ins, thank you pages, and non-hosted pages with
      unrelated editorial and advertising content. They do not include banners,
      skyscrapers and other, similar ad units, which to date we have elected not
      to
      support with our Dynamic Revenue Optimization system. The overall performance
      of
      these other placements has been widely variable historically, yet the supply
      of
      impressions in these other formats on a publisher’s site can be substantial.




Our
      website publishers measure our performance by comparing the revenue per thousand
      impression results to other available revenue generating solutions. An
      impression occurs each time an offer is displayed on a user’s computer screen.
      While we do not use average revenue per impression or per lead in evaluating
      the
      performance of our business, website publishers do use this metric in comparing
      various advertising options. Publishers can source advertisements directly
      from
      advertisers and agencies, they can contract with advertising networks like
      our
      network to satisfy their advertising requirements or they can do a combination
      of both. Almost exclusively publishers use revenue per impression when comparing
      the relative benefits of these various options. In addition, because of its
      value as a marketing tool to the publisher base, industry analysts find revenue
      per impression data useful. We thus have regularly provided data on average
      revenues per impression in our public filings, intend to do so in the future
      and
      discuss average revenues per impression in our Results of Operations
      below.




However,
      the most important, consistent and reliable business metrics management
      considers in determining the health of the business are revenues and net profit
      (loss).




In
      2005,
      we initiated a focused drive to improve lead quality and customer conversion
      for
      our advertising clients. To this end, we terminated relationships with
      publishers with lower quality traffic and added or enhanced a number of
      automated data validation processes that screen in real time the lead data
      a
      user submits before that lead is passed on to our advertisers. We also directed
      considerable energy in the year toward building distribution relationships
      with
      name brand and high quality web sites. Going forward, to support enhanced lead
      quality and attract new and larger advertisers and budgets, Aptimus will
      continue to expand our technology and validation capabilities, add innovative
      product solutions, as well as develop focused marketing strategies around
      specific targeted verticals such as our newly updated www.euniversitydegree.com
      education site. We will also continue pursuing distribution relationships with
      name brand and high quality publishers. Finally, we plan to hire seasoned sales
      professionals and support staff to target the primary education, finance,
      technology and other industry verticals.




In
      March
      2005, the Company completed a $6 million private placement investment with
      seven
      accredited investors. The Company sold the accredited investors 351,083 shares
      of unregistered Aptimus, Inc. common stock at a price of $17.09 per share.
      In
      connection with this sale warrants for an additional 70,216 shares of common
      stock at a strike price of $20.22 were also issued to the investors and warrants
      for an additional 21,065 shares of common stock at a strike price of $18.15
      were
      also issued to an entity who acted as a financial advisor in the transactions.
      On April 28, 2005 we filed a registration statement on Form S-3 to register
      these shares. The SEC declared the registration statement effective on May
      13,
      2005.




In
      March
      2005, shares of our common stock were re-listed on the Nasdaq National Market
      Exchange under the symbol APTM.




On
      March
      9, 2006, the Company’s board of directors repriced the strike price of certain
      option grants issued to certain employees and directors in 2005, including
      Rob
      Wrubel, Director and President, Bob Bejan, Director, senior members of the
      Company’s sales and business development groups, and other employees. The
      original strike price of the grants that were affected by the repricing ranged
      from $14.45 to $17.50. The new strike price is $7.00. A total of 38 individuals
      representing 360,775 option shares were affected by the repricing. In addition,
      the board of directors authorized the grant of 70,000 option shares to Mr.
      Wrubel, and the grant an additional 65,000  to
      certain other senior members of the Company’s sales and business development
      groups. Each of these grants has a strike price of $4.58 and vest over a
      four-year period from the date of grant. We are still in the process of
      evaluating the impact of the repricing and option grants on the quarter ended
      March 31, 2006 and future periods. However, the impact is expected to be
      material.




32


**Results
      of Operations**




**Year
      Ended December 31, 2005 Compared to Year Ended December 31,
      2004**




*Revenues.* We
      derive
      our revenues primarily from response-based advertising contracts. Leads are
      obtained through promoting our clients’ offers across our Aptimus Network of web
      site publishers and opt-in email lists. Revenues generated through network
      publishers and opt-in email list owners are recorded on a gross basis in
      accordance with Emerging Issues Task Force Issue Number 99-19 (EITF 99-19).
      Fees
      paid to network publishers and, formerly, opt-in email list owners related
      to
      these revenues are shown as Cost of revenues on the Statement of
      Operations.




Revenue
              (In
                thousands, except percentages)
            
            2005
            
            2004
            
            Percentage
              IncreaseYear
                ended December 31,
            
            $
            15,894
            
            $
            13,993
            
            
            13.6
            %





Year
                Ended December 31,Revenue
                Per Thousand Impression (CPM)
              (In
                thousands, except percentages and CPM data)
            
            
            2005
            
            
            2004
            
            
            Percentage
                Increase (Decrease)Core
                placement CPM
            
            $
            243.70
            
            $
            377.02
            
            
            (35.4
            )%Core
                placement page impressions
            
            
            47,367
            
            
            23,373
            
            
            102.7
            %Other
                placement CPM
            
            $
            17.96
            
            $
            20.24
            
            
            (11.3
            )%Other
                placement page impressions
            
            
            162,561
            
            
            133,737
            
            
            21.6
            %





The
      increase in revenue is primarily due to expansion of our Aptimus Network,
      including the addition of new web site distribution publishers thereby
      increasing our page impressions and corresponding user transactions, and the
      expansion of our advertiser client base. A primary focus for the company in
      2005
      was to continue expanding the number of publishers in our Network, thereby
      increasing the number of placements, both core and other, and corresponding
      page
      impressions. Offsetting the increase in website distribution publishers revenues
      was a reduction in the revenue derived from email activity for the year ended
      December 31, 2005. Email revenues decreased to $1.4, or 9% of total revenue,
      from $2.5 million, or 18% of total revenue, in 2004. This decrease both in
      total
      and as a percentage of overall revenue is primarily a result of growing
      resistance from ISPs and resulting deliverability challenges that made growth
      and stability in email uncertain. As discussed in the overview section in
      December of 2005 we indefinitely suspended our email channel as a vehicle for
      generating leads so that we could focus all of our attention and efforts on
      expansion of our network of website publishers.





For
      the
      year ended December 31, 2005, our average revenue per thousand impressions
      (CPM)
      for our core placements decreased to $244 per thousand impressions compared
      to
      $377 for the comparable period in 2004. Our average revenue per thousand
      impressions for our other placements for the year ended December 31, 2005
      decreased to $18 from $20 for the comparable period of 2004. The decrease in
      CPM
      rates for both our core and other placements resulted from our significant
      efforts in the current year to increase the back-end conversion, or quality
      from
      an advertiser perspective, of the leads being delivered to our clients. A
      primary change we made to effect client back end conversion quality was that
      during the second half of 2005 we ended multiple existing publisher
      relationships. We identified the sites in our network that had high impression
      volume yet had a user experience that involved a more promotion-oriented
      approach that, for our clients, delivered a lower quality user profile that
      failed to achieve back end conversion levels consistent with client
      expectations. We then looked to build the majority of our publisher network
      with
      impressions from non-promotional oriented sites that will yield a better lead
      for our clients. The number of page impressions for core placements and other
      placements for the year ending December 31, 2005 increased to 47.4 million
      and
      162.6 million, respectively, compared to 23.4 million and 133.7 million,
      respectively, for the comparable period in 2004. The increase in page
      impressions was the result of adding more publishers to the Aptimus Network
      and
      adding additional placements within existing publisher websites. We expect
      the
      average revenue per thousand impressions of both our core and other placements
      to be consistent with their respective current levels over the long term while
      they each might fluctuate quarter-to-quarter depending on the mix of publishers
      added to our network and the specific placements within those publishers as
      well
      as the mix and relative values of our offer inventory.





33




Our
      plan
      remains to continue our efforts to expand our network with new distribution
      publishers, client offers and product types and placements. We expect that
      these
      efforts will result in the continued growth in our revenues.





*Cost
      of revenues* .
      Cost of
      revenues consists of fees to web site publishers and email list owners
      participating in our network.




(In
                thousands, except percentages)
            
            2005
            
            %
                of
              revenue
            
            2004
            
            %
                of
              revenue
            
            Percentage
              IncreaseYear
                Ended December 31,
            
            $
            7,316
            
            
            46.0
            %
            
            6,262
            
            
            44.8
            %
            
            16.8
            %





Cost
      of
      revenues has increased primarily as a result of the increase in total revenue.
      Cost of revenues have also increased on a percentage of revenue basis, as a
      result of the growth in web site network revenues compared to email based
      revenues. The effective rate at which we share revenues for email-based revenue
      is lower than that of website network based revenues. So, as email revenues
      declined year over year, the percentage of revenue paid to our publishers
      increased. During 2005, we also experimented with paying network publishers
      on a
      cost per thousand impressions basis, which has contributed to the increase
      in
      costs as a percentage of revenue for the year. Cost of revenues for 2006 is
      expected to increase further as a percentage of revenues and is expected to
      normalize at around 50% of revenues.





*Sales
      and Marketing.* Sales
      and
      marketing expenses consist primarily of marketing and operational personnel
      costs, bad debts, and outside sales costs.





(In
                thousands, except percentages)
            
            2005
            
            %
                of
              revenue
            
            2004
            
            %
                of
              revenue
            
            Percentage
              IncreaseYear
                Ended December 31,
            
            $
            3,598
            
            
            22.6
            %
            $
            2,316
            
            
            16.6
            %
            
            55.4
            %





The
      increase in sales and marketing expenses was a result of the hiring of
      additional personnel, costs of trade shows and their related marketing and
      travel expenses and outside services related to the operation of our email
      division, Neighbornet. These items accounted for 52.1%, 22.9% and 5.6% of the
      increase in expense, respectively. During 2005, the number of sales and
      marketing employees increased by 13 people. Also in 2005, we hosted a booth
      at
      three of the major direct marketing trade shows. We did not have a booth at
      any
      trade shows in 2004. Going forward, sales and marketing costs are expected
      to
      increase as additional employees are hired and new employee stock option expense
      rules take effect. However, sales and marketing expense is not expected to
      increase as a percentage of revenues.





34


*Connectivity
      and Network Costs.* Connectivity and network costs consist of expenses associated with the
      maintenance and usage of our network as well as email delivery costs. Such
      costs
      include Internet connection charges, hosting facility costs, email delivery
      costs and personnel costs.





(In
                thousands, except percentages)
            
            2005
            
            %
                of
              revenue
            
            2004
            
            %
                of
              revenue
            
            Percentage
              IncreaseYear
                Ended December 31,
            
            $
            865
            
            
            5.4
            %
            $
            812
            
            
            5.8
            %
            
            6.5
            %





This
      increase was primarily the result of additional fees paid to outside vendors
      related to our quality initiative that has resulted in the addition of several
      new types of lead validations such as full lead confirm and call confirm
      validations. Data verification costs are unique to each specific offer in our
      network and will vary from month to month depending on the number of offers
      requiring this service. Connectivity and network costs for 2006 are expected
      to
      increase slightly as additional costs are incurred for data validation, annual
      pay increases and also as a result of the expensing of employee stock
      options.





*Research
      and Development.* Research
      and development expenses primarily consist of personnel costs related to
      maintaining and enhancing the features, content and functionality of our Web
      sites, network and related systems.





(In
                thousands, except percentages)
            
            2005
            
            %
                of
              revenue
            
            2004
            
            %
                of
              revenue
            
            Percentage
              IncreaseYear
                Ended December 31,
            
            $
            658
            
            
            4.1
            %
            $
            615
            
            
            4.4
            %
            
            7.0
            %





This
      increase in research and development expense was primarily due to increases
      in
      labor costs. The increase in labor costs was due to the hiring of an additional
      developer in the first quarter of 2005. Research and development expense for
      2006 is expected to be slightly higher than levels in 2005 as a result of annual
      pay increases and also as a result of the expensing of employee stock
      options.





*General
      and Administrative.* General
      and administrative expenses primarily consist of management, financial and
      administrative personnel expenses and related costs and professional service
      fees.





(In
                thousands, except percentages)
            
            2005
            
            %
                of
              revenue
            
            2004
            
            %
                of
              revenue
            
            Percentage
              IncreaseYear
                Ended December 31,
            
            $
            2,004
            
            
            12.6
            %
            $
            1,564
            
            
            11.2
            %
            
            28.1
            %





The
      majority, 98.9%, of the increase in general and administrative expense was
      due
      to increases in outside services related to compliance with Sarbanes Oxley
      and
      increases in audit fees. Total general and administrative expenses for 2006
      are
      expected to be somewhat lower than 2005 as the Company has now completed its
      first internal controls assessment and the remediation work discussed in Item
      9A
      of this annual report.





*Depreciation
      and Amortization.* Depreciation
      and amortization expenses consist of depreciation on leased and owned computer
      equipment, software, office equipment and furniture and amortization on
      intellectual property and purchased email lists.





(In
                thousands, except percentages)
            
            2005
            
            %
                of
              revenue
            
            2004
            
            %
                of
              revenue
            
            Percentage
              IncreaseYear
                Ended December 31,
            
            $
            356
            
            
            2.2
            %
            $
            255
            
            
            1.8
            %
            
            39.6
            %





Depreciation
      and amortization expense increased in 2005 as additional computer equipment
      and
      software was purchased. We anticipate depreciation and amortization expense
      in
      2006 to continue to increase slightly as compared to 2005 as the company plans
      on spending approximately $600,000 on improvements and upgrades to its computer
      hardware and software.





35


*Loss
      (gain) on disposal of long-term assets.* Loss
      (gain) on disposal of long-term assets primarily consists of an impairment
      charge taken on the Neighbornet assets that were acquired in May 2005. No
      material gains or losses are expected in 2006.





*Interest
      Expense.* There
      is
      no interest expense in the current year, as the Company had no amounts
      outstanding under capital equipment leases or other debt instruments. Interest
      expense is expected to be zero in 2006 as well.





*Interest
      Income.* Interest
      income results from earnings on our available cash reserves. Interest income
      totaled $261,000 in the year ended December 31, 2005 and $33,000 in 2004. The
      increase in interest income is primarily a result of our improved cash position
      resulting from the proceeds from the sale of common stock in March 2005 and
      the
      positive cash flow generated by operations during the 2005. Interest income
      is
      expected to increase slightly in 2006 as the Company’s cash position is expected
      to continue to improve and interest rates are expected to continue to
      increase.





*Income
      Taxes.* No
      provision for federal income taxes has been recorded for any of the periods
      presented due to taxable losses incurred in those years. The Company has
      provided full valuation allowances on the related net deferred tax assets
      because of the uncertainty regarding their realizability. As of December 31,
      2005, approximately $65.9 million of net operating losses remain for federal
      income tax reporting purposes. We have determined that a change in ownership,
      as
      defined in the Internal Revenue Code Section 382 and similar state provisions,
      has occurred and may substantially limit the utilization of the net operating
      loss carry-forwards. The annual limitation may result in the expiration of
      $46.4
      million in net operating losses before utilization.





**Year
      Ended December 31, 2004 Compared to Year Ended December 31,
      2003**




*Revenues.* We
      derive
      our revenues primarily from response-based advertising contracts. Leads are
      obtained through promoting our clients’ offers across our Aptimus Network of web
      site publishers and opt-in email lists. Revenues generated through network
      publishers and opt-in email list owners are recorded on a gross basis in
      accordance with Emerging Issues Task Force Issue Number 99-19 (EITF 99-19).
      Fees
      paid to network publishers and opt-in email list owners related to these
      revenues are shown as Cost of revenues on the Statement of
      Operations.




Revenue
              (In
                thousands, except percentages)
            
            2004
            
            2003
            
            Percentage
              IncreaseYear
                ended December 31,
            
            $
            13,993
            
            $
            4,571
            
            
            206.1
            %





Year
                Ended December 31,Revenue
                Per Thousand Impression (CPM)
              (In
                thousands, except percentages and CPM data)
            
            2004
            
            2003
            
            Percentage
              IncreaseCore
                placement CPM
            
            $
            377.02
            
            $
            266.06
            
            
            41.7
            %Core
                placement page impressions
            
            
            23,373
            
            
            3,172
            
            
            636.9
            %Other
                placement CPM
            
            $
            20.24
            
            $
            14.08
            
            
            43.8
            %Other
                placement page impressions
            
            
            133,737
            
            
            117,000
            
            
            14.5
            %





The
      increase in revenue is primarily due to expansion of our Aptimus Network,
      including the addition of new web site distribution publishers thereby
      increasing our page impressions and corresponding user transactions, and the
      expansion of our advertiser client base. A primary focus for the company in
      2004
      was to continue expanding the number of publishers in our Network, thereby
      increasing the number of placements, both core and other, and corresponding
      page
      impressions. We source our results based leads from two primary network sources
      - web sites and email lists. For the year ended December 31, 2003, leads derived
      from email list sources accounted for $2.1 million or 45% of our overall revenue
      compared to $2.3 million or 16% for the year ended December 31, 2004.





36


For
      the
      year ended December 31, 2004, our average revenue per thousand impressions
      for
      our core placements increased to $377 per thousand impressions compared to
      $266
      for the comparable period in 2003. Our average revenue per thousand impressions
      for our other placements for the year ended December 31, 2004 increased to
      $20
      from $14 for the comparable period in 2003. The number of page impressions
      for
      core placements and other placements for the year ending December 31, 2004
      increased to 23.4 million and 133.7 million, respectively, compared to 3.2
      million and 117 million, respectively, for the comparable period in 2004. The
      increase in page impressions was the result of adding more publishers to the
      Aptimus Network and adding additional placements within existing publisher
      websites. In addition, the average revenue per thousand impressions for our
      core
      placements increased as a result of further refinements to our Dynamic Revenue
      Optimization technology and a higher performing offer mix. The average revenue
      per thousand impressions for our other placements increased slightly also as
      a
      result of further refinements to our Dynamic Revenue Optimization technology
      and
      a higher performing offer mix.





*Cost
      of revenues* .
      Cost of
      revenues consists of fees to web site publishers and email list owners
      participating in our network.




(In
                thousands, except percentages)
            
            2004
            
            %
                of
              revenue
            
            2003
            
            %
                of
              revenue
            
            Percentage
              Inc.
                (Dec.)Year
                Ended December 31,
            
            $
            6,262
            
            
            44.8
            %
            $
            1,436
            
            
            31.4
            %
            
            336.1
            %





Cost
      of
      revenues has increased primarily as a result of the increase in total revenue.
      Cost of revenues have increased on a percentage of revenue basis, as a result
      of
      the growth in web site network revenues outpacing the growth of our email based
      revenues. The effective rate at which we share revenues for email based revenue
      is lower than that of web site network based revenues as a result of our
      ownership of a large portion of the names mailed and that we deduct the cost
      of
      delivering the emails before calculating the fees due publishers for email
      based
      revenues.





*Sales
      and Marketing.* Sales
      and
      marketing expenses consist primarily of marketing and operational personnel
      costs, bad debts, and outside sales costs.





(In
                thousands, except percentages)
            
            2004
            
            %
                of
              revenue
            
            2003
            
            %
                of
              revenue
            
            Percentage
              IncreaseYear
                Ended December 31,
            
            $
            2,316
            
            
            16.6
            %
            $
            1,288
            
            
            28.2
            %
            
            79.8
            %





The
      increase in sales and marketing expenses was a result of hiring of additional
      personnel, increases in sales commissions due to increased sales, accrual of
      a
      net income based bonus pool for the year, and increases in bad debt expense.
      These items accounted for 53.0%, 29.0% 10.0% and 9.8% of the increase in
      expense, respectively. The majority of the new employees in sales and marketing
      were in the business development department, which focuses on signing up new
      publishers. Bad debts increased due to an increase in the reserve and the
      write-off of approximately $60,000 in accounts during the year.





37


*Connectivity
      and Network Costs.* Connectivity and network costs consist of expenses associated with the
      maintenance and usage of our network as well as email delivery costs. Such
      costs
      include Internet connection charges, hosting facility costs, email delivery
      costs and personnel costs.





(In
                thousands, except percentages)
            
            2004
            
            %
                of
              revenue
            
            2003
            
            %
                of
              revenue
            
            Percentage
              DecreaseYear
                Ended December 31,
            
            $
            812
            
            
            5.8
            %
            $
            1,023
            
            
            22.4
            %
            
            (20.6
            )%





This
      decrease was primarily the result of decreases in connectivity and email
      delivery costs, which were offset by increases in labor costs, maintenance
      agreement costs and address verification costs. As a percentage of the total
      change in this account these factors accounted for 75%, 131%, (61%), (16%)
      and
      (26%), respectively. The decrease in connectivity resulted from moving our
      network production environment in-house. In the first six months of 2003, the
      network production environment was hosted by EDS Corporation. Similarly the
      decrease in email delivery costs was a result of moving the remaining email
      programs in-house. In 2003, a third party performed the majority of the email
      delivery. The increase in labor related costs is a result of pay reductions,
      which were in place in the first quarter of 2003, the hiring of an additional
      network engineer during the quarter, and a net income based bonus that was
      accrued in 2004. In the fourth quarter of 2002 and the first quarter of 2003,
      our existing employees agreed to a reduction in pay to improve our cash flows.
      In the first quarter of 2004, we paid our employees an amount equal to the
      reduction in pay they agreed to during these two quarters. The increased
      maintenance is related to additional maintenance contracts on hardware and
      software. Address verification costs are campaign related and vary from month
      to
      month depending on the number of offers requiring this service.





*Research
      and Development.* Research
      and development expenses primarily consist of personnel costs related to
      maintaining and enhancing the features, content and functionality of our Web
      sites, network and related systems.





(In
                thousands, except percentages)
            
            2004
            
            %
                of
              revenue
            
            2003
            
            %
                of
              revenue
            
            Percentage
              IncreaseYear
                Ended December 31,
            
            $
            615
            
            
            4.4
            %
            $
            527
            
            
            11.5
            %
            
            16.7
            %





This
      increase in research and development expense was primarily due to increases
      in
      labor costs. In the fourth quarter of 2002 and the first quarter of 2003, our
      existing employees agreed to a reduction in pay to improve our cash flows.
      In
      the first quarter of 2004, we paid our employees an amount equal to the
      reduction in pay they agreed to during these two quarters, resulting in an
      increase in labor related costs in 2004. In addition there was also a bonus
      based on net income that was accrued in 2004.





*General
      and Administrative.* General
      and administrative expenses primarily consist of management, financial and
      administrative personnel expenses and related costs and professional service
      fees.





(In
                thousands, except percentages)
            
            2004
            
            %
                of
              revenue
            
            2003
            
            %
                of
              revenue
            
            Percentage
              IncreaseYear
                Ended December 31,
            
            $
            1,564
            
            
            11.2
            %
            $
            1,423
            
            
            31.1
            %
            
            9.9
            %





The
      majority, 53%, of the increase in general and administrative expense was due
      to
      increases in labor costs. In the fourth quarter of 2002 and the first quarter
      of
      2003, our existing employees agreed to a reduction in pay to improve our cash
      flows. In the first quarter of 2004, we paid our employees an amount equal
      to
      the reduction in pay they agreed to during these two quarters, resulting in
      an
      increase in labor related costs in 2004. In addition there was also a bonus
      based on net income that was accrued in 2004. The primary other cause of the
      increase in general and administrative costs was an increase in business taxes
      paid. These taxes are based on revenues for Washington State and the city of
      Seattle and gross payroll for the city of San Francisco. Since both revenues
      and
      labor costs increased in 2004 the related tax liabilities also
      increased.





38


*Depreciation
      and Amortization.* Depreciation
      and amortization expenses consist of depreciation on leased and owned computer
      equipment, software, office equipment and furniture and amortization on
      intellectual property and purchased email lists.





(In
                thousands, except percentages)
            
            2004
            
            %
                of
              revenue
            
            2003
            
            %
                of
              revenue
            
            Percentage
              DecreaseYear
                Ended December 31,
            
            $
            255
            
            
            1.8
            %
            $
            315
            
            
            6.9
            %
            
            (19.0
            )%





Depreciation
      and amortization expense decreased in 2004 as additional computer equipment
      has
      become fully depreciated.





*Loss
      (gain) on disposal of long-term assets.* Loss
      (gain) on disposal of long-term assets consists of gains and losses on disposals
      of assets and impairments on long-term investments. Some computer hardware,
      furniture, and leasehold improvements were retired in the second quarter,
      however the majority of the assets were fully depreciated or insurance proceeds
      were received and no material gain or loss was recorded during 2004. No material
      gains or losses are expected in 2005.





*Interest
      Expense.* Interest
      expense in the current year results from capital equipment leases and
      convertible notes payable. Interest expense totaled $35,000 for the year ended
      December 31, 2004 and $41,000 in 2003. Interest expense is expected to be zero
      2005 as the convertible notes payable were converted to common stock on March
      30, 2004 and the capital equipment leases were paid in full in July
      2004.





*Interest
      Income.* Interest
      income results from earnings on our available cash reserves. Interest income
      totaled $33,000 in the year ended December 31, 2004 and $8,000 in 2003. The
      increase in interest income is primarily a result of our improved cash position
      resulting from the proceeds from the sale of common stock in December 2003
      and
      the positive cash flow generated in the second half of 2004.





*Income
      Taxes.* No
      provision for federal income taxes has been recorded for any of the periods
      presented due to taxable losses incurred in those years. The Company has
      provided full valuation allowances on the related net deferred tax assets
      because of the uncertainty regarding their realizability. As of December 31,
      2004, approximately $64.6 million of net operating losses remain for federal
      income tax reporting purposes. We determined that a change in ownership, as
      defined in the Internal Revenue Code Section 382 and similar state provisions,
      has occurred and may substantially limit the utilization of the net operating
      loss carry-forwards. The annual limitation may result in the expiration of
      net
      operating losses before utilization.





**Liquidity
      and Capital Resources**




Since
      we
      began operating as an independent company in July 1997, we have financed our
      operations primarily through the issuance of equity securities. Net proceeds
      from the issuance of stock through December 31, 2005, totaled $73.2 million.
      As
      of December 31, 2005, we had approximately $10.4 million in cash, cash
      equivalents and short-term investments, providing working capital of $11.7
      million. Other than the deferred tax asset, as described more fully below,
      no
      off-balance sheet assets or liabilities existed at December 31,
      2005.




Net
      cash
      provided by operating activities was $1.3 million during the year ended December
      31, 2005. Net cash provided by operating activities was $1.6 million during
      the
      year ended December 31, 2004. Cash provided by (used in) operating activities
      consisted of:


39




Years
                ended December 31,2005
            
            2004Cash
                received from customers
            
            $
            15,934
            
            $
            11,928Cash
                paid to employees and vendors
            
            
            (14,791
            )
            
            (10,297
            )Interest
                received
            
            
            195
            
            
            32Interest
                paid
            
            
            —
            
            
            (30
            )Net
                cash provided by (used in) operations
            
            $
            1,338
            
            $
            1,633





Net
      cash
      used in investing activities was $6.6 million and $382,000 in the years ended
      December 31, 2005 and 2004, respectively. For the year ended December 31, 2005,
      $438,000 was used to acquire fixed assets, $150,000 was used to acquire the
      assets of Neighbornet, $9,000 was used to acquire intangible assets, and
      $6,025,000 was used to acquire short-term investments. For the year ended
      December 31, 2004 $415,000 was used to acquire fixed assets, $8,000 was used
      to
      acquire intangible assets, and $41,000 was provided by proceeds from disposal
      of
      fixed assets.




Net
      cash
      provided by (used in) financing activities was $6.0 million and $(9,000) for
      the
      years ended December 31, 2005 and 2004, respectively. Net cash provided by
      financing activities during the year ended December 31, 2005 resulted from
      the
      sale of $6.0 million from the sale of stock in a private placement in March
      of
      2005 and $287,000 from the issuance of stock in connection with the exercise
      of
      options, warrants and the employee stock purchase plan. These sources of cash
      were offset by the payment of $267,000 of costs related to the March 2005
      private placement. Net cash used in financing activities during the year ended
      December 31, 2004 resulted from $101,000 in principal payments made on capital
      leases and $168,000 in payments made related to the registration of shares
      offset by $260,000 in proceeds from option and warrant exercises.




We
      believe our current cash and cash equivalents will be sufficient to meet our
      anticipated cash needs for working capital and capital expenditures for the
      foreseeable future. This is based on the cash generated by operations during
      the
      year ended December 31, 2005 and 2004. We currently anticipate spending $500,000
      to $600,000 on capital expenditures in 2006 in order to expand and improve
      our
      network infrastructure. Should our goal of maintaining positive cash flow not
      be
      met, we may need to raise additional capital to meet our long-term operating
      requirements.




Our
      cash
      requirements depend on several factors, including the rate of market acceptance
      of our services and the extent to which we use cash for acquisitions and
      strategic investments. Although, no acquisitions or major strategic investments
      are currently planned, unanticipated expenses, poor financial results or
      unanticipated opportunities requiring financial commitments could give rise
      to
      earlier financing requirements. In addition, we do not currently anticipate
      any
      expenditure outside the ordinary course of business in pursuing the market
      strategies described in this annual report. If we raise additional funds through
      the issuance of equity or convertible debt securities, the percentage ownership
      of our shareholders would be reduced, and these securities might have rights,
      preferences or privileges senior to those of our common stock. Additional
      financing may not be available on terms favorable to us, or at all. If adequate
      funds are not available or are not available on acceptable terms, our ability
      to
      fund our expansion, take advantage of business opportunities, develop or enhance
      services or products or otherwise respond to competitive pressures would be
      significantly limited, and we might need to significantly restrict our
      operations.




The
      following table summarizes the contractual obligations and commercial
      commitments entered into by the Company, in thousands.


40




**Payments
                Due by Period****Year
                ending December 31,**Contractual
                Obligations
            
            Total
            
            **Less
                than 1 year**
            
            **1-3
                years**
            
            **3-5
                years**
            
            **More
                than 5 years**Operating
                leases (1)
            
            
            785
            
            
            314
            
            
            421
            
            
            50
            
            
            —Operating
                agreements (2)
            
            
            104
            
            
            83
            
            
            21
            
            
            —
            
            
            —Total
                Contractual Obligations
            
            $
            889
            
            $
            397
            
            $
            442
            
            $
            50
            
            $
            —




(1)  These
      commitments relate to the leasing of our offices in Seattle and San Francisco.
      We expect to fund these commitments with existing cash and cash flows from
      operations.




(2)  These
      commitments relate to connectivity and collocation contracts. We expect to
      fund
      these commitments with existing cash and cash flows from
      operations.






**Off-Balance
      Sheet Arrangements**




No
      off-balance sheet arrangements existed as of December 31, 2005.




**Critical
      Accounting Policies**




Our
      significant accounting policies are described in Note 2 to the financial
      statements included in this annual report. We believe those areas subject to
      the
      greatest level of uncertainty are the valuation allowance for deferred tax
      assets, the allowance for doubtful accounts receivable and depreciation of
      fixed
      and intangible assets. In addition to those areas subject to the greatest level
      of uncertainty revenue recognition is also considered a critical accounting
      policy.




**Revenue
      Recognition**




The
      Company currently derives revenue from providing response-based advertising
      programs through a network of web site distribution publishers.




Revenue
      earned for response-based advertising through the Aptimus network is based
      on a
      fee per lead and is recognized when the lead information is delivered to the
      client. Revenue earned for email mailings can be based on a fee per lead, a
      percentage of revenue earned from the mailing, or a cost per thousand emails
      delivered. Revenue from email mailings delivered on a cost per thousand basis
      is
      recognized when the email is delivered. Revenues from email mailings sent on
      a
      fee per lead or a percentage of revenue earned from the mailing basis are
      recognized when amounts are determinable, generally when the customer receives
      the leads.




Revenues
      generated through network publishers and opt-in email list owners are recorded
      on a gross basis in accordance with Emerging Issues Task Force Issue Number
      99-19 (EITF 99-19). Fees paid to network publishers and opt-in email list owners
      related to these revenues are shown as Publisher fees on the Statement of
      Operations. Aptimus shares a portion of the amounts it bills its advertiser
      clients with the third-party web site owners or “publishers” and email list
      owners on whose web properties and email lists Aptimus distributes the
      advertisements. While this “revenue share” approach is Aptimus’ primary payment
      model, it will as a rare alternative pay web site owners either a fixed fee
      for
      each completed user transaction or a fee for each impression of an advertisement
      served on the web site. Email based campaigns that are sent to Company owned
      lists do not have publisher fees associated with them. Going forward, due to
      the
      indefinite suspension of our email business, we do not expect to generate or,
      consequently, share any email-related revenues.




The
      Company has evaluated the guidance provided by EITF 99-19 as it relates to
      determining whether revenue should be recorded gross or net for the payments
      made to network publishers and opt-in email list owners. The Company has
      determined the recording of revenues gross is appropriate based upon the
      following factors:




·
            Aptimus
                acts as a principal in these
                transactions;




41




·
            Aptimus
                and its customer are the only companies identified in the signed
                contracts;




·
            Aptimus
                and its customer are the parties who determine pricing for the
                services;




·
            Aptimus
                is solely responsible to the client for fulfillment of the
                contract;




·
            Aptimus
                bears the risk of loss related to
                collections




·
            Aptimus
                determines how the offer will be presented across the network;
                and




·
            Amounts
                earned are based on leads or emails delivered and are not based on
                amounts
                paid to publishers.




**Valuation
      Allowance for Deferred Tax Assets**




SFAS
      109,
“Accounting for Income Taxes,” requires that deferred tax assets be evaluated
      for future realization and reduced by a valuation allowance to the extent we
      believe a portion will not be realized. We consider many factors when assessing
      the likelihood of future realization of our deferred tax assets including our
      recent cumulative earnings experience by taxing jurisdiction, expectations
      of
      future taxable income, the carry-forward periods available to us for tax
      reporting purposes, and other relevant factors. At December 31, 2005, our net
      deferred tax assets are $23.1 million. Currently a valuation allowance equal
      to
      the balance of the deferred tax assets has been recorded. This valuation
      allowance has been recorded, as the ability of the Company to utilize the
      deferred tax assets has not been assessed as being more likely than not.




Any
      change in the assessment of whether it is more likely than not that the deferred
      tax assets will be utilized will have a significant impact on the estimate
      of
      the valuation allowance. We believe the impact of he section 382 change in
      control limitations may result in an inability to fully remove the valuation
      allowance. Should the ability of the company to utilize the deferred tax assets
      not be assessed as more likely than not, no reduction in the valuation allowance
      would be made.




**Allowance
      for Doubtful Accounts**




The
      estimate of allowance for doubtful accounts is comprised of two parts, a
      specific account analysis and a general reserve. Accounts where specific
      information indicates a potential loss may exist are reviewed and a specific
      reserve against amounts due is recorded. As additional information becomes
      available such specific account reserves are updated. Additionally, a general
      reserve is applied to the aging categories based on historical collection and
      write-off experience. As trends in historical collection and write-offs change,
      the percentages applied against the aging categories are updated. Except where
      specific information indicates otherwise, the following rates were applied
      against the total balance due from the client when they had an amount in the
      applicable aging category as of the date the reserve analysis was
      performed:




As
                of December 31,2005
            
            2004
            
            2003Current
            
            
            0
            %
            
            0
            %
            
            0
            %Past
                due 1-30 days
            
            
            0
            %
            
            0
            %
            
            0
            %Past
                due 31-60 days
            
            
            25
            %
            
            25
            %
            
            25
            %Past
                due 61-90 days
            
            
            50
            %
            
            50
            %
            
            50
            %Past
                due greater than 90 days
            
            
            100
            %
            
            100
            %
            
            100
            %





Additional
      metrics related to the allowance for doubtful accounts are as
      follow:






42




As
                of December 31,2005
            
            2004
            
            2003Reserve
                balance
            
            $
            223,000
            
            $
            100,000
            
            $
            61,000%
                Of overall AR reserved
            
            
            8.2
            %
            
            3.4
            %
            
            6.2
            %Days
                sales outstanding (1)
            
            
            62
            
            
            55
            
            
            64




(1)  Days
      sales outstanding is calculated by dividing net accounts receivable by revenue
      for the preceding quarter divided by the number of days in the preceding
      quarter.





As
      of
      December 31, 2005, $64,000 of the reserve related to specifically identified
      accounts that are expected be uncollectible. As of December 31, 2004, and 2003,
      reserves were based on applying the standard rates to the aging categories
      as no
      specific accounts were identified as needing to be reserved.




Over
      the
      past three years accounts receivable has increased and the allowance for
      doubtful accounts has remained relatively consistent. This trend results from
      the recovery of the economic downturn that occurred in 2001. As a result of
      the
      economic downturn in 2001, a large number of companies went out of business
      or
      filed for bankruptcy protection during 2001 and 2002. As a consequence of these
      events, the collectibility of our accounts receivable was reduced and we
      recorded additional reserves to properly value accounts receivable. All of
      the
      accounts from this time period were written off or collected by the third
      quarter of 2003. As these problem accounts were addressed and written off or
      collected the reserve declined as a percentage of total accounts receivable.
      We
      do not expect to see this trend continue but rather expect our overall reserve
      balance will stabilize around the 4-7% range as the economy stabilizes. Prior
      to
      this challenging time, reserves were historically in the range of 7-10% of
      accounts receivable. As a result of our focus on credit and collections we
      believe the 4-7% range is a more accurate expectation of reserve balances,
      although they could be reduced further or increase again should future
      information indicate a need to do so. As of December 31, 2005, the reserve
      balance is higher than the expected range as a result of several accounts that
      have been identified as uncollectible that have not been written-off as December
      31, 2005.




Days
      sales outstanding has remained relatively consistent between 55-64 days over
      the
      three years ended December 31, 2005.




Any
      increase in the rates used to calculate the reserve would result in the
      recognition of additional bad debts expense and reduce the net accounts
      receivable balance.




**Depreciation
      of Fixed and Intangible Assets**





Property
      and equipment are stated at cost less accumulated depreciation and are
      depreciated using the straight-line method over their estimated useful lives.
      Leasehold improvements are amortized on a straight-line method over their
      estimated useful lives or the term of the related lease, whichever is shorter.
      Equipment under capital leases, which all contain bargain purchase options,
      is
      recorded at the present value of minimum lease payments and is amortized using
      the straight-line method over the estimated useful lives of the related assets.
      The estimated useful lives are as follows:




Office
                furniture and equipment
            Five
                yearsComputer
                hardware and software
            Three
                yearsLeasehold
                improvements
            Three
                to Five years




Intangible
      assets are stated at cost less accumulated amortization and are amortized using
      the straight-line method over their estimated useful lives. The estimated useful
      lives are as follows:





Email
                names
            Two
                yearsAptimus
                patents and trademarks
            Three
                years






43


The
      cost
      of normal maintenance and repairs are charged to expense as incurred and
      expenditures for major improvements are capitalized. Gains or losses on the
      disposition of assets in the normal course of business are reflected in
      operating expenses as part of the results of operations at the time of
      disposal.




Changes
      in circumstances such as technological advances or changes to our business
      model
      can result in the actual useful lives differing from our estimates. In the
      event
      we determine that the useful life of a capital asset should be shortened we
      would depreciate the net book value in excess of the estimated salvage value,
      over its remaining useful life thereby increasing depreciation expense.
      Long-lived assets, including fixed assets and intangible assets other than
      goodwill, are reviewed for impairment whenever events or changes in
      circumstances indicate the carrying amount of the asset may not be recoverable.
      A review for impairment involves developing an estimate of undiscounted cash
      flow and comparing this estimate to the carrying value of the asset. The
      estimate of cash flow is based on, among other things, certain assumptions
      about
      expected future operating performance. Our estimates of undiscounted cash flow
      may differ from actual cash flow due to, among other things, technological
      changes, economic conditions, changes to our business model or changes in our
      operating performance.







**RECENT
      ACCOUNTING PRONOUNCMENTS**




In
      May
      2005, the FASB issued SFAS No. 154, “ *Accounting
      Changes and Error Corrections, A Replacement of APB Opinion No. 20 and FASB
      Statement No. 3* .”
SFAS
      154 requires retrospective application to prior periods’ financial statements
      for changes in accounting principles, unless it is impracticable to determine
      either the period-specific effects or the cumulative effect of the change.
      SFAS
      154 also requires that retrospective application of a change in accounting
      principle be limited to the direct effects of the change. Indirect effects
      of a
      change in accounting principle, such as a change in non-discretionary
      profit-sharing payments resulting from an accounting change, should be
      recognized in the period of the accounting change. SFAS 154 also requires that
      a
      change in depreciation, amortization, or depletion method for long-lived,
      non-financial assets be accounted for as a change in accounting estimate
      effected by a change in accounting principle. SFAS 154 is effective for
      accounting changes and corrections of errors made in fiscal years beginning
      after December 15, 2005. Early adoption is permitted for accounting changes
      and
      corrections of errors made in fiscal years beginning after the date this
      Statement is issued. The
      Company does not anticipate a material impact on the financial statements from
      the adoption of this consensus.




In
      December 2004, the FASB issued SFAS No. 123(R) “ *Share-Based
      Payment* ”.
      This
      Statement requires a public entity to measure the cost of employee services
      received in exchange for an award of equity instruments based on the grant-date
      fair value of the award (with limited exceptions). That cost will be recognized
      over the period during which an employee is required to provide service in
      exchange for the award—the requisite service period (usually the vesting
      period). No compensation cost is recognized for equity instruments for which
      employees do not render the requisite service. Employee stock purchase plans
      (ESPP) will result in recognition of compensation cost if certain conditions
      are
      not met. As currently structured the Company’s ESPP plan will not meet those
      conditions and compensation will be recognized. This statement is effective
      as
      of the beginning of the first interim or annual reporting period that begins
      after January 1, 2006. Early adoption is encouraged and retroactive application
      of the provisions of SFAS 123® to the beginning of the fiscal year that includes
      the effective date is permitted, but not required. This statement will be
      implemented using a modified version of prospective application. Under that
      transition method, compensation cost is recognized on or after the required
      effective date for the portion of outstanding awards for which the requisite
      service has not yet been rendered, based on the grant-date fair value of those
      awards calculated under Statement 123 for either recognition or pro forma
      disclosures. For periods before the required effective date, those entities
      may
      elect to apply a modified version of retrospective application under which
      financial statements for prior periods are adjusted on a basis consistent with
      the pro forma disclosures required for those periods by Statement 123. The
      impact of adoption of this statement on net income is expected to be a reduction
      of $54,000 related to stock option grants issued prior to January 1, 2006 in
      the
      quarter ended March 31, 2006. Total compensation related to such option grants
      is expected to be $196,000, for the year ended December 31, 2006. Additionally,
      the impact of any realized excess tax benefits will be shown as financing cash
      inflows instead of operating cash inflows in future periods.




44


Other
      recent pronouncements are not expected to have a material effect on the
      financial position or result of operations of Aptimus.




**Item
      7A:** ***Quantitative
      And Qualitative Disclosures About Market Risk***




All
      of
      our cash equivalents and short-term investments are at fixed interest rates
      and
      therefore the fair value of these instruments is affected by changes in market
      interest rates. As of December 31, 2005, however, our cash equivalents mature
      within three months and our short-term investment mature within one year. As
      of
      December 31, 2005, we believe the reported amounts of cash equivalents to be
      reasonable approximations of their fair values. As a result, we believe that
      the
      market risk and interest risk arising from its holding of financial instruments
      is minimal.




45


**Item
      8** ***:
      Financial Statements and Supplementary Data***




**INDEX
      TO CONOLIDATED FINANCIAL STATEMENTS**





**Aptimus,
      Inc.**


**Financial
      Statements**





**Page**Reports
                of Moss Adams, LLP, Independent Registered Public Accounting
                Firm
            47Consolidated
                Balance Sheets as of December 31, 2005 and 2004
            48Consolidated
                Statements of Operations for the years ended December 31,2005,
                2004 and 2003
            49Consolidated
                Statements of Shareholders' Equity for the years endedDecember
                31, 2005, 2004 and 2005
            50Consolidated
                Statements of Cash Flows for the years ended December 31, 2005, 2004
                and
                2003
            51Notes
                to Consolidated Financial Statements
            52


46




**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**





To
      the
      Board of Directors and Stockholders of


Aptimus,
      Inc.




We
      have
      audited the accompanying consolidated balance sheets of Aptimus, Inc. and
      subsidiary (“the Company”) as of December 31, 2005 and 2004, and the
      related consolidated statements of operations, stockholders’ equity and cash
      flows for each of the three years in the period ended December 31, 2005. These
      financial statements are the responsibility of the Company’s management. Our
      responsibility is to express an opinion on these financial statements based
      on
      our audit.






We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audit provides a
      reasonable basis for our opinion.






In
      our
      opinion, the financial statements referred to above present fairly, in all
      material respects, the consolidated financial position of Aptimus Inc. and
      subsidiary as of December 31, 2005 and 2004, and the consolidated results
      of its operations and its cash flows for each of the three years in the period
      ended December 31, 2005, in conformity with accounting principles generally
      accepted in the United States of America.




We
      also
      have audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the effectiveness of Aptimus Inc.’s internal
      control over financial reporting as of December 31, 2005, based on criteria
      established in Internal Control-Integrated Framework issued by the Committee
      of
      Sponsoring Organizations of the Treadway Commission, and
      our
      report dated March 14, 2006 expressed an unqualified opinion
      thereon.













/S/
      Moss
      Adams LLP


Seattle,
      Washington


March
      15,
      2006





47





**APTIMUS,
      INC.**





**CONSOLIDATED
      BALANCE SHEETS**


**(in
      thousands)**




**December
                31,****2005**
            
            **2004**Cash
                and cash equivalents
            
            $
            4,349
            
            $
            3,610Accounts
                receivable, net
            
            
            2,498
            
            
            2,857Prepaid
                expenses and other assets
            
            
            140
            
            
            130Marketable
                securities
            
            
            6,091
            
            
            —Total
                current assets
            
            
            13,078
            
            
            6,597Fixed
                assets, net of accumulated depreciation
            
            
            690
            
            
            549Intangible
                assets, net
            
            
            20
            
            
            15Deposits
            
            
            39
            
            
            45$
            13,827
            
            $
            7,206**LIABILITIES
                AND SHAREHOLDERS’ EQUITY**Accounts
                payable
            
            $
            1,016
            
            $
            1,375Accrued
                and other liabilities
            
            
            325
            
            
            631Total
                current liabilities
            
            
            1,341
            
            
            2,006Commitments
                and contingent liabilities (note 8)Shareholders’
                equity Common stock, no par value; 100,000 Shares authorized, 6,528
                and
                5,973 issued and outstanding at December 31, 2005 and 2004,
                respectively
            
            
            69,223
            
            
            63,495Additional
                paid-in capital
            
            
            2,850
            
            
            2,644Accumulated
                deficit
            
            
            (59,587
            )
            
            (60,939
            )Total
                shareholders’ equity
            
            
            12,486
            
            
            5,200$
            13,827
            
            $
            7,206








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





48





**APTIMUS,
      INC.**





**CONSOLIDATED
      STATEMENTS OF OPERATIONS**


**(in
      thousands, except per share data)**








**Year
                ended December 31,****2005**
            
            **2004**
            
            **2003**Revenues
            
            $
            15,894
            
            $
            13,993
            
            $
            4,571Operating
                expenses:Cost
                of revenues
            
            
            7,316
            
            
            6,262
            
            
            1,436Sales
                and marketing
            
            
            3,598
            
            
            2,316
            
            
            1,288Connectivity
                and network costs
            
            
            865
            
            
            812
            
            
            1,023Research
                and development
            
            
            658
            
            
            615
            
            
            527General
                and administrative
            
            
            2,004
            
            
            1,564
            
            
            1,423Depreciation
                and amortization
            
            
            356
            
            
            255
            
            
            315Loss
                on disposal/impairment of long-term assets
            
            
            95
            
            
            1
            
            
            37Total
                operating expenses
            
            
            14,892
            
            
            11,825
            
            
            6,049Operating
                income (loss)
            
            
            1,002
            
            
            2,168
            
            
            (1,478
            )Interest
                expense
            
            
            —
            
            
            35
            
            
            41Gain
                on warrant liability
            
            
            89
            
            
            —
            
            
            —Interest
                income
            
            
            261
            
            
            33
            
            
            8Impairment
                of long-term investment
            
            
            —
            
            
            40
            
            
            —Net
                income (loss)
            
            $
            1,352
            
            $
            2,126
            
            $
            (1,511
            )Earnings
                (loss) per share:Basic
            
            $
            0.21
            
            $
            0.38
            
            $
            (0.35
            )Diluted
            
            $
            0.18
            
            $
            0.30
            
            $
            (0.35
            )Weighted
                average shares outstanding:Basic
            
            
            6,351
            
            
            5,630
            
            
            4,333Diluted
            
            
            7,575
            
            
            7,182
            
            
            4,333







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





49


**APTIMUS,
      INC.**





**CONSOLIDATED
      STATEMENTS OF SHAREHOLDERS’ EQUITY**


**(in
      thousands)**





**Additional**
            
            **Deferred**
            
            
            
            **Total****Common
                stock**
            
            **Paid-in**
            
            **Stock**
            
            **Accumulated**
            
            **Shareholders’****Shares**
            
            **Amount**
            
            **Capital**
            
            **Compensation**
            
            **Deficit**
            
            **Equity****Balance
                on December 31, 2002**
            
            
            4,221
            
            $
            60,282
            
            $
            2,506
            
            $
            (2
            )
            $
            (61,554
            )
            $
            1,232Issuance
                of stock
            
            
            777
            
            
            2,694
            
            
            
            
            
            
            
            
            
            
            
            2,694Exercise
                of stock options and warrants
            
            
            221
            
            
            129
            
            
            
            
            
            
            
            
            
            
            
            129Issuance
                of warrants and options
            
            
            
            
            
            
            
            
            166
            
            
            
            
            
            
            
            
            166Forfeiture
                of shares
            
            
            (6
            )
            
            (7
            )
            
            7
            
            
            
            
            
            
            
            
            —Amortization
                of deferred stock
              Compensation
            
            
            
            
            
            
            
            
            
            
            
            2
            
            
            
            
            
            2Net
                loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (1,511
            )
            
            (1,511
            )
                  )**Balance
                on December 31, 2003**
            
            
            5,213
            
            $
            63,098
            
            $
            2,679
            
            $
            —
            
            $
            (63,065
            )
            $
            2,712Costs
                related to issuance of stock
            
            
            
            
            
            (168
            )
            
            
            
            
            
            
            
            
            
            
            (168
            )Issuance
                of shares under employee stock purchase program
            
            
            10
            
            
            44
            
            
            
            
            
            
            
            
            
            
            
            44Exercise
                of stock options and warrants
            
            
            369
            
            
            216
            
            
            
            
            
            
            
            
            
            
            
            216Conversion
                of Note Payable
            
            
            381
            
            
            305
            
            
            (35
            )
            
            
            
            
            
            
            
            270Net
                income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2,126
            
            
            2,126**Balance
                on December 31, 2004**
            
            
            5,973
            
            $
            63,495
            
            $
            2,644
            
            $
            —
            
            $
            (60,939
            )
            $
            5,200Costs
                related to issuance of stock
            
            
            
            
            
            (559
            )
            
            
            
            
            
            
            
            
            
            
            (559
            )Issuance
                of stock
            
            
            351
            
            
            6,000
            
            
            203
            
            
            
            
            
            
            
            
            6,203Issuance
                of shares under employee stock purchase program
            
            
            7
            
            
            95
            
            
            
            
            
            
            
            
            
            
            
            95Exercise
                of stock options and warrants
            
            
            197
            
            
            192
            
            
            
            
            
            
            
            
            
            
            
            192Disgorgement
                of profit
            
            
            
            
            
            
            
            
            3
            
            
            
            
            
            
            
            
            3Net
                income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,352
            
            
            1,352**Balance
                on December 31, 2005**
            
            
            6,528
            
            $
            69,223
            
            $
            2,850
            
            $
            —
            
            $
            (59,587
            )
            $
            12,486





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








50


**APTIMUS,
      INC.**





**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**(in
      thousands)**




**Year
              ended December 31,****2005**
            
            **2004**
            
            **2003****Cash
              flows
              from operating activities**Net
                income (loss)
            
            $
            1,352
            
            $
            2,126
            
            $
            (1,511
            )Adjustments
                to reconcile net income (loss) to net cash used in operating
                activities:Depreciation
                and amortization
            
            
            356
            
            
            255
            
            
            315Bad
                debt expense (recovery)
            
            
            123
            
            
            127
            
            
            26Amortization
                of deferred stock compensation
            
            
            —
            
            
            —
            
            
            103Loss
                on disposal/impairment of property and equipment
            
            
            —
            
            
            1
            
            
            37Loss
                on impairment of intangible assets
            
            
            95
            
            
            —
            
            
            —Impairment
                of long-term investment
            
            
            —
            
            
            40
            
            
            —Gain
                on warrant liability
            
            
            (89
            )
            
            —
            
            
            —Amortization
                of discount on short-term investments
            
            
            (66
            )
            
            —
            
            
            —Amortization
                of discount on convertible notes payable
            
            
            —
            
            
            3
            
            
            7Changes
                in assets and liabilities:Accounts
                receivable
            
            
            236
            
            
            (2,065
            )
            
            (415
            )Prepaid
                expenses and other assets
            
            
            (4
            )
            
            35
            
            
            (17
            )Accounts
                payable
            
            
            (359
            )
            
            739
            
            
            339Accrued
                and other liabilities
            
            
            (306
            )
            
            372
            
            
            (85
            )Net
                cash used by operating activities
            
            
            1,338
            
            
            1,633
            
            
            (1,201
            )**Cash
              flows
              from investing activities**Purchase
                of property and equipment
            
            
            (438
            )
            
            (415
            )
            
            (118
            )Proceeds
                from disposal of fixed assets
            
            
            —
            
            
            41
            
            
            18Acquisition
                of business
            
            
            (150
            )
            
            —
            
            
            —Purchase
                of intangible asset
            
            
            (9
            )
            
            (8
            )
            
            (35
            )Purchase
                of marketable securities
            
            
            (6,025
            )
            
            —
            
            
            —Sale
                of marketable securities
            
            
            —
            
            
            —
            
            
            51Net
                cash provided (used) by investing activities
            
            
            (6,622
            )
            
            (382
            )
            
            (84
            )**Cash
              flows
              from financing activities**Proceeds
                from convertible note payable
            
            
            —
            
            
            —
            
            
            305Proceeds
                from disgorgement of profit
            
            
            3
            
            
            —
            
            
            —Principal
                payments under capital leases
            
            
            —
            
            
            (101
            )
            
            (162
            )Issuance
                of common stock
            
            
            6,287
            
            
            260
            
            
            2,887Costs
                of issuing common stock
            
            
            (267
            )
            
            (168
            )
            
            (44
            )Net
                cash provided (used) by financing activities
            
            
            6,023
            
            
            (9
            )
            
            2,986Net
                increase in cash and cash equivalents
            
            
            739
            
            
            1,242
            
            
            1,701Cash
                and cash equivalents at beginning of period
            
            
            3,610
            
            
            2,368
            
            
            667Cash
                and cash equivalents at end of period
            
            $
            4,349
            
            $
            3,610
            
            $
            2,368




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


51


**APTIMUS,
      INC.**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**1.
      Organization and business**




Aptimus
      operates an online direct marketing network. Aptimus is primarily an online
      marketing service that generates sales leads, creates product awareness, and
      initiates consumer purchases through promotional offers. Aptimus began as a
      division of Online Interactive, Inc. (Online), a Washington corporation,
      incorporated in July 1994. On June 30, 1997, Online Interactive contributed
      the
      FreeShop Division, including certain net assets, to its wholly owned subsidiary,
      FreeShop International, Inc., a Washington corporation incorporated on June
      23,
      1997, which then began operating as a separate entity.




On
      February 19, 1999, FreeShop International, Inc. changed its name to
      FreeShop.com, Inc. On October 16, 2000, FreeShop.com, Inc. changed its name
      to
      Aptimus, Inc. (Aptimus).




**2.
      Summary of significant accounting policies**




*Principles
      of Consolidation*





The
      financial statements include the accounts of the Company and its wholly-owned
      subsidiary, Neighbornet LLC. Inter-company balances and transactions have been
      eliminated.




*Reclassifications*





Certain
      prior year amounts have been reclassified to conform to the current year's
      presentation. Amounts previously included in the statement of operations as
      partner fees have been reclassified to cost of revenues for all periods
      presented. Cost of revenues consists entirely of the reclassified partner fees.
      Also amounts related to the impairment of certain long-term investments were
      previously included in the statement of operations under the caption “Loss
      (gain) on disposal of long-term assets.” Amounts related to the impairment of
      certain long-term investments have been reclassified to the “Impairment of
      long-term investment” caption.




*Use
      of estimates*





The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States of America requires management to make
      estimates and assumptions that affect the reported amounts of assets and
      liabilities and disclosure of contingent assets and liabilities at the date
      of
      the financial statements and the reported amounts of revenues and expenses
      during the reporting period. Actual results could differ materially from those
      estimates. Significant accounting policies and estimates underlying the
      accompanying financial statements include:




·
            the
                timing of revenue recognition;


·
            the
                allowance for doubtful accounts;


·
            the
                lives and recoverability of
                equipment;


·
            our
                determination of the need for reserves for deferred tax
                assets;


·
            stock-based
                compensation.




It
      is
      reasonably possible that the estimates we make may change in the
      future.




*Cash,
      and cash equivalents*




Aptimus
      generally considers any highly liquid investments purchased with an original
      or
      remaining maturity of three months or less at the date of purchase to be cash
      equivalents.




52


Aptimus
      invests its cash and cash equivalents in deposits at a major financial
      institution that may, at times, exceed federally insured limits. We believe
      that
      the risk of loss is minimal. To date, we have not experienced any losses related
      to temporary cash investments.




*Marketable
      securities*




Aptimus
      classifies, at the date of acquisition, its marketable securities into
      categories in accordance with the provisions of Statement of Financial
      Accounting Standards No. 115, “Accounting for Certain Investments in Debt and
      Equity Securities.” At December 31, 2005, short-term investments consisted of a
      commercial paper with maturities of less than one year. There were no short-term
      investments at December 31, 2004. Realized gains and losses and declines in
      value of securities judged to be other than temporary are included in other
      income (expense), net.




*Accounts
      receivable*




Aptimus
      grants credit to its customers for substantially all of its sales. Accounts
      receivable are stated at their estimated net realizable value. The estimate
      of
      allowance for doubtful accounts is comprised of two parts, a specific account
      analysis and a general reserve. Accounts where specific information indicates
      a
      potential loss may exist are reviewed and a specific reserve against amounts
      due
      is recorded. As additional information becomes available such specific account
      reserves are updated. Additionally, a general reserve is applied to the aging
      categories based on historical collection and write-off experience. As trends
      in
      historical collection and write-offs change, the percentages applied against
      the
      aging categories are updated. Accounts receivable are considered past due when
      payment has not been received within the contractual terms, which are generally
      net 30 days from invoice date. Amounts are considered uncollectible and written
      of to the reserve for bad debts when all internal collection efforts have been
      exhausted.




*Fixed
      assets*




Property
      and equipment are stated at cost less accumulated depreciation and are
      depreciated using the straight-line method over their estimated useful lives.
      Leasehold improvements are amortized on a straight-line method over their
      estimated useful lives or the term of the related lease, whichever is shorter.
      The estimated useful lives for financial reporting purposes are as
      follows:







Office
                furniture and equipment
            Five
                yearsComputer
                hardware and software
            Three
                yearsLeasehold
                improvements
            Three
                to Five years





The
      cost
      of normal maintenance and repairs are charged to expense as incurred and
      expenditures for major improvements are capitalized. Gains or losses on the
      disposition of assets in the normal course of business are reflected in the
      results of operations at the time of disposal.




*Intangible
      assets*




Intangible
      assets are stated at cost less accumulated amortization and are amortized using
      the straight-line method over their estimated useful lives. The estimated useful
      lives are as follows:





Email
                names
            Two
                yearsAptimus
                trademarks, logo and patents
            Three
                years





*Long-term
      investments*




Long-term
      investments consist of minority equity investments in non-public companies.
      These investments are being accounted for on the cost basis and will be
      evaluated for impairment each quarter. During the year ended December 31, 2004,
      Aptimus recorded a charge of approximately $40,000, related to the impairment
      of
      these investments. During 2003, there were no identified events or changes
      in
      circumstances that would have a significant adverse effect on the fair value
      of
      the investments.




53


*Impairment
      of long-lived assets*




Aptimus
      evaluates its long-lived assets for impairment and continues to evaluate them
      as
      events or changes in circumstances indicate that the carrying amount of such
      assets may not be fully recoverable. We evaluate the recoverability of
      long-lived assets by measuring the carrying amount of the assets against the
      estimated undiscounted future cash flows associated with these assets. If at
      the
      time, such evaluations indicate that the future undiscounted cash flows of
      certain long-lived assets are not sufficient to recover the carrying value
      of
      such assets, the assets are adjusted to their fair values. A charge of $95,000
      was recorded in December 2005 related to the impairment of intangible assets
      acquired in May 2005. No impairment charges were recognized during the year
      ended December 31, 2004 or 2003.




*Fair
      value of financial instruments*




The
      carrying amounts of financial instruments, including cash and cash equivalents,
      accounts receivable, marketable securities, accounts payable, and accrued
      liabilities approximate fair value because of their short
      maturities.




*Deferred
      revenues*




Deferred
      revenues consist of advance billings and payments on marketing contracts and
      are
      included in accrued and other liabilities in the accompanying balance
      sheet.




*Revenue
      recognition*





In
      the
      three years ended December 31, 2005, Aptimus derived revenue from providing
      response-based advertising programs through a network of web site and email
      distribution publishers.




Revenue
      earned for response-based advertising through the Aptimus network is based
      on a
      fee per lead and is recognized when the lead information is delivered to the
      client. Revenue earned for email mailings can be based on a fee per lead, a
      percentage of revenue earned from the mailing, or a cost per thousand emails
      delivered. Revenue from email mailings delivered on a cost per thousand basis
      is
      recognized when the email is delivered. Revenues from email mailings sent on
      a
      fee per lead or a percentage of revenue earned from the mailing basis are
      recognized when amounts are determinable, generally when the customer receives
      the leads.




Revenues
      generated through network publishers and opt-in email list owners are recorded
      on a gross basis in accordance with Emerging Issues Task Force consensus 99-19
      (EITF 99-19). Fees paid to network publishers and opt-in email list owners
      related to these revenues are shown as Cost of revenues on the Statement of
      Operations. Aptimus shares a portion of the amounts it bills its advertiser
      clients with the third-party web site owners or “publishers” and email list
      owners on whose web properties and email lists Aptimus distributes the
      advertisements. While this “revenue share” approach is Aptimus’ primary payment
      model, it will as an alternative occasionally pay web site owners either a
      fixed
      fee for each completed user transaction or a fee for each impression of an
      advertisement served on the web site. Email based campaigns that are sent to
      Company owned lists do not have publisher fees associated with them. In the
      future, due to the indefinite suspension of our email business, we do not expect
      to generate or, consequently, share any email-related revenues.




54




We
      have
      evaluated the guidance provided by EITF 99-19 as it relates to determining
      whether revenue should be recorded gross or net for the payments made to network
      publishers and opt-in email list owners and have determined the recording of
      revenues gross is appropriate based upon the following factors:




·
            Aptimus
                acts as a principal in these
                transactions;




·
            Aptimus
                and its customer are the only companies identified in the signed
                contracts;




·
            Aptimus
                and its customer are the parties who determine pricing for the
                services;




·
            Aptimus
                is solely responsible to the client for fulfillment of the
                contract;




·
            Aptimus
                bears the risk of loss related to
                collections




·
            Aptimus
                determines how the offer will be presented across the network;
                and




·
            Amounts
                earned are based on leads or emails delivered and are not based on
                amounts
                paid to publishers.




In
      addition to response-based advertising revenues, Aptimus earns revenue from
      list
      rental activities. List rental revenues are received from the rental of customer
      names to third parties through the use of list brokers. Revenue from list rental
      activities are recognized in the period the payment is received due to
      uncertainty surrounding the net accepted number of names.




*Advertising
      costs*




Aptimus
      expenses advertising costs as incurred. Total advertising expense for the years
      ended December 31, 2005, 2004 and 2003, were $205,000, $67,000, and $45,000,
      respectively.




*Research
      and development costs*




Research
      and development costs are expensed as incurred.




*Web
      site development costs*




Costs
      incurred in developing our web sites are accounted for in accordance with
      Emerging Issues Task Force Issues Number 00-02, “Accounting for web site
      Development Costs.” As such, we expense all costs incurred that relate to the
      planning and post implementation phases of development. Costs incurred in the
      development phase are capitalized and recognized over the web site’s estimated
      useful life if the web site is expected to have a useful life beyond one year.
      Costs capitalized are included in fixed assets and are amortized over three
      years. Costs associated with the repair or maintenance of existing sites or
      development costs of web site content are expensed as incurred.




*Income
      taxes*




Aptimus
      accounts for income taxes under the asset and liability method, which requires
      recognition of deferred tax assets and liabilities for the expected future
      tax
      consequences of temporary differences between the carrying amounts and the
      tax
      bases of assets and liabilities. If it is more likely than not that some portion
      of a deferred tax asset will not be realized, a valuation allowance is
      recorded.




*Net
      earnings (loss) per share*




Basic
      earnings (loss) per share represents net income (loss) available to common
      shareholders divided by the weighted average number of shares outstanding during
      the period. Diluted earnings (loss) per share represents net income (loss)
      available to common shareholders divided by the weighted average number of
      shares outstanding, including the potentially dilutive impact of common stock
      options and warrants. Common stock options and warrants are converted using
      the
      treasury stock method.




55




The
      following table sets forth the computation of the numerators and denominators
      in
      the basic and diluted earnings (loss) per share calculations for the periods
      indicated and those common stock equivalent securities not included in the
      diluted net loss per share calculation as their effect on earnings (loss) per
      share is anti-dilutive (in thousands, except per share data):







**Year
                ended December 31,****2005**
            
            **2004**
            
            **2003**Numerator:Net
                income (loss) (A)
            
            $
            1,352
            
            $
            2,126
            
            $
            (1,511
            )Denominator:Weighted
                average outstanding shares of common stock (B)
            
            
            6,351
            
            
            5,630
            
            
            4,333Weighted
                average dilutive effect of options to purchase common
                stock
            
            
            1,121
            
            
            1,326
            
            
            —Weighted
                average dilutive effect of shares to be issued on conversion of
                convertible notes payable
            
            
            —
            
            
            86
            
            
            —Weighted
                average dilutive effect of warrants to purchase common
                stock
            
            
            103
            
            
            140
            
            
            —Weighted
                average of common stock and common stock equivalents (C)
            
            
            7,575
            
            
            7,182
            
            
            4,333Earnings
                (loss) per share:Basic
                (A) / (B)
            
            $
            0.21
            
            $
            0.38
            
            $
            (0.35
            )Diluted
                (A) / (C)
            
            $
            0.18
            
            $
            0.30
            
            $
            (0.35
            )Antidilutive
                securities excluded consist of the following:Options
                to purchase common stock
            
            
            52
            
            
            32
            
            
            1,522Warrants
                to purchase common stock
            
            
            91
            
            
            —
            
            
            183Shares
                to be issued on conversion of convertible notes payable
            
            
            —
            
            
            —
            
            
            381143
            
            
            32
            
            
            2,086







*Concentrations
      of credit risk*




Concentrations
      of credit risk with respect to accounts receivable exist due to the large number
      of Internet based companies that we do business with. This risk is mitigated
      due
      to the wide variety of customers to which Aptimus provides services, as well
      as
      the customer’s dispersion across many different geographic areas. During the
      year ended December 31, 2005, one customer accounted for 10.2% of total
      revenues. During the year ended December 31, 2004, two customers accounted
      for
      20.2% and 12.3% of revenues. During the year ended December 31, 2003, two
      customers accounted for 13.6% and 10.1% of revenues. As of December 31, 2005,
      one customer accounted for 13.5% of outstanding accounts receivable. As of
      December 31, 2004, three customers accounted for 18.6%, 11.6% and 11.1%, of
      outstanding accounts receivable. As of December 31, 2003, two customers
      accounted for 34.4% and 17.2%, of outstanding accounts receivable. The Company
      maintains an allowance for doubtful accounts receivable based upon its
      historical experience and the expected collectibility of all accounts
      receivable. During the year ended December 31, 2005, one publisher accounted
      for
      10.6% of total revenues. During the year ended December 31, 2004, one publisher
      accounted for 23.7% of revenues. During the year ended December 31, 2003, no
      publisher accounted for more than 10% of revenues.




56


*Stock
      compensation*




At
      December 31, 2005, Aptimus had two stock-based employee compensation plans,
      which are more fully described in Note 10. Through December 31, 2005, Aptimus
      accounted for those plans under the recognition and measurement principles
      of
      APB Opinion No. 25, *Accounting
      for Stock Issued to Employees* ,
      and
      related Interpretations. Effective January 1, 2006 the Company has adopted
      Statement of Financial Accounting Standards No. 123(R) “Share-Based Payment”,
      (SFAS 123(R)), using the modified prospective application transition method.
      SFAS 123(R) requires the measurement and recognition of compensation expense
      for
      all share-based payment awards made to employees and directors, including
      employee stock options and restricted stock grants related to the Company’s
      incentive plans, to be based on fair values. SFAS 123(R) requires companies
      to
      estimate the fair value of share-based payment awards on the date of grant
      using
      an option-pricing model. The Company will use the Black-Scholes model to
      determine the fair value of employee stock options granted. Financial statements
      for prior interim periods and fiscal years do not reflect any restated amounts
      as a result of this adoption in accordance with the modified prospective
      transition method under SFAS 123(R). The following table illustrates the effect
      on net income and earnings per share if the Company had applied the fair value
      recognition provisions of FASB Statement No. 123, *Accounting
      for Stock-Based Compensation* ,
      to
      stock-based employee compensation for the periods indicated (in thousands,
      except per share data):





**Years
                ended December 31,****2005**
            
            **2004**
            
            **2003**Net
                income (loss), as reported
            
            $
            1,352
            
            $
            2,126
            
            $
            (1,511
            )Add:
                Total stock-based employee compensation expense, included in the
                determination of net income as reported, net of related tax
                effects
            
            
            —
            
            
            —
            
            
            104Deduct:
                Total stock-based employee compensation expense determined under
                fair
                value based method for all awards, net of related tax
                effects
            
            
            (4,978
            )
            
            (552
            )
            
            (249
            )Pro
                forma net income (loss)
            
            $
            (3,626
            )
            $
            1,574
            
            $
            (1,656
            )**Earnings
                per share:**Basic
                - as reported
            
            $
            0.21
            
            $
            0.38
            
            $
            (0.35
            )Basic
                - pro forma
            
            $
            (0.57
            )
            $
            0.28
            
            $
            (0.38
            )Diluted
                - as reported
            
            $
            0.18
            
            $
            0.30
            
            $
            (0.35
            )Diluted
                - pro forma
            
            $
            (0.57
            )
            $
            0.22
            
            $
            (0.38
            )




*Comprehensive
      income*




To
      date,
      Aptimus has not had any transactions required to be reported in comprehensive
      income other than its net income (loss).




*Segment
      information*





Aptimus
      has organized and managed its operations in a single operating segment providing
      results based advertising to direct marketing clients. An additional operating
      segment was identified in the third quarter. However in the fourth quarter
      it
      was determined that this potential operating segment was not material and
      operating results would not be provided to the chief decision maker on a segment
      basis. See 18. Segment Information.




57


*Recent
      accounting pronouncements*




In
      May
      2005, the FASB issued SFAS No. 154, “ *Accounting
      Changes and Error Corrections, A Replacement of APB Opinion No. 20 and FASB
      Statement No. 3* .”
SFAS
      154 requires retrospective application to prior periods’ financial statements
      for changes in accounting principles, unless it is impracticable to determine
      either the period-specific effects or the cumulative effect of the change.
      SFAS
      154 also requires that retrospective application of a change in accounting
      principle be limited to the direct effects of the change. Indirect effects
      of a
      change in accounting principle, such as a change in non-discretionary
      profit-sharing payments resulting from an accounting change, should be
      recognized in the period of the accounting change. SFAS 154 also requires that
      a
      change in depreciation, amortization, or depletion method for long-lived,
      non-financial assets be accounted for as a change in accounting estimate
      effected by a change in accounting principle. SFAS 154 is effective for
      accounting changes and corrections of errors made in fiscal years beginning
      after December 15, 2005. Early adoption is permitted for accounting changes
      and
      corrections of errors made in fiscal years beginning after the date this
      Statement is issued. The
      Company does not anticipate a material impact on the financial statements from
      the adoption of this consensus.




In
      December 2004, the FASB issued rSFAS No. 123(R) “ *Share-Based
      Payment* ”.
      This
      Statement requires a public entity to measure the cost of employee services
      received in exchange for an award of equity instruments based on the grant-date
      fair value of the award (with limited exceptions). That cost will be recognized
      over the period during which an employee is required to provide service in
      exchange for the award—the requisite service period (usually the vesting
      period). No compensation cost is recognized for equity instruments for which
      employees do not render the requisite service. Employee stock purchase plans
      (ESPP) will result in recognition of compensation cost if certain conditions
      are
      not met. As currently structured the Company’s ESPP plan will not meet those
      conditions and compensation will be recognized. This statement is effective
      as
      of the beginning of the first interim or annual reporting period that begins
      after January 1, 2006. Early adoption is encouraged and retroactive application
      of the provisions of SFAS 123(R) to the beginning of the fiscal year that
      includes the effective date is permitted, but not required. This statement
      will
      be implemented using a modified version of prospective application. Under that
      transition method, compensation cost is recognized on or after the required
      effective date for the portion of outstanding awards for which the requisite
      service has not yet been rendered, based on the grant-date fair value of those
      awards calculated under Statement 123 for either recognition or pro forma
      disclosures. For periods before the required effective date, those entities
      may
      elect to apply a modified version of retrospective application under which
      financial statements for prior periods are adjusted on a basis consistent with
      the pro forma disclosures required for those periods by Statement 123. The
      impact of adoption of this statement on net income is expected to be a reduction
      of $54,000 related to stock option grants issued prior to January 1, 2006 in
      the
      quarter ended March 31, 2006. Total compensation related to such option grants
      is expected to be $196,000, for the year ended December 31, 2006. Additionally,
      the impact of any realized excess tax benefits will be shown as financing cash
      inflows instead of operating cash inflows in future periods.




**3.
      Accounts receivable**




Accounts
      receivable consist of the following (in thousands):





**December
                31,****2005**
            
            **2004**Accounts
                receivable
            
            $
            2,721
            
            $
            2,957Less:
                Allowance for doubtful accounts
            
            
            (223
            )
            
            (100
            )$
            2,498
            
            $
            2,857





58


**4.
      Property and equipment**





Property
      and equipment consists of the following (in thousands):





**December
                31,****2005**
            
            **2004**Computer
                hardware and software
            
            $
            2,518
            
            $
            2,426Office
                furniture and equipment
            
            
            179
            
            
            141Leasehold
                improvements
            
            
            77
            
            
            74$
            2,774
            
            
            2,641Less:
                Accumulated depreciation
            
            
            (2,084
            )
            
            (2,092
            )$
            690
            
            $
            549




Depreciation
      expense for the years ended December 31, 2005, 2004 and 2003, was $297,000,
      $232,000 and $286,000, respectively.





**5.
      Intangible assets**




Intangible
      assets consists of the following (in thousands):





**December
                31,****2005**
            
            **2004**Email
                names and acquired relationships
            
            $
            55
            
            $
            36Aptimus
                trademarks, logo and patents
            
            
            83
            
            
            74$
            138
            
            
            110Less:
                Accumulated amortization
            
            
            (118
            )
            
            (95
            )$
            20
            
            $
            15





Amortization
      expense for the years ended December 31, 2005, 2004 and 2003, was $59,000,
      $95,000 and $72,000, respectively.





Expected
      future amortizations expense is as follows:





**Year
                ending December 31,**
            
            **Amortization**2006
            
            $
            162007
            
            
            22008
            
            
            2Total
                expected future amortization
            
            $
            20





**6.
      Accrued and other liabilities**




Accrued
      and other liabilities consist of the following (in thousands):




59





**December
                31,****2005**
            
            **2004**Accrued
                network publisher fees
            
            $
            63
            
            $
            73Accrued
                commissions
            
            
            26
            
            
            92Deferred
                revenue
            
            
            10
            
            
            44Accrued
                vacation
            
            
            73
            
            
            62Accrued
                bonus
            
            
            —
            
            
            236Other
            
            
            153
            
            
            124$
            325
            
            $
            631





**7.
      Convertible note payable**




In
      July
      2003, Aptimus borrowed $305,000 pursuant to the terms of a Convertible
      Promissory Note, which paid interest of 6% per annum, but could be converted
      to
      shares of common stock at the option of the holder at a fixed price of $0.80
      per
      share. The note had a 36-month term. Accrued interest was payable quarterly,
      commencing one year from the closing date. In addition to the notes, Aptimus
      issued warrants to the investors to purchase a total of 127,094 shares of common
      stock for $0.50 per share. The warrants have a term of five years. On March
      30,
      2004, the Convertible Promissory Note was converted into 381,250 shares of
      common stock. On conversion of the Convertible Promissory Note, $35,000 of
      the
      $46,000 discount recorded related to the warrants issued in connection with
      the
      Convertible Promissory Note was reversed against paid in capital. The difference
      of $11,000 was reported as interest expense, throughout the period the
      Convertible Promissory Note was outstanding. In addition, $13,000 of accrued
      interest was paid directly to the holders of the Convertible Promissory Note
      in
      April 2004.




**8.
      Related party transactions**




In
      May
      2002, 23,600 shares of our common stock were purchased from a departing
      executive officer, on a ratable basis, by four of our executive officers for
      total purchase consideration of $27,376. To facilitate this transaction Aptimus
      loaned each of the four executive officers the $6,844 necessary to purchase
      their respective shares. The notes receivable bear interest at the prime rate,
      are secured by the stock purchased with the loan proceeds and are non-recourse.
      The terms of the notes receivable called for repayment on the earlier of demand
      by Aptimus or the self-initiated, voluntary termination of employment by the
      executive officer. The terms also called for the loan to be forgiven on the
      earlier of two years, the merger or sale of Aptimus, the filing of a bankruptcy
      petition by or against Aptimus or election by the Company Board of Directors
      in
      its sole discretion. However, due to the flexibility of the note terms, Aptimus
      felt the value of the notes should not be reflected on the balance sheet. The
      value of these notes of $27,376 was expensed as compensation expense in
      September 2002. In June 2003, 5,900 of the shares outstanding were cancelled
      along with $6,844 of notes receivable as a result of one of the executive
      officers leaving the Company. As of June 2004, by their terms the remaining
      notes have expired and the underlying loans have been forgiven.




In
      July
      2003, we borrowed $305,000 pursuant to the terms of a Convertible Note Purchase
      Agreement (see Note 7). The payment obligation, memorialized in a secured
      convertible promissory note issued to each investor, had a 36-month term, bore
      interest at 6% per annum, and could be converted to shares of common stock
      at
      the option of the holder at a fixed price of $0.80 per share. Accrued interest
      was payable quarterly, commencing one year from the closing date. As part of
      the
      transaction, we issued to the investors warrants to purchase a total of 127,094
      shares of our common stock for $0.50 per share. The warrants have a term of
      five
      years. The $45,627 value of these warrants was recorded as a discount on the
      convertible note obligation and amortized to expense over the 36-month term
      of
      the obligation. In July 2003, Timothy C. Choate, our CEO, and Robert W. Wrubel,
      one of our independent directors and an employee as of June 2005, each
      participated in the convertible note financing in the amount of $50,000 and
      $15,000, respectively. In his capacity as an investor, Mr. Choate was granted
      a
      warrant to purchase 20,835 shares of our common stock; and Mr. Wrubel was
      granted a warrant to purchase 6,250 shares of our common stock. On March 30,
      2004, the Convertible Promissory Note was converted into 381,250 shares of
      common stock of which Mr. Choate received 62,500 and Mr. Wrubel received 18,750.
      In April 2004 Mr. Choate and Mr. Wrubel received payments of $2,252.05 and
      $650.96, respectively, representing interest on the convertible promissory
      notes.




60


In
      July
      2003, Aptimus obtained a line-of-credit with Comerica Bank for up to $500,000,
      with a term of one year, which is renewable at our option, and is secured by
      the
      Company’s assets. The line-of-credit bears interest at prime plus three percent.
      Timothy C. Choate, the Company Chief Executive Officer, personally guaranteed
      the line-of-credit. In August 2003, Mr. Choate was granted an option to purchase
      25,000 shares of our common stock at an exercise price of $0.00 per share in
      recognition of and gratitude for his personal guarantee of the line-of-credit
      debt. Equity-based compensation of $15,500, representing the fair market value
      of the underlying shares at the time of the grant, was recorded related to
      this
      option grant.




**9.
      Commitments and contingencies**




The
      Company’s office facilities are leased under operating leases that provide for
      minimum rentals and require payment of property taxes and include escalation
      clauses. Aptimus has two material operating leases. The operating lease for
      the
      Seattle office has a term that started In June of 2004 and ends in June of
      2009.
      The Seattle office lease can be extended for an additional five years. The
      initial rental rate for the extension period shall be the then current market
      rate similar “class-A” office space. The operating lease for the San Francisco
      office has a term that started In December of 2003 and ends in December of
      2007.
      The San Francisco office lease can be extended for an additional three years.
      The initial rental rate for the extension period shall equal the prevailing
      market rate as defined in the lease.




Future
      minimum lease payments under the non-cancelable leases are as follows (in
      thousands).





**Year
                ending December 31,**
            
            **Operating
                leases**2006
            
            
            3142007
            
            
            3212008
            
            
            1002009
            
            
            50Total
                minimum lease payments
            
            $
            785





Rent
      expense for the years ended December 31, 2005, 2004 and 2003, was $231,000,
      $224,000 and $206,000 respectively.




*Litigation*




The
      Company may be subject to various claims and pending or threatened lawsuits
      in
      the normal course of business. Management believes that the outcome of any
      such
      lawsuits would not have a materially adverse effect on the Company’s financial
      position, results of operations or cash flows.




*Change
      in Control Agreement*




In
      December 2002, the Board of Directors approved a Change in Control Agreement.
      Under the terms of this agreement, key members of management are to receive
      a
      severance package ranging between eight and twelve months salary in the event
      of
      a change in control of the Company and termination of the employee.




61


*Guarantees
      and Indemnifications*




The
      following is a summary of our agreements that hawse have determined are within
      the scope of Interpretation No. 45 Guarantor’s Accounting and Disclosure
      Requirements of Guarantees, Including Indirect Guarantees of Indebtedness of
      Others, or FIN 45, which are separately grandfathered because the guarantees
      were in effect prior to December 31, 2002. Accordingly, we have no liabilities
      recorded for these agreements as of December 31, 2005.




As
      permitted under Washington law and our by-laws and certificate of incorporation,
      Aptimus has agreements whereby we indemnify our officers and directors for
      certain events or occurrences while the officer or director is, or was serving,
      at our request in such capacity. The term of the indemnification period is
      the
      applicable statute of limitations for indemnifiable claims. The maximum
      potential amount of future payments we could be required to make under these
      indemnification agreements is unlimited; however, Aptimus has a directors’ and
      officers’ insurance policy that may enable us to recover a portion of any future
      amounts paid. Assuming the applicability of coverage and the willingness of
      the
      insurer to assume coverage and subject to certain retention, loss limits and
      other policy provisions, we believe the estimated fair value of this
      indemnification obligation is not material. However, no assurances can be given
      that the insurers will not attempt to dispute the validity, applicability or
      amount of coverage, which attempts may result in expensive and time-consuming
      litigation against the insurers.




Aptimus’
      standard advertising client and distribution publisher contracts include
      standard cross indemnification language that requires, among other things,
      that
      we indemnify the client or publisher, as the case may be, for certain claims
      and
      damages asserted by third-parties that arise out of Aptimus’ breach of the
      contract. In the past, Aptimus has not been subject to any claims for such
      losses and has thus not incurred any material costs in defending or settling
      claims related to these indemnification obligations. Accordingly, we believe
      the
      estimated fair value of these obligations is not material.




Pursuant
      to these agreements, Aptimus may indemnify the other party for certain losses
      suffered or incurred by the indemnified party in connection with various types
      of third-party claims, which may include, claims of intellectual property
      infringement, breach of contract and intentional acts in the performance of
      the
      contract. The term of these indemnification obligations is generally limited
      to
      the term of the contract at issue. In addition, Aptimus limits the maximum
      potential amount of future payments we could be required to make under these
      indemnification obligations to the consideration paid during a limited period
      of
      time under the applicable contract, but in some infrequent cases the obligation
      may not be so limited. In addition, our standard policy is to disclaim most
      warranties, including any implied or statutory warranties such as warranties
      of
      merchantability, fitness for a particular purpose, quality and non-infringement,
      as well as any liability with respect to incidental, indirect, consequential,
      special, exemplary, punitive or similar damages. In some states, such
      disclaimers may not be enforceable. If necessary, the Company would provide
      for
      the estimated cost of service warranties based on specific warranty claims
      and
      claim history. Aptimus has not been subject to any claims for such losses and
      has not incurred any costs in defending or settling claims related to these
      indemnification obligations. Accordingly, we believe the estimated fair value
      of
      these agreements is not material.




**10.
      Shareholders’ equity**




*Preferred
      stock*




Subject
      to the provisions of the articles of incorporation and limitations prescribed
      by
      law, the Board of Directors has the authority to issue, without further vote
      or
      action by the shareholders, up to 6,814,516 additional shares of preferred
      stock
      in one or more series.




62


In
      March
      2002, the Board of Directors of Aptimus declared a dividend distribution of
      one
      preferred share purchase right (a “right”) for each outstanding share of our
      Common Stock. The dividend was payable to the stockholders of record on March
      29, 2002. Each right entitles the registered holder to purchase from Aptimus
      one
      one-thousandth of a share of Series C Preferred Stock at a price of $15 per
      one
      one-thousandth of a Preferred Share. In the event of an acquisition, except
      pursuant to a tender or exchange offer which is for all outstanding Common
      Shares at a price and on terms which a majority of certain members of the Board
      of Directors determines to be adequate, each holder of a right will thereafter
      have the right to receive upon exercise the number of Common Shares or of one
      one-thousandth of a share of Preferred Shares having a value equal to two times
      the exercise price of the right. There were no transactions during 2005, 2004
      or
      2003 related to the rights.




*Common
      stock*




In
      March
      2005, the Company completed a $6 million private placement transaction with
      seven accredited investors. The Company sold the accredited investors 351,083
      shares of the Company’s unregistered common stock at a price of $17.09 per
      share. The shares were issued in reliance upon the exemptions from registration
      provided by Rule 506 of Regulation D and Section 4(2) under the Securities
      Act.
      The warrants are exercisable upon issuance and expire March 24, 2010. Net
      proceeds from the transactions, after issuance costs and placement fees, were
      approximately $5.7 million.




Within
      30
      calendar days following the closing date, the Company was required to file
      with
      the Securities and Exchange Commission (SEC) a registration statement covering
      the resale of all of the common stock purchased and the common stock underlying
      the warrants issued to the investors. The Company was required to use its
      commercially reasonable efforts to obtain effectiveness of the registration
      statement before the earlier of (a) the 120th calendar day following the closing
      date or (b) the fifth trading day following notification by the SEC that the
      registration statement will not be reviewed or is no longer subject to further
      review and comment.




The
      registration rights agreement provides that if a registration statement is
      not
      filed, or does not become effective, within the defined time period, then in
      addition to any other rights the investors may have, the Company would be
      required to pay to each investor an amount in cash, as liquidated damages,
      equal
      to 1.5% per month of the aggregate purchase price, prorated daily.




On
      March
      30, 2004, the Convertible Promissory Note described in Note 7 was converted
      into
      381,250 shares of unregistered common stock. These shares were subsequently
      registered on November 12, 2004.




In
      December 2003, 776,690 shares of unregistered common stock were issued to
      investors at a price of $3.55 per share. Gross proceeds were $2.757 million
      with
      costs of approximately $64,000, including $20,000 of compensation related to
      the
      issuance of warrants. On December 4, 2003, the date this sale closed, the price
      of our shares on the over-the-counter market was $4.65 per share. This sale
      was
      priced at $3.55 as the negotiations were initiated in November 2003, when our
      stock traded between $3.25 and $4.10, the shares were not registered, and the
      sale was for a significant quantity of shares. These shares were subsequently
      registered on November 12, 2004.




*Warrants*




In
      March
      of 2005, in connection with the completion of the $6 million private equity
      placement transaction, warrants for an additional 70,216 shares of common stock
      at a strike price of $20.22 were issued to the investors. In addition to the
      warrants issued to the seven purchasers warrants to purchase a total of 21,065
      shares of common stock at a strike price of $18.15 were also issued to an entity
      who acted as our financial advisor in the transaction and an accredited-investor
      assignee of the financial advisor.




63


The
      fair
      value of the warrants was estimated to be $955,000 on the closing date of the
      transaction, calculated using the Black-Scholes option-pricing model with the
      following assumptions: no dividends; risk-free interest rate of 4.3%, the
      contractual life of 5 years and volatility of 100%.




In
      accordance with EITF 00-19, “Accounting for Derivative Financial Instruments
      Indexed To, and Potentially Settled In a Company’s Own Stock,” and the terms of
      the warrants, the fair value of the warrants issued to the investors was
      accounted for as a liability, with an offsetting reduction to the carrying
      value
      of the common stock.




On
      May
      13, 2005 the registration statement related to the March 2005 offering was
      declared effective and the warrant liability was reclassified to equity. At
      the
      time of the reclassification the fair value of the warrants was estimated to
      be
      $866,000, calculated using the Black-Scholes option-pricing model with the
      following assumptions: no dividends; risk-free interest rate of 3.83%, the
      contractual life of 4.863 years and volatility of 100%. The $89,000 decrease
      in
      the fair market value of the warrants was recorded as a gain on warrant
      liability in the Statement of Income.




In
      December of 2003, Aptimus issued a warrant to purchase 5,634 shares of common
      stock related to the sale of 776,690 shares of common stock. The warrant is
      fully vested, has an exercise price of $5.00 per share and a term of five years.
      Compensation related to the issuance of this warrant in the amount of $20,000
      was recorded and is included as an offset to common stock in the balance
      sheet.




In
      October of 2003, Aptimus issued a warrant to purchase 50,000 shares of common
      stock for services. The warrant is fully vested, has an exercise price of $2.05
      per share and a term of five years. Compensation related to the issuance of
      this
      warrant in the amount of $78,000 was recorded and is included in equity based
      compensation on the statement of operations.




In
      July
      of 2003, in connection with the issuance of the $305,000 convertible note
      payable, Aptimus issued warrants for 127,095 shares of common stock. The
      warrants are fully vested, have an exercise price of $0.50 per share and a
      term
      of five years. Compensation related to the issuance of the warrants in the
      amount of $46,000 was recorded as a discount and was being amortized to interest
      expense over the life of the notes. On March 30, 2004, the Convertible
      Promissory Note was converted into 381,250 shares of common stock. On conversion
      of the Convertible Promissory Note, $35,000 of the $46,000 discount recorded
      related to the warrants issued in connection with the Convertible Promissory
      Note was reversed against paid in capital. The difference of $11,000 was
      reported as interest expense, throughout the period the Convertible Promissory
      Note was outstanding.




In
      return
      for various services and in connection with various investment transactions,
      Aptimus has issued warrants to purchase shares of common stock. At December
      31,
      2005, warrants outstanding are as follows:




**Year
                of issue**
            **Shares**
            **Exercise
                price**
            **Year
                of expiration**2003
            27,085
            $0.50
            20082003
            43,125
            $2.05
            20082003
            5,634
            $5.00
            20082005
            70,216
            $20.22
            20102005
            21,065
            $18.15
            2010





*Stock
      options*




Effective
      June 30, 1997, Aptimus approved the 1997 Stock Option Plan (the 1997 Plan)
      to
      provide for the granting of stock options for up to 2.4 million shares to
      employees, directors and consultants of Aptimus to acquire ownership in Aptimus
      and provide them with incentives for their service. As of December 31, 2005,
      under the terms of the 1997 Plan, 151,167 shares of common stock remain unissued
      and not subject to options and have been reserved for issuance to plan
      participants.




64


Effective
      June 12, 2001, the shareholders approved the 2001 Stock Plan (the 2001 Plan)
      to
      provide for the granting of stock options and restricted stock for up to 2.4
      million shares to employees, directors and consultants of Aptimus to provide
      them with incentives for their service. As of December 31, 2005, under the
      terms
      of the 2001 Plan, 919,267 shares of common stock remain unissued and not subject
      to options and have been reserved for issuance to plan
      participants.




The
      Board
      of Directors of Aptimus, which determines the terms and conditions of the
      options or restricted stock shares granted, including exercise price, number
      of
      shares granted and the vesting period of such shares, administers the Plans.
      The
      maximum term of options is ten years from the date of grant. The options are
      generally granted at the estimated fair value of the underlying stock, as
      determined by the closing market price, on the date of grant and are generally
      granted with a vesting period of from one to four years. Shares used to settle
      options issued under the plan are issued from the Company’s authorized but
      unissued shares. For the years ended December 31, 2003, 2004 and 2005, there
      was
      no deferred compensation recorded for options and restricted stock grants for
      which the exercise price was lower than the fair market value at the date of
      grant.




On
      December 22, 2005 the Board of Directors approved the acceleration of vesting
      of
      the unvested portion of certain "out-of-the money" non-qualified stock options
      previously awarded to employees, officers and directors with option exercise
      prices greater than $13.97 to be effective as of December 31, 2005. The
      Company's directors, executive officers, and certain senior-level managers,
      prior to the acceleration effective date, entered into a Resale Restriction
      Agreement that imposes restrictions on the sale of any shares received through
      the exercise of accelerated options until the earlier of the original vesting
      dates set forth in the option or the individual holder’s termination of
      employment or Board service, as the case may be. The accelerated options
      represent approximately 23% of the total of all outstanding Company options.
      The
      Board of Directors' decision to accelerate the vesting of these options was
      in
      anticipation of compensation expense to be recorded subsequent to the applicable
      effective date of Statement of Financial Accounting Standards No. 123 (Revised
      2004), “ *Share-Based
      Payment”* ("SFAS
      123(R)"). SFAS 123(R) requires companies to recognize the grant-date fair value
      of stock options issued to employees as an expense in the income statement
      and,
      as of the applicable effective date, will require the Company to recognize
      the
      compensation costs related to share-based payment transactions, including stock
      options. In addition, the Board of Directors considered that because these
      options had exercise prices in excess of the current market value, they were
      not
      fully achieving their original objectives of incentive compensation, employee
      retention and goal alignment. The acceleration of the vesting of these options
      resulted in approximately $3.0 million of additional stock-based employee
      compensation expense as determined under the fair value based
      method.




The
      fair
      value of each option grant under the plans was estimated on the date of grant
      using the Black Scholes Merton option-pricing model. Expected volatilities
      are
      based on the historical volatility of Aptimus common stock and other factors.
      The expected term of options granted is based on the assumptions related to
      the
      vesting schedule and contractual life of the grant. The expected term for grants
      in the future will be based on an analysis of historical exercise behavior
      and
      employee termination activity. The risk-free rate used is based on the U.S.
      Treasury Constant Maturities for the applicable grant date and expected term.
      Assumptions used to value employee options granted were as follows:




**Year
                ended December 31,****2005**
            **2004**
            **2003**Range
                of expected volatility
            88.0
                - 92.4%%
            100.0%
            100.0%Weighted-average
                expected volatility
            91.8%
            100.0%
            100.0%Range
                of risk free interest rates
            3.70
                - 4.43%
            2.60
                - 3.61%
            1.86
                - 3.21%Weighted-average
                risk free interest rates
            3.88%
            3.16%
            2.53%Range
                of expected term
            4.0
                years
            4.0
                years
            3.0
                - 5.0 yearsWeighted-average
                expected term
            4.0
                years
            4.0
                years
            4.0
                yearsExpected
                dividends
            0.0%
            0.0%
            0.0%







65


A
      summary
      of option activity and stock options outstanding under the Plans is presented
      below (in thousands, except prices):







**Year
                ended December 31,****2005**
            
            **2004**
            
            **2003****Shares**
            
            **Weighted
                Average Exercise Price**
            
            **Shares**
            
            **Weighted
                Average Exercise Price**
            
            **Shares**
            
            **Weighted
                Average Exercise Price**Options
                outstanding at beginning of period
            
            
            1,376
            
            $
            1.98
            
            
            1,522
            
            $
            1.98
            
            
            1,394
            
            $
            1.02Options
                granted
            
            
            530
            
            
            14.13
            
            
            174
            
            
            9.32
            
            
            643
            
            
            0.42Options
                exercised
            
            
            (155
            )
            
            1.10
            
            
            (303
            )
            
            0.57
            
            
            (228
            )
            
            0.60Options
                forfeited
            
            
            (54
            )
            
            7.99
            
            
            (17
            )
            
            2.73
            
            
            (287
            )
            
            6.92Options
                outstanding at end of period
            
            
            1,697
            
            $
            5.67
            
            
            1,376
            
            $
            1.98
            
            
            1,522
            
            $
            0.87Weighted
                average grant-date fair value of options granted during the
                period
            
            
            
            
            $
            9.45
            
            
            
            
            $
            5.83
            
            
            
            
            $
            0.32




The
      following table summarizes information about stock options outstanding under
      the
      Plans at December 31, 2005 (in thousands, except prices and remaining
      contractual life):




**Options
                outstanding**
            
            
            **Options
                exercisable****Range
                of****exercise
                prices**
            
            **Number
                of****shares**
            
            
            **Weighted****average****remaining****contractual****life****(in
                years)**
            
            
            **Weighted****average****exercise****price**
            
            
            **Number
                of****shares**
            
            
            **Weighted****average**
              **exercise****price**$   
                0.00
            
            25
            
            
            7.6
            
            $
            0.00
            
            
            25
            
            $
            0.000.28 — 0.82
            
            837
            
            
            6.3
            
            
            0.44
            
            
            822
            
            
            0.441.02
                — 1.95
            
            105
            
            
            4.8
            
            
            1.60
            
            
            101
            
            
            1.604.27 — 6.90
            
            146
            
            
            6.7
            
            
            6.31
            
            
            107
            
            
            6.158.37
                — 20.60
            
            584
            
            
            9.1
            
            
            13.98
            
            
            528
            
            
            14.551,697
            
            
            7.2
            
            $
            5.67
            
            
            1,583
            
            $
            5.60





The
      weighted average fair values and weighted average exercise prices per share
      at
      the date of grant for options granted under the plans were as
      follows:


66





**Year
                ended December 31,****Weighted
                average**
              **fair
                value**
            
            **Weighted
                average**
              **exercise
                price****2005**
            
            **2004**
            
            **2003**
            
            **2005**
            
            **2004**
            
            **2003**Options
                granted with exercise prices less thanthe
                fair value of the stock on the date ofgrant
            
            $
            —
            
            $
            —
            
            $
            0.58
            
            $
            —
            
            $
            —
            
            $
            0.07Options
                granted with exercise prices equal to thefair
                value of the stock on the date of grant
            
            $
            9.45
            
            $
            6.36
            
            $
            0.31
            
            $
            14.13
            
            $
            9.06
            
            $
            0.44Options
                granted with exercise prices greater thanthe
                fair value of the stock on the date ofgrant
            
            $
            —
            
            $
            4.43
            
            $
            —
            
            $
            —
            
            $
            10.00
            
            $
            —





During
      the years ended December 31, 2005, 2004 and 2003, Aptimus granted options to
      purchase zero, zero, and 35,000 shares of common stock, respectively, to
      consultants and advisors.




Aptimus
      follows SFAS No. 123 in accounting for options and warrants issued to
      non-employees. Aptimus did not issue any options to non-employees during the
      year ended December 31, 2005 or 2004. During the year ended December 31, 2003,
      we recognized $8,000, of expense in connection with options issued to
      consultants and advisors. In determining the fair value of the options and
      warrants granted or issued to non-employees on the date of grant, we used the
      Black-Scholes option-pricing model with the following assumptions:




**Year
                ended December 31,****2005**
            **2004**
            **2003**Weighted
                average risk free interest rate
            N/A
            N/A
            2.53%Weighted
                average expected term
            N/A
            N/A
            4.0
                yearsExpected
                volatility
            N/A
            N/A
            100%Expected
                dividends
            N/A
            N/A
            none





**11.
      Equity based compensation**





Amounts
      included in the statement of operations for equity-based compensation are as
      follows, in thousands:





**Year
                ended December 31,****2005**
            
            **2004**
            
            **2003**Sales
                and marketing
            
            $
            —
            
            $
            —
            
            $
            1Internet
                and network
            
            
            —
            
            
            —
            
            
            —Research
                and development
            
            
            —
            
            
            —
            
            
            —General
                and administrative
            
            
            —
            
            
            —
            
            
            103Total
                Equity-based compensation
            
            $
            —
            
            $
            —
            
            $
            104





Equity-based
      compensation of $54,000 related to stock option grants issued prior to January
      1, 2006 is expected to be recorded, in the quarter ended March 31, 2006. Total
      compensation related to such option grants is expected to be $196,000, for
      the
      year ended December 31, 2006.





**12.
      Stock purchase plan**




Aptimus’
      Board of Directors adopted the Employee Stock Purchase Plan (the Purchase Plan)
      on April 17, 2000, under which two million shares have been reserved for
      issuance. Under the Purchase Plan, eligible employees may purchase common stock
      in an amount not to exceed 50% of the employees’ cash compensation or 1,800
      shares per purchase period. The purchase price per share will be 85% of the
      common stock fair value at the lower of certain plan-defined dates. Pursuant
      to
      the Purchase Plan, 7,171 and 9,906 shares were purchased at a weighted average
      price of $13.29 and $4.42 per share for the years ended December 31, 2005 and
      2004, respectively. No shares were purchased under the Purchase Plan in the
      year
      ended December 31, 2003. The current period of the Purchase Plan started on
      September 16, 2005 and will end on March 15, 2006. Estimated equity-based
      compensation expense to be recorded in the quarter ending March 31, 2006 related
      to the Purchase Plan is $4,000.




67


**13.
      Employee retirement plan**




During
      1999, Aptimus established the Aptimus 401(k) plan, a tax-qualified savings
      and
      retirement plan intended to qualify under Section 401 of the Internal Revenue
      Code. All employees who satisfy the eligibility requirements relating to minimum
      age and length of service are eligible to participate in the plan and may enter
      the plan on the first day of any month after they become eligible to
      participate. Participants may make pre-tax contributions to the plan of up
      to
      50% of their eligible earnings, subject to a statutorily prescribed annual
      limit. Aptimus may make matching contributions of up to 100% of the first 6%
      of
      the compensation elected for contribution to the plan by an employee. Each
      participant is fully vested in his or her contributions and the investment
      earnings thereon, but vesting in any matching contributions by Aptimus takes
      place over a period of five years. Aptimus has made no matching contributions
      to
      the plan as of December 31, 2005, 2004 or 2003.




**14.
      Income taxes**




A
      current
      provision for income taxes was not recorded for the years ended December 31,
      2005, 2004 and 2003 due to taxable losses incurred in those years. In addition,
      no benefit for income taxes has been recorded due to the uncertainty of the
      realization of any tax assets. A valuation allowance has been recorded for
      the
      full value of deferred tax assets because realization is primarily dependent
      on
      generating sufficient taxable income prior to the expiration of net operating
      loss carry-forwards.




Items
      that account for differences between income taxes computed at the federal
      statutory rate and the provision (benefit) recorded for income taxes are as
      follows:




**December
                31,****2005**
            
            **2004**
            
            **2003**Federal
                Statutory rate
            
            
            34.00
            %
            
            34.00
            %
            
            (34.00
            )%Change
                in valuation allowance
            
            
            (38.91
            )%
            
            (37.07
            )%
            
            36.50
            %Impact
                of state tax provision
            
            
            3.07
            %
            
            2.92
            %
            
            (2.63
            )%Other
            
            
            1.84
            %
            
            0.15
            %
            
            0.13
            %Effective
                income tax rate
            
            
            0.00
            %
            
            0.00
            %
            
            0.00
            %







Deferred
      income taxes reflect the net tax effects of temporary differences between the
      carrying amounts of assets and liabilities for financial statement purposes
      and
      the amounts used for income tax purposes. Significant components of our deferred
      tax assets and liabilities at December 31, 2004 and 2005 are as follows (in
      thousands):  68




**December
                31,****2005**
            
            **2004**Deferred
                tax assets:Net
                operating loss carryforwards
            
            $
            22,707
            
            $
            22,396Write
                down of long-term investment
            
            
            128
            
            
            132Nondeductible
                allowances and accruals
            
            
            140
            
            
            99Expense
                related to stock options and warrants
            
            
            75
            
            
            78Difference
                between book and tax depreciation
            
            
            44
            
            
            —Total
                deferred tax assets
            
            
            23,094
            
            
            22,705Deferred
                tax liabilities:Difference
                between book and tax depreciation
            
            
            —
            
            
            (14
            )Net
                Deferred tax assets before valuation allowance
            
            
            23,094
            
            
            22,691Less:
                Valuation allowance
            
            
            (23,094
            )
            
            (22,691
            )$
            —
            
            $
            —





The
      valuation allowance has increased (decreased) by approximately $403,000, $2.3
      million, and $(564,000) in the years ended December 31, 2005, 2004, and 2003,
      respectively. In addition to the decrease in valuation allowance impacting
      the
      tax provision of $526,000, the valuation allowance was increased by stock
      compensation amounts of $929,000 that will be recorded to stockholder’s equity
      when realized.





At
      December 31, 2005, Aptimus had approximately $65.9 million of federal and $5.4
      million of state net operating losses. The net operating loss carryforwards,
      if
      not utilized, will begin to expire in 2017 for federal purposes and in 2012
      for
      California purposes. We determined that a change in ownership, as defined in
      the
      Internal Revenue Code Section 382 and similar state provisions, has occurred
      and
      may substantially limit the utilization of the net operating loss
      carry-forwards. The annual limitation may result in the expiration of $46.4
      million in net operating losses before utilization.




Approximately
      $3.3 million of the valuation allowance is attributable to stock options, the
      benefit of which will be credited to additional paid in capital when
      realized.





**15.
      Neighbornet acquisition**





On
      May
      16, 2005, we completed the formation of a wholly owned subsidiary, Neighbornet
      LLC. On May 20, 2005, Neighbornet LLC acquired substantially all of the assets
      of the Neighbornet division of Adfinis LLC. The aggregate purchase price
      consisted of $150,000 cash and direct transactional costs of $2,500 and was
      allocated to email list database and customer relationships and contracts
      intangible assets. The acquired intangible assets are to be amortized over
      their
      estimated useful lives of two years. The results of operations of Neighbornet
      have been included in our consolidated results from May 20, 2005, forward.
      The
      effect of these acquisitions on consolidated revenues and operating income
      for
      the twelve months ended December 31, 2005 was to reduce net income by
      approximately $268,000.





**16.
      Supplemental cash flow information**





The
      following items are supplemental information required for the statement of
      cash
      flows (in thousands):





**Year
                ended December 31,****2005**
            
            **2003**
            
            **2004**Cash
                paid during the period for interest
            
            $
            —
            
            $
            24
            
            $
            30Fixed
                assets acquired with capital leases
            
            $
            —
            
            $
            203
            
            $
            —





**17.
      Quarterly financial information (unaudited)**





The
      following table sets forth Aptimus’ unaudited quarterly financial information
      for the years ending December 31, 2005, 2004, and 2003 (in thousands, except
      per
      share data).




69




**Three
                months ended****3/31/05**
            
            **6/30/05**
            
            **9/30/05**
            
            **12/31/05**Revenue
            
            $
            3,852
            
            $
            4,483
            
            $
            3879
            
            $
            3,680Net
                income (loss)
            
            $
            681
            
            $
            949
            
            $
            10
            
            $
            (288
            )Basic
                net income (loss) per share
            
            $
            0.11
            
            $
            0.15
            
            $
            0.00
            
            $
            (0.04
            )Diluted
                net income (loss) per share
            
            $
            0.09
            
            $
            0.12
            
            $
            0.00
            
            $
            (0.04
            )





**Three
                months ended****3/31/04**
            
            **6/30/04**
            
            **9/30/04**
            
            **12/31/04**Revenue
            
            $
            1,806
            
            $
            2,976
            
            $
            4,441
            
            $
            4,770Net
                income (loss)
            
            $
            (65
            )
            $
            300
            
            $
            901
            
            $
            990Basic
                net income (loss) per share
            
            $
            (0.01
            )
            $
            0.05
            
            $
            0.16
            
            $
            0.17Diluted
                net income (loss) per share
            
            $
            (0.01
            )
            $
            0.04
            
            $
            0.13
            
            $
            0.14







**18. 
      Segment Information**




Statement
      of Financial Accounting Standards (“SFAS”) No. 131, *Disclosures
      about Segments of an Enterprise and Related Information,* establishes
      standards for the manner in which public companies report information about
      operating segments in annual and interim financial statements. It also
      establishes standards for related disclosures about products and services,
      geographic areas, and major customers. The method for determining what
      information to report is based on the way management organizes the operating
      segments within the Company for making operating decisions and assessing
      financial performance. Aptimus’ chief operating decision-maker is considered to
      be our chief executive officer (“CEO”). The CEO reviews financial information
      presented on an entity level basis for purposes of making operating decisions
      and assessing financial performance. In addition the CEO also receives
      disaggregated information about revenues by client, offer, web site publisher
      and email list owner. The entity level financial information is identical to
      the
      information presented in the accompanying statements of operations. Therefore,
      Aptimus has determined that it operates in a single operating segment: results
      based advertising services. An additional operating segment was identified
      in
      the third quarter. However in the fourth quarter it was determined that this
      potential operating segment was not material and operating results would not
      be
      provided to the chief decision maker on a segment basis. All third quarter
      results have been restated to combine the two previously identified segments
      into one operating segment.




Aptimus
      has no operations outside of the United States and no significant amount of
      revenues are derived from outside of the United States.




**19. 
      Subsequent Events**




On
      March
      9, 2006, the Company’s board of directors repriced the strike price of certain
      option grants issued to certain employees and directors in 2005, including
      Rob
      Wrubel, Director and President, Bob Bejan, Director, senior members of the
      Company’s sales and business development groups, and other employees. The
      original strike price of the grants that were affected by the repricing ranged
      from $14.45 to $17.50. The new strike price is $7.00. A total of 38 individuals
      representing 360,775 option shares were affected by the repricing. In addition,
      the board of directors authorized the grant of 70,000 option shares to Mr.
      Wrubel, and the grant of an additional 65,000  to
      certain other senior members of the Company’s sales and business development
      groups. Each of these grants has a strike price of $4.58 and vest over a
      four-year period from the date of grant. We are still in the process of
      evaluating the impact of the repricing and option grants on the quarter ended
      March 31, 2006 and future periods. However, the impact is expected to be
      material.


70


**Item
      9:** ***Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure***




Not
      applicable.




**Item
      9A:** ***Controls
      And Procedures***




***Evaluation
      of Disclosure Controls and Procedures***





We
      maintain disclosure controls and procedures designed to ensure that information
      required to be disclosed in reports filed under the Securities Exchange Act
      of
      1934, as amended, is recorded, processed, summarized and reported within the
      specified time periods. Disclosure controls are also designed to reasonably
      assure that such information is accumulated and communicated to our management,
      including the Chief Executive Officer and Chief Financial Officer, as
      appropriate to allow timely decisions regarding required disclosure. As of
      the
      end of the Company’s 2005 fiscal year, management conducted an assessment of the
      effectiveness of the design and operation of the Company’s disclosure controls.
      Based on this assessment, management has determined that the Company’s
      disclosure controls as of December 31, 2005 is effective.





**Managements
      Report On Internal Controls Over Financial Reporting**





Our
      management is responsible for establishing and maintaining adequate internal
      control over financial reporting. Internal control over financial reporting
      is a
      process designed by, or under the supervision of, our Chief Executive Officer
      and Chief Financial Officer, and effected by our board of directors, management
      and other personnel, to provide reasonable assurance regarding the reliability
      of financial reporting and the preparation of financial statements for external
      reporting purposes in accordance with generally accepted accounting
      principles.





As
      of
      December 31, 2005, management conducted an assessment of the effectiveness
      of
      the Company’s internal control over financial reporting based on the framework
      established in *Internal
      Control - Integrated Framework* issued
      by
      the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).
      Based on this assessment, management has determined that the Company’s internal
      control over financial reporting as of December 31, 2005 is
      effective.





Our
      management’s assessment of the effectiveness of our internal control over
      financial reporting as of December 31, 2005 has been audited by Moss Adams,
      LLP,
      an independent registered public accounting firm, as stated in their report
      which is included herein.





**Changes
      in Internal Controls**




We
      reported in our Financial Report for the period ended September 30, 2005, that
      we believed there existed at that time strong indicators of material weaknesses
      in respect to one or more of the following:




·
            Internal
                controls over financial reporting, primarily due to finance and accounting
                staff levels


·
            General
                computer controls due to the limited time available to analyze, remediate,
                test and season the documented controls then in
                place


·
            Concern
                about overall entity level controls due to our past focus on efficiency
                and cost savings in implementing and effecting Company-wide policies
                and
                procedures.





During
      the six month period ended December 31, 2005, we actively implemented certain
      changes to our internal controls to remediate the identified potential
      deficiencies and otherwise to enhance the reliability of our internal controls
      over financial reporting, including the retention of outside experts to assist
      in certain reporting matters, the establishment of new policies and procedures
      implemented to monitor and ensure remediated controls operate as designed,
      and
      the continuing education of personnel. Management considered the remedial steps
      taken by the company in assessing the effectiveness of our internal controls
      over financial reporting for the year ended December 31, 2005 and, as noted
      in
      Managements Report On Internal Controls Over Financial Reporting above,
      concluded that our internal controls over financial reporting were effective
      as
      of such date.





II-1


Other
      than as discussed above, during the year ended December 31, 2005, there have
      been no changes in our internal control over financial reporting (as defined
      in
      Rule 13a-15(f) under the Exchange Act) that has materially affected, or is
      reasonably likely to materially affect, our internal control over financial
      reporting.





***Inherent
      Limitations on Effectiveness of Controls***





Our
      management, including our Chief Executive Officer and Chief Financial Officer,
      does not expect that our disclosure controls and procedures or our internal
      controls will prevent or detect all error and all fraud. A control system,
      no
      matter how well conceived and operated, can provide only reasonable, not
      absolute, assurance that the objectives of the control system are met. The
      design of a control system must reflect the fact that there are resource
      constraints, and the benefits of controls must be considered relative to their
      costs. Further, because of the inherent limitations in all control systems,
      no
      evaluation of controls can provide absolute assurance that misstatements due
      to
      error or fraud will not occur or that all control issues and instances of fraud,
      if any, within the Company have been detected. These inherent limitations
      include the realities that judgments in decision-making can be faulty and that
      breakdowns can occur because of simple error or mistake. Controls can also
      be
      circumvented by the individual acts of some persons, by collusion of two or
      more
      people, or by management override of the controls. The design of any system
      of
      controls is based in part on certain assumptions about the likelihood of future
      events, and there can be no assurance that any design will succeed in achieving
      its stated goals under all potential future conditions. Projections of any
      evaluation of controls effectiveness to future periods are subject to risks.
      Over time, controls may become inadequate because of changes in conditions
      or
      deterioration in the degree of compliance with policies or
      procedures.





***REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM***





To
      the
      Board of Directors and Stockholders of


Aptimus,
      Inc.




We
      have
      audited management’s assessment, included in the accompanying Management’s
      Report on Internal Control over Financial Reporting that Aptimus, Inc. and
      Subsidiary (“the Company”) maintained effective internal control over financial
      reporting as of December 31, 2005, based on criteria established in
      Internal Control-Integrated Framework issued by the Committee of Sponsoring
      Organizations of the Treadway Commission (“the COSO criteria”). The Company’s
      management is responsible for maintaining effective internal control over
      financial reporting and for its assessment of the effectiveness of internal
      control over financial reporting. Our responsibility is to express an opinion
      on
      management’s assessment and an opinion on the effectiveness of the company’s
      internal control over financial reporting based on our audit.




We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether effective
      internal control over financial reporting was maintained in all material
      respects. Our audit included obtaining an understanding of internal control
      over
      financial reporting, evaluating management’s assessment, testing and evaluating
      the design and operating effectiveness of internal control, and performing
      such
      other procedures as we considered necessary in the circumstances. We believe
      that our audit provides a reasonable basis for our opinion.




II-2


A
      company’s internal control over financial reporting is a process designed to
      provide reasonable assurance regarding the reliability of financial reporting
      and the preparation of financial statements for external purposes in accordance
      with generally accepted accounting principles. A company’s internal control over
      financial reporting includes those policies and procedures that (1) pertain
      to the maintenance of records that, in reasonable detail, accurately and fairly
      reflect the transactions and dispositions of the assets of the company;
      (2) provide reasonable assurance that transactions are recorded as
      necessary to permit preparation of financial statements in accordance with
      generally accepted accounting principles, and that receipts and expenditures
      of
      the company are being made only in accordance with authorizations of management
      and directors of the company; and (3) provide reasonable assurance
      regarding prevention or timely detection of unauthorized acquisition, use,
      or
      disposition of the company’s assets that could have a material effect on the
      financial statements.




Because
      of its inherent limitations, internal control over financial reporting may
      not
      prevent or detect misstatements. Also, projections of any evaluation of
      effectiveness to future periods are subject to the risk that controls may become
      inadequate because of changes in conditions, or that the degree of compliance
      with the policies or procedures may deteriorate.




In
      our
      opinion, management’s assessment that Aptimus Inc. maintained effective internal
      control over financial reporting as of December 31, 2005, is fairly stated,
      in all material respects, based on the COSO criteria. Also,
      in
      our opinion, Aptimus Inc. maintained, in all material respects, effective
      internal control over financial reporting as of December 31, 2005, based on
      the COSO criteria.




We
      also
      have audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the consolidated balance sheet of Aptimus
      Inc.
      and subsidiary as of December 31, 2005 and 2004, and the related
      consolidated statements of operations, stockholders’ equity, and cash flows for
      each of the three years in the period ended December 31, 2005, and our report
      dated March 14, 2006 expressed an unqualified opinion thereon.










/S/
      Moss
      Adams LLP


Seattle,
      Washington


March
      15,
      2006





**Item
      9B:** ***Other
      Information***




None.




II-3


**PART
      III**




**Item
      10:** ***Directors
      and Executive Officers of the Registrant***




Information
      with respect to Directors may be found under the caption "Election of Directors
      and Management Information" in the Company's Proxy Statement for the Annual
      Meeting of Shareholders to be held June 9, 2006 (the "Proxy Statement"). Such
      information is incorporated herein by reference.





Code
      of
      Ethics





We
      have
      adopted a Code of Ethics that applies to all directors, officers and employees
      of Aptimus, Inc., including the Chief Executive Officer and Chief Financial
      Officer. The key principles of the Code of Ethics are to act legally and with
      integrity in all work for Aptimus, Inc. The Code of Ethics is posted on the
      corporate governance page of our website at http://www.aptimus.com/ethics.shtml.
      We will post any amendments to our Code of Ethics on our website. In the
      unlikely event that the Board of Directors approves any sort of waiver to the
      Code of Ethics for our executive officers or directors, information concerning
      such waiver will also be posted on our website. In addition to posting
      information regarding amendments and waivers on our website, the same
      information will be included in a Current Report on Form 8-K within four
      business days following the date of the amendment or waiver, unless website
      posting of such amendments or waivers is permitted by the rules of The Nasdaq
      Stock Market, Inc.





**Item
      11: Executive Compensation**





The
      information in the Proxy Statement set forth under the captions "Information
      Regarding Executive Officer Compensation" and "Information Regarding the Board
      and its Committees" is incorporated herein by reference.





**Item
      12: Security Ownership of Certain Beneficial Owners and Management and related
      Stockholder Matters**





The
      information set forth under the caption "Information Regarding Beneficial
      Ownership of Principal Shareholders, Directors, and Management" of the Proxy
      Statement is incorporated herein by reference.





**Securities
      Authorized for Issuance under Equity Compensation Plans [SEE S-K
      201(d)]**




The
      following table sets forth the number of securities issuable under our equity
      compensation plans and indicates whether or not the plan received shareholder
      approval:




II-4




Plan
                Category
            A
            B
            CNumber
                of securities to be issued upon exercise of options, warrants and
                rights
            Weighted-average
                exercise price of outstanding options, warrants and rights
            Number
                of securities remaining available for future issuance under equity
                compensation plans (excluding securities reflected in Column
                A)Equity
                compensation plans approved by security holders
            1,697,062
            $5.67
            3,644,349*Equity
                compensation plans not approved by security holders
            —
            —
            —Total
            1,697,062
            $5.67
            3,644,349*




*Includes
      1,947,287 shares of common stock subject to the 2000 Employee Stock Purchase
      Plan





**Item
      13: Certain Relationships and Related Transactions**





The
      information set forth under the caption "Certain Relationships and Related
      Transactions" of the Proxy Statement is incorporated herein by
      reference.





**Item
      14: Principal Accountant Fees and Services**




It
      is the
      policy of the Company for the Audit Committee to pre-approve all audit, tax
      and
      financial advisory services. All services rendered by Moss Adams were
      pre-approved by the audit committee in the years ended December 31, 2005 and
      2004. The aggregate fees billed by Moss Adams for professional services rendered
      for the audit of the Company’s financial statements and other services were as
      follows:




Year
                ended December 31,2005
            
            2004Audit
                fees
            
            $
            427,194
            
            $
            132,351Audit
                related fees
            
            $
            6,056
            
            $
            48,982Tax
                fees
            
            $
            4,209
            
            $
            17,713All
                other fees
            
            $
            —
            
            $
            —







II-5


**PART
      IV**




**Item
      15.** ***Exhibits
      and Financial Statement Schedules***




(a)1. *Financial
      Statements*




The
      following financial statements of the registrant and the Reports of our
      Independent Registered Public Accounting Firm thereon are included herewith
      in
      Item 8 above.




**Page**Reports
                of Independent Registered Public Accounting Firm
            47Consolidated
                Balance Sheet as of December 31, 2005 and 2004
            48Consolidated
                Statement of Operations for the years ended December 31, 2005, 2004
                and
                2003
            49Consolidated
                Statement of Shareholders' Equity for the years endedDecember
                31, 2005, 2004 and 2003
            50Consolidated
                Statement of Cash Flows for the years ended December 31, 2005, 2004
                and
                2003
            51Notes
                to Consolidated Financial Statements
            52





(a)2. *Financial
      Statement Schedules*





**Schedule
                No.**
            **Description**1.1
            Valuation
                and Qualifying Accounts and Reserves Yeah Ended December 31, 2005,
                2004
                and 2003





**Valuation
      and Qualifying Accounts and Reserves Year Ended December 31, 2005, 2004 and
      2003**





**Balance
                at**
              **beginning**
              **of
                period**
            
            **Charges
                to**
              **costs
                and**
              **expenses**
            
            **Charges
                to**
              **other**
              **accounts**
            
            **Deductions**
            
            **Balance
                at**
              **end
                of**
              **period**Year ended
              December
              31, 2005Allowance
                for doubtful accounts
            
            
            100,000
            
            
            123,000
            
            
            —
            
            
            —
            
            
            223,000Tax
                valuation allowance
            
            
            22,691,000
            
            
            —
            
            
            403,000
            
            
            —
            
            
            23,094,000Year ended
              December
              31, 2004Allowance
                for doubtful accounts
            
            
            61,000
            
            
            39,000
            
            
            —
            
            
            
            
            
            100,000Tax
                valuation allowance
            
            
            20,436,000
            
            
            —
            
            
            2,255,000
            
            
            
            
            
            22,691,000Year ended
              December
              31, 2003Allowance
                for doubtful accounts
            
            
            76,000
            
            
            26,395
            
            
            —
            
            
            (41,395
            )
            
            61,000Tax
                valuation allowance
            
            
            21,000,000
            
            
            —
            
            
            (564,000
            )
            
            —
            
            
            20,436,000




(a)3
      Exhibits:


II-6






**Exhibit**
              **Number**
            
            **Description**3.1*
            
            Second
                Amended and Restated Articles of Incorporation of
                registrant.3.1.1(2)
            
            Articles
                of Amendment filed September 16, 2000.3.1.2(6)
            
            Articles
                of Amendment filed March 29, 2002.3.2*
            
            Amended
                and Restated Bylaws of registrant.4.1*
            
            Specimen
                Stock Certificate.4.3(3)
            
            Rights
                Agreement dated as of March 12, 2002 between registrant and Mellon
                Investor Services LLC, as rights agent.10.1*(7)
            
            Form
                of Indemnification Agreement between the registrant and each of its
                directors.10.2*(7)
            
            1997
                Stock Option Plan, as amended.10.3*(7)
            
            Form
                of Stock Option Agreement.10.4(1)(7)
            
            Aptimus,
                Inc. 2001 Stock Plan.10.4.1(2)(7)
            
            Form
                of Stock Option Agreement.10.4.2(2)(7)
            
            Form
                of Restricted Stock Agreement (for grants).10.4.3(2)(7)
            
            Form
                of Restricted Stock Agreement (for rights to purchase).10.5(4)(7)
            
            Change
                in Control Agreement, dated as of December 6, 2002, by and between
                registrant and Timothy C. Choate10.6(4)(7)
            
            Form
                of Change in Control Agreement, dated as of December 6, 2002, by
                and
                between registrant and each of certain executive managers of
                registrant10.7(5)
            
            Form
                of Convertible Note Purchase Agreement, dated as of July 1, 2003,
                by and
                between the Company and certain investors.10.8(5)
            
            Form
                of Convertible Secured Promissory Note, dated July 2003, executed
                by and
                between the Company and payable to the order of certain
                investors.10.9(5)
            
            Form
                of Common Stock Warrant, dated July 2003, by and between the Company
                and
                certain investors.10.10(5)
            
            Form
                of Security Agreement, dated as of July 1, 2003, by and between the
                Company and certain investors.10.11(5)
            
            Form
                of Registration Rights Agreement, dated as of July 1, 2003, by and
                between
                the Company and certain investors.10.12(11)
            
            Agreement
                of Lease, dated as of November 18, 2003, by and between 100 Spear
                Street
                Owner’s Corp. and the Company.10.13(9)
            
            Agreement
                of Lease, dated as of April 29, 2004, by and between Sixth and Virginia
                Properties and the Company.10.14(8)
            
            Stock
                Purchase Agreement, dated as of December 4, 2003, by and between
                the
                Company and certain investors.10.15(10)
            
            Stock
                Purchase Agreement, dated as of March 25, 2005, by and between the
                Company
                and certain investors.10.16(10)
            
            Form
                of Common Stock Warrant, dated March 25 2005, by and between the
                Company
                and certain investors and service providers.10.17(7)
            
            Form
                of Stock Resale Restriction Agreement, dated as of December 23, 2005,
                by
                and between registrant and each of certain executive managers and
                key
                employees of registrant.23.1
            
            Consent
                of Moss Adams LLP, Independent Registered Public Accounting
                Firm.31.1
            
            Rule
                13a-14(a) Certification of the Chief Executive Officer31.2
            
            Rule
                13a-14(a) Certification of the Chief Financial Officer32.1
            
            Section
                1350 Certification of the Chief Executive Officer32.2
            
            Section
                1350 Certification of the Chief Financial
                Officer






II-7


__________




*  Incorporated
      by reference to the Company’s Registration Statement on Form S-1 (No.
      333-81151).





(1)
            Incorporated
                by reference to the Company’s Proxy Statement on Schedule 14A, dated May
                17, 2001.(2)
            Incorporated
                by reference to the Company’s Quarterly Report on Form 10-Q, dated
                November 14, 2001.(3)
            Incorporated
                by reference to the Company’s Current Report on Form 8-K, dated March 12,
                2002.(4)
            Incorporated
                by reference to the Company’s Annual Report on Form 10-K, dated March 28,
                2003.(5)
            Incorporated
                by reference to the Company’s Quarterly Report on Form 10-Q, dated August
                14, 2003.(6)
            Incorporated
                by reference to the Company’s Quarterly Report on Form 10-Q, dated May 15,
                2002.(7)
            Management
                compensation plan or agreement.(8)
            Incorporated
                by reference to the Company’s Annual Report on Form 10-K, dated March 30,
                2004(9)
            Incorporated
                by reference to the Company’s Quarterly Report on Form 10-Q, dated May 17,
                2004.(10)
            Incorporated
                by reference to the Company’s Registration Statement on Form S-3 (No.
                333-124403), dated April 28, 2005.(11)
            Incorporated
                by reference to the Company’s Quarterly Report on Form 10-Q, dated May 13,
                2005.





II-8


**SIGNATURES**





Pursuant
      to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
      1934, Aptimus, Inc. has duly caused this report to be signed on its behalf
      by
      the undersigned, thereunto duly authorized.




March
              15,
              2006
            
            
            APTIMUS,
              INC./s/ Timothy
              C. ChoateTimothy
                C. Choate,
              *Chief
                Executive Officer*




Pursuant
      to the requirements of the Securities Exchange Act of 1934, this report to
      be
      signed by the following persons on behalf of the registrant in the capacities
      and on the dates indicated.





**Signature**
            **Title**
            **Date**/s/Timothy
                C. Choate
            Chairman
                of the Board,
            March
                15, 2006Timothy
                C. Choate
            Chief
                Executive Officerand
                Director/s/John
                A. Wade
            Vice
                President, Finance
            March
                15, 2006John
                A. Wade
            Chief
                Financial Officer andChief
                Accounting Officer/s/
                Robert W. Wrubel
            President
                and Director
            March
                15, 2006Robert
                W. Wrubel/s/John
                B. Balousek
            Director
            March
                15, 2006John
                B. Balousek/s/Bob
                Bejan
            Director
            March
                15, 2006Bob
                Bejan/s/
                Eric Helgeland
            Director
            March
                15, 2006Eric
                Helgeland





II-9


**EXHIBITS
      INDEX**


****


**Exhibit**
                **Number**
              
              **Description**3.1*
              
              Second
                  Amended and Restated Articles of Incorporation of
                  registrant.3.1.1(2)
              
              Articles
                  of Amendment filed September 16, 2000.3.1.2(6)
              
              Articles
                  of Amendment filed March 29, 2002.3.2*
              
              Amended
                  and Restated Bylaws of registrant.4.1*
              
              Specimen
                  Stock Certificate.4.3(3)
              
              Rights
                  Agreement dated as of March 12, 2002 between registrant and Mellon
                  Investor Services LLC, as rights agent.10.1*(7)
              
              Form
                  of Indemnification Agreement between the registrant and each of
                  its
                  directors.10.2*(7)
              
              1997
                  Stock Option Plan, as amended.10.3*(7)
              
              Form
                  of Stock Option Agreement.10.4(1)(7)
              
              Aptimus,
                  Inc. 2001 Stock Plan.10.4.1(2)(7)
              
              Form
                  of Stock Option Agreement.10.4.2(2)(7)
              
              Form
                  of Restricted Stock Agreement (for grants).10.4.3(2)(7)
              
              Form
                  of Restricted Stock Agreement (for rights to purchase).10.5(4)(7)
              
              Change
                  in Control Agreement, dated as of December 6, 2002, by and between
                  registrant and Timothy C. Choate10.6(4)(7)
              
              Form
                  of Change in Control Agreement, dated as of December 6, 2002, by
                  and
                  between registrant and each of certain executive managers of
                  registrant10.7(5)
              
              Form
                  of Convertible Note Purchase Agreement, dated as of July 1, 2003,
                  by and
                  between the Company and certain investors.10.8(5)
              
              Form
                  of Convertible Secured Promissory Note, dated July 2003, executed
                  by and
                  between the Company and payable to the order of certain
                  investors.10.9(5)
              
              Form
                  of Common Stock Warrant, dated July 2003, by and between the Company
                  and
                  certain investors.10.10(5)
              
              Form
                  of Security Agreement, dated as of July 1, 2003, by and between
                  the
                  Company and certain investors.10.11(5)
              
              Form
                  of Registration Rights Agreement, dated as of July 1, 2003, by
                  and between
                  the Company and certain investors.10.12(11)
              
              Agreement
                  of Lease, dated as of November 18, 2003, by and between 100 Spear
                  Street
                  Owner’s Corp. and the Company.10.13(9)
              
              Agreement
                  of Lease, dated as of April 29, 2004, by and between Sixth and
                  Virginia
                  Properties and the Company.10.14(8)
              
              Stock
                  Purchase Agreement, dated as of December 4, 2003, by and between
                  the
                  Company and certain investors.10.15(10)
              
              Stock
                  Purchase Agreement, dated as of March 25, 2005, by and between
                  the Company
                  and certain investors.10.16(10)
              
              Form
                  of Common Stock Warrant, dated March 25 2005, by and between the
                  Company
                  and certain investors and service providers.10.17(7)
              
              Form
                  of Stock Resale Restriction Agreement, dated as of December 23,
                  2005, by
                  and between registrant and each of certain executive managers and
                  key
                  employees of registrant.23.1
              
              Consent
                  of Moss Adams LLP, Independent Registered Public Accounting
                  Firm.31.1
              
              Rule
                  13a-14(a) Certification of the Chief Executive Officer31.2
              
              Rule
                  13a-14(a) Certification of the Chief Financial Officer32.1
              
              Section
                  1350 Certification of the Chief Executive Officer32.2
              
              Section
                  1350 Certification of the Chief Financial
                  Officer





II-10




__________





*
            Incorporated
                by reference to the Company’s Registration Statement on Form S-1 (No.
                333-81151).(1)
            Incorporated
                by reference to the Company’s Proxy Statement on Schedule 14A, dated May
                17, 2001.(2)
            Incorporated
                by reference to the Company’s Quarterly Report on Form 10-Q, dated
                November 14, 2001.(3)
            Incorporated
                by reference to the Company’s Current Report on Form 8-K, dated March 12,
                2002.(4)
            Incorporated
                by reference to the Company’s Annual Report on Form 10-K, dated March 28,
                2003.(5)
            Incorporated
                by reference to the Company’s Quarterly Report on Form 10-Q, dated August
                14, 2003.(6)
            Incorporated
                by reference to the Company’s Quarterly Report on Form 10-Q, dated May 15,
                2002.(7)
            Management
                compensation plan or agreement.(8)
            Incorporated
                by reference to the Company’s Annual Report on Form 10-K, dated March 30,
                2004(9)
            Incorporated
                by reference to the Company’s Quarterly Report on Form 10-Q, dated May 17,
                2004.(10)
            Incorporated
                by reference to the Company’s Registration Statement on Form S-3 (No.
                333-124403), dated April 28, 2005.(11)
            Incorporated
                by reference to the Company’s Quarterly Report on Form 10-Q, dated May 13,
                2005.





II-11