** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

** **

** **

----

 

**FORM 10-Q**

**(Mark  One)**
| **x** | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** | ** ** |
|-------|------------|--------------------------------------------------------------------------------------------------------|------------|

######  

###### **For the quarterly period ended March 31,2006**

** **

###### **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:  000-51746**

** **

** **

----

 

**Traffic.com, Inc.**

(Exact Name of Registrantas Specified in its Charter)

 

| **Delaware**                              | ** ** | **25-1823631**                        |
|-------------------------------------------|------------|---------------------------------------|
| (State of  Incorporation)                 |       | (IRS Employer  Identification Number) |
| ** **                                | ** ** | ** **                            |
| **851  Duportail Road**                   | ** ** | ** **                            |
| **Wayne,  Pennsylvania**                  | ** ** | **19087**                             |
| (Address of  principal executive offices) |       | (Zip Code)                            |

** **

Registrant’s telephonenumber, including area code:  **(610) 725-9700**

 

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

** **

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

** **

| Large Accelerated Filer **o** |   | Accelerated  filer **o** |   | Non-Accelerated  Filer **x** |
|-------------------------------|--------|--------------------------|--------|------------------------------|

** **

**Indicate by checkmark whether theregistrant is a shell company (as defined in Rule 12b-2 of theExchange Act)  YES **o   NO x

 

At April 30, 2006 , there were 20,408,941 shares of common stockoutstanding.

 

 

----

**TRAFFIC.COM, INC.**

**INDEX**

 
|               | ** ** | ** **                                                   | ** ** | ** **                                                                                                                           | ** ** | **Page** | ** ** |
|---------------|------------|--------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Part I   |       | Financial Information                                        |       |                                                                                                                                 |       |
|          |       | Item 1.                                                      |       | Unaudited Condensed Consolidated Financial Statements                                                                                |       |     |       |
|          |       |                                                         |       | Condensed Consolidated Balance Sheets at  March 31, 2006 (unaudited) and December 31, 2005                  |       | 3        |       |
|          |       |                                                         |       | Condensed Consolidated Statements of Operations  (unaudited) for the three months ended March 31, 2006 and March 31,  2005 |       | 4        |       |
|          |       |                                                         |       | Condensed Consolidated Statements of Cash Flows  (unaudited) for the three months ended March 31, 2006 and March 31,  2005 |       | 5        |       |
|          |       |                                                         |       | Notes to Unaudited Condensed Consolidated Financial  Statements                                                                      |       | 6        |       |
|          |       | Item 2.                                                      |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                                     |       | 11       |       |
|          |       | Item 3                                                       |       | Quantitative and Qualitative Disclosures About Market  Risk                                                                          |       | 18       |       |
|          |       | Item 4.                                                      |       | Controls and Procedures                                                                                                              |       | 18       |       |
| Part II. |       | Other  Information        |       |                                                                                                                                 |       |
|          |       | Item  1A.                                               |       | Risk Factors                                                                                                                         |       | 19       |       |
|          |       | Item 4.                                                      |       | Submission of Matters to a Vote of Security Holders                                                                                  |       | 19       |       |
|          |       | Item  5.                                                     |       | Other  Information                                                                                                                   |       | 20       |       |
|          |       | Item 6.                                                      |       | Exhibits                                                                                                                             |       | 20       |       |
| Signatures    |       | 21                                                           |       |
| Exhibits      |       | 22                                                           |       |

 

2

----

**Traffic.com, Inc.**

**Condensed Consolidated Balance Sheets**

*(In Thousands,Except Share Amounts)*
| ** **                                                                                                                                                                                         | ** ** | **As of  March 31,  2006** | ** ** | **As of  December 31,  2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                                                                                                                         | ** ** | **(unaudited)**                      | ** ** | ** **                              | ** ** |
| **Assets**                                                                                                                                                                                         |       |                                 |       |                                    |       |
| Current assets:                                                                                                                                                                                    |       |                                 |       |                                    |       |
| Cash and cash equivalents                                                                                                                                                                          |       | $                                    | 9,081      |                                    | $          | 13,143 |   |
| Short-term investments                                                                                                                                                                             |       | 24,666                               |       | —                                  |       |
| Accounts receivable, net of allowance of $750 and $779  at March 31, 2006 and December 31, 2005, respectively                                                                                 |       | 10,000                               |       | 10,177                                  |       |
| Government services receivables                                                                                                                                                                    |       | 2,073                                |       | 2,091                                   |       |
| Deferred offering costs                                                                                                                                                                            |       | —                               |       | 2,368                                   |       |
| Other current assets                                                                                                                                                                               |       | 1442                                 |       | 723                                     |       |
| Total current  assets                                                                                                                                                                              |       | 47,262                               |       | 28,502                                  |       |
| Property and  equipment, net                                                                                                                                                                       |       | 25,088                               |       | 23,816                                  |       |
| Other long-term  assets                                                                                                                                                                            |       | 1,018                                |       | 2,660                                   |       |
| Total assets                                                                                                                                                                                       |       | $                                    | 73,368     |                                    | $          | 54,978 |   |
| **Liabilities, redeemable  convertible preferred stock, and stockholders’ deficit**                                                                                                           |       |                                 |       |                                    |       |
| Current liabilities:                                                                                                                                                                               |       |                                 |       |                                    |       |
| Accounts payable                                                                                                                                                                                   |       | $                                    | 3,595      |                                    | $          | 3,023 |   |
| Accrued station compensation                                                                                                                                                                       |       | 2,981                                |       | 3,032                                   |       |
| Accrued legal settlements                                                                                                                                                                          |       | —                               |       | 7,125                                   |       |
| Other accrued expenses                                                                                                                                                                             |       | 2,369                                |       | 4,528                                   |       |
| Revolving credit facility                                                                                                                                                                          |       | —                               |       | 4,128                                   |       |
| Current portion of deferred revenue                                                                                                                                                                |       | 1,919                                |       | 1,711                                   |       |
| Current portion of deferred license fees                                                                                                                                                           |       | 2,677                                |       | 1,148                                   |       |
| Total current  liabilities                                                                                                                                                                         |       | 13,541                               |       | 24,695                                  |       |
| Senior secured  credit facility and accrued interest                                                                                                                                               |       | —                               |       | 37,659                                  |       |
| Deferred revenue                                                                                                                                                                                   |       | 24,541                               |       | 23,261                                  |       |
| Deferred license  fees                                                                                                                                                                             |       | 7,667                                |       | 9,385                                   |       |
| Other long-term  liabilities                                                                                                                                                                       |       | 1,161                                |       | 678                                     |       |
|                                                                                                                                                                                               |       | 46,910                               |       | 95,678                                  |       |
| Redeemable convertible  preferred stock, $0.01 par value, 30,000,000 authorized at March 31,  2006:                                                                                           |       |                                 |       |                                    |       |
| Series E; 18,000,000 shares authorized at  December 31, 2005; 16,265,094 issued and outstanding at  December 31, 2005; liquidation preference of $65,060 at  December 31, 2005 |       | —                               |       | 32,530                                  |       |
| Series E-1; 6,419,811 shares authorized,  issued and outstanding at December 31, 2005; liquidation preference of  $12,364 at December 31, 2005                                      |       | —                               |       | 9,321                                   |       |
| Series F; 6,000,000 shares authorized and  5,042,090 issued and outstanding at December 31, 2005; liquidation  preference of $20,168 at December 31, 2005                           |       | —                               |       | 15,126                                  |       |
|                                                                                                                                                                                               |       | —                               |       | 56,977                                  |       |
| Stockholders’ equity  (deficit):                                                                                                                                                              |       |                                 |       |                                    |       |
| Common stock, $0.01 par value, 100,000,000 shares  authorized and 3,826,325 and 20,337,484 shares issued and outstanding at  December 31, 2005 and March 31, 2006, respectively;         |       | 204                                  |       | 39                                      |       |
| Additional paid-in capital                                                                                                                                                                         |       | 191,804                              |       | 61,566                                  |       |
| Treasury stock at cost; 24,792 shares at March 31,  2006                                                                                                                                      |       | (298                                 | )          | —                                  |       |
| Notes receivable from stockholders                                                                                                                                                                 |       | (125                                 | )          | (177                                    | )          |
| Deferred stock based compensation                                                                                                                                                                  |       | —                               |       | (1,672                                  | )          |
| Accumulated deficit                                                                                                                                                                                |       | (165,127                             | )          | (157,433                                | )          |
| Total  stockholders’ equity (deficit)                                                                                                                                                         |       | 26,458                               |       | (97,677                                 | )          |
| Total liabilities,  redeemable convertible preferred stock and stockholders’ equity (deficit)                                                                                                 |       | $                                    | 73,368     |                                    | $          | 54,978 |   |

 

See accompanying notes.

3

----

**Traffic.com, Inc.**

**Condensed Consolidated Statements of Operations**

*(In Thousands,Except Per Share Amounts)*

 
| ** **                                                        | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                        | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| ** **                                                        | ** ** | **(unaudited)**                                  | ** ** |
| Revenue:                                                          |       |                                             |       |   |   |
| Advertising                                                       |       | $                                                | 9,327      |   | $ | 8,330 |   |
| Traffic data services                                             |       | 1,457                                            |       | 930 |   |
|                                                              |       | 10,784                                           |       | 9,260 |   |
| Cost of revenue                                                   |       | 9,498                                            |       | 7,627 |   |
| Gross margin                                                      |       | 1,286                                            |       | 1,633 |   |
| Operating expenses:                                               |       |                                             |       |   |   |
| Research and development                                          |       | 1,268                                            |       | 807 |   |
| Sales and marketing                                               |       | 4,256                                            |       | 3,783 |   |
| General and administrative                                        |       | 2,157                                            |       | 1,697 |   |
|                                                              |       | 7,681                                            |       | 6,287 |   |
| Loss from operations                                              |       | (6,395                                           | )          | (4,654 | ) |
| Interest income  (expense), net                                   |       | (1,299                                           | )          | (1,127 | ) |
| Net loss                                                          |       | $                                                | (7,694     | ) | $ | (5,781 | ) |
| Accretion of  redeemable convertible preferred stock              |       | (108                                             | )          | (536 | ) |
| Net income  (loss) attributable to common stockholders            |       | $                                                | (7,802     | ) | $ | (6,317 | ) |
| Net income (loss)  attributable to common stockholders per share: |       |                                             |       |   |   |
| Basic                                                             |       | $                                                | (0.49      | ) | $ | (1.89 | ) |
| Diluted                                                           |       | $                                                | (0.49      | ) | $ | (1.89 | ) |
| Number of shares used  in per share calculation:                  |       |                                             |       |   |   |
| Basic                                                             |       | 15,771                                           |       | 3,346 |   |
| Diluted                                                           |       | 15,771                                           |       | 3,346 |   |

 

See accompanying notes.

4

----

**Traffic.com, Inc.**

**Condensed Consolidated Statements of Cash Flows**

***(In thousands)***

 
| ** **                                                                                 | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| ** **                                                                                 | ** ** | **(unaudited)**                                  | ** ** |
| **Operating activities**                                                                   |       |                                             |       |   |   |
| Net loss                                                                                   |       | $                                                | (7,694     | ) | $ | (5,781 | ) |
| Adjustments to  reconcile net loss to net cash (used in) provided by operating activities: |       |                                             |       |   |   |
| Depreciation of property and equipment                                                     |       | 757                                              |       | 458 |   |
| Amortization of deferred financing fees and  intangible assets                             |       | 1,531                                            |       | 20 |   |
| Stock based compensation expense                                                           |       | 289                                              |       | — |   |
| Provision for bad debts                                                                    |       | 33                                               |       | 40 |   |
| Changes in  assets and liabilities:                                                        |       |                                             |       |   |   |
| Accounts and government services receivables                                               |       | 162                                              |       | 1,476 |   |
| Other assets                                                                               |       | 2,475                                            |       | 966 |   |
| Accounts payable and accrued expenses                                                      |       | (2,290                                           | )          | 242 |   |
| Accrued legal settlements                                                                  |       | (7,125                                           | )          | — |   |
| Deferred revenue                                                                           |       | 1,488                                            |       | 1,540 |   |
| Deferred license agreement                                                                 |       | (189                                             | )          | 90 |   |
| Other liabilities                                                                          |       | 209                                              |       | — |   |
| Net cash used in  operating activities                                                     |       | (10,354                                          | )          | (949 | ) |
| **Investing activities**                                                                   |       |                                             |       |   |   |
| Purchases of  property and equipment                                                       |       | (1,961                                           | )          | (2,694 | ) |
| Change in  restricted cash                                                                 |       | 187                                              |       | — |   |
| Purchases of  short-term investments                                                       |       | (24,666                                          | )          | — |   |
| Net cash used in  investing activities                                                     |       | (26,440                                          | )          | (2,694 | ) |
| **Financing activities**                                                                   |       |                                             |       |   |   |
| Proceeds from  the sales of common stock in an initial public offering                     |       | 77,693                                           |       | — |   |
| Offering  issuance costs                                                                   |       | (3,195                                           | )          | — |   |
| Repayment of the  senior secured credit facility                                           |       | (37,697                                          | )          | — |   |
| Net proceeds  from (payments of) the revolving credit facility                             |       | (4,128                                           | )          | 2,316 |   |
| Proceeds from  the exercise of common stock options and warrants                           |       | 7                                                |       | 2 |   |
| Proceeds from  the payment of shareholder notes                                            |       | 52                                               |       | — |   |
| Payment of long-term  debt                                                                 |       | —                                           |       | (16 | ) |
| Net cash  provided by financing activities                                                 |       | 32,732                                           |       | 2,302 |   |
| Net decrease in  cash and cash equivalents                                                 |       | (4,062                                           | )          | (1,341 | ) |
| Cash and cash  equivalents at beginning of period                                          |       | 13,143                                           |       | 4,898 |   |
| Cash and cash  equivalents at end of period                                                |       | 9,081                                            |       | 3,557 |   |
| **Supplemental cash flow disclosures**                                                     |       |                                             |       |   |   |
| Conversion of redeemable  convertible preferred stock                                      |       | 57,086                                           |       | — |   |
| Accretion of preferred stock                                                               |       | (108                                             | )          | (536 | ) |
| Repurchase of stock for exercise of common stock warrants                                  |       | (298                                             | )          | — |   |
|                                                                                            |            |                                                  |            |  |  |  |  |

 

See accompanying notes.

 

5

----

**Traffic.com, Inc.Notes to Condensed Consolidated Financial Statements**

**1. Organizationand Summary of Accounting Policies**

Traffic.com, Inc. (the “Company”),formerly known as Mobility Technologies, Inc., is deploying a nationwidetraffic and logistics data collection network and a proprietary TrafficInformation Management System (“TIMS”) with the goal of becoming the nation’spremier provider of real-time digital predictive traffic and logisticsinformation for businesses, consumers, and government agencies. The Company isbuilding a network of wireless sensors (the “digital sensor network”) andintegrating government agency sensors along major highways. The digital sensornetwork collects vehicle counts, vehicle speeds, classification (car or truck),and roadway density and transmits the data over a wireless network to TIMS.Initially, the Company’s revenues were generated solely through traditionalradio and television syndication of the Company’s traffic data content and thelicensing of its traffic data to the federal and certain state and localgovernmental entities. The Company has broadened its revenue approach toinclude commercial sales and licenses of its traffic data (“Traffic DataServices”) and syndication of the Company’s traffic content in the contextof  Internet, wireless and otherinteractive and non-traditional media.

On January 25, 2006, theCompany completed an initial public offering and began trading on the NASDAQNational Market under the symbol “TRFC”. In the initial public offering, atotal of 6,950,000 shares of common stock were sold,  including the exercised portion of theunderwriter’s over-allotment option. Of the 6,950,000 shares of common stocksold in the initial public offering, 62,334 shares were sold by sellingshareholders and 6,887,666 shares were sold by the Company, generatingapproximately $74.5 million in proceeds to the Company, net of offeringexpenses and underwriters’ discounts. In connection with the consummation ofthe offering, 9,242,312 shares of common stock were issued upon conversion ofthe Company’s redeemable convertible preferred stock. Upon consummation of theoffering, the Company’s Fifth Amended and Restated Certificate of Incorporationbecame effective. The Fifth Amended and Restated Certificate of Incorporationauthorizes 100,000,000 shares of common stock and  30,000,000 shares of undesignated preferredstock. No shares of preferred stock were outstanding at March 31, 2006.

**Principles ofConsolidation**

The accompanying condensedconsolidated financial statements include the accounts of the Company and itswholly owned subsidiaries. All inter-company transactions and balances havebeen eliminated.

**UnauditedInterim Financial Information**

Theaccompanying condensed consolidated balance sheet as of March 31, 2006,the condensed consolidated statements of operations and the condensedconsolidated statements of cash flows for the three months ended March 31,2006 and 2005 are unaudited. These unaudited interim condensed consolidatedfinancial statements have been prepared in accordance with U.S. generallyaccepted accounting principles. In our opinion, the unaudited interim condensedconsolidated financial statements include all adjustments of a normal recurringnature necessary for the fair presentation of our financial position at March 31,2006, and our results of operations and our cash flows for the three monthsended March 31, 2006 and 2005. The results of operations for the threemonths ended March 31, 2006, are not necessarily indicative of the resultsto be expected for the year ending December 31, 2006.

Theseunaudited interim condensed consolidated financial statements should be read inconjunction with the consolidated financial statements and related notesincluded in our 2005 Annual Report on Form 10-K, filed on March 24,2006.

**Use of Estimates**

The preparation of financialstatements in conformity with U.S. generally accepted accounting principlesrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period. Actual results could differfrom those estimates.

On an ongoing basis, the Companyevaluates its estimates, including those related to accounts receivableallowance, useful lives of long lived assets, its asset retirement obligation,revenue recognition on the Company’s contract 

6

----

with the United States Department of Transportation,the value of common stock for the purpose of determining stock-basedcompensation, and income taxes, among others. The Company bases its estimateson historical experience and on various other assumptions that are believed tobe reasonable, the results of which form the basis for making judgments aboutthe carrying value of assets and liabilities.

**Stock-basedCompensation**

**On January 1, 2006, theCompany adopted Statement of Financial Accounting Standards No. 123(revised 2004), “Share-Based Payment” (SFAS 123(R)). SFAS 123(R)requires all share-based payments to employees, including grants of stockoptions, to be recognized in the financial statements based on their fair value.Under SFAS 123(R), pro forma disclosure is no longer an alternative tofinancial statement recognition for stock option awards made after theCompany’s adoption of SFAS 123(R). See Note 5 for further details.**

**IncomeTaxes**

**There was no provision for incometaxes for the three months ended March 31, 2006 and 2005.**

**Reclassifications**

Certain amounts in the condensed consolidated balancesheet as of December 31, 2005 have been reclassified to conform to the March 31,2006 presentation.

**Short-TermInvestments**

Investments with original maturities longer than threemonths, but less than one year, are classified as short-term investments. At March 31,2006, these investments consisted of certificates of deposits. Short-terminvestments are stated at their fair value.

**2. Net Loss Attributable to Common Stockholders perCommon Share**

Basic net loss attributable to common stockholdersper common share excludes dilution for potential common stock issuances and iscomputed by dividing the net loss attributable to common stockholders by theweighted-average number of common shares outstanding for the period.Diluted net loss attributable to common stockholders per common share reflectsthe potential dilution that could occur if securities or other contracts toissue common stock were exercised or converted into common stock. The followingtable provides a reconciliation of the numerators and denominators used incomputing basic and diluted net loss attributable to common stockholders percommon share and pro forma loss attributable to common stockholders per commonshare *(in thousands, except per shareamounts)*:

|                                                                                       | ** ** | **Three Months Ended  March 31** | ** ** |
|---------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                            | ** ** | **2006**                                        | ** ** | **2005** | ** ** |
| **Basic net loss per share**                                                          |       |                                            |       |   |   |
| Numerator:                                                                            |       |                                            |       |   |   |
| Net loss                                                                              |       | $                                               | (7,694     | ) | $ | (5,781 | ) |
| Accretion of redeemable convertible preferred stock                                   |       | (108                                            | )          | (536 | ) |
| Numerator for per share calculation—basic and  diluted                           |       | $                                               | (7,802     | ) | $ | (6,317 | ) |
| Denominator:                                                                          |       |                                            |       |   |   |
| Weighted-average common shares outstanding                                            |       | 15,771                                          |       | 3,427 |   |
| Less: Weighted-average unvested common stock  subject to repurchase agreements        |       | —                                          |       | (81 | ) |
| Denominator for per share calculation—basic and  diluted                         |       | 15,771                                          |       | 3,346 |   |
| Net income (loss)  attributed to common stockholders per share—basic and diluted |       | $                                               | (0.49      | ) | $ | (1.89 | ) |

 

The following table shows stockequivalents that were not considered in the computation of the diluted net lossattributable to common stockholders per common share for the three months endedMarch 31, 2006 and 2005 as their effect is anti-dilutive:

7

----

 

|                                                       | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                            | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| Shares of  preferred stock (on an as converted basis) |       | —                                           |       | 7,561,623 |   |
| Stock options                                         |       | 2,532,751                                        |       | 1,902,957 |   |
| Warrants                                              |       | 1,272,904                                        |       | 1,339,138 |   |

 

**3. InterestIncome (Expense), Net***(in thousands)*:

|                                               | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|
| ** **                                    | ** ** | **Mar 31,  2006**           | ** ** | **Mar 31,  2005** | ** ** |
| Interest income                               |       | $                                | 335        |   | $ | 22 |   |
| Amortization of  deferred financing fees      |       | (1,531                           | )          | (20 | ) |
| Accretion of the  asset retirement obligation |       | (14                              | )          | — |   |
| Interest expense                              |       | (89                              | )          | (1,129 | ) |
| Interest income  (expense), net               |       | $                                | (1,299     | ) | $ | (1,127 | ) |

 

**4. Debt**

**Senior Secured Credit Facility**

In January 2006, the Companyrepaid the $37.7 million of outstanding principal and interest outstandingunder its senior secured credit facility using a portion of the proceeds raisedin the initial public offering. As a result of the repayment of the facility,the Company accelerated the amortization of $1.5 million of deferred financingfees into interest expense.

**Revolving Credit Facility**

In February 2006, theCompany repaid the outstanding obligation due under its revolving creditfacility with a portion of the proceeds from the initial public offering. In March 2006,the facility expired upon its terms.

**5**. **Stockholders’ Equity (Deficit):**

**Reverse StockSplit**

In October 2005, the Company’sboard of directors approved a one-for-three reverse stock split of common stockto be effected prior to the effective date of the Company’s  initial public offering of common stock. Thereverse stock split was approved by the Company’s stockholders in January 2006.In connection with the reverse stock split, the par value of the Company’scommon stock was adjusted to remain at $0.01. The accompanying condensedconsolidated financial statements give retroactive effect as though theone-for-three reverse split of the Company’s common stock occurred for allperiods presented.

**TreasuryStock**

In February 2006, the Companywithheld 24,792 shares issuable upon the exercise of warrants for theacquisition of 396,666 shares of common stock in lieu of payment of theexercise price. These shares have been recorded at cost as treasury stock.

**Stock Options**

In January 2006, the Company’s2005 Long-Term Incentive Plan (the 2005 Plan), which was approved by the boardof directors in October 2005, became effective following approval by theCompany’s stockholders and the

8

----

 consummation ofthe Company’s initial public offering. The 2005 Plan provides for the grant ofstock options, stock appreciation rights, restricted stock, restricted stockunits and other equity-based awards. No additional awards will be made underthe Company’s 1999 Long-Term Incentive Plan or the 1999 Non-Employee’s StockPlan (the 1999 Plans). Upon effectiveness of the 2005 Plan, in addition to theshares remaining for grants under the 1999 Plans which flowed through to the2005 Plan, an additiona1 1,750,000 shares of common stock became reserved forissuance under the 2005 Plan. In addition, the 2005 Plan contains an “evergreenprovision” which allows for an annual increase in the number of sharesavailable for issuance under the plan on the first day of each of the Company’sfiscal years beginning in fiscal year 2007. The annual increase in the numberof shares shall be equal to the lesser of: (i) 350,000 shares;  (ii) 1%of the Company’s outstanding shares of common stock on the first day of thefiscal year; or (iii) an amount determined by the Company’s board ofdirectors. Stock option terms are generally 10 years, with optionsgenerally becoming exercisable on a pro rata basis over 4 years from thedate of the grant.

**Impact ofthe Adoption of SFAS 123(R)**

SFAS123(R) requires all share-based payments to employees, including grants ofstock options, to be recognized in the financial statements based on their fairvalues. Under SFAS 123(R), pro forma disclosure is no longer an alternative tofinancial statement recognition for stock option awards made after the Company’sadoption of SFAS 123(R). The Company adopted SFAS 123(R) on January 1,2006.

Priorto August 30, 2005, the date that the Company filed a Form S-1with the Securities and Exchange Commission, the Company used the minimum valuemethod to calculate the pro forma disclosure required by SFAS 123. When theCompany adopted SFAS 123(R) on January 1, 2006, the Company continuedto account for the portion of awards outstanding prior to August 30, 2005using the provisions of APB Opinion No. 25, “Accounting for Stock Issuedto Employees” (APB 25) and its related interpretative guidance. The Company didnot make any stock option grants in the period from August 30, 2005through December 31, 2005. Accordingly, since the Company valued stockoption grants using the minimum-value method in prior years, pro formainformation would not be meaningful and is not being provided.

We adopted SFAS 123(R) using the modifiedprospective method beginning January 1, 2006. For stock-based awardsgranted after January 1, 2006, we have recognized compensation expenseduring the three months ended March 31, 2006 based on the estimated grantdate fair value using the Black-Scholes valuation model. For these awards, wehave recognized compensation expense using a straight-line amortization method.As SFAS 123(R) requires that stock-based compensation expense be based onawards that are ultimately expected to vest, stock-based compensation for thethree-month period ended March 31, 2006 has been reduced for estimatedforfeitures. When estimating forfeitures, we consider voluntary terminationbehaviors as well as trends of actual option forfeitures. As a result ofadopting Statement 123 (R) on January 1, 2006, the Company’s net incomefor the three months ended March 31, 2006 is $0.2 million lower thanif it had continued to account for share-based compensation underOpinion 25. Basic and diluted earnings per share for the three monthsended March 31, 2006 would have been $(0.48) per share if the Company hadnot adopted Statement 123 (R), compared to reported basic and dilutedearnings per share of $(0.49).

In connection with certain stock options grantedduring the second quarter of 2005, the Company, in accordance with APB 25,recorded deferred stock compensation aggregating $1.8 million, net ofsubsequent cancellations, representing the difference between the exerciseprice of the options and the deemed fair value of the Company’s common shareson the dates the options were granted. This deferred stock-based compensationis being amortized on a straight line basis over the vesting periods of theunderlying stock options of 4 years. Through March 31, 2006, theCompany has amortized approximately $0.2 million of such compensationexpense, with approximately $0.1 million being amortized in the threemonths ended March 31, 2006. Upon the adoption of SFAS 123(R) in January 2006,the unearned stock-based compensation balance of approximately $1.7 million wasreclassified to additional paid-in capital.

***Valuation Assumptions***

We calculated the fair value of each option award onthe date of grant using the Black-Scholes option pricing model. The followingassumptions were used for valuing grants made during the three months ended March 31,2006:

| Risk-free interest rates     |   | 4.54 - 4.85  | %      |
|------------------------------|--------|--------------|--------|
| Expected lives  (in years)   |   | 5.50 - 6.25  |   |
| Dividend yield               |   | 0            | %      |
| Expected  volatility         |   | 79.0% - 82.0 | %      |
| Weighted-average  volatility |   | 81.8         | %      |

                Due to our limited tradinghistory in a public market, the Company’s computation of stock-price volatilityis based on the volatility rates of comparable publicly-held companies over aperiod equal to the estimated useful life of the options granted by the Company.These rates may or may not reflect the Company’s stock-price volatility afterit has been a publicly-held company for a meaningful period of time. If theCompany had made different assumptions about the stock-price volatility rates,the related compensation expense and its net income and net income per shareamounts could have been significantly different. Our computation of expectedlife was determined using the “simplified” method

9

----

wherebythe vesting period plus the original contractual term is divided by two. Therange provided above relates to options being granted with different vestingperiods. The interest rate for periods within the contractual life of the awardis based on the U.S. Treasury yield curve in effect at the time of the grant.

***Stock-based Payment AwardActivity***

The following table summarizes activity under ourequity incentive plans for the three months ended March 31, 2006:
| ** **                                                   | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted Average  Remaining  Contractual Term  (in years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|--------------------------------------------|------------|------------------------------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at  January 1, 2006                         |       | 2,000,478  |       | $                                          | 2.43       |                                                                         |       |                            |       |   |
| Granted                                                      |       | 550,430    |       | $                                          | 12.12      |                                                                         |       |                            |       |   |
| Exercised                                                    |       | (9,307     | )          | $                                          | 0.82       |                                                                         |       |                            |       |   |
| Expired                                                      |       | (8,333     | )          | $                                          | 9.00       |                                                                         |       |                            |       |   |
| Forfeited                                                    |       | (577       | )          | $                                          | 2.00       |                                                                         |       |                            |       |   |
| Outstanding at  March 31, 2006                          |       | 2,532,701  |       | $                                          | 4.52       |                                                                         | 7.37       |                            | $          | 11,825,000 |   |
|                                                         |       |       |       |                                       |       |                                                                         |       |                            |       |
| Options vested  and expected to vest                         |       | 2,390,211  |       | $                                          | 4.23       |                                                                         | 7.33       |                            | $          | 11,571,000 |   |
|                                                         |       |       |       |                                       |       |                                                                         |       |                            |       |
| Options vested  and exercisable at March 31, 2006  |       | 1,334,365  |       | $                                          | 2.61       |                                                                         | 6.16       |                            | $          | 7,778,000 |   |

                The aggregate intrinsic value iscalculated as the difference between the exercise price of the underlyingawards and the quoted price of our common stock for the 1,894,631 options thatwere in-the-money at March 31, 2006. As of March 31, 2006, there wasapproximately $5.3 million of total unrecognized compensation expense relatedto unvested stock options issued under the Company’s stock option plans whichis expected to be recognized over a weighted average period of 3.7 years. Theweighted average fair value of a common stock option granted during the threemonths ended March 31, 2006 was $8.88. The total intrinsic value (marketvalue on date of exercise less the exercise price) of the options exercisedduring the three months ended March 31, 2006 was $0.1 million.

                Cash received from optionexercises under all share-based payment arrangements for the three months endedMarch 31, 2006 was approximately $7,000.

**Stock Warrants**

                The Company has fully vestedcommon stock warrants that were issued prior to January 1, 2006. Duringthe quarter ended March 31, 2006, 396,666 warrants were exercised at aprice of $0.75. The Company did not receive any cash proceeds as the warrantholders surrendered 24,792 shares as payment. The shares surrendered have beenrecorded as Treasury Stock in the balance sheet as of March 31, 2006. Thetotal intrinsic value (market value on date of exercise less exercise price) ofthe warrants exercised during the three months ended March 31, 2006 was$4.5 million.

**6. Commitmentsand Contingencies**

In January 2006,the Company paid $7.125 million in connection with the settlement of  a litigation matter, pursuant to a settlementagreement entered into with Santa Fe Technologies, Inc. and TL Ventures,LLC in November 2006. Upon payment of the settlement amount, the matterwas resolved.

10

----

**Item 2. Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

*The followingdiscussion of our financial condition and results of operations should be readin conjunction with our unaudited interim condensed consolidated financialstatements and the notes to those statements appearing elsewhere in thisdocument.*

**Overview**

        Weare a leading provider of accurate, real-time traffic information in the UnitedStates, based on the quality of our traffic data and the extent of ourgeographic coverage. We combine traffic incident and event information,collected using traditional methods, with comprehensive flow data collectedthrough our network of roadside sensors to offer detailed traffic information,including specific speeds, travel times and delay times. We have built our TIMSdata management system to process the above information in real time and todeliver customized reports to large numbers of radio, television, Internet,wireless device, and in-vehicle navigation system users.

***Revenue Profileand Business Trends***

To date, substantially all of ourrevenue has been derived from the sale of advertising on radio and televisionstations, as well as from providing our traffic data to the U.S. DOT andcertain state and local government agencies. We believe that our newer revenueopportunities, including Internet and wireless advertising, and commercialtraffic data services, will become an increasingly larger percentage of ourtotal revenue. We are investing, and intend to continue to invest, significant resources in our marketingcampaign in order to increase brand recognition of Traffic.com.

***Advertising.***In 2000, we enteredinto our first contracts with radio stations to provide traffic information inexchange for advertising inventory, which we then sell through our own directsales force. In 2001, we signed our first contracts with television stations,under which we also provide traffic information in exchange for advertisinginventory. Certain of our radio and television contracts require us to provideproduction services, such as announcers and producers, and/or make cashpayments, in addition to providing traffic information. We also enter into contractswith certain radio stations under which we buy advertising time solely inexchange for cash in order to be able to offer advertisers access to a morecomprehensive range of markets. We do not provide traffic information underthese agreements. Our television and radio contracts are generally for a termof one to three years and may be terminated with no penalty by either party ifthe other party breaches the agreement or is in bankruptcy. Some of thethree-year agreements may be terminated by the customer after 18 monthsupon 30 days notice to us.

In July 2005, we began tooffer Internet advertising on our enhanced website and the websites of our partnersand we recently began to offer advertising on our wireless consumer services.Based on industry reports of projected growth in the Internet advertisingmarket, from $12.0 billion in 2004 to $22.0 billion in 2008, andbased on our strategy to increase awareness of our Traffic.com brand, webelieve that Internet and wireless advertising provide us with an attractiveopportunity to increase our revenue. The Internet and wireless advertisingmarkets, however, are new and rapidly evolving. We have had no significantrevenue from Internet and wireless advertising to date. Our success inattracting Internet and wireless advertisers will depend, in large part, on ourability to significantly increase the number of visitors to our website and thenumber of persons who subscribe to our wireless services. We intend to continueto invest significant resources in our branding campaign to increase brandrecognition of Traffic.com.

We currently expect Internet andwireless advertising to increase to between 15% and 30% of our total revenuewithin the next three years, as we invest in our branding campaign in the expectationthat the number of visitors to our www.traffic.com website, the websites of ourpartners, and users of our wireless services will grow. We expect our radio andtelevision advertising revenue to increase in dollar amount as we expand thenumber of metropolitan areas in which we provide traffic information, but todecrease as a percentage of total revenue to between 55% and 65% within thenext three years. We are actively seeking to stimulate growth of Internet andwireless advertising by developing co-branding opportunities on our media partners’websites, such as www.weather.com and www.comcast.net and by increasing theservices offered on our own website.  Werefer to these partner websites as TrafficOnes and at the end of the firstquarter of 2006 we had 39 live TrafficOnes installed. As of that date, we alsohad agreements in place to install TrafficOnes for another 29 partners.

***TrafficData Services.***In thefirst quarter of 2004, we entered into our first commercial traffic dataservices agreement with XM Satellite Radio Holdings, Inc., which currentlyuses our traffic data for 21 metropolitan areas. The XM Satellite Radioagreement has a term of five years. Subsequently, we entered into a five-yeartraffic data services agreement 

11

----

with NAVTEQ Corporation, which has been using ourtraffic data since June 2004 in conjunction with its mapping data ascontent in a variety of services, including in-vehicle navigation systems. In2005, we entered into a three-year agreement with The Weather Channel, Inc.,which uses our traffic data to provide traffic information on its website,cable networks, local programming and desktop application. We also entered intoa two-year agreement with Motorola, Inc., which has been using our trafficdata since March 2005 to provide traffic information in its VIAMOTOsolution, a suite of location software for cell phones. In June 2005, weentered into a three-year agreement with Comcast Cable CommunicationsManagement LLC, pursuant to which we provide our traffic service incident,event and flow data to Comcast for use on its www.comcast.net website. In February 2006,we entered into an agreement with Microsoft Corporation, whereby they will useour traffic data across multiple products. In each of these agreements, eitherparty may terminate the agreement with no penalty, if the other party breachesthe agreement or is in bankruptcy. We currently expect that our traffic dataservices revenue, excluding government data services, will increase to between8% to 10% of total revenue within the next three years.

***Traffic.comWebsite and Consumer Wireless Services.***In July 2005, we launched our enhancedwww.traffic.com website and we began to offer our consumer wireless services,which allow drivers to receive route-specific information on wirelessdevices. We are in the process of a focused campaign to attract users andadvertisers to our website and to websites of our media customers that areco-branded with www.traffic.com. These new distribution channels are designedto provide advertising opportunities for our advertising customers. We beganoffering all of our consumer services free of charge in January 2006.

***Operationsand Infrastructure Support for New Revenue Opportunities.***Since 1999, we have made a significant investmentin our development and enhancement of TIMS. TIMS is our proprietary system forcollecting traffic data through our sensor network; analyzing such data; anddistributing the analyzed data through a variety of delivery channels, in realtime. Based on this investment, TIMS is very scalable and flexible. It isdesigned to allow for very high and increasing transaction volumes and tointegrate with new technologies with minimal additional development effort., Webelieve that we should be able to incorporate new revenue opportunities atrelatively low additional cost.

***Sources of Revenue***

***Advertising***

***Radio andTelevision Advertising****.*Inexchange for providing traffic information, cash and/or production services(including announcers and producers) to radio and television station customers,we receive the right to sell advertising time adjacent to traffic, news orweather reports as well as the right to sell advertisements on these stations’websites. Additionally, under certain of our contracts with radio stations to whichwe do not provide traffic information, we buy for cash the right to sell a setamount of advertising time, primarily to expand our advertising sales coverage.We refer to the advertising time that we receive in exchange for these twotypes of contracts as “owned inventory.” As of April 15, 2006, we hadcontracts to acquire owned inventory from over 475 radio stations (including122 to which we provided our traffic information services, including both ourTraffic Pulse Broadcaster and/or our affiliate web offering) and with 50television stations.

We supplement our owned inventoryby purchasing additional advertising time for cash from time to time from radiostations that are not under contract with us. These purchases, referred to as “cashbuys,” usually are made to satisfy specific advertisers’ needs for additionalcoverage on particular stations or in smaller markets. Because cash buys arepurchased in the spot market on an as-needed basis, the cost of acquiring thisadvertising is higher than the cost of owned inventory. As a result, marginsfor the sale of cash buys are generally lower than the margins that can beachieved from the sale of owned inventory.

Revenue from our radio andtelevision advertising is recognized in the month that an advertisement isaired.

In May 2005, we launched ourfirst traffic-focused, four-hour television news program, which isbroadcast during the morning commuting hours on a Viacom-owned UPNstation in the Philadelphia, PA area. This program changes the standard morningnews format by focusing first on traffic, which constitutes approximately 40%of airtime, then approximately 40% on weather, and the balance on news. Weproduce and broadcast this program from our own studio facility in ourprincipal office. This type of program, which we expect to introduce in othermarkets, provides us with significant opportunities for promoting our brandname on air, which we believe could lead to an increase in the number of usersof our other services, such as our website and consumer wireless services. Inreturn for this service, we received an upfront fee from Viacom, and receiveadvertising inventory. In addition, we are entitled to all of the advertisingrevenues 

12

----

earned from the sale of any naming, sponsorship orother promotional rights related to NeXgen. Viacom has a one-time right toterminate this agreement at a specified time.

We are amortizing the initiallicense fee received from Viacom ratably over a period of five years, whichrepresents the initial contract term. We intend to recognize any sponsorshipand promotional revenues generated from the contract with Viacom over theperiod that the sponsorship or promotion is aired. As of March 31, 2006,no revenues had yet been generated from sponsorships or promotional rights. Inaddition, we recognize revenue from the advertising spots we receive fromViacom at the time an advertisement airs.

***Internet andWireless Advertising****.*Weintroduced our enhanced website and consumer wireless services in July 2005,and are offering advertising on our own www.traffic.com website and inconnection with our wireless services, in addition to offering advertising onthe websites of a number of our partners. We have not generated any significantrevenue from either Internet or wireless advertising to date. We intend toinvest a total of $4 million to $5 million in 2006 in our brandingcampaign to increase brand recognition of Traffic.com. Revenue from Internetand wireless advertising will be recognized over the period during which theadvertisement is displayed or aired. We price Internet and wirelessadvertisements based upon a cost per thousand impressions delivered. We are notrequired to display or air any minimum number of Internet or wirelessadvertisements.

We believe that our multiple mediadelivery platforms provide advertisers with an attractive cross-mediacampaign opportunity. Our advertisers can reach their customers at varioustimes of day using advertisements associated with our traffic content aired onradio and television, placed on our website and embedded in our wirelessservices. We believe that this cross-media opportunity will result inheightened interest in our services from advertisers. An example of this typeof opportunity is the agreement we recently entered into, pursuant to which weprovide targeted, cross-platform advertising solutions for Lexus dealerships in11 major metropolitan markets across the U.S.

***Traffic DataServices***

***GovernmentServices****.*In 1999, we wereawarded, as principal subcontractor to the U.S. DOT, a subcontract to enable usto deploy an intelligent transportation infrastructure system to collect anddistribute traffic flow data. Under the terms of this subcontract, of the$2.0 million received by our prime contractor for each designated metropolitanarea, we are paid 95% or $1.9 million, to provide to federal and statetransportation agencies the traffic flow data from our sensor network in theseareas for non-commercial purposes.. We retain the exclusive right to use thisdata for commercial purposes.

Under our subcontract, we own andare responsible for constructing, operating and maintaining our sensornetworks. We have engaged a third party contractor for the installation of thesensors used in our network. We pay the contractor a specified amount per site,which varies per metropolitan area based on the number of sites to be installedin that area. There are a number of third parties capable of providing siteinstallation services.

Our ability to recognize revenuefrom our federal subcontract is based on when we obtain formal customeracceptance of the system. Revenue is then recognized over the estimated serviceperiod of the contract of 15 years.

In addition, as a subcontractorto the U.S. DOT, we must enter into agreements with state or local governmentagencies responsible for the metropolitan areas in which we deploy our sensornetwork, in order to proceed with deployment of the network. Once the relevantstate or local agency accepts our proposal and enters into a contract with us,we are required to meet certain milestones, including federal acceptance of ourplans, designs and architecture. As of March 31, 2006, we were recognizingrevenue from our sensor network in connection with our subcontract from theU.S. DOT regarding Boston, Chicago, Oklahoma City, Philadelphia, Pittsburgh,Providence, San Diego, St. Louis and Tampa. Since then we have also begunrecognizing revenue in connection with our subcontract regarding San Francisco.

***CommercialTraffic Data Services****.*In the firstquarter of 2004, we began to enter into agreements with companies to provideour traffic data directly to these customers for their own use in theirwebsites and media and service offerings. Our first such agreement was with XMSatellite Radio and, since that time, we have entered into agreements withNAVTEQ, Motorola, The Weather Channel, Comcast and Microsoft. Revenue from ourother traffic data services agreements includes one or more of annual usage andexclusivity fees, fees for 24/7 support services, and in-vehicle traffic datasubscription fees. Revenue recognition from these contracts varies, based uponcontract minimums, subscriber growth and special services provided by us.

13

----

Under our NAVTEQ agreement,NAVTEQ has paid us $9.9 million as an advance against subscription,license and other fees payable by NAVTEQ. Upon expiration or earliertermination of the agreement, we are required to repay NAVTEQ an amount equalto (i) any portion of the $9.9 million advance payment that has notyet been earned, less (ii) aggregate specified annual minimum license feesof $0.4 million in each of the first, second and third years of theagreement, $0.8 million in the fourth year of the agreement and$1.0 million in the fifth year of the agreement. Upon expiration of theagreement, if it is not renewed, up to $1.9 million of any remainingportion of the advance fee that we are required to repay may, at our option, berepaid in quarterly installments over three years at an interest rate of primeplus 1%.

The NAVTEQ agreement, entered intoin 2004, has a term of five years. The agreement may be terminated by eitherparty upon a material breach not cured within thirty days’ notice, aperformance failure caused by a force majeure event not cured within six monthsor bankruptcy of the other party. A material breach includes a material breachby us of our service level commitment to NAVTEQ, but only if more than 15% ofthe covered population is affected by the service failure for more than180 days or the failure lasts longer than 270 days. Each party mayterminate the agreement if the other sells all or substantially all of itsbusiness to certain specified entities.

***ConsumerWireless Subscriptions****.*Followingthe completion of our enhanced website, we began to offer subscription wirelessservices to consumers in July 2005. On January 14, 2006, we began tooffer all of our wireless services free of charge to consumers, as we plan tofocus on obtaining advertising-based revenues from these services. Userscan sign up for a number of *my traffic.com*personalized traffic services within the *mytraffic.com* section of the traffic.com website.

We have begun to offeradvertising opportunities and sponsorships associated with our free wirelessservices to our advertising customers, although we have generated only minimaladvertising revenue from this source to date.

Revenue from advertising andsponsorships in connection with our wireless services is recognized over theperiod during which the advertisement or sponsorship is displayed and isincluded in advertising revenue in our statement of operations.

***Cost of Revenue***

Cost of revenue consists of mediainventory expenses, traffic data collection expenses, and other technologycosts associated with maintaining TIMS.

***Media Inventory****.*Media inventory expenses consist of cash paid topurchase advertising inventory under long-term contracts with radio stations.In addition, media inventory expenses include cash payments to radio stationsto purchase additional advertising inventory in the spot market on an as-neededbasis, which we refer to as “cash buys.” As we expand our presence into alarger number of metropolitan areas in the United States, we expect our mediainventory expenses to decrease as a percentage of total revenue.

***Traffic DataCollection Expenses****.*Traffic datacollection expenses consist of the costs of personnel, both full-time andpart-time, the costs of aircraft and automobiles, the monitoring of police andemergency response vehicles, the depreciation of our traffic flow data sensornetwork, the use of state and local agency data sources where available(including sensors and cameras), and our own camera network. These expensesalso include occupancy and communications costs for our national operationscenter and local operations centers. Traffic data collection costs are expectedto continue to increase as we expand from our presence in 40 metropolitan areasas of April 15, 2006. We plan to utilize existing operations centers whereit is efficient and effective to do so.

***OtherTechnology Expenses****.*Technologyexpenses primarily consist of personnel and related costs for employees engagedin the development and ongoing maintenance of TIMS, including hardware andinternal product development expenses and the cost of consultants engaged toassist with various software development programs. In addition, these expensesinclude communications costs; capital depreciation of computer hardware; andthe depreciation of certain technology costs capitalized in accordance with SOP98-1, “*Accounting for the Costs ofComputer Software Developed or Obtained for Internal Use.*” We expectto continue to incur development costs as we add products and services.

14

----

***OperatingExpenses***

***Research andDevelopment***  In accordance with Statement of Position(SOP) 98-1 “Accounting for the Costs of Computer Software Developed orObtained for Internal Use,” research and development costs include those laborcosts incurred during the application development stage of internally developedsoftware. In addition, research and development costs also include costsassociated with licensing third-party software and other qualityassurance costs.

***Sales andMarketing Expenses****.*Sales andmarketing expenses primarily consist of personnel and related costs foremployees engaged in sales, business development and marketing, includingsalaries, commissions, and other variable compensation, travel expenses andcosts associated with trade shows, advertising and other marketing efforts andbad debt expense. While the operating costs associated with our traditionalradio and television relationships have remained relatively flat over the lastyear, we have incurred additional costs in connection with our businessdevelopment efforts related to Internet advertising and product development.Since mid-2005, we have significantly increased our expenditure of fundsfor brand marketing and expect to continue or increase this spending for theforeseeable future. We currently expect to spend approximately$4.0 million to $5.0 million on sales and marketing in 2006.

***General andAdministrative Expenses****.*Generaland administrative expenses consist of personnel and related costs of ourmanagement, finance, human resources, technology support and administrativepersonnel, professional fees and other corporate expenses, and stock-basedcompensation*.* As we expand ourbusiness and incur additional expenses associated with being a public company,we believe that general and administrative expenses will also increase. Whilewe cannot predict with certainty what the additional costs of being a publiccompany will be, a review of comparable companies would suggest that additionalcosts could be between $1.5 million and $3.0 million annually.

**Results ofOperations**

***Comparison ofthe Three Months Ended March 31, 2005 and 2006***

***Revenue***

Revenue increased from$9.3 million for the three months ended March 31, 2005 to$10.8 million for the three months ended March 31, 2006, a 16.5%increase.

***Advertising****.*Advertising revenue increased from$8.3 million for the three months ended March 31, 2005 to$9.3 million for the three months ended March 31, 2006, a 12.0%increase. Owned inventory revenue, which generates higher margins, increasedfrom $7.1 million, or 85.5% of advertising revenue, for the three monthsended March 31, 2005, to $8.0 million, or 86.2% of advertisingrevenue, for the three months ended March 31, 2006, a 12.8% increase.Owned inventory revenue has steadily increased, both in absolute dollars and asa percentage of total advertising revenue, as the number of our radio and televisioncustomers has grown, due in part to the launch of Traffic Pulse NeXgen in thefourth quarter of 2004. We recognized $0.1 million in Internet and wirelessadvertising revenues during the three months ended March 31, 2006.

***Traffic dataservices****.*Traffic data servicesrevenue grew from $0.9 million for the three months ended March 31,2005 to $1.5 million for the three months ended March 31, 2006, a56.7% increase. The increase was due to commencing revenue recognition withrespect to four additional cities under the U.S. DOT contract and increases inrevenue generated from the XM Satellite Radio, The Weather Channel, Viacom,Motorola agreements, as well as the recently executed Microsoft contract.

***Cost of revenue***

Cost of revenue increased from$7.6 million for the three months ended March 31, 2005 to$9.5 million for the three months ended March 31, 2006, a 24.5%increase. Cost of revenue as a percentage of revenue increased from 82.4% forthe three months ended March 31, 2005 to 88.1% for the three months ended March 31,2006.

***Media Inventory****.*Media inventory expenses increased from$3.9 million for the three months ended March 31, 2005 to$4.5 million for the three months ended March 31, 2006, a 15.2%increase. Our media inventory expenses decreased as a percentage of revenuefrom 42.3% for the three months ended March 31, 2005 to 41.8% for thethree months ended March 31, 2006. The increase in absolute dollars wasprimarily due to a $0.6 million increase in expenses for stations underlong-term agreements. Media inventory costs decreased as a percentage ofrevenue due to the revenue growth these additional contracts contributed.

15

----

***Traffic datacollection****.*Traffic datacollection expenses increased from $3.6 million for the three months endedMarch 31, 2005 to $4.6 million for the three months ended March 31,2006, a 30.3% increase. Our traffic data collection costs as a percentage ofrevenue increased from 38.5% for the three months ended March 31, 2005 to43.1% for the three months ended March 31, 2006. The increase both inamount and as a percentage of revenue was primarily due to an increase incompensation and related costs, including on-air talent and production staff,of $0.6 million. This increase directly corresponds to our increasednumber of radio and television customers and expansion in the number of marketsbeing serviced from 24 at March 31, 2005 to 40 at March 31, 2006. Inaddition, depreciation expense increased $0.1 million, as a result ofcommencing depreciation of our sensor network in four additional cities, andmaintenance and communication costs relating to the digital sensor networkincreased $0.1 million, primarily as a result of additional sensors beinginstalled under new city contracts.

***Othertechnology expenses****.*Othertechnology expenses increased from $0.2 million for the three months endedMarch 31, 2005 to $0.3 million for the three months ended March 31, 2006.Our other technology expenses increased as a percentage of revenue from 1.6%for the three months ended March 31, 2005 to 3.2% for the three monthsended March 31, 2006. The increase in both the amount and as a percentageof revenue was due to a $0.2 million increase in depreciation from internallydeveloped software and capital asset purchases supporting the delivery of datato additional digital cities and traffic data service and consumer customers.

***Operatingexpenses***

***Research anddevelopment****.*Research anddevelopment expenses increased from $0.8 million for the three monthsended March 31, 2005 to $1.3 million for the three months ended March 31,2006, a 58.0% increase. Research and development expenses increased as apercentage of revenue from 8.7% for the three months ended March 31, 2005to 11.8% for the three months ended March 31, 2006. The increase in bothamount and as a percentage of revenue was due primarily to a $0.3 millionincrease in compensation and related employee expenses directly related toincreased headcount.

***Sales andmarketing****.*Sales and marketingexpenses increased from $3.8 million for the three months ended March 31,2005 to $4.3 million for the three months ended March 31, 2006, a12.5% increase. Our sales and marketing expenses as a percentage of revenuedecreased from 40.9% for the three months ended March 31, 2005 to 39.5%for the three months ended March 31, 2006. The increase in absolutedollars was due to a $0.5 million of additional marketing expenses forbranding, external product marketing, and public relations.

***General andadministrative****.*General andadministrative expenses increased from $1.7 million for the three monthsended March 31, 2005 to $2.2 million for the three months ended March 31,2006, a 27.1% increase. Our general and administrative expenses as a percentageof revenue increased from 18.3% for the three months ended March 31, 2005to 20.2% for the three months ended March 31, 2006. The increase in bothamount and as a percentage of revenue was due primarily to stock basedcompensation charges of $0.3 million resulting from the newly adoptedrequirements of FAS 123(R) and increases in certain expenses such asdirector and officers insurance and audit fees due to our recently completedpublic offering.

***Interest income(expense), net****.*Net interestexpense increased from $1.1 million for the three months ended March 31,2005 to $1.3 million for the three months ended March 31, 2006, a15.3% increase. Net interest expense was impacted during the three months endedMarch 31, 2006 by the repayment of our senior secured credit facility in January 2006.The repayment resulted in the acceleration of $1.5 million of costs deferred atthe commencement of the facility and a decrease of $1.0 million in interestexpense from the three months ended March 31, 2005 to the three monthsended March 31, 2006. Interest income increased by $0.3 million from thethree months ended March 31, 2005 to the three months ended March 31,2006, due to increased investable cash from the initial public offering.

**Seasonality**

Due to the seasonal nature of broadcastadvertising revenue and the percentage of our total revenue historicallyrepresented by these sources, we have typically experienced lower revenueduring the first quarter, following the holiday season, and the third quarter,during the summer months.

16

----

**Liquidity andCapital Resources**

Since inception, we haveprincipally financed our operations through private sales of our preferredstock, internally generated funds, a secured credit facility, a revolving lineof credit, and, most recently, an initial public offering of common stock . At March 31,2006, we had $33.7 million of cash and cash equivalents and short-terminvestments compared to $13.1 million at December 31, 2005. As of March 31,2005, we had raised an aggregate of $101.9 million through our preferredstock financings. In January and February 2006, we raised a total ofapproximately $74.5 million from our initial public offering, net of feesand expenses. We generally invest our cash in highly liquid investments with amaturity of six months or less at the date of purchase. To date, inflation hasnot had a material effect on our business.

Cash flows used in operatingactivities were $0.9 million for the three months ended March 31,2005 and $10.4 million for the three months ended March 31, 2006. Cashflows used in operating activities for the three months ended March 31,2005 were primarily due to a net loss of $5.8 million which was offset byadjustments for depreciation and amortization, and changes in accounts andgovernment services receivable, other assets, and deferred revenue. Cash flowsused in operating activities for the three months ended March 31, 2006were primarily due to a net loss of $7.7 million, adjustments for depreciationand amortization; the payment of $7.1 million in connection with the settlementof litigation; and changes in accounts payable and accrued expenses anddeferred revenue.

Cash flows used in investingactivities were $2.7 million for the three months ended March 31,2005 and $31.4 million for the three months ended March 31, 2006. Cashflows used in investing activities for the three months ended March 31,2005 were due to the purchase of fixed assets. Cash flows used in investingactivities for the three months ended March 31, 2006 were primarily due tothe purchase of $24.7 million of short term investments following thecompletion of our initial public offering and the purchase of $2.0 million offixed assets.

Cash flows provided by financingactivities were $2.3 million for the three months ended March 31,2005 and $32.7 million for the three months ended March 31, 2006. Cashflows provided by financing activities for the three months ended March 31,2005 were due to $2.3 million in borrowing under the revolving credit facility.Cash flows provided by financing activities for the three months ended March 31,2006 were primarily due to $74.5 million in proceeds, after deductingunderwriters’ fees and expenses, from our initial public offering, therepayment of $37.7 million due under our senior secured credit facility,and the repayment of $4.1 million under our revolving credit facility.

Our capital requirements dependon many factors, including our planned geographic expansion into newmetropolitan areas. We currently expect to expand our traffic informationcoverage and service offerings to a total of 50 U.S. metropolitan areas by theend of 2006. We expect to incur capital expenditures of approximately$15.0 million in 2006. The majority of these expenditures relate to theconstruction of our sensor network in a number of new metropolitan areas, withapproximately $10 million to $12 million expected in 2006. Theseexpenditures, however, are expected to be balanced by a comparable amount ofreceipts under our data services agreement with the U.S. DOT associated withthese new metropolitan areas.

Recently, we have focused on newrevenue opportunities, including the enhancement of our website and theintroduction of our in-vehicle and consumer wireless services, and have devotedincreasing resources to developing and marketing these new services. Ourability to generate revenue from these services will have a material impact onour future cash needs. We expect to devote significant capital resources tocontinued product development, brand marketing, expansion of operationalsystems and other general corporate activities. Specifically, we expect tospend approximately $4.0 million to $5.0 million in 2006 on ourbranding initiative. We expect to spend approximately $1.0 million to $2.0 millionon facilities, principally traffic operations centers, in 2006. We expect tospend approximately $3.0 million to $4.0 million on technologydevelopment and infrastructure during the same period.

Based on our current operationsand planned expansion, we expect that our available funds are sufficient tomeet our expected needs for working capital and capital expenditures throughthe end of 2007. Thereafter, if we do not have sufficient cash available tofinance our operations, we may be required to obtain additional public orprivate debt or equity financing. We cannot be certain that additionalfinancing will be available to us on favorable terms, if at all. If we areunable to raise sufficient funds, we may need to reduce our operations, delayour geographic expansion, and reduce our product development and marketingactivities.

**Indebtedness**

In January 2006 we repaidthe outstanding principal and interest outstanding under our senior securedcredit facility using a portion of the proceeds raised in our initial publicoffering. We anticipate entering into a new credit facility, although we havenot reached an agreement with any lender.

17

----

Our revolving credit facilityterminated upon its own terms in March 2006. We anticipate entering into anew credit facility, although we have not reached an agreement with any lender.

**Inflation**

We do not believe that inflationhad a material impact on our earnings from operations.

**Off-BalanceSheet Arrangements**

At December 31, 2005 and March 31,2006, we did not have any relationships with unconsolidated entities orfinancial partnerships which were established for the purposes of facilitatingoff-balance sheet arrangements or other contractually narrow or limitedpurposes.

**RecentAccounting Pronouncements**

For a discussion of SFAS 123(R) pleaserefer to Note 1 in the Notes to our Unaudited Condensed Consolidated FinancialStaements included elsewhere herein.

**Item 3.**                          Quantitativeand Qualitative Disclosures About Market Risk

        We do not use derivativefinancial instruments for speculation or trading purposes. Our current policyis to maintain an investment portfolio consisting mainly of U.S. Governmentobligations or other securities rated AAA or comparably, with a maximummaturity of 12 months and a weighted average maturity for the portfolio ofsix months. Our cash is deposited in and invested through highly ratedfinancial institutions in North America. Our marketable securities are subjectto interest rate risk and will fall in value if market interest rates increase.

        As of March 31,2006, we had no exposure to interest rate risk as our outstanding short andlong-term debt instruments were repaid during the first quarter.

**Item 4.**                          Controlsand Procedures

***Evaluation of disclosure controls andprocedures***

        We maintain disclosurecontrols and procedures (as defined in Rule 13a-15(e) promulgatedunder the Securities Exchange Act of 1934, as amended (the “Exchange Act”))that are designed to ensure that information that would be required to bedisclosed in Exchange Act reports is recorded, processed, summarized andreported within the time periods specified in the Securities ExchangeCommission’s rules and forms, and that such information is accumulated andcommunicated to our management, including the Chief Executive Officer,President, Chief Operating Officer and Chief Financial Officer, as appropriate,to allow timely decisions regarding required disclosure.

        As of March 31,2006, our management, including the Chief Executive Officer, Chief OperatingOfficer and Chief Financial Officer, evaluated the effectiveness of the designand operation of our disclosure controls and procedures. Based on suchevaluation, management concluded that our disclosure controls and procedureswere effective as of the end of the period covered by this report.

18

----

**Part II. OtherInformation**

**Item 1A. RiskFactors**

*The Private Securities LitigationReform Act of 1995 (the Act) provides a safe harbor for “forward-lookingstatements” made by or on our behalf of our company. This Quarterly Report on Form 10-Q,including the Item labeled “Management’s Discussion and Analysis of FinancialCondition and Results of Operations”, contains forward-looking statements thatyou should read in conjunction with the financial statements and notes tofinancial statements that we have included elsewhere in this report. Thesestatements are based on our current expectations, assumptions, estimates andprojections about our business and our industry, and involve known and unknownrisks, uncertainties, and other factors that may cause our or our industry’sresults, levels of activity, performance or achievements to be materiallydifferent from any future results, levels of activity, performance orachievements expressed or implied in, or contemplated by, the forward-lookingstatements. We generally identify these statements by words or phases such as “believe,”“anticipate,” “expect,” “intend,” “plan,” “will,” “may,” “should,” “estimate,” “predict,”“potential,” “continue,” or the negative of such terms or other similarexpressions. Our actual results and the timing of events may differsignificantly from the results discussed in the forward-looking statements, andyou should not place undue reliance on these statements. Factors that mightcause such a difference include those discussed under the heading “RiskFactors,” in our Annual Report on Form 10-K, filed on March 24,2006, as well as those discussed elsewhere therein and in this Quarterly Reporton Form 10-Q. We disclaim any intent or obligation to update any forward-lookingstatements as a result of developments occurring after the period covered bythis report or otherwise*

**Item 4. Submissionof Matters to a Vote of Security Holders**

During January 2006, prior to our initial public offering, wedelivered to all of our stockholders written consents in lieu of meetingsconcerning the following matters:

·                  The adoption of an amendment to our FourthAmended and Restated Certificate of Incorporation regarding a  three-for-one reverse split regarding ourcommon stock, and related matters;

·                  The adoption of our current Fifth Amended andRestated Certificate of Incorporation;

·                  The adoption of our  current Amended and Restated Bylaws; and

·                  The adoption of our 2005 Long term IncentivePlan.

All of such matters were submitted in connection with the preparationfor and consummation of our initial public offering.

The passage of each of such matters required: 1) at least a majority ofour outstanding Series E Convertible Preferred Stock, voting as a separateclass; 2) at least a majority of our outstanding Series E-1Convertible Preferred Stock, voting as a separate class; 3) at least a majorityof our outstanding Series F Convertible Preferred Stock, voting as aseparate

19

----

class; and, 4) at least a majority of our common stock, Series EStock, Series E-1 Stock and Series F Stock, voting together asa single class on an as converted basis. Each of the above matters wereapproved by all required votes and the approved actions were effected inconnection with the consummation of our initial public offering. We receivedwritten consents in the following percentages regarding each individual matter(all share amounts are reported on a pre-reverse split basis):  Series E — out of a total of 16,265,094shares, 15,299,114, or approximately 94.1% joined in the written consents onall matters; Series E-1 - out of a total of 6,419,811 shares,6,287,414, or approximately 97.9% joined in the written consents on allmatters; Series F - out of a total of 5,042,090 shares, 4,274,918, orapproximately 84.8% joined in the written consents on all matters; CommonStock, Series E, Series E-1 and Series F, voting as aclass - out of a total of 39,205,120 shares, 28,983,547 or approximately 73.9%joined in the written consents on all matters. No persons voted against any ofsuch matters and no abstentions were noted by any stockholder.

**Item 5. OtherInformation**

Effective May 8, 2006 our Board of Directorsappointed Tom A. Vadnais as a Class  I director. Mr. Vadnais willstand for election by the Company’s stockholders at the Company’s AnnualMeeting presently scheduled for June 27, 2006. From April 2001 to October 2001,Mr. Vadnais was President, Chief Executive Officer and a director ofMediaplex, Inc., a provider of technology-based marketing and products andservices. Prior to joining Mediaplex, Mr. Vadnais was the Executive VicePresident of Professional Services for Compuware Corporation, a software andprofessional services provider for IT professionals, where he was retained toperform the integration of Data Processing Resources Corporation (DPRC) andmanaged mergers and acquisitions. Mr. Vadnais was the President and ChiefOperating Officer of DPRC, prior to its acquisition by Compuware. From 1992 to1999, Mr. Vadnais was the President and Chief Operating Officer of Tascor, Inc.,a wholly-owned subsidiary of Norrell Inc., where he was a member of Norrell’sboard of directors. Until 1992, Mr. Vadnais worked at IBM for twenty-threeyears in various management roles, where he had experience in sales, marketing,and as Vice President of Operations. He graduated with a B.A. from theUniversity of California, Los Angeles, and an M.B.A. from Golden GateUniversity. Mr. Vadnais is also a member of the Board of Directors ofValueClick, Inc., (Nasdaq: VCLK), a provider of digital marketingsolutions and advertising technology tools. He has served as a director ofValueClick since October 2001. Consistent with our policy regarding optiongrants to directors, Mr. Vadnais was granted an optionto purchase 8,500 shares of our common stockat an exercise price of $5.52 per share, the fair market value as of theeffective date of Mr. Vadnais’ appointment. Half of these options vestedimmediately upon grant and the remainder will vest on the first anniversary ofgrant.

Effective May 8, 2006, the Company entered intoIndemnification Agreements with each of the Company’s Directors and ExecutiveOfficers. Pursuant to the Indemnification Agreements, we have agreed toindemnify our directors and executive officers to the fullest extent of the lawpermitted or required by the State of Delaware. In connection therewith,Indemnitees will have the right to the advancement of expenses resulting fromany claim for indemnity.   TheIndemnification Agreements requires us to use commercially reasonable effortsto maintain directors’ and officers’ liability insurance in amounts that arereasonable in scope and amount. The rights of the Indemnitees toindemnification pursuant to the Indemnification Agreements are in addition toany other rights the Indemnitees may have under our Certificate ofIncorporation, Bylaws or any other agreement between us and the Indemnitee. Acopy of the form of Indemnification Agreement is attached to this Form 10-Qas Exhibit 10.24 and incorporated herein by reference.

**Item 6. Exhibits**
| 10.3.1 |   | Form of 2005 Long-Term Incentive Plan Stock  Option Agreement.                                                               |   |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------|--------|
| 10.3.2 |   | Form of 2005 Long-Term Incentive Plan Executive  Stock Option Agreement.                                                     |   |
| 10.24  |   | Form of Directors and Officers Indemnification  Agreement.                                                                   |   |
| 31.1   |   | Certification by the Chief Executive Officer  pursuant to Rule 13a-14(a) under the Securities Exchange Act  of 1934.    |   |
| 31.2   |   | Certification by the Chief Financial Officer  pursuant to Rule 13a-14(a) under the Securities Exchange Act  of 1934.    |   |
| 32.1   |   | Certification  Pursuant to 18 USC. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |   |
|   |   |                                                                                                                              |   |
|   |   |                                                                                                                              |   |
|   |   |                                                                                                                              |   |
|   |   |                                                                                                                              |   |

 

20

----

**Signatures**

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|   |              |   | Traffic.com, Inc.                       |   |
|--------|-------------------|--------|----------------------------------------------|--------|
|   |              |   | (Registrant)                                 |
| Date:  | May 10, 2006 | By:    | /s/ Robert N. Verratti                       |   |
|   |              |   | Robert N. Verratti                           |
|   |              |   | Chief Executive Officer                      |
|   |              |   | (Principal Executive Officer)                |
| Date:  | May 10, 2006 | By:    | /s/ Andrew Maunder                           |   |
|   |              |   | Andrew Maunder                               |
|   |              |   | Chief Financial Officer                      |
|   |              |   | (Principal Financial and Accounting Officer) |

 

21

----

**EXHIBIT INDEX**
| Exhibit  No. | ** ** | **Description**                                                                                                                   | ** ** |
|--------------|------------|-----------------------------------------------------------------------------------------------------------------------------------|------------|
| 10.3.1       |       | Form of  2005 Long-Term Incentive Plan Stock Option Agreement.                                                               |       |
| 10.3.2       |       | Form of  2005 Long-Term Incentive Plan Executive Stock Option Agreement.                                                     |       |
| 10.24        |       | Form of  Directors and Officers Indemnification Agreement.                                                                   |       |
| 31.1         |       | Certification by  the Chief Executive Officer pursuant to Rule 13a-14(a) under  the Securities Exchange Act of 1934.    |       |
| 31.2         |       | Certification by  the Chief Financial Officer pursuant to Rule 13a-14(a) under  the Securities Exchange Act of 1934.    |       |
| 32.1         |       | Certification Pursuant  to 18 USC. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |       |

 

22

----