**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-Q**

 
| **ý**                                             | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|--------------------------------------------------------|---------------------------------------------------------------------------------------------------------|
|                                                   |                                                                                                    |
| **FOR THE  QUARTERLY PERIOD ENDED JUNE 30, 2005** |
|                                                   |
| **Or**                                                 |
|                                                   |
| **o**                                                  | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition period from            to           **

 

**Commission file number 000-51226**

 

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**FASTCLICK, INC.**

(Exact name of registrant asspecified in its charter)

 
| **Delaware**                                                     | ** ** | **77-0540202**                        |
|------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of incorporation or  organization) |       | (I.R.S. Employer  Identification No.) |

 

**360 OliveStreet**

**SantaBarbara, California 93101**

(Address of principalexecutive offices, including zip code)

 

**(805)568-5334**

(Registrant’s telephonenumber, including area code)

 

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Indicate by check markwhether the registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days: Yes  o  No  ý

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2): Yes  o  No  ý

 

Indicate the number of shares outstanding of each of the issuer’s classesof common stock, as of the latest practicable date.

 
| **Class**                                 | ** ** | **Outstanding  at August 11, 2005** |
|-------------------------------------------|------------|------------------------------------------|
| Common  Stock, Par Value $0.001 per share |       | 19,661,745 shares                        |

 

 

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**FASTCLICK, INC.**

**INDEX TO FORM 10-QFOR THE**

**QUARTERLYPERIOD ENDED JUNE 30, 2005**

 
| **PART I.**  | **FINANCIAL  INFORMATION**                                                                  |
|-------------------|---------------------------------------------------------------------------------------------|
| Item 1.           | Financial Statements                                                                        |
|              | Balance Sheets                                                                              |
|              | Statements of Income                                                                        |
|              | Statements of Cash Flows                                                                    |
|              | Notes to Financial  Statements                                                              |
| Item 2.           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
| Item  3.          | Quantitative  and Qualitative Disclosure about Market Risk                                  |
| Item 4.           | Controls and Procedures                                                                     |
|              |                                                                                        |
| **PART II.** | **OTHER INFORMATION AND  SIGNATURES**                                                       |
| Item 1.           | Legal  Proceedings                                                                          |
| Item  2.          | Unregistered  Sales of Equity Securities and Use of Proceeds                                |
| Item  3.          | Defaults  Upon Senior Securities                                                            |
| Item  4.          | Submission  of Matters to a Vote of Security Holders                                        |
| Item 5.           | Other  Information                                                                          |
| Item 6.           | Exhibits                                                                                    |
|              | Signatures                                                                                  |
|              | Exhibit Index                                                                          |

 

1

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**PART I.  FINANCIAL INFORMATION**

ITEM1.  FINANCIAL STATEMENTS

 

**FASTCLICK, INC.**

**BALANCE SHEETS**

**(Dollars inthousands, except share and per share data)**

 
| ** **                                                                                                                                                                                                                                                                   | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                                                   | ** ** | **(unaudited)**         | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                   |       |                    |       |                        |       |
| Current assets:                                                                                                                                                                                                                                                              |       |                    |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                                                                                                    |       | $                       | 13,926     |                        | $          | 12,397 |   |
| Short-term investments                                                                                                                                                                                                                                                       |       | 67,313                  |       | 7,954                       |       |
| Accounts receivable, net of allowance of  $563 (2005) and $591 (2004)                                                                                                                                                                                                        |       | 10,025                  |       | 9,003                       |       |
| Prepaid expenses and other current assets                                                                                                                                                                                                                                    |       | 1,549                   |       | 232                         |       |
|                                                                                                                                                                                                                                                                         |       |                    |       |                        |       |
| Total current assets                                                                                                                                                                                                                                                         |       | 92,813                  |       | 29,586                      |       |
|                                                                                                                                                                                                                                                                         |       |                    |       |                        |       |
| Property and equipment, net                                                                                                                                                                                                                                                  |       | 2,405                   |       | 2,078                       |       |
| Other assets                                                                                                                                                                                                                                                                 |       | 2,329                   |       | 2,219                       |       |
|                                                                                                                                                                                                                                                                         |       |                    |       |                        |       |
| Total assets                                                                                                                                                                                                                                                                 |       | $                       | 97,547     |                        | $          | 33,883 |   |
|                                                                                                                                                                                                                                                                         |       |                    |       |                        |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY (DEFICIT)**                                                                                                                                                                                                                     |       |                    |       |                        |       |
| Current liabilities:                                                                                                                                                                                                                                                         |       |                    |       |                        |       |
| Accounts payable                                                                                                                                                                                                                                                             |       | $                       | 5,757      |                        | $          | 5,695 |   |
| Deferred revenue                                                                                                                                                                                                                                                             |       | 771                     |       | 738                         |       |
| Accrued payroll                                                                                                                                                                                                                                                              |       | 962                     |       | 2,048                       |       |
| Accrued other liabilities                                                                                                                                                                                                                                                    |       | 389                     |       | 410                         |       |
| Income taxes payable                                                                                                                                                                                                                                                         |       | 632                     |       | 77                          |       |
| Current portion of loans payable                                                                                                                                                                                                                                             |       | —                  |       | 46                          |       |
| Deferred income taxes                                                                                                                                                                                                                                                        |       | 348                     |       | 500                         |       |
|                                                                                                                                                                                                                                                                         |       |                    |       |                        |       |
| Total current liabilities                                                                                                                                                                                                                                                    |       | 8,859                   |       | 9,514                       |       |
|                                                                                                                                                                                                                                                                         |       |                    |       |                        |       |
| Long-term portion of loans payable, net of  current portion                                                                                                                                                                                                                  |       | —                  |       | 75                          |       |
| Deferred tax liabilities                                                                                                                                                                                                                                                     |       | 736                     |       | 806                         |       |
|                                                                                                                                                                                                                                                                         |       |                    |       |                        |       |
| Total long-term liabilities                                                                                                                                                                                                                                                  |       | 736                     |       | 881                         |       |
|                                                                                                                                                                                                                                                                         |       |                    |       |                        |       |
| Total liabilities                                                                                                                                                                                                                                                            |       | 9,595                   |       | 10,395                      |       |
|                                                                                                                                                                                                                                                                         |       |                    |       |                        |       |
| Commitments and contingencies                                                                                                                                                                                                                                                |       |                    |       |                        |       |
| Redeemable convertible preferred stock, no  par value; 0 shares authorized, issued or outstanding at June 30, 2005,  and 2,131,285 shares authorized, issued and outstanding at December 31,  2004                                                                 |       | —                  |       | 73,416                      |       |
|                                                                                                                                                                                                                                                                         |       |                    |       |                        |       |
| Stockholders’ equity (deficit):                                                                                                                                                                                                                                         |       |                    |       |                        |       |
| Preferred stock, $0.001 par value;  10,000,000 shares authorized and 0 shares issued and outstanding as of  June 30, 2005, 0 shares authorized, issued and outstanding as of  December 31, 2004                                                                    |       | —                  |       | —                      |       |
| Common stock; $0.001 par value, 100,000,000  shares authorized, 19,598,780 shares issued and outstanding as of  June 30, 2005; and no par value, 18,750,000 shares authorized,  11,991,315 shares issued and 3,076,595 shares outstanding as of  December 31, 2004 |       | 20                      |       | 8,395                       |       |
| Additional paid-in capital                                                                                                                                                                                                                                                   |       | 87,108                  |       | —                      |       |
| Unrealized loss on investments                                                                                                                                                                                                                                               |       | (28                     | )          | —                      |       |
| Deferred compensation                                                                                                                                                                                                                                                        |       | (4,820                  | )          | (7,249                      | )          |
| Treasury stock                                                                                                                                                                                                                                                               |       | —                  |       | (54,386                     | )          |
| Retained earnings                                                                                                                                                                                                                                                            |       | 5,672                   |       | 3,312                       |       |
|                                                                                                                                                                                                                                                                         |       |                    |       |                        |       |
| Total stockholders’ equity (deficit)                                                                                                                                                                                                                                    |       | 87,952                  |       | (49,928                     | )          |
|                                                                                                                                                                                                                                                                         |       |                    |       |                        |       |
| Total liabilities and stockholders’ equity  (deficit)                                                                                                                                                                                                                   |       | $                       | 97,547     |                        | $          | 33,883 |   |

 

See accompanying notes.

 

2

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**FASTCLICK, INC.**

**STATEMENTS OF INCOME**

**(inthousands, except per share amounts)**

 
| ** **                                  | ** ** | **Three Months  Ended  June 30,** | ** ** | **Six Months  Ended  June 30,** | ** ** |
|---------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                                  | ** ** | **2005**                               | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                  | ** ** | **(unaudited)**                        | ** ** |
|                                        |       |                                   |       |                                 |       |   |   |   |   |
| Revenue                                     |       | $                                      | 19,295     |                                 | $          | 12,222 |   | $ | 38,918 |   | $ | 23,144 |   |
| Cost of revenue(a)                          |       | 12,727                                 |       | 8,056                                |       | 25,578 |   | 15,436 |   |
|                                        |       |                                   |       |                                 |       |   |   |   |   |
| Gross profit                                |       | 6,568                                  |       | 4,166                                |       | 13,340 |   | 7,708 |   |
| Operating costs:                            |       |                                   |       |                                 |       |   |   |   |   |
| Sales and marketing                         |       | 2,026                                  |       | 1,409                                |       | 4,488 |   | 2,302 |   |
| Technology                                  |       | 684                                    |       | 532                                  |       | 1,297 |   | 905 |   |
| General and administrative                  |       | 1,422                                  |       | 492                                  |       | 2,998 |   | 896 |   |
| Stock-based compensation(b)                 |       | 611                                    |       | —                               |       | 1,342 |   | — |   |
|                                        |       |                                   |       |                                 |       |   |   |   |   |
| Total operating costs                       |       | 4,743                                  |       | 2,433                                |       | 10,125 |   | 4,103 |   |
|                                        |       |                                   |       |                                 |       |   |   |   |   |
| Operating income                            |       | 1,825                                  |       | 1,733                                |       | 3,215 |   | 3,605 |   |
| Interest and dividend income                |       | 553                                    |       | 6                                    |       | 651 |   | 10 |   |
| Interest expense                            |       | —                                 |       | (2                                   | )          | (1 | ) | (2 | ) |
|                                        |       |                                   |       |                                 |       |   |   |   |   |
| Income before provision for income taxes    |       | 2,378                                  |       | 1,737                                |       | 3,865 |   | 3,613 |   |
| Provision for income taxes                  |       | 869                                    |       | 14                                   |       | 1,505 |   | 57 |   |
|                                        |       |                                   |       |                                 |       |   |   |   |   |
| Net income                                  |       | $                                      | 1,509      |                                 | $          | 1,723 |   | $ | 2,360 |   | $ | 3,556 |   |
|                                        |       |                                   |       |                                 |       |   |   |   |   |
| Earnings per share:                         |       |                                   |       |                                 |       |   |   |   |   |
| Basic                                       |       | $                                      | 0.08       |                                 | $          | 0.16 |   | $ | 0.21 |   | $ | 0.33 |   |
| Fully diluted                               |       | $                                      | 0.07       |                                 | $          | 0.15 |   | $ | 0.13 |   | $ | 0.32 |   |
|                                        |       |                                   |       |                                 |       |   |   |   |   |   |   |   |   |
| Weighted average common shares outstanding: |       |                                   |       |                                 |       |   |   |   |   |
| Basic                                       |       | 19,578                                 |       | 10,817                               |       | 11,493 |   | 10,783 |   |
| Fully diluted                               |       | 21,137                                 |       | 11,140                               |       | 17,825 |   | 11,103 |   |

 

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(a) Stock-basedcompensation charges are included in the following statement of incomecategory:

 
| Cost of revenue |   | $ | 9 |   | $ |  — |   | $ | 19 |   | $ |  — |   |
|-----------------|--------|---|---|--------|---|--------------|--------|---|----|--------|---|--------------|--------|

 

(b) Stock-basedcompensation charges are excluded from the following statement of incomecategories:

 
| Sales and marketing        |   | $   | 266    |   | $      | — |   | $      | 657    |   | $ | — |   |
|----------------------------|--------|-----|--------|--------|--------|--------|--------|--------|--------|--------|---|--------|--------|
| Technology                 |   | 117 |   | — |   | 241    |   | — |   |
| General and administrative |   | 228 |   | — |   | 444    |   | — |   |
|                       |   | $   | 611    |   | $      | — |   | $      | 1,342  |   | $ | — |   |

 

See accompanying notes.

 

3

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**FASTCLICK, INC.**

**STATEMENTS OF CASH FLOWS**

**(inthousands)**

 
| ** **                                                                         | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| ** **                                                                         | ** ** | **(unaudited)**                     | ** ** |
|                                                                               |       |                                |       |   |   |
| **Cash flow from operating activities:**                                           |       |                                |       |   |   |
| Net income                                                                         |       | $                                   | 2,360      |   | $ | 3,556 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                                |       |   |   |
| Amortization of deferred compensation                                              |       | 1,361                               |       | — |   |
| Depreciation and amortization                                                      |       | 667                                 |       | 184 |   |
| Deferred income taxes                                                              |       | (222                                | )          | — |   |
| Changes in operating assets and  liabilities:                                      |       |                                |       |   |   |
| Accounts receivable                                                                |       | (1,022                              | )          | (2,517 | ) |
| Prepaid expenses and other current assets                                          |       | (1,317                              | )          | (10 | ) |
| Other assets                                                                       |       | (39                                 | )          | (9 | ) |
| Accounts payable                                                                   |       | 83                                  |       | 2,176 |   |
| Deferred revenue                                                                   |       | 33                                  |       | 159 |   |
| Accrued payroll                                                                    |       | (1,086                              | )          | 621 |   |
| Accrued other liabilities                                                          |       | (21                                 | )          | (29 | ) |
| Income taxes payable                                                               |       | 555                                 |       | 56 |   |
|                                                                               |       |                                |       |   |   |
| Net cash provided by operating activities                                          |       | 1,352                               |       | 4,187 |   |
|                                                                               |       |                                |       |   |   |
| **Cash flow from investing activities:**                                           |       |                                |       |   |   |
| Purchase of short-term investments                                                 |       | (59,387                             | )          | — |   |
| Purchase of property and equipment                                                 |       | (840                                | )          | (347 | ) |
| Purchase of domain names and website  development costs                            |       | (44                                 | )          | (87 | ) |
| Software development costs                                                         |       | (977                                | )          | — |   |
|                                                                               |       |                                |       |   |   |
| Net cash used in investing activities                                              |       | (61,248                             | )          | (434 | ) |
|                                                                               |       |                                |       |   |   |
| **Cash flow from financing activities:**                                           |       |                                |       |   |   |
| Financing services                                                                 |       | —                              |       | (274 | ) |
| Net borrowings under loans payable                                                 |       | (121                                | )          | (14 | ) |
| Proceeds from sale of common stock                                                 |       | 61,546                              |       | 22 |   |
| Distributions to shareholders                                                      |       | —                              |       | (3,084 | ) |
|                                                                               |       |                                |       |   |   |
| Net cash provided by (used in) financing  activities                               |       | 61,425                              |       | (3,350 | ) |
|                                                                               |       |                                |       |   |   |
| Increase in cash and cash equivalents                                              |       | 1,529                               |       | 403 |   |
| Cash and cash equivalents, beginning of  period                                    |       | 12,397                              |       | 1,657 |   |
|                                                                               |       |                                |       |   |   |
| Cash and cash equivalents, end of period                                           |       | $                                   | 13,926     |   | $ | 2,060 |   |
|                                                                               |       |                                |       |   |   |   |   |
| Supplemental disclosures to the statements of cash flows were as  follows:         |       |                                |       |   |   |
|                                                                               |       |                                |       |   |   |
| Cash paid for income taxes                                                         |       | $                                   | 1,091      |   | $ | — |   |
|                                                                               |       |                                |       |   |   |   |   |
| Supplemental disclosure of cash flow  information:                                 |       |                                |       |   |   |
| Conversion of preferred stock to common  stock                                     |       | $                                   | 73,416     |   | $ | — |   |
| Initial public offering, net of costs of  issuance                                 |       | $                                   | 61,240     |   | $ | — |   |
| Retirement of treasury stock                                                       |       | $                                   | 54,386     |   | $ | — |   |
| Deferred compensation, net                                                         |       | $                                   | (1,069     | ) | $ | — |   |

 

See accompanying notes.

 

4

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**FASTCLICK, INC.**

**NOTESTO FINANCIAL STATEMENTS**

**(All interim information relatingto the three- and six-month**

**periods ended June 30, 2005and 2004 is unaudited)**

 

**1. The Company and Summary of Significant Accounting Policies**

 

*The Company*—Fastclick, Inc.(“Fastclick” or the “Company”) is a provider of Internet advertisingtechnologies and services. Advertisers pay the Company to place their Internetads on third-party websites in the Company’s network and the Company shares therevenue it receives from placing those ads with the website owners, orpublishers, that provided the ad space. The Company’s technologies andservices, including its proprietary Optimization Engine, Internet ad placementbidding system and reporting and campaign management tools are designed toimprove the effectiveness of Internet ad campaigns, provide advertisers with anincreased return on their advertising expenditures and enhance the value ofInternet ad space available on the Company’s network of third-party websites.

 

Fastclick was incorporated on March 31, 2000under the laws of California, and on March 29, 2005 reincorporated underthe laws of Delaware. The Company’s headquarters are located in Santa Barbara,California.

 

*Basis of Presentation*—The accompanying financial statements are unaudited and reflect allmaterial adjustments, consisting only of normal recurring adjustments which, inthe opinion of management are necessary to fairly state our financial position,results of operations and cash flows for the interim periods.  The results of operations for the currentinterim period are not necessarily indicative of results to be expected for theentire year.

 

These financial statements have been prepared inaccordance with the rules and regulations of the Securities and Exchange Commission.  Certain information and footnote disclosuresnormally included in financial statements prepared in accordance with generallyaccepted accounting principles in the United States have been condensed or omittedpursuant to such rules and regulations. These financial statements should be read in conjunction with thefinancial statements and the notes thereto included in the Company’s RegistrationStatement on Form S-1 initially filed on December 22, 2004, assubsequently amended (the “Registration Statement”) (File No. 333-121528).

 

On March 29, 2005, the Company completed afive-for-one stock split of its outstanding common stock.  All share andper share amounts for all periods presented in this report reflect thissplit.  Prior to the consummation of the Company’s initial public offeringon April 6, 2005, the Company amended and restated its certificate ofincorporation to authorize 100,000,000 shares common stock, $0.001 par value,and 10,000,000 shares of preferred stock, $0.001 par value, and retire all ofits treasury stock.

 

*Use of Estimates—*The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenue and expensesduring the reporting period. Actual results could differ from those estimates.

 

*Income Taxes*—Frominception to December 31, 2001, the Company operated as a C corporation.Effective January 1, 2002, the Company elected to be taxed as a subchapterS corporation for federal and state income tax purposes. Income, deductions,gains, losses, tax credits and other tax attributes of the Company passedthrough and were taxed directly to the stockholders for all of 2002 and 2003and the period from January 1, 2004 through September 27, 2004. On September 28,2004, Fastclick completed a private placement of preferred shares, whichresulted in the revocation of its subchapter S corporation status. The Companynow operates as a C corporation and is subject to tax in the United States.Consequently, no federal income tax provision is recorded in the accompanyingfinancial statements for the three- or six-month periods ended June 30,2004. Under state laws, certain taxes (net of available tax credits) areimposed upon subchapter S corporations and are provided for in the accompanyingfinancial statements. As a subchapter S corporation, the Company’s policy wasto disburse the necessary amount of funds to satisfy the stockholders’ estimateof income tax liabilities based upon the Company’s taxable income.

 

As a C corporation, the Company is taxed atstatutory corporate rates. Deferred tax assets and liabilities are recognizedfor the tax consequences attributable to differences between the financialstatement carrying amounts of

 

5

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existing assets and liabilities and theirrespective tax bases. Deferred tax assets and liabilities are measured usingenacted tax rates expected to apply to taxable income in the years in whichthose temporary differences are expected to be recovered or settled. A deferredtax asset valuation allowance will be recorded if it is more likely than notthat all or a portion of the recorded deferred tax assets will not be realized.

 

*Earnings per share*—Basic earnings per share is calculated using the weighted averagecommon shares outstanding for the period, and excludes dilutive securities.Diluted earnings per share reflects the dilution to earnings that would occurif employee stock options and other dilutive securities resulted in theissuance of common stock. The weighted average number of shares used for basicand diluted earnings per share were as follows (in thousands, except per shareamounts):

 
| ** **                                              | ** ** | **Three Months  Ended June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                              | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                              | ** ** | **(unaudited)**                       | ** ** |
| Numerator:                                              | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                              |       | $                                     | 1,509      |                                | $          | 1,723 |   | $ | 2,360 |   | $ | 3,556 |   |
|                                                    |       |                                  |       |                                |       |   |   |   |   |
| Denominator:                                            |       |                                  |       |                                |       |   |   |   |   |
| Weighted average common shares outstanding—basic   |       | 19,578                                |       | 10,817                              |       | 11,493 |   | 10,783 |   |
| Effect of dilutive securities:                          |       |                                  |       |                                |       |   |   |   |   |
| Employee stock options                                  |       | 1,559                                 |       | 323                                 |       | 1,092 |   | 320 |   |
| Redeemable convertible preferred stock                  |       | —                                |       | —                              |       | 5,240 |   | — |   |
|                                                    |       |                                  |       |                                |       |   |   |   |   |
| Weighted average common shares outstanding—diluted |       | 21,137                                |       | 11,140                              |       | 17,825 |   | 11,103 |   |
|                                                    |       |                                  |       |                                |       |   |   |   |   |
| Basic earnings per share                                |       | $                                     | 0.08       |                                | $          | 0.16 |   | $ | 0.21 |   | $ | 0.33 |   |
|                                                    |       |                                  |       |                                |       |   |   |   |   |   |   |   |   |
| Diluted earnings per share                              |       | $                                     | 0.07       |                                | $          | 0.15 |   | $ | 0.13 |   | $ | 0.32 |   |

 

*Recent Accounting Pronouncements*—On December 16, 2004, the FinancialAccounting Standards Board (FASB) issued its final standard on accounting forShare-Based Payment in FASB Statement 123R, which requires all companies tomeasure compensation cost for all share-based payments (including stockoptions) at fair value.  Thispronouncement will be effective for public companies for the first annual reportingperiod of the registrant’s first fiscal year beginning on or after June 15,2005. The Company intends to adopt the standard in the quarter ending March 31,2006, or earlier, and could adopt the new standard in one of two ways-themodified prospective transition method or the modified retrospective transitionmethod.

 

On June 7, 2005, TheFASB issued Statement No. 154, Accounting Changes and Error Corrections, areplacement of Accounting Principals Board Opinion No. 20, AccountingChanges, and FASB Statement No. 3, Reporting Accounting Changes in InterimFinancial Statements. Statement 154 requires retrospective application to priorperiods’ financial statements of a voluntary change in accounting principleunless it is impracticable. Opinion 20 previously required that most voluntarychanges in accounting principle be recognized by including in net income of theperiod of the change the cumulative effect of changing to the new accountingprinciple. Statement 154 is effective for accounting changes and corrections oferrors made in fiscal years beginning after December 15, 2005.

 

**2. Commitments and Contingencies**

 

During the second quarter of 2005, the Company beganleasing office space in Los Angeles, California and New York, New York forsales and marketing purposes.  The leaseterms are through November 2010 for the Los Angeles lease and September 2010for the New York lease.  As collateralfor performance by the Company of its obligations under the Los Angeles lease,the Company has provided through a bank an unsecured letter of credit with aninitial face amount of $85,000.  The faceamount of the letter of credit may be reduced at certain future times pursuantto its terms.  The Company also leasesoffice space at two locations in downtown Santa Barbara, California, foradministration, research, and operations purposes, with lease terms through April 2006.

 

The Company has existing legal claims against it andmay encounter future legal claims in the normal course of business.  After consulting with outside legal counsel,the Company is of the opinion that, the resolution of the existing legal claimsis not expected to have a

 

6

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material impact on the Company’s financialposition, results of operations or cash flows. During 2005 the Company recorded charges to operations of approximately $120,000for the settlement of one of these claims.

 

**3. Deferred Compensation**

 

The Company accounts for stock options using theintrinsic-value method under APB No. 25. Accordingly, the Company hasrecorded deferred compensation of $4,820,000 through June 30, 2005 for thedifference between the original exercise price per share determined by theBoard of Directors and the estimated fair value per share of the underlyingcommon stock at the options’ respective grant dates, net of amortization and reversalsupon employee terminations.  Deferredcompensation is recognized and amortized on a straight-line basis over thevesting period of the related options, generally four years. The Companyrecorded no deferred compensation or compensation expense under APB No. 25prior to the third quarter of 2004 as the exercise prices of all option grants inthose periods were at the deemed fair value of the underlying common stock.Compensation expense under APB No. 25 related to stock options granted tothe Company’s employees was $620,000 and $0 for the three-month periods, and$1,361,000 and $0 for the six-month periods ended June 30, 2005 and 2004, respectively.

 

Had the Company recognized employee stock optionrelated compensation expense in accordance with SFAS No. 123 and used theminimum-value method for determining the weighted average fair value of optionsgranted, the net income would have been as follows (in thousands, except pershare amounts):

 
| ** **                                                                                                                                   | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                                                   | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                                                   | ** ** | **(unaudited)**                       | ** ** |
| ** **                                                                                                                                   | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income—as reported                                                                                                                  |       | $                                     | 1,509      |                                | $          | 1,723 |   | $ | 2,360 |   | $ | 3,556 |   |
| Add: Deferred stock-based compensation  expense included in reported net income, net of related income tax effects                           |       | 742                                   |       | —                              |       | 1,361 |   | — |   |
| Less: Deferred stock-based compensation  expense determined under fair value based method for all awards, net of  related income tax effects |       | (107                                  | )          | (9                                  | )          | (233 | ) | (18 | ) |
| Pro forma net income                                                                                                                         |       | $                                     | 2,144      |                                | $          | 1,714 |   | $ | 3,488 |   | $ | 3,538 |   |
|                                                                                                                                         |       |                                  |       |                                |       |   |   |   |   |
| Earnings per share:                                                                                                                          |       |                                  |       |                                |       |   |   |   |   |
| Basic—as reported                                                                                                                       |       | $                                     | 0.08       |                                | $          | 0.16 |   | $ | 0.21 |   | $ | 0.33 |   |
| Basic—pro forma                                                                                                                         |       | $                                     | 0.11       |                                | $          | 0.16 |   | $ | 0.30 |   | $ | 0.33 |   |
|                                                                                                                                         |       |                                  |       |                                |       |   |   |   |   |
| Fully diluted—as reported                                                                                                               |       | $                                     | 0.07       |                                | $          | 0.15 |   | $ | 0.13 |   | $ | 0.32 |   |
| Fully diluted—pro forma                                                                                                                 |       | $                                     | 0.10       |                                | $          | 0.15 |   | $ | 0.20 |   | $ | 0.32 |   |

 

The compensation portion of the Company’s stockoption grants was estimated at the date of the grant using the minimum-valueoption-pricing model through March 31, 2005 and the Black-Scholes option pricingmodel for awards granted after Company’s March 2005 initial publicoffering of its common stock with the following assumptions:

 
| ** **                                          | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-----------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Risk-free interest rate                             |       | 4          | %          | 3          | %          |
| Expected option life (years)                        |       | 3          |       | 3          |       |
| Expected volatility (grants after  March 2005) |       | 52         | %          | —     | %          |
| Dividend yield                                      |       | —     | %          | —     | %          |

 

For purposes of pro forma disclosures, the estimatedfair value of the options is amortized ratably over the option’s vestingperiod. The pro forma effect on net income for the periods presented is notrepresentative of the pro forma effect on net income in future periods becausecompensation expense in future periods could reflect the amortization of agreater or lesser number of stock options granted in succeeding periods. Inaddition to the factors used to estimate the fair value of stock options issuedusing the minimum-value method, the Black-Scholes model

 

7

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considers the expected volatility of theCompany’s stock price, determined in accordance with SFAS 123, in arriving atan estimated fair value. The minimum-value method does not consider stock pricevolatility.

 

**4. Initial Public Offering**

 

On March 31, 2005 theCompany agreed to sell 5,649,860 shares of common stock at a price of $12.00per share in its initial public offering. On April 6, 2005 the Company received proceeds from the offering of$60,385,000, net of underwriting discounts, commissions, and professional andother costs.  The net proceeds of the offeringare included as cash and cash equivalents, short-term investments and long-terminvestments, and the other offering costs incurred of approximately $2,667,000are classified as a reduction to additional paid-in capital in the accompanyingunaudited balance sheet as of June 30, 2005.  In connection with the closingof the offering, each of the Company’s 2,131,285 shares of redeemableconvertible preferred stock converted into five shares of common stock, or10,656,425 shares of common stock in total. As a result, upon the closing of the offering, there were 19,464,280shares of common stock issued and outstanding.

 

**5. Subsequent Event**

 

On August 11, 2005, ValueClick, Inc. andthe Company jointly announced that they had entered into a merger agreement inwhich Fastclick would become a wholly-owned subsidiary of ValueClick. Under theterms of the merger agreement, ValueClick would first commence an exchangeoffer in which tendering Fastclick stockholders would receive 0.7928 of a shareof ValueClick common stock for each share of Fastclick common stock tendered inthe offer.

 

ValueClickannounced that it expects to issue approximately 15.6 million shares ofValueClick common stock and options to purchase approximately 1.2 millionshares of ValueClick common stock (on a treasury stock basis) in thestock-for-stock transaction valued at approximately $214 million ($10.11 pershare for Fastclick stockholders), or approximately $133 million net of cashacquired, based on ValueClick’s closing stock price on August 10, 2005.The exchange offer, if completed, will be followed by a back-end merger for thesame consideration as offered in the exchange offer.

 

Thetransaction has been approved by the board of directors of each company and issubject to the acceptance by ValueClick in the exchange offer of a minimum of66.7% of the Fastclick shares outstanding, and customary representations,warranties, covenants, closing conditions and regulatory approvals. Certain ofFastclick’s management and significant stockholders entered into lock-upagreements with the lead underwriters in connection with Fastclick’s initialpublic offering that may place restrictions on their ability to tender theirshares in the exchange offer. In connection with the execution of the mergeragreement, Fastclick’s major stockholders, who in the aggregate holdapproximately 58% of the outstanding shares of Fastclick, have entered intoagreements with ValueClick pursuant to which they will be required to tendertheir shares in the exchange offer, subject to certain conditions, once thelock-up agreements have been waived by the underwriters or have expired. Thelock-up agreements expire by their terms at 11:59 pm Pacific Time on September 27,2005 unless the underwriters provide an earlier waiver of the lock-upagreements.

 

TheCompany expects the transaction to qualify as a tax-free reorganization forfederal income tax purposes, and to close in the fourth quarter of 2005.

 

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ITEM2.  MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

**Special Note RegardingForward-Looking Statements**

 

This report contains “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933, as amended, or the Securities Act, and Section 21E of the SecuritiesExchange Act of 1934, as amended, or the Exchange Act. In making suchstatements, we must rely on estimates and assumptions drawn in light of ourexperience and our perception of historical trends, current conditions andexpected future developments, as well as other factors we believe areappropriate under the circumstances. These estimates and assumptions areinherently subject to significant business, economic and competitiveuncertainties, many of which are beyond our control. These uncertainties andcontingencies could affect actual results and could cause actual results todiffer materially from those expressed or implied in any forward-lookingstatements made by us, or on our behalf.

 

In particular, the words “expect,”“anticipate,” “estimate,” “may,” “will,” “should,” “intend,” “believe,” andsimilar expressions are intended to identify forward-looking statements. Inlight of the risks and uncertainties inherent in all forward-lookingstatements, you should not consider the inclusion of forward-looking statementsin this report to be a representation by us or any other person that ourobjectives or plans will be achieved.

 

Risks and uncertainties thatcould cause actual results to differ from our forward-looking statementsinclude those discussed under the caption “Management’s Discussion and Analysisof Financial Condition and Results of Operations—Factors That May AffectFuture Results of Operations” and elsewhere in this report.

 

We undertake no obligationto update our forward-looking statements to reflect events or circumstancesafter the date of this report or to reflect the occurrence of unanticipatedevents.  The following should be read inconjunction with, and is qualified in its entirety by, the financial statementsand notes thereto included in Item 1 of this report and in conjunction with ourRegistration Statement on Form S-1, filed on December 22, 2004 assubsequently amended.

 

The “Fastclick” family ofrelated marks, images and symbols are our properties, trademarks and servicemarks. All other trade names, trademarks and service marks appearing in this reportare the property of their respective owners. References to “Fastclick” “we,” “us,” “our,” or similar terms refer toFastclick, Inc.

 

**General**

 

We are a provider ofperformance-based Internet advertising technologies and services to advertisersand website owners, or publishers. Our technologies and services, including ourproprietary Optimization Engine, Internet ad placement bidding system, andreporting and campaign management tools, are designed to improve theeffectiveness of Internet ad campaigns and provide advertisers with anincreased return on their advertising expenditures. We believe our technologiesand services also enhance the value of Internet advertising space available onour network of third-party websites.

 

Our advertisers include direct response marketers,brand marketers and advertising agencies. We represent advertisers in a varietyof industries, including travel, financial services, education, telecommunications,retail, automotive, entertainment, finance, pharmaceutical and health andinformation technology, either directly or indirectly through an advertisingagency.  Our publishers includepublishers of branded websites that offer large amounts of advertising space aswell as a substantial number of websites that reach Internet users withhighly-targeted demographics and interests.

 

**Overview**

 

***Our History***

 

We were founded in March 2000 and engaged primarily in the developmentof our proprietary technologies throughout 2000. We began generating revenue in2000, and have since increased our revenue from $0.1 million in 2000, to$4.5 million in 2001, $17.7 million in 2002, $28.7 million in2003 and $58 million in 2004. We introduced our proprietary OptimizationEngine and our ad placement bidding system in late 2000 and became profitablein the first quarter of 2001. We generated a net loss of $0.1 million for2000 and net income of $0.5 million, $4.1 million, $5.8 millionand $5.1 million in 2001, 2002, 2003 and 2004, respectively.

 

9

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Our early operations were financed with $0.4 million of equityfinancing in March 2000. Thereafter, we financed our operations primarilythrough internally generated funds through September 2004. On September 28,2004, we sold 2,131,285 shares of our preferred stock, (which converted into10,656,425 shares of common stock prior to the completion of our initial publicoffering) at a price per share of $35.19, for total proceeds of approximately$75 million. Approximately $55 million of these proceeds were used torepurchase 1,562,944 shares (on a pre-split basis, or 7,814,720 shares aftergiving effect to our five-for-one stock split) of our common stock held by ourfounders, employees and investors at $35.19 per share. We made a final cashdistribution to our former subchapter S corporation stockholders ofapproximately $3.2 million on December 16, 2004.  Approximately $18.5 million of our netproceeds from the sale of our preferred stock remains on our balance sheet ascash, cash equivalents and short-term investments and we expect to use thesefunds to finance our future growth. On April 6, 2005, we completed our initial public offering of5,649,860 shares of common stock at a price of $12.00 per share, and received netproceeds of $60,393,000, net of underwriting discounts, commissions, andprofessional and other fees.

 

From our inception to December 31,2001, we operated as a C corporation. Effective January 1, 2002, we electedto be taxed as a subchapter S corporation for federal and state income taxpurposes. For the years ended December 31, 2002 and 2003 and the periodfrom January 1, 2004 through September 27, 2004, we did not incur anyprovision for federal income taxes as the income, deductions, gains, losses,tax credits and other tax attributes of the corporation for these periodspassed through and were taxed directly to the stockholders. We were subject toa 1.5% California subchapter S corporation income tax during theseperiods. We made distributions to our stockholders of $0.6 million,$4.4 million and $7.1 million for the years ended December 31,2002, 2003 and 2004, respectively. Our subchapter S corporation status wasrevoked on September 27, 2004 in connection with the issuance of our preferredstock and we now operate as a C corporation and are subject to federal andstate tax in the United States.

 

We have grown our employee base from three employees at inception to 101 employeesas of June 30, 2005. While we have increased the number of our employeesin all areas, our highest growth has been in our sales and marketingdepartments. We expect our headcount to continue to grow as our businessexpands. We have two office locations in Santa Barbara, California, includingour corporate headquarters.  In April 2005, we began leasing officespace in Los Angeles, California, and in June 2005 we began leasing officespace in New York, New York. We currently havesales and marketing employees in San Francisco, Los Angeles and New York. Welease server space in San Jose, California and Ashburn, Virginia.

 

***Our Business Model***

 

We generate revenueprimarily from the sale of Internet advertising space across our network ofwebsites. Advertising space on this network of websites is priced through ourad placement bidding system, which values advertising space based on marketdemand by matching the advertisers bidding the highest price for theadvertising space that meets their campaign objectives with the websites ableto supply that space, subject to certain rules that may be set by us, ouradvertisers or our publishers.

 

We offer advertisersmultiple pricing options to achieve their desired results. These alternativesinclude:

 

•                  Cost-per-action, where the advertiser pays usa fee based on the number of specified Internet user responses, such asregistrations, requests for information or sales that its ads produce;

 

•                  Cost-per-click, where the advertiser pays usa fee based on the number of clicks its ads generate; and

 

•                  Cost-per-thousand impressions, where theadvertiser pays us a fee based on the number of times its ads are displayed,referred to as impressions.

 

While we allow advertisers to purchase websiteadvertising space based on a cost-per-action, cost-per-click or cost-per-thousandimpressions pricing model, we pay for a majority of our publishers’ websiteadvertising space on a cost-per-thousand impressions basis. This allows ourpublishers to be paid for the impressions they serve and our advertisers toreceive the performance-based pricing model they desire for their advertisingcampaigns.

 

10

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Our standard advertising contract covers both campaign management and addelivery. We generally bill advertisers on a 30-day, net basis, although aportion of our advertisers prepay us for their campaigns. Our advertisingcontracts are terminable at any time by the advertiser or us with no penaltyupon one business day prior notice. Our standard publishers’ agreement coversthe provision and use of Internet advertising campaigns and the relatedpayments. We typically pay our publishers within 25 business days afterthe end of the month under the revenue-sharing provisions of our publisher’sagreement. Under these agreements we generally pay them up to 65% of theadvertising revenue we generate from ads placed on their websites. We canterminate our publisher’s agreement at any time without penalty.

 

**Componentsof Gross Margin**

 

***Sources of Revenue***

 

We principally derive revenue from the sale of Internet advertising spaceacross our network of websites. With respect to the Internet advertisingservices we provide to advertisers, we recognize revenue when the advertisingimpression is served (for cost-per-thousand impressions contracts) or when thespecified click or other action occurs or when lead-based information isdelivered (for cost-per-click and cost-per-action contracts), provided that wehave no significant remaining obligations, collection of the resultingreceivable is reasonably assured and prices are fixed and determinable. Ourrevenue recognition policy is discussed in more detail in the section belowentitled “Critical Accounting Policies and the Use of Estimates—RevenueRecognition.”

 

***Cost of Revenue***

 

Cost of revenue consists primarily of amounts we incur and pay to ourpublishers for their share of revenue we derive from the sale of their websiteadvertising space and, to a lesser extent, the cost of maintaining the computersystems infrastructure which supports our proprietary technologies, thesalaries and benefits of network operations personnel, bandwidth andcommunications costs, depreciation of network infrastructure equipment and thecost of database maintenance and support.

 

**Componentsof our Operating Costs and Other Items**

 

The following describes certain line items in our statement of operations:

 

***Operating Costs***

 

Our operating costs include sales and marketing, technology, general andadministrative and stock-based compensation expenses. Since we expect the growthof our operating expenses to be driven, in part, by the growth of our business,we are currently unable to accurately estimate the anticipated increases inthese costs.

 

*Sales and marketing.*  Our sales and marketing expenses primarily consist of the compensationand associated costs for sales and marketing personnel, marketing andadvertising, public relations and other promotional activities, generalbusiness development activities, publisher acquisition and product developmentexpenses. We expect sales and marketing expenses to increase in absolute termswith the growth of our business as we expand our sales and marketing workforceand further promote our products and services.

 

*Technology.*  Technologycosts include expenses for the research and development of new technologiesdesigned to enhance our Internet advertising services and costs associated withthe maintenance and administrative support of our technology team, includingthe salaries and related expenses for our research and development, as well ascosts for contracted services and supplies. Also included in technology is theamortization of capitalized software development costs. We expect ourtechnology expenses to increase slightly in absolute terms as we grow andcontinue to invest in new technologies and hire additional technologypersonnel.

 

*General and administrative.*  Our general and administrative expenses primarily consist ofthe compensation and associated costs for general and administrative personneland facility costs. We expect that general and administrative expenses willincrease in absolute terms as we hire additional personnel and incur costs relatingto the anticipated growth of our business and our operation as a publiccompany.

 

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*Stock-based compensation.*  We have recorded stock-based compensation expense for some ofour equity awards provided to employees and non-employee directors. Ouraccounting policy for recognizing stock-based compensation expense is describedin the section below entitled “Critical Accounting Policies and the Use ofEstimates—Accounting for Stock-Based Compensation.” As of June 30, 2005,we had an aggregate of $4.8 million of deferred stock-based compensationexpense, which will be recognized over the next four years as the relatedawards vest.

 

We expect sales and marketing, technology and general and administrativeoperating expenses to increase quarter over quarter commensurate with our expectedrevenue growth over the same periods. The largest impact on these expensesrelate to public company costs, which we estimate to be approximately$2 million for 2005. We expect to fund the increase in these expenses byfuture cash flow from operations and our current cash position.

 

***Income Taxes***

 

Accounting for income taxes is discussed in more detail in the section belowentitled “Critical Accounting Policies and Use of Estimates—Accounting forIncome Taxes.”

 

**Trendsthat Affect our Business**

 

Our business has grown rapidly since our inception in March 2000, andwe expect that it will continue to grow; however, we anticipate that our growthrate will slow as our revenue base increases. We expect that some of thehistorical trends or patterns in our business will change over time, and inmanaging and evaluating our business we are focused on several trends,including the following:

 

•  *Revenue growth*.    Ourrevenue depends on the volume of paid ads, pricing of advertising and ad formatmix that our advertisers purchase. Over the past several years we haveexperienced a significant increase in the volume of paid ads we deliver acrossour network. Additionally, we have generally experienced a gradual increase inad pricing. The historical increase in ad volume and pricing has been partiallyoffset by the introduction of new, lower-priced ad formats and other newproducts in response to demand from both advertisers and publishers. Weanticipate that the volume of paid ads, pricing of advertising and ad formatmix will continue to be key revenue drivers in the future. Although we areunable to predict the future demand for ad types and the impact on theanticipated sales mix of our ad formats, we expect a continued increase in thevolume of lower-priced ad formats. An increased demand for lower priced adformats could potentially displace or reduce the demand for higher priced adformats, and, to the extent not offset by an increase in ad volume, result inlower overall revenue for us. In addition, to the extent that the lower pricedad formats do not have a correspondingly lower revenue share payment, theycould result in a lower gross profit margin.

 

•  *Gross profit margin*.    Theprimary component of our cost of revenue is the revenue share payments we maketo our publishers. The percentage of revenue we share with our publishers hasremained relatively constant. We anticipate that our gross profit margin willincrease as advertisers continue to shift to cost-per-action and cost-per-clickbased pricing models. Our advertisers increasingly prefer to purchaseadvertising on a cost-per-action or cost-per-click basis because they pay onlyfor ads which result in the desired action. Our publishers typically preferpayment on a cost-per-thousand impressions basis, in which they are paid forthe impressions they serve and do not assume any risk relating to theperformance of an ad. In order to mitigate the performance risks associatedwith paying publishers on a cost-per-thousand impressions basis for thecost-per-action based and cost-per-click based campaigns of our advertisers, wetypically build in a higher profit margin when pricing these campaigns. We dothis by initially running tests on an advertising campaign priced on acost-per-action or cost-per-click basis, which measures user responses to thecampaign to determine how many impressions it takes to achieve the action orclick. Based on this information, we may then adjust the pricing of thecampaign in an effort to mitigate our performance risk associated with payingfor the campaign on a cost-per-thousand impressions basis, thereby increasingour gross margin. To the extent that we are able to manage the risks associatedwith advertisers purchasing on a cost-per-action and cost-per-click basis andpaying publishers on a cost-per-thousand impression basis, we believe that ourgross profit margins will increase.

 

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•  *Sales and marketing*.    Weanticipate that our sales and marketing expenses will increase over the nextseveral quarters. In addition, as we continue to grow, we expect to hireadditional sales and marketing personnel and expand to new facilities toaccommodate our growing sales and marketing team.

 

•  *Technology*.    Weanticipate increasing our investment in the development and deployment of newproducts, services and features to our existing technologies and services.  In the future, we expect our technologyexpense in absolute dollars to increase. In addition, as we continue to grow,we expect to hire additional technology personnel and expand to new facilities.

 

•  *General and administrative*.    We anticipate that our general and administrativeexpenses will increase over the next several quarters as we incur expensesrelated to being a public company, including increased legal, accounting andinsurance expenses. We estimate increased expenses related to public companycosts of approximately $2 million for 2005. In addition, as we continue togrow, we expect to hire additional senior management personnel and expand tonew facilities.

 

•  *Seasonality and cyclicality*.    We believe that our business is subject toseasonal and cyclical fluctuations. Generally, our advertisers and advertisingagencies place more ads in the fourth calendar quarter and fewer ads in thefirst calendar quarter of each year. Overall Internet usage generally declinesduring the summer months, resulting in lower inventories in our website networkand lower revenue for us. In addition, domestic advertising spending generallyis cyclical in reaction to overall conditions in the United States economy. Ourrapid historical growth rate has masked the impact of seasonality on ourbusiness. As our growth rate slows, however, we expect the seasonal pattern ofour business to become more pronounced.

 

•  *Volume of advertising space*.    Over the past several years our website networkand advertising space volume have increased significantly. In order to continueto grow our revenue we must increase the volume of advertising space that weare able to sell to advertisers. We anticipate that our ability to growadvertising space volume will be influenced by a number of factors includingthe size of our website network and Internet advertising market dynamics suchas sector consolidation.

 

•  *Provision for income taxes.*    From our inception to December 31, 2001 weoperated as a C corporation. From January 1, 2002 through September 27,2004 we operated as a subchapter S corporation. In connection with our issuanceof preferred stock our subchapter S corporation status was revoked and wenow operate as a C corporation. During the period we were a subchapterS corporation, we did not incur any provision for federal income taxes andwe were subject to a 1.5% California income tax. As a C corporation, wewill now pay C corporation income taxes. We currently anticipate oureffective tax rate to be approximately 43%, excluding the effects of any futuretax credits during the remainderof 2005.

 

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**Results of Operations**

 

The following table setsforth the items in our statements of income for the periods indicated as apercentage of revenue: 

 
| ** **                   | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                   | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                   | ** ** | **(unaudited)**                       | ** ** |
| ** **                   | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue                      |       | 100.0                                 | %          | 100.0                               | %          | 100.0 | % | 100.0 | % |
| Cost of revenue              |       | 66.0                                  |       | 65.9                                |       | 65.7 |   | 66.7 |   |
|                         |       |                                  |       |                                |       |   |   |   |   |
| Gross profit                 |       | 34.0                                  |       | 34.1                                |       | 34.3 |   | 33.3 |   |
| Operating costs:             |       |                                  |       |                                |       |   |   |   |   |
| Sales and marketing          |       | 10.5                                  |       | 11.5                                |       | 11.5 |   | 9.9 |   |
| Technology                   |       | 3.5                                   |       | 4.4                                 |       | 3.3 |   | 3.9 |   |
| General and administrative   |       | 7.4                                   |       | 4.0                                 |       | 7.7 |   | 3.9 |   |
| Stock-based compensation     |       | 3.1                                   |       | —                              |       | 3.5 |   | — |   |
|                         |       |                                  |       |                                |       |   |   |   |   |
| Total operating costs        |       | 24.5                                  |       | 19.9                                |       | 26.0 |   | 17.7 |   |
|                         |       |                                  |       |                                |       |   |   |   |   |
| Operating income             |       | 9.5                                   |       | 14.2                                |       | 8.3 |   | 15.6 |   |
| Interest and dividend income |       | 2.8                                   |       | —                              |       | 1.6 |   | — |   |
| Interest expense             |       | —                                |       | —                              |       | — |   | — |   |
|                         |       |                                  |       |                                |       |   |   |   |   |
| Income before income taxes   |       | 12.3                                  |       | 14.2                                |       | 9.9 |   | 15.6 |   |
| Provision for income taxes   |       | 4.5                                   |       | 0.1                                 |       | 3.8 |   | 0.2 |   |
|                         |       |                                  |       |                                |       |   |   |   |   |
| Net income                   |       | 7.8                                   | %          | 14.1                                | %          | 6.1 | % | 15.4 | % |

 

***Comparison of theQuarters Ended June 30, 2005 and 2004***

 

*Revenue.*  Revenue increased to $19.3 million in thesecond quarter of 2005 from $12.2 million in the second quarter of 2004, a58% increase. This increase was primarily due to a significant increase in thenumber of paid ads delivered across our website network offset partially by a decreasein the average price of existing ad formats as compared to the prior year periodand by a shift in mix toward new, lower priced advertising formats. We expectrevenue to continue to increase during 2005 and, although we are unable topredict the future demand for ad types and the impact on the anticipated salesmix of our ad formats, we expect a continued increase in the volume oflower-priced ad formats.

 

*Cost ofrevenue.*    Costof revenue increased to $12.7 million, or 66% of revenue, in the second quarterof 2005 from $8.1 million, or 65.9% of revenue, in the second quarter of2004.  The increase in absolute dollarswas primarily due to an increase in the volume of advertising sold toadvertisers resulting in increased publisher revenue-share costs. The percentageof revenue we shared with publishers remained constant in 2005 as compared to2004 and we continued to pay our publishers primarily on a cost-per thousandimpressions basis while continuing our shift to cost-per-action and cost-per-clickpriced advertising campaigns. We anticipate that our cost of revenue willincrease in absolute terms as our revenue increases, and will decrease slightlyas a percentage of revenue as advertisers continue to shift to cost-per-actionand cost-per-click based pricing models.

 

*Sales andmarketing.*    Sales and marketing expenses increased in absolute dollars to $2.0 million, or10.5% of revenue, in the second quarter of 2005 from $1.4 million, or 11.5% ofrevenue, in the second quarter of 2004. This increase in sales and marketingexpenses was primarily the result of hiring additional sales and marketingpersonnel to support the increased revenue levels, combined with expandedmarketing costs. We anticipate that our sales and marketing expenses willincrease in absolute dollars but decrease as a percentage of revenue over thenext several quarters as we expect to hire additional sales and marketingpersonnel and expand to new facilities to accommodate our growing sales andmarketing team.

 

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*Technology.*    Technology expensesincreased in absolute dollars to $0.7 million, or 3.5% of revenue, in the secondquarter of 2005 from $0.5 million, or 4.4% of revenue, in the second quarter of2004.  The increase in our technology expensesprimarily resulted from the employment costs of additional personnel. We expectour technology expenses to increase in absolute terms but decrease as apercentage of revenue over the next several quarters as we continue to investin new technologies and employ additional personnel.

 

*General and administrative.*     General andadministrative expenses increased to $1.4 million, or 7.4% of revenue, in the secondquarter of 2005 from $0.5 million, or 4.0% of revenue, in the second quarter of2004. This increase in general and administrative expenses was primarily due tothe employment cost of additional administrative personnel and other costsrequired for operation as a public company and to support growth of the company.We expect that general and administrative expenses will increase in absoluteterms but decrease as a percentage of revenue during the remainder of 2005 aswe bear the increased compliance costs of operating as a public company.

* *

*Stock-based compensation.*  We have recorded deferred stock-basedcompensation for some of our equity awards provided to employees andnon-employee directors. Stock-based compensation expense increased to $0.6 million,or 3.1% of revenue, in the second quarter of 2005 from $0 in 2004. The increasein stock-based compensation was a result of recognizing the intrinsic value of ourstock option grants during the period. As of June 30, 2005, we had anaggregate of $4.8 million of deferred compensation, which will be recognizedover the next four years as the related awards vest.  During the second quarterof 2005, we reversed $0.3million of deferred stock-based compensation upon the termination of employees.

 

*Interest and dividend income andinterest expense.*    Interestand dividend income when offset by interest expense increased to $0.6 million,or 2.8% of revenue, in the second quarter of 2005, from $4,000 in the second quarterof 2004. The change was primarily a result of the increased average balances inour money market accounts and short-term investments.  We expect interest and dividend income toincrease slightly during the remainder of 2005 as we invest the cash proceedsfrom our initial public offering.

 

*Provision for income taxes.*    Provision for incometaxes increased to $0.9 million, an effective tax rate of 36.5%, in the second quarterof 2005 from $14,000, an effective tax rate of 0.8%, in 2004. During all of2003 and through September 27, 2004, we elected to be taxed as asubchapter S corporation for federal and state income tax purposes, andour income, deductions, gains, losses, tax credits and other tax attributeswere passed through and taxed directly to our stockholders. Our subchapterS corporation status was revoked on September 27, 2004 in connectionwith our issuance of preferred stock and we now operate as a C corporationand are subject to federal and state income tax in the United States.  We currently expect our effective tax rate tobe approximately 43% during the remainder of 2005.

 

***Comparison of theSix-Month Periods Ended June 30, 2005 and 2004***

 

*Revenue.*  Revenue increased to $38.9 million for thesix-month period ended June 30, 2005 from $23.1 million for thesix-month period ended June 30, 2004, a 68% increase. This increase wasprimarily due to significant increase in the number of paid ads deliveredacross our website network offset partially by a decrease in the average priceof existing ad formats as compared to the prior year period and by a shift inmix toward new, lower priced advertising formats.

 

*Cost ofrevenue.*    Costof revenue increased in absolute dollars to $25.6 million, or 65.7% of revenue,for the six-month period ended June 30, 2005 from $15.4 million, or 66.7%of revenue, for the six-month period ended June 30, 2004.  This increase in absolute dollars wasprimarily due to an increase in the volume of advertising sold to advertisersresulting in increased publisher revenue-share costs. The percentage of revenuewe shared with publishers declined slightly which resulted in improved grossmargins in the six-month 2005 period as we continued to pay our publishersprimarily on a cost-per thousand impressions basis while continuing our shiftto cost-per-action and cost-per-click priced advertising campaigns.

 

*Sales andmarketing.*    Sales and marketing expenses increased to $4.5 million, or 11.5% of revenue, inthe second quarter of 2005 from $2.3 million, or 9.9% of revenue, in the secondquarter of 2004. This increase in sales and marketing expenses was primarilythe result of hiring additional sales and marketing personnel to support theincreased revenue levels, combined with expanded marketing and advertisingcosts.

 

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*Technology.*    Technology expensesincreased in absolute dollars to $1.3 million, or 3.3% of revenue, for thesix-month period ended June 30, 2005 from $0.9 million, or 3.9% ofrevenue, for the six-month period ended June 30, 2004.  The increase in our technology expensesprimarily resulted from the employment costs of additional personnel.

 

*General and administrative.*     General andadministrative expenses increased to $3.0 million, or 7.7% of revenue, for thesix-month period ended June 30, 2005 from $0.9 million, or 3.9% ofrevenue, for the six-month period ended June 30, 2004. This increase ingeneral and administrative expenses was primarily due to the employment cost ofadditional administrative personnel and other costs required for operation as apublic company and to support the growth of the company.

 

*Stock-based compensation.*  Stock-based compensation expenseincreased to $1.3 million, or 3.5% of revenue, for the six-month period ended June 30,2005 from $0 in 2004 as result of recognizing the intrinsic value of our stockoption grants during the period. During the six-month period ended June 30, 2005, we recorded deferred stock-based compensation to stockholders equityof $1.0 million related to the final remeasurement of the grant of options.  Wereversed $2.1 million of deferred stock-based compensation during the six-monthperiod ended June 30, 2005 upon the termination of employees.

 

*Interest and dividend income andinterest expense.*    Interestand dividend income when offset by interest expense increased to $0.7 million,or 1.6% of revenue, for the six-month period ended June 30, 2005, from $8,000for the six-month period ended June 30, 2004. The change was primarily aresult of increased average balances in our money market accounts and short-terminvestments.

 

*Provision for income taxes.*    Provision for incometaxes increased to $1.5 million, an effective tax rate of 38.9%, for thesix-month period ended June 30, 2005 from $57,000, an effective tax rateof 1.6%, in 2004. During all of 2003 and through September 27, 2004, weelected to be taxed as a subchapter S corporation for federal and state incometax purposes, and our income, deductions, gains, losses, tax credits and othertax attributes were passed through and taxed directly to our stockholders. Oursubchapter S corporation status was revoked on September 27, 2004 inconnection with our issuance of preferred stock and we now operate as aC corporation and are subject to federal and state income tax in theUnited States.

 

**Liquidity and Capital Resources**

 

We have financed ouroperations principally through internally generated funds as well as privatesales of equity securities and our initial public offering.  Our principal sources of liquidity are ourcash, cash equivalents and short-term investments as well as the cash flow thatwe generate from our operations. As of June 30, 2005, our short-terminvestments consisted of highly-liquid auction rate securities, U.S. andCanadian corporate notes, and U.S. government securities.

 

Our net cash provided by operating activities was $1.4million for the six-month period ended June 30, 2005, as compared to $4.2 millionfor the six-month period ended June 30, 2004. Net cash provided byoperating activities during the six-month period ended June 30, 2005 wasprimarily due to our net income before deducting amortization of deferredcompensation and depreciation and amortization, and to growth in income taxespayable, offset by partially by increases in accounts receivable and prepaidexpenses and a reduction in accrued payroll.

 

Accounts receivable from ouradvertisers has increased with our revenue growth. Our accounts receivablebalance increased by $1.0 million during the six-month period ended June 30,2005 and by $2.5 million during the six-month period ended June 30, 2004. The growth in accounts receivable isanticipated to continue if our revenue continues to increase resulting in asignificant impact on our cash flows from operations.  Our prepaid expenses and other current assetsgrew by $1.3 million during the six-month period ended June 30, 2005 duelargely to the renewal of our commercial and liability insurance policies.  Our accounts payable balance increased by $2.2million during the six-month period ended June 30, 2004, due to the timingof payments to our publishers.

 

Our net cash used in investing activities was $61.2 millionfor the six-month period ended June 30, 2005 compared to $0.4 millionfor the six-month period ended June 30, 2004. During the six-month periodended June 30, 2005, we invested $59.4 million of the proceeds from ourinitial public offering into short-term investments.  In addition, we invested $1.0 million insoftware development and $0.8 million in property and equipment, including

 

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capital expenditures to enhance our serverinfrastructure. We expect to continue to invest in our facilities andtechnology to support our operations and remain competitive and expect to spendapproximately $0.8 million to $1.25 million in capital expenditures in theremainder of 2005.

 

Our net cash provided by financing activities was $61.4 millionfor the six-month period ended June 30, 2005 and our net cash used infinancing activities was $3.4 million for the six-month period ended June 30,2004. During the six-month period ended June 30, 2005, we received netproceeds of $61.5 million from the sale of common stock in our initial publicoffering, net of discounts, commissions and professional and other fees, andfrom the exercise of stock options by our employees.  Cash used in financing activities during the six-monthperiod ended June 30, 2004 was primarily for distributions of $3.1 millionto stockholders relating to the time period that we elected to be treated as asubchapter S corporation.

 

We believe that our current cash and cashequivalents, short-term investments, net proceeds from our initial offering,and cash flow from operations will be sufficient to meet our anticipated cashneeds, including for working capital purposes, planned capital expenditures,and various contractual obligations, for at least the next 12 months.  Our primary uses of cash in our operations areto make the required payments to our website publishers, as well as to coveroperating expenses and meet future tax obligations. We expect that our futurecash requirements will be significantly higher than our historical cashrequirements as we continue to grow our business. We also expect that theimpact of the seasonality of our business will be more pronounced in thefuture, and the timing of our expenditures, including those related topersonnel and capital items, may not coincide with our cash collections.

 

Historically, our cash flowfrom operations has generated sufficient cash to cover our operations and meetobligations. Although our historical cash flows are not a predictor of futurecash flows, we expect that future revenues and related collections should besufficient to meet our anticipated obligations and we believe our current cash,cash equivalent and short-term investment position is sufficient to cover anydisparity in timing between receipt of our revenues and payment of ourexpenses. Factors which impact the timing of our receipt of revenue includecompetitive conditions in our industry for extending credit to customers, thefinancial health of our customers and their ability to make payments to us inaccordance with the credit terms we established with them. The timing ofpayments for our expenses are dependent on the amounts and timing of servicesand obligations contracted for, however, we currently anticipate no materialchange in the timing of payments we make to our publishers.

 

We may require additionalcash resources due to changed business conditions or other future developments,including any investments or acquisitions we may decide to pursue. If thesesources of cash are insufficient to satisfy our cash requirements, we may seekto sell debt securities or additional equity securities or to obtain a creditfacility. The sale of convertible debt securities or additional equitysecurities could result in additional dilution to our stockholders. Theincurrence of indebtedness would result in incurring debt service obligationsand could result in operating and financial covenants that would restrict ouroperations. In addition, there can be no assurance that any additionalfinancing will be available on acceptable terms, if at all.

 

***Indebtedness***

 

As of June 30, 2005, we had no outstanding debt securities, materialcontingent liabilities or material mortgages or liens.

 

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**Critical Accounting Policies andthe Use of Estimates**

 

Our financial statements are prepared in accordancewith accounting principles generally accepted in the United States. Thepreparation of these financial statements requires us to make estimates andassumptions that affect the reported amounts of assets, liabilities, revenue,costs and expenses and related disclosures. We base our estimates on historicalexperience and on various other assumptions that we believe to be reasonableunder the circumstances, the results of which form the basis for makingjudgments about the carrying value of assets and liabilities that are notreadily apparent from other sources. We evaluate our estimates and assumptionson an ongoing basis. Actual results may differ from these estimates under differentassumptions or conditions.

 

We believe that, of our accounting policies, thefollowing policies involve the greatest degree of judgment and complexity.Accordingly, these are the policies we believe are the most critical to aid infully understanding and evaluating our financial condition and results ofoperations.

 

***RevenueRecognition***

 

We recognize revenue in accordance with theguidelines of SEC Staff Accounting Bulletin, or SAB, No. 104 “RevenueRecognition” and Emerging Issues Task Force Issue (“EITF”) 00-21 “RevenueArrangements with Multiple Deliverables.” Accordingly, we recognize revenue when the advertising impression isserved (for cost-per-thousand impressions contracts) or when the specifiedclick or other action occurs or when lead-based information is delivered (forcost-per-click and cost-per-action contracts), provided that we have nosignificant remaining obligations, collection of the resulting receivable isreasonably assured and prices are fixed and determinable.

 

We assess the likelihood of collection based on anumber of factors, including past transaction history with the customer and thecredit worthiness of the customer. We do not request collateral from ourcustomers. If we determine that collection of a fee is not reasonably assured,we defer the fee and recognize revenue at the time collection becomesreasonably assured, which is generally upon receipt of cash. Cash received inadvance is recorded as deferred revenue until earned.

 

***Accounting forStock-Based Compensation***

 

We account for stock-basedemployee compensation arrangements in accordance with the provisions ofAccounting Principles Board, or APB, Opinion No. 25, “Accounting for StockIssued to Employees” and related interpretations, and comply with thedisclosure requirements of SFAS No. 123, “Accounting for Stock-BasedCompensation.” Under APB Opinion No. 25, compensation cost, if any, isrecognized over the respective vesting period based on the difference betweenthe deemed fair value of our common stock and the exercise price on the date ofgrant. We account for non-employee stock-based awards, in which goods orservices are the consideration received for the equity instruments issued, inaccordance with the provisions of SFAS No. 123 and relatedinterpretations.

 

We have recorded deferredstock-based compensation charges for issuances of common stock awards where theexercise price was less than the deemed fair value of the underlying stock forfinancial accounting purposes.  Werecognize compensation expense as we amortize the deferred stock-basedcompensation amounts on a straight-line basis over the related vesting periods,generally over three to four years.  See “Results of Operations—Stock-BasedCompensation.”

 

All stock options granted to our employees, officersand directors under our equity plans were intended to be exercisable at a priceper share not less than the deemed fair value of the shares of our common stockunderlying those options or awards on their respective dates of grant. Becausethere had not been a public market for our shares until our initial publicoffering, our board of directors determined these exercise prices in goodfaith, based on the best information available to the board and our managementat the time of grant.  During 2004 and the first three months of 2005 wegranted stock options with exercise prices ranging from $2.55 per share to$12.00 per share resulting, due to the final remeasurement of the grants, indeferred stock-based compensation of $7.9 million and $1.0 million, respectively.  We reversed $2.1 million of deferredstock-based compensation during the first six months of 2005 upon employeeterminations.

 

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***Accounts Receivable and the Allowance for Doubtful Accounts***

 

We perform ongoing credit evaluations of our customers and adjust creditlimits based upon payment history and the customer’s current credit worthiness,as determined by a review of their current credit information. We regularlymonitor collections and payments from our customers and maintain a provisionfor estimated credit losses based upon historical experience and any specificcustomer collection issues that have been identified. While such credit losseshave historically been within our expectations and the provisions established,we cannot guarantee that we will continue to experience the same credit lossrates that have been experienced in the past.

 

The allowance for doubtful accounts for estimated losses results from theinability of our customers to make required payments. If the financialcondition of our customers were to deteriorate, resulting in an impairment oftheir ability to make payments, additional allowances may be required.

 

***Short-Term Investments***

 

We record an impairment charge when we believe our short-term investmentshave experienced a decline in value that is other than temporary. Futureadverse changes in market conditions or poor operating results of underlyinginvestments could result in losses or an inability to recover the carrying valueof the investments that may not be reflected in an investment’s currentcarrying value, thereby possibly requiring an impairment charge in the future. As of June 30, 2005, our short-terminvestments consisted of highly-liquid auction rate securities, U.S. andCanadian corporate notes, and U.S. government securities.

 

***Accounting for Software Development Costs for Internal Use***

 

In accordance with SOP 98-1, “Accounting for the Costs of Computer SoftwareDeveloped or Obtained for Internal Use,” we capitalize and amortize over theexpected life of a software asset the costs incurred during the applicationdevelopment stage including the following: (1) external direct costs ofmaterials and services consumed in developing or obtaining software, (2) payrolland payroll-related costs for employees who are directly associated with andwho devote time to the project, and (3) interest costs incurred, whenmaterial. We expense the costs of research, during the preliminary projectstage and costs incurred for training and maintenance.

 

***Impairment of Long-Lived Assets***

 

We assess impairment of our other long-lived assets in accordance with theprovisions of SFAS No. 144, “Accounting for the Impairment or Disposal ofLong-lived Assets.” An impairment review is performed whenever events orchanges in circumstances indicate that the carrying value may not berecoverable. Factors considered by us include:

 

•                  significant underperformance relative to expected historical or projectedfuture operating results;

 

•                  significant changes in the manner of use of the acquired assets or thestrategy for our overall business; and

 

•                  significant negative industry or economic trends.

 

When we determine that the carrying value of a long-lived asset may not berecoverable based upon the existence of one or more of the above indicators ofimpairment, we estimate the future undiscounted cash flows expected to resultfrom the use of the asset and its eventual disposition. If the sum of theexpected future undiscounted cash flows and eventual disposition is less thanthe carrying amount of the asset, we recognize an impairment loss. We report animpairment loss in the amount by which the carrying amount of the asset exceedsthe fair value of the asset, based on the fair market value if available, or discountedcash flows if not. To date, we have not had an impairment of long-lived assets.

 

***Accounting forIncome Taxes***

 

We account for income taxes using the asset andliability method in accordance with SFAS 109, “Accounting for IncomeTaxes,” which requires the recognition of deferred tax assets and liabilitiesfor the expected future tax

 

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consequences of temporary differences betweenthe carrying amounts and tax bases of the assets and liabilities. We periodicallyreview the likelihood that we will realize the value of our deferred tax assetsto determine if a valuation allowance is necessary. At June 30, 2005 therewas no valuation allowance against net deferred tax assets. If we determine inthe future that it is more likely than not that we will realize any futuredeferred tax assets for which we previously provided a valuation allowance, wewould reduce the existing valuation allowance and recognize income in theamount of the reduction. Conversely, if we determine that we would not be ableto realize any future recorded net deferred tax asset, we would increase thevaluation allowance and recognize the increase as a charge to our results ofoperations in the period when we reached the conclusion.

 

From inception to December 31, 2001, weoperated as a C corporation. Effective January 1, 2002, we elected tobe taxed as a subchapter S corporation for income tax purposes. Income,deductions, gains, losses, tax credits and other tax attributes of the corporationpass through were taxed directly to the stockholders for 2002, 2003 and theperiod from January 1, 2004 through September 27, 2004. On September 27,2004, we revoked our subchapter S corporation status and we now operate asa C corporation. Under SFAS 109, in connection with the revocation ofsubchapter S, we recognized both a federal and state income tax provision inthe amount of $1.2 million and $0.2 million, respectively, arisingfrom the change from non-taxable subchapter S to taxable entity status asa C corporation.

 

In addition, we operate within multiple domestictaxing jurisdictions and are subject to audit in those jurisdictions. Theseaudits can involve complex issues, which may require an extended period of timefor resolution. Although we believe that our financial statements reflect areasonable assessment of our income tax liability, it is possible that theultimate resolution of these issues could significantly differ from ouroriginal estimates.

 

***Contingencies and Litigation***

 

We evaluate contingent liabilities including threatened or pendinglitigation in accordance with SFAS No. 5, “Accounting for Contingencies”and record accruals when the outcome of each of these matters is deemedprobable and the liability is reasonably estimable. We make these assessmentsbased on the facts and circumstances and in some instances based in part on theadvice of outside legal counsel.

 

***Proceeds ofInitial Public Offering***

 

On March 31, 2005, we agreedto sell 5,649,860 shares of common stock at a price to the public of $12.00 pershare in our initial public offering.  Theaggregate gross proceeds to us from the public offering were approximately $67.8million. We incurred expenses of approximately $7.2 million, of whichapproximately $4.7 million represented underwriting discounts and commissionsand approximately $2.7 million represented expenses related to the offering.Net proceeds to us from the offering were $63.1 million. We classified the netproceeds of the offering as common stock subscribed and classified the expensesrelated to the offering as a reduction to additional paid-in capital in theaccompanying unaudited balance sheet as of June 30, 2005.  Inconnection with the closing of the offering, each of the Company’s 2,131,285shares of redeemable convertible preferred stock converted into five shares ofcommon stock, or 10,656,425 shares of common stock.  As a result, upon the closing of theoffering, we had 19,464,280 shares of common stock issued and outstanding.  As of June 30, 2005, substantially allof the net proceeds were invested in highly-liquid auction rate securities,U.S. and Canadian corporate notes, and U.S. government securities.

 

The principal purposes forour initial public offering are to increase our working capital, create apublic market for our common stock, facilitate our future access to the publiccapital markets and increase our visibility in our markets. We intend to usethe net proceeds from our offering for working capital, expansion of ouroperations, investment in new product development and strategic initiatives,including spending an estimated $800,000 to $1.25 million in capitalexpenditures in the remainder of 2005. We may use a portion of the net proceedsto partially fund the anticipated increase in our sales and marketing,technology and general and administrative operating expenses, including anestimated $2 million in expenses throughout 2005 relating to public companycosts. We may also use a portion of the net proceeds to pursue acquisitioncandidates to grow our advertising and publishing base and access technologyand talent. However, we have no present understandings, commitments oragreements with respect to the acquisition of other businesses or technologies.

 

We have not yet determined all of our anticipatedexpenditures and therefore cannot estimate the amounts to be used for all ofthe purposes discussed above. The amounts and timing of any expenditure willvary depending on the

 

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amount of cash generated by our operations,competitive and technological developments and the rate of growth, if any, ofour business. Accordingly, our management will have broad discretion inapplying the net proceeds from our offering. Pending the uses described above, weintend to invest the net proceeds from our offering in short-term,interest-bearing, investment-grade securities.

 

**Off-Balance Sheet Arrangements**

 

We do not have anyoutstanding derivative financial instruments, off-balance sheet guarantees,interest rate swap transactions or foreign currency forward contracts, or anyother off-balance sheet arrangements.

 

**Factors That May Affect FutureResults of Operations**

 

*You shouldconsider carefully the following risks described below, together with the otherinformation contained in this quarterly report and in our other public filingsin evaluating our business. If any of the following risks actually occurs, ourbusiness, financial condition, results of operations and future growthprospects would likely be materially and adversely affected. In thesecircumstances, the market price of our common stock would likely decline.*

 

***Risks Related toOur Business and Industry***

 

**We have a limited operatinghistory, operate in an immature industry and have a relatively new businessmodel, all of which may make it difficult for you to evaluate our business andprospects.**

 

We were incorporated in California in March 2000and began offering Internet advertising technologies and services in September 2000.Accordingly, we have a limited operating history, and as a result, we havelimited financial data that you can use to evaluate our business and prospects.In addition, we derive nearly all of our revenue from Internet advertising,which is an immature industry that has undergone rapid and dramatic changes inits short history. Our business model is also evolving, is distinct from othercompanies in our industry, and may not be successful. As a result of thesefactors, the future revenue and income potential of our business is uncertain.Although we have experienced significant revenue growth in recent periods, wemay not be able to sustain this growth. Any evaluation of our business and ourprospects must be considered in light of these factors and the risks anduncertainties often encountered by companies in our stage of development. Someof these risks and uncertainties relate to our ability to do the following:

 

•                  maintain our current relationships, anddevelop new relationships, with advertisers, advertising agencies, directmarketers, and website publishers;

 

•                  continue to grow our revenue and meetanticipated growth targets;

 

•                  manage our expanding operations and implementand improve our operational, financial and management controls;

 

•                  adapt to industry consolidation;

 

•                  continue to grow our website network;

 

•                  successfully introduce new, and upgrade ourexisting technologies and services for Internet advertisers and websitepublishers;

 

•                  respond to government regulations relating tothe Internet and other aspects of our business;

 

•                  respond effectively to competition; and

 

•                  attract and retain qualified management andemployees.

 

If we are unable to address these risks, ourbusiness, results of operations and prospects could suffer.

 

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**If we do not effectively manage ourgrowth, our operating performance will suffer and we may lose advertisers andwebsites.**

 

We have experienced rapid growth in both ourheadcount and operations, and we may experience continued growth in ourbusiness, both through acquisitions and internal growth. This growth hasplaced, and will continue to place, significant demands on our management andour operational and financial infrastructure. In particular, continued growthwill make it more difficult for us to accomplish the following:

 

•                  recruit, train and retain a sufficient numberof highly skilled personnel;

 

•                  maintain our customer service standards;

 

•                  maintain the quality of websites on ournetwork;

 

•                  develop and improve our operational,financial and management controls and maintain adequate reporting systems andprocedures;

 

•                  successfully scale our software andtechnology to accommodate a larger business; and

 

•                  maintain advertiser satisfaction.

 

The improvements required to manage our growth willrequire us to make significant expenditures and allocate valuable managementresources. For example, we have implemented a new accounting system. If thisnew system does not prove to have been implemented successfully, it couldadversely affect our ability to timely and accurately report our operations. Ifwe fail to effectively manage our growth, our operating performance will sufferand we may lose advertisers and websites.

 

**If we are unable to retain oursenior management or attract and retain qualified senior management in thefuture, we may not be able to implement our business strategy effectively andour revenue may decline.**

 

We depend on the continued contributions of oursenior management and, in particular, Kurt A. Johnson, our president and chiefexecutive officer, and Fred J. Krupica, our chief financial officer. We currentlymaintain key person life insurance only for Mr. Johnson.  Several members of our senior management havebeen with us for a short time. For example, Mr. Johnson has served as ourchief executive officer since March 2004, Mr. Krupica has served asour chief financial officer since September 2004, and James Aviani hasserved as our chief technology officer since March 2004. It is possiblethat personality conflicts and differences in management styles may surface,which could slow our decision-making process or prevent us from makingstrategic decisions in a timely manner. These or other reasons could cause usto lose members of our senior management team. In addition, some members of oursenior management have become, or will soon become, fully or substantiallyvested in their initial stock option grants. These individuals may be morelikely to leave us if the shares underlying their options have significantlyappreciated in value relative to the option exercise price.

 

We also need to hireadditional members of senior management to adequately manage our growingbusiness. We may not be able to identify and attract additional qualifiedsenior management. Competition for senior management in our industry isintense. Qualified individuals are in high demand, and we may incur significantcosts to attract them. Volatility or lack of performance in our stock price mayalso affect our ability to attract and retain senior management. If we are unableto attract and retain qualified senior management, we may not be able toimplement our business strategy effectively and our revenue may decline.

 

**We need tohire additional qualified personnel to grow and manage our business. If we areunable to retain our existing personnel or attract qualified new personnel, wemay not be able to grow our business or effectively compete in our industry.**

 

Our performance depends onthe talents and efforts of our employees. Our future success will depend on ourability to retain and motivate our existing personnel and attract, retain andmotivate additional, highly skilled

 

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personnel in all areas ofour organization and, in particular, in our technology, finance, and sales andmarketing teams. We plan to continue to grow our business and will need to hireadditional personnel to support this growth. We have experienced difficultiesin attracting and retaining qualified personnel in the past, particularly inthe Santa Barbara, California area where our headquarters are located. If weexperience difficulties attracting new qualified personnel in the future, ourgrowth may be hindered. If we were to lose our existing personnel, our businesswould be harmed. Qualified individuals are in high demand, and we may incursignificant costs to attract them. Some of our employees have also become, orwill soon become, substantially vested in their stock option grants. Employeesmay be more likely to leave us if the shares underlying their options havesignificantly appreciated in value relative to the option exercise price. If weare unable to retain our existing personnel and attract and retain theadditional personnel we need to succeed, we may not be able to grow our businessor effectively compete in our industry.

 

**Ouroperating results have fluctuated in the past and may do so in the future,which could make our results of operations difficult to predict or cause themto fall short of expectations.**

 

Our prior operating resultshave fluctuated due to changes in our business and the Internet advertisingindustry. Similarly, our future operating results may vary significantly fromquarter to quarter due to a variety of factors, many of which are beyond ourcontrol and could cause our results to be below investors’ expectations,causing the price of our common stock to fall. Because our business is changingand evolving, our historical operating results may not be useful to you inpredicting our future operating results. Factors that may increase thevolatility of our operating results include the following:

 

•                  the addition of new advertisers or websitesor the loss of existing advertisers or websites;

 

•                  changes in demand and pricing for ouradvertising services;

 

•                  the timing of our introduction of newadvertising technologies and the costs we incur to develop these technologies;

 

•                  the timing and amount of sales and marketingexpenses incurred to attract new advertisers, advertising agencies andwebsites;

 

•                  changes in the economic prospects ofadvertisers or the economy generally, which could alter current or prospectiveadvertisers’ spending priorities, or could increase the time it takes us toclose sales with advertisers;

 

•                  new product launches by advertisers;

 

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

 

•                  overall Internet usage, which generallydeclines during the summer months;

 

•                  timing differences at the end of each quarterbetween our payments to website publishers for advertising space and ourcollection of advertising revenue related to that space;

 

•                  introduction of new ad formats and shifts inad format mix;

 

•                  costs related to acquisitions of businessesor technologies; and

 

•                  Internet advertising is a relatively newmedium and advertisers have not settled into consistent spending patterns.

 

In addition, advertisingspending has historically been cyclical in nature, reflecting overall economicconditions as well as budgeting and buying patterns. Our rapid growth hashistorically masked the cyclicality and seasonality of

 

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our business. As our rate of growth slows, we expectthat the cyclicality and seasonality in our business may become more pronouncedand may in the future cause our operating results to fluctuate.

 

**If we failto compete effectively against other Internet advertising companies, we couldlose advertisers or advertising space and our revenue may decline.**

 

The market for Internetadvertising technologies and services is intensely competitive. We expect thiscompetition to continue to increase because there are no significant barriersto entry into our market. We compete both for advertisers and for the highquality advertising space that is available through websites. We compete foradvertisers on the basis of a number of factors, including price, return onadvertising expenditures, volume of available advertising space and customerservice.

 

Our primary current andpotential competitors include:

 

•                  Internet advertising networks such asAdvertising.com (acquired by AOL), Google Inc., ValueClick, Tribal Fusion andBurst Media;

 

•                  Internet advertising technology providers,including search engine optimization companies; and

 

•                  other performance-based Internet marketers,including affiliate networks.

 

We also compete with largeInternet companies and traditional media for a share of advertisers’ overallmarketing budgets, including:

 

•                  website publishers with their own salesforces that sell their advertising space directly to advertisers;

 

•                  major Internet portals and search enginecompanies with advertising networks such as Google and Yahoo!; and

 

•                  direct marketing, television, radio, cableand print companies.

 

Competition for ads amongwebsites, search engines, Internet service providers, or ISPs, as well ascompetition with traditional media companies, could result in significant pricepressure, declining margins, reductions in advertising revenue and loss of ourmarket share. In addition, as we continue to expand the scope of our services,we may compete with a greater number of websites, advertisers and traditionalmedia companies across an increasing range of different services, including invertical markets where competitors may have advantages in expertise, brandrecognition and other areas. Large websites with brand recognition, such asYahoo!, AOL, Google and MSN, have direct sales personnel and substantialproprietary advertising space that provides a significant competitive advantagecompared to our network of websites and have a significant impact on pricingfor Internet advertising. Many of our current and potential competitors alsoenjoy other competitive advantages over us, such as longer operating histories,larger advertiser bases, greater access to advertising space on high-trafficwebsites, and significantly greater financial, technical and marketingresources. As a result, we may not be able to compete successfully. If we failto deliver advertising results that are superior to those that advertisers orwebsites could achieve directly or through the use of our competitors, we couldlose advertisers or advertising space and revenue may decline.

 

**We dependon websites for advertising space, and any decline in the supply of advertisingspace available through our network could cause our revenue to decline or thecost to acquire advertising space to increase.**

 

We generate a significantportion of our revenue from the advertising space provided by a limited numberof websites. Expenses for our top ten website publishers accounted for 23% and 25%of our publisher expenses for the second quarter of 2005 and 2004,respectively. In most instances, website publishers can change the amount ofadvertising space they make available to us at any time and therefore impactour revenue. In addition, website publishers may place significant restrictionson our use of their advertising space. These restrictions may prohibit ads fromspecific advertisers or specific industries, or restrict the use of certaincreative content or format. If a website publisher decides not to makeadvertising space available to us, or decides to demand a higher revenue share

 

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or places significantrestrictions on the use of such advertising space, we may not be able toreplace the space with advertising space from other websites that satisfy ourrequirements in a timely and cost-effective manner. In addition, the number ofcompeting Internet advertising networks that acquire space from websitescontinues to increase. We cannot assure you that we will be able to acquireadvertising space that meets our advertisers’ performance, price and qualityrequirements. If any of these things occur, our revenue could decline or ourcost of acquiring advertising space may increase.

 

**If we offernew technologies and services that compete with products or services offered byour advertisers or website publishers, we could lose advertisers or advertisingspace and our revenue could decrease.**

 

We intend to expand thescope of our services and develop new technologies and services. As we do so,we will compete with a greater number of advertisers, website publishers andother media companies across an increasing range of markets, which may includeadvertisers or publishers to whom we currently provide technologies andservices. For example, we are currently developing a search engine advertisingtechnology, which is designed to help advertisers manage their advertisingcampaigns across multiple third-party Internet search engines, including bidsfor search terms. Some of our publishers and advertisers already offer, or inthe future may offer, similar or competing technologies and services. Wedepend, and expect to continue to depend, on our relationships with ouradvertisers and publishers. If we develop new technologies and services thatcompete with our current advertisers or publishers, they may materially reduceor cease their use of our advertising technologies and services and our revenuecould decrease.

 

**Asubstantial portion of our revenue is generated from a limited number ofadvertisers, and if we lose a major advertiser our revenue could decrease.**

 

A substantial portion of ourrevenue is generated from a limited number of advertisers and advertisingagencies. Our advertisers can generally terminate their contracts with us atany time, with no penalty upon one business day prior notice. Our top tenadvertisers accounted for 53% and 50% of our advertising revenue for the secondquarter of 2005 and 2004, respectively. We expect that a limited number ofadvertisers may continue to account for a significant percentage of our revenueand the loss of or material reduction in their advertising purchases coulddecrease our revenue and harm our business.

 

**Because ouradvertiser contracts generally can be cancelled by the advertiser with nopenalty upon one business day prior notice, the cancellation of one or morecontracts could result in an immediate decline in our revenue.**

 

We derive substantially allof our revenue from Internet advertising campaigns under short-term contracts,most of which are cancelable with one business day prior notice. In addition,these contracts do not contain penalty provisions for cancellation before the endof the contract term. The non-renewal, renegotiation, cancellation or deferralof large contracts, or a number of contracts that in the aggregate account fora significant amount of revenue, is difficult to anticipate and could result inan immediate decline in our revenue.

 

**We maypursue the acquisition of other businesses in order to grow our advertiser andwebsite base and access technology and talent, which may not achieve thedesired results or could result in operating difficulties, dilution and otherharmful consequences.**

 

A component of our strategyis to acquire other businesses in order to grow our advertiser and website baseand access technology and talent. However, suitable acquisition candidates maynot be available on terms and conditions we find acceptable. In pursuingacquisitions, we will compete with other companies, many of which have greaterfinancial and other resources than we do. Further, if we do succeed inconsummating acquisitions, these acquisitions could be material to our business,operating results and financial condition. Any future acquisition or investmentmay require us to use significant amounts of cash, issue potentially dilutiveequity securities with rights, preferences or privileges greater than ourcommon stock, incur debt or assume contingent liabilities, any of which couldharm our results of operations and financial position. In addition, theanticipated benefits of our acquisitions may not materialize and the acquiredbusiness may not achieve anticipated revenue, earnings or cash flow. Inaddition, acquisitions involve numerous risks, any of which could harm ourbusiness, including:

 

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•                  diversion of management’s attention andresources from other business concerns;

 

•                  difficulties and expenditures associated withintegrating the operations and employees from the acquired company into ourorganization, and integrating each company’s accounting, managementinformation, human resources and other administrative systems to permiteffective management;

 

•                  inability to maintain the key businessrelationships and the reputations of the acquired businesses;

 

•                  ineffectiveness or incompatibility ofacquired technologies or services with our existing technologies and systems;

 

•                  potential loss of key employees of acquiredbusinesses;

 

•                  integrating new business lines with which wemay have little or no experience or which may compete with our advertisers orpublishers;

 

•                  responsibility for liabilities of acquiredbusinesses;

 

•                  unavailability of favorable financing forfuture acquisitions;

 

•                  inability to maintain our standards,controls, procedures and policies, which could affect our ability to receive anunqualified attestation from our independent accountants regarding management’srequired assessment of the effectiveness of our internal control structure andprocedures for financial reporting; and

 

•                  increased fixed costs.

 

We also may pursue theacquisition of businesses outside the United States. Foreign acquisitionsinvolve unique risks in addition to those mentioned above, including thoserelated to integration of operations across different cultures and languages,currency risks and the particular economic, political and regulatory risksassociated with specific countries.

 

**Interruptionor failure of our information technology and communications systems couldimpair our ability to effectively deliver our technologies and services, whichcould cause us to lose advertisers or advertising space and harm our operatingresults.**

 

Our delivery of technologiesand services depends on the continuing operation of our technologyinfrastructure and systems. Any damage to or failure of our systems couldresult in interruptions in our ability to deliver ads quickly and accuratelyand to process users’ responses to ads. Interruptions in our service couldreduce our revenue and profits, and our reputation could be damaged if peoplebelieve our system is unreliable. Our systems are vulnerable to damage orinterruption from earthquakes, terrorist attacks, floods, fires, power loss,telecommunications failures, computer viruses or other attempts to harm oursystems, and similar events. We have critical systems in our Santa Barbara,California headquarters and lease server space in San Jose, California andAshburn, Virginia. Our California facilities are located in areas with a highrisk of major earthquakes. Our facilities are also subject to break-ins,sabotage and intentional acts of vandalism, and to potential disruptions if theoperators of these facilities have financial difficulties. Some of our systemsare not fully redundant, and our disaster recovery planning cannot account forall eventualities. The occurrence of a natural disaster, a decision to close afacility we are using without adequate notice for financial reasons or otherunanticipated problems at our facilities could result in lengthy interruptionsin our service.

 

We have experienced limitedsystem failures in the past and may in the future. Any unscheduled interruptionin our service puts a burden on our entire organization and results in animmediate loss of revenue. If we experience frequent or persistent systemfailures, the attractiveness of our technologies and services to advertisersand website publishers could be permanently harmed. Our insurance policies maynot adequately compensate us for any losses that occur due to failure in oursystems. The steps we have taken to increase the reliability and redundancy ofour

 

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systems are expensive,reduce our operating margin and may not be successful in reducing the frequencyor duration of unscheduled interruptions.

 

**Anyconstraints on the capacity of our technology infrastructure could delay theeffectiveness of our operations or result in system failures, which couldresult in the loss of advertisers and a decline in our revenue.**

 

Our future success dependsin part on the efficient performance of our software and technologyinfrastructure. As the numbers of websites and Internet users increase, ourtechnology infrastructure may not be able to meet the increased demand. Asudden and unexpected increase in the volume of ads delivered by us or in userresponses could strain the capacity of our technology infrastructure. Any capacityconstraints we experience could lead to slower response times or systemfailures and adversely affect the availability of ads, the number of adsdelivered and the level of user responses received, which could result in theloss of advertisers and a decline in our revenue.

 

**OurInternet advertising technologies and services incorporate multiple proprietarytechnologies and our intellectual property rights are key to the success of ourbusiness. If we do not adequately protect our intellectual property rights, ourcompetitive position may suffer.**

 

We rely on a combination ofpatent, copyright, trademark and trade secret laws of the United States andother countries, and confidentiality procedures to protect our intellectualproperty rights. Despite our efforts to protect our intellectual propertyrights, unauthorized parties may attempt to copy or otherwise obtain and useour proprietary technology. The use of our intellectual property rights byothers could reduce any competitive advantage we have developed and cause us tolose advertisers or websites or otherwise harm our business. We have from timeto time become aware of third parties who we believe may have infringed on ourintellectual property rights. The steps we currently take to monitor the unauthorizeduse of our proprietary technology are difficult and costly, and we cannot becertain that the steps we have taken and continue to take will preventunauthorized distribution and use of our proprietary technology, particularlyin foreign countries, where the laws may not protect our intellectual propertyrights as fully as in the United States. In addition, in the future it maybecome necessary for us to resort to litigation to protect these rights, andany proceedings could be burdensome and costly and we may not prevail.

 

**Thirdparties may sue us for our use of Internet advertising technologies or otherintellectual property and allege that we have infringed on their intellectualproperty rights. If successful, these lawsuits could require us to pay significantdamage awards or curtail our technology or service offerings.**

 

From time to time thirdparties have alleged that we have infringed their intellectual property rights.We cannot be certain that we do not and will not infringe the intellectual propertyrights of others and we may be subject to legal proceedings and claims in theordinary course of our business, including suits for intellectual propertyinfringement or proceedings to invalidate our intellectual property. Anyintellectual property claims, whether or not meritorious, could result incostly litigation and could divert management resources and attention.Moreover, should we be found liable for infringement, we may be required toenter into licensing agreements (if available on acceptable terms or at all),pay damages or limit or curtail our product or service offerings. We may alsoneed to redesign some of our products or processes to avoid future infringementliability. Any of the foregoing could prevent us from competing effectively andincrease our costs.

 

**Ourproprietary technologies, including our Optimization Engine, may include designor performance defects and may not achieve their intended results, any of whichcould impair our future revenue growth.**

 

Our Optimization Engine andother proprietary technologies are relatively new, and they may contain designor performance defects that are not yet apparent. We cannot assure you that theuse of our proprietary technologies will achieve the intended results aseffectively as other technologies that exist now or may be introduced by ourcompetitors, in which case our business could be harmed.

 

In addition, we recentlyhave spent significant resources developing our search engine advertisingtechnology which we currently intend to launch in the third quarter of 2005. Ifthis technology does not achieve the results we desire, our expected growth infuture revenue and margins may not materialize. Our success also depends on ourability to develop and introduce new proprietary technologies that address ouradvertisers’ and website publishers’ changing needs. Any new products that wedevelop may not achieve significant market acceptance. Our competitors

 

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may introduce new productsthat compete with our proprietary technologies and render our proprietarytechnologies unmarketable. Developing new technologies and services requires asignificant commitment of technology and other resources. If revenue generatedfrom the use of our proprietary technologies does not cover our developmentcosts, our results of operations may be harmed.

 

**If we areunable to accurately price advertising space on our network, our margins andrevenue may decline.**

 

Our advertisers can purchaseadvertising space on our network based on the following pricing options:

 

•                  Cost-per-action, where the advertiser pays usa fee based on the number of specified Internet user responses, such asregistrations, requests for information or sales that its ads produce;

 

•                  Cost-per-click, where the advertiser pays usa fee based on the number of clicks its ads generate; and

 

•                  Cost-per-thousand impressions, where theadvertiser pays us a fee based on the number of times its ads are displayed,referred to as impressions.

 

Regardless of how an advertiserpays for space, we pay the vast majority of our website publishers on acost-per-thousand impressions basis. However, the number of impressions itactually takes to achieve an action can be far greater than the number weanticipate. This can result in us paying a higher price to our publishers foradvertising space than our advertisers pay us for that space. If we are unableto accurately convert advertising campaigns that are priced on acost-per-action or cost-per-click basis to an effective cost-per-thousandimpressions based price that reflects the actual amount of impressions it takesto achieve an action or click, our results of operations will suffer. Duringthe second quarter of 2005, approximately 35% of the advertising space on ournetwork was purchased on a cost-per-action basis and we paid the vast majorityof our website publishers displaying these ads on a cost-per-thousandimpressions basis. We expect that advertising purchased based on this pricingwill increase over time.

 

**Any decreasein demand for our technologies and services could substantially reduce ourrevenue.**

 

To date, substantially allof our revenue has been derived from Internet advertising. We expect thatInternet advertising will continue to account for substantially all our revenuein the future. However, our revenue from Internet advertising may decrease inthe future for a number of reasons, including the following:

 

•                  the rate at which Internet users take actionin response to an ad may decrease;

 

•                  the popularity of the Internet as anadvertising medium could decrease;

 

•                  Internet users may install existing orto-be-developed software programs that allow them to prevent ads from appearingon their screens;

 

•                  advertisers may prefer an alternativeInternet advertising format, product or service which we might not offer; and

 

•                  we may be unable to make the transition tonew Internet advertising formats preferred by advertisers.

 

**If****we****fail to keep pace withrapidly changing technologies we could lose advertisers and advertising spaceand our revenue may decline.**

 

The Internet advertisingmarket is characterized by rapidly changing technologies, evolving industrystandards, frequent new product and service introductions and changing userdemands. The introduction of new products and services embodying newtechnologies and the emergence of new industry standards and practices canrender existing products and services obsolete and unmarketable or requireunanticipated investments in technology. Our future success will depend on ourability to adapt to rapidly changing advertising formats and othertechnologies.

 

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We will need to enhance ourexisting technologies and services and develop and introduce a variety of newtechnologies and services to address our advertisers’ changing demands. Inaddition, an increase in the bandwidth of Internet access resulting in fasterdata delivery may provide new products and services that will take advantage ofthis expansion in delivery capability. If we fail to adapt successfully to suchdevelopments, we could lose advertisers or advertising space. We may alsoexperience difficulties that could delay or prevent the successful design,development, introduction or marketing of new technologies and services. Anynew technologies and services or enhancement that we develop will need to meetthe requirements of our current and prospective advertisers and may not achievesignificant market acceptance. If the new technologies and services we introduceare not ultimately successful, the time and resources we devoted to theirdevelopment may be wasted. We have spent significant resources developing thesenew technologies and expect their results to be material to our future growth.If we do not successfully introduce new technologies and services or if we failto keep pace with technological developments and the introduction of newindustry and technology standards on a cost-effective basis, we could loseadvertisers and advertising space and our revenue may decline.

 

**Changes ingovernment regulation and industry standards applicable to the Internet coulddecrease demand for our technologies and services or increase our costs.**

 

Laws and regulations thatapply to Internet communications, commerce and advertising are becoming moreprevalent. These regulations could affect the costs of communicating on theInternet and could decrease demand for our technologies and services orincrease our costs.

 

In the United States,federal and state laws have been enacted regarding children’s privacy,copyrights, sending of unsolicited commercial email, user privacy, searchengines, Internet tracking technologies, direct marketing, data security,pricing, sweepstakes, promotions, intellectual property ownership and infringement,trade secrets, export of encryption technology, taxation and acceptable contentand quality of goods. The European Union has also adopted directives that mayaffect our ability to collect and use information regarding Internet users inEurope. Other laws and regulations may be adopted in the future. Thislegislation could hinder growth in the use of the Internet generally, anddecrease the acceptance of the Internet as a communications, commercial andadvertising medium.

 

Several recent federal lawscould have an impact on our business. The Digital Millennium Copyright Act isintended, in part, to limit the liability of eligible Internet serviceproviders for listing or linking to third-party websites that include materialsthat infringe copyrights or other rights of others. The Children’s OnlineProtection Act and the Children’s Online Privacy Protection Act are intended torestrict the distribution of certain materials deemed harmful to children andimpose additional restrictions on the ability of Internet services to collectuser information from minors. In addition, the Protection of Children from SexualPredators Act of 1998 requires Internet service providers to report evidence ofviolations of federal child pornography laws under certain circumstances.Though we specifically prohibit the use of our website network for any suchactivities, and refuse to transact business with any advertiser or websiteparticipating in such activities, such legislation may impose significantadditional costs on our business or subject us to additional liabilities.

 

The laws governing theInternet remain largely unsettled, even in areas where there has been somelegislative action. We are not certain how our business might be affected bythe application of existing laws governing issues such as property ownership,copyrights, encryption and other intellectual property issues, libel, obscenityand export or import matters to the Internet advertising industry. The vastmajority of such laws were adopted prior to the advent of the Internet. As aresult, they do not contemplate or address the unique issues of the Internetand related technologies. Changes in laws intended to address such issues couldcreate uncertainty in the Internet market. It may take years to determine howexisting laws apply to the Internet and Internet advertising. Such uncertaintycan make it difficult to predict costs and could reduce demand for ourtechnologies and services or increase the cost of doing business as a result oflitigation costs or increased service delivery costs.

 

The growth and developmentof the market for Internet commerce may prompt calls for more stringent lawsand regulations governing the Internet, both in the United States and abroad,which may impose additional burdens on companies conducting business over theInternet. In addition to governmental regulation, privacy advocacy groups andthe advertising, technology and direct marketing industries are all consideringvarious new, additional or different self-regulatory standards applicable tothe Internet. Demand for our technologies and services may decrease and ourbusiness could be materially and adversely affected by the adoption ormodification of laws,

 

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regulations or industryguidelines relating to the Internet, or the application of existing laws to theInternet or Internet-based advertising.

 

**We may besubject to regulations and taxes in locations from which our transmissions donot originate and we may not accurately determine our tax liabilities, eitherof which could materially affect our financial results.**

 

Due to the global nature ofthe Internet, it is possible that, although our transmissions originate inSanta Barbara, California, San Jose, California and Ashburn, Virginia, thegovernments of other states or foreign countries might attempt to regulate ourtransmissions or levy sales or other taxes relating to our activities. Forexample, we file tax returns in the states where we are required to by law,based on principles applicable to traditional businesses. However, one or morestates could seek to impose additional income tax obligations or sales taxcollection obligations on out-of-state companies, such as us, that engage in orfacilitate electronic commerce. A number of proposals have been made at stateand local levels that could impose such taxes on the sale of products andservices through the Internet or the income derived from such sales. Ifadopted, these proposals could substantially impair the growth of electroniccommerce and seriously harm our profitability.

 

The determination of ourprovision for income taxes and other tax liabilities requires significantjudgment and, in the ordinary course of our business, there are manytransactions and calculations where the ultimate tax determination isuncertain. Although we believe our estimates are reasonable, the ultimate taxoutcome may differ from the amounts recorded in our financial statements andmay materially affect our financial results in the period or periods for whichsuch determination is made.

 

**If thetechnology that we currently use to target the delivery of Internetadvertisements and to prevent fraud on our network is restricted by or becomessubject to regulation, our expenses could increase and we could loseadvertisers or advertising space.**

 

Websites typically placesmall files of non-personalized, or anonymous, information, commonly known ascookies and action tags, on an Internet user’s hard drive, generally withoutthe user’s knowledge or consent. Cookies generally collect aggregateinformation about users on a non-personalized basis to enable websites toprovide users with a more customized experience. Cookie information is passedto the website through an Internet user’s browser software. We use cookies tocollect information regarding the ads we deliver to Internet users and theirinteraction with these ads. An action tag functions similarly to a banner ad,except that the action tag is not visible. Action tags may be placed on certainpages of a website, which enables us to measure an advertising campaign’seffectiveness in driving Internet users to take specific actions. We use thisinformation to identify Internet users who have received our ads in the pastand to monitor and prevent potentially fraudulent activity. In addition, ourproprietary technologies use this information to monitor the performance ofongoing advertising campaigns and plan future campaigns. Most currentlyavailable Internet browsers allow Internet users to modify their browsersettings to prevent cookies from being stored on their hard drives, and someusers currently do so. Internet users can also delete cookies from their harddrives at any time. Recently, technologies have been developed, like thePlatform for Privacy Preferences Project, or P3P, which limit the collection ofcookie and action tag information. Finally, third parties have brought classaction lawsuits against other companies relating to the use of cookies, and wemay be subject to similar lawsuits in the future. The use of such technologiesor the results of such lawsuits could limit or eliminate our ability to usecookies and action tags.

 

Some Internet commentatorsand privacy advocates have suggested limiting or eliminating the use of cookiesand certain software programs which allow the monitoring of Internet users’activities without their consent; these programs are commonly known as “spyware.”Legislation has been passed or is pending in several states and in the UnitedStates Congress that restricts the use of certain of these types oftechnologies. For example, in California, the Consumer Protection AgainstComputer Spyware Act was passed and took effect on January 1, 2005. InUtah, the Spyware Control Act took effect in 2004, and regulates certain typesof advertising software.   In March andApril of 2005, Virginia’s governor signed the Computer Crimes Act, whichprovides criminal penalties for the malicious, unauthorized installation ofsoftware on the computer of another, and the Arizona, Arkansas, Georgia andWashington state legislatures all passed laws regulating the use of “spyware”.   In the United States Congress, the House ofRepresentatives recently passed two separate bills known as the SecurelyProtect Yourself Against Cyber Trespass Act, or the SPY Act, and the InternetSpyware Prevention Act of 2005, or the I-SPY Act. Both the SPY Act and theI-SPY Act are pending in the United States Senate. The Senate has also reportedout the Software

 

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Principles Yielding BetterLevels of Consumer Knowledge, or SPY BLOCK Act, which would overlapsignificantly with the SPY Act.  Inaddition, the European Union has adopted a directive requiring that whencookies are used, the user must be informed regarding the use and purpose ofcookies and provided instructions on how to remove cookies. The State AttorneyGeneral of New York filed a suit alleging that use of spyware or adware violatesstate statutes against false advertising and deceptive business practices andthat it constitutes a trespass under New York common law, but recentlyannounced that this case has been settled. A consumer class action case has also been filed in Illinois seekingdamages and alleging that a marketing software for tracking web users andsending them pop up ads and which is bundled with other free downloadablesoftware such as for video games violates the Illinois Consumer Fraud Act andfurther alleges trespass to personal property, unjust enrichment, negligenceand computer tampering

 

Although, we require ourpublishers and advertisers to adhere to advertising standards that are designedto protect Internet users’ privacy, including prohibitions against the use ofspyware, and we monitor our network to ensure compliance with these standards,it is unclear how new regulations and standards of business conduct will affectour company.  New regulations and standards of business conduct may:

 

•                  reduce the effectiveness of our proprietarytechnologies;

 

•                  require us to replace or re-engineer ourproprietary technologies, which could require significant amounts of our timeand resources, may not be completed in time to avoid losing advertisers oradvertising space, and may not be commercially or technically feasible; and

 

•                  cause us to become subject to costly andtime-consuming litigation or investigations due to our use of cookie technologyor other technologies designed to collect Internet usage information or deliverinternet advertising.

 

Any one or more of theseoccurrences could result in increased costs, require us to change our businesspractices or divert management’s attention.

 

**Newtechnologies could block our ability to serve advertisements, and may reducedemand for our technologies and services.**

 

During the quarters ended June 30,2005 and 2004, we derived approximately 36% and 51%, respectively, of ourrevenue from our deployment of pop-under ads across our network. Technologieshave been developed and distributed that are designed to block the appearanceof pop-up and pop-under ads on website pages viewed by Internet users.These ad- blocking technologies may become more effective and their use maybecome more widespread, and they may block the display of other current orfuture formats that we may use to deploy our ads. Substantially all of ourrevenue is derived from fees paid to us by advertisers in connection with thedisplay of ads on websites. As a result, ad-blocking technology could reducedemand for our technologies and services and harm our business.

 

**Disputeswith advertisers or website publishers over our measurement of Internet userimpressions, clicks or actions may cause us to lose advertisers and publishers.**

 

We earn advertising revenueand make payments to website publishers based on the number of impressions,clicks and actions from ads delivered on our network of websites. Advertisers’and publishers’ willingness to use our services and join our network willdepend on the extent to which they perceive our measurements to be accurate andreliable. Advertisers and publishers often maintain their own technologies andmethodologies for counting impressions, clicks and actions from ads, and wefrequently have had to resolve differences between our measurements and theirs,none of which we consider to be significant based on the amount subject to thedispute. Any significant dispute over the proper measurement of impressions,clicks and actions from ads could cause us to lose advertisers or publishersand the related revenue.

 

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**If ourpricing models are not accepted by our advertisers, we****could****lose advertisers and ourrevenue could decrease.**

 

Many of our technologies andservices are offered to advertisers based on cost-per-action or cost-per-clickpricing models, under which advertisers only pay us if the user takes aspecific action in response to the ad, such as clicking on it or registering ona website. These performance-based pricing models differ from the fixed-ratepricing model used by many Internet advertising companies, under which thesecompanies are paid based on the number of times the ad is shown without regardto effectiveness. Our ability to generate significant revenue from advertiserswill depend, in part, on our ability to demonstrate the effectiveness of ourprimary pricing models to advertisers, who may be more accustomed to afixed-rate pricing model. Furthermore, intense competition among websites andother Internet advertising providers has led to the development of a number ofalternative pricing models for Internet advertising. The proliferation ofmultiple pricing alternatives may confuse advertisers and make it moredifficult for them to differentiate among these alternatives. In addition, itis possible that new pricing models may be developed and gain widespreadacceptance that are not compatible with our business model or our technologies.These alternatives, and the likelihood that additional pricing models will beintroduced, make it difficult for us to project the levels of advertisingrevenue or the margins that we or the Internet advertising industry in generalwill realize in the future. If advertisers do not understand the benefits ofour pricing models, then the market for our services may decline or developmore slowly than we expect, which may limit our ability to grow our revenue orcause our revenue to decline.

 

**Limitationson our ability to collect and use data derived from advertising campaigns couldsignificantly diminish the value of our technologies and services and cause usto lose advertisers and revenue.**

 

When a user visits thewebsites on our network, we use technologies, including cookies, to collectinformation such as the user’s IP address, ads delivered by us that have beenpreviously viewed by the user and responses by the user to those ads. In orderto determine the effectiveness of an advertising campaign by one of ouradvertisers and to determine how to modify the campaign, we need to access andanalyze this information. Certain of our advertisers and publishers prohibit orlimit our collection or use of this data. Interruptions, failures or defects inour data collection systems, as well as privacy concerns regarding thecollection of user data, could also limit our ability to analyze data from ouradvertisers’ advertising campaigns. If that happens, we may be unable toprovide effective technologies and services to advertisers and we may loseadvertisers.

 

**We couldlose advertisers if we fail to detect click-through fraud on advertisements ina manner that is acceptable to our advertisers.**

 

We are exposed to the riskof fraudulent clicks on our ads by individuals seeking to increase theadvertising fees paid to our website publishers. We may in the future have torefund revenue that our advertisers have paid to us and that was laterattributed to click-through fraud. Click-through fraud occurs when anindividual clicks on an ad displayed on a website for the sole intent ofgenerating the revenue share payment to the publisher rather than to view theunderlying content. From time to time we have experienced fraudulent clicks onour network and we do not charge our advertisers for such fraudulent clicks.This negatively affects our profitability, and this type of fraudulent actcould hurt our brand. If fraudulent clicks are not detected, the affectedadvertisers may experience a reduced return on their investment in ouradvertising programs, which could lead the advertisers to become dissatisfiedwith our advertising campaigns, and in turn, lead to loss of advertisers andthe related revenue.

 

**Consolidationof website publishers may impair our ability to provide marketing services andacquire advertising space at favorable rates.**

 

The consolidation ofInternet advertising networks and website publishers could eventually lead to aconcentration of desirable advertising space on a small number of networks andlarge websites. Such concentration could:

 

•                  increase our costs if these publishers usetheir greater bargaining power to increase revenue share rates for advertisingspace;

 

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•                  impair our ability to provide advertisingtechnologies and services if these publishers prevent us from distributing ouradvertisers’ advertising campaigns on their websites or if they adopt addelivery systems that are not compatible with our ad delivery systems; and

 

•                  lessen the value of our services as anintermediary if these publishers choose to negotiate directly with advertisersor use the services of our competitors rather than us.

 

**If any ofour advertisers are unable to pay for our technologies and services, we willlose the revenue related to the technologies and services we provided.**

 

Some of our advertisers havelimited operating histories, are unprofitable and may not be able to pay forour services. In the past we have lost advertisers, or have had difficultycollecting payments from advertisers, who could not pay for our servicesbecause they were unprofitable and unable to secure funding. The ability ofseveral of our advertisers to meet their payment obligations is affected by therisks and difficulties encountered by companies with limited operatinghistories, particularly in the evolving Internet market. We typically pay ourpublishers within 25 business days after the end of the month, regardless ofwhether we have received payment from our advertisers. If any of our current orfuture advertisers are unable to pay for our services, we will lose the revenuerelated to the services we provided.

 

**We may beliable for content displayed on our network of websites which could increaseour expenses.**

 

We may be liable to thirdparties for content in the ads we deliver if the artwork, text or other contentincluded in the ads violates copyright, trademark, or other intellectual propertyrights of third parties or if the content is defamatory. From time to time wehave received notice from third parties alleging that the content displayed onour network infringes their intellectual property rights. In the event any ofthese allegations result in claims or counterclaims, it could betime-consuming, result in costly litigation and divert management’s attention.

 

**If themarket for Internet advertising fails to continue to develop, our future growthmay be limited and our revenue may decrease.**

 

Our future success is highlydependent on the continued use and growth of the Internet as an advertisingmedium. The Internet advertising market is relatively new and rapidly evolving,and it uses different measurements than traditional media to gauge itseffectiveness. As a result, demand for and market acceptance of Internetadvertising services is uncertain. Many of our current or potential advertisershave little or no experience using the Internet for advertising purposes andhave allocated only limited portions of their advertising budgets to theInternet. The adoption of Internet advertising, particularly by those entitiesthat have historically relied upon traditional media for advertising, requiresthe acceptance of a new way of conducting business, exchanging information,measuring success and evaluating new advertising products and services. Suchadvertisers may find Internet advertising to be less effective for promotingtheir products and services than traditional advertising media. They may neveradopt Internet advertising or cease using it. We cannot assure you that themarket for Internet advertising will continue to grow or become sustainable. Ifthe market for Internet advertising fails to continue to develop or developsmore slowly than we anticipate, our ability to grow may be limited and ourrevenue may decrease.

 

**Theadvertising industry, including Internet advertising, could be adverselyaffected by general economic downturns, catastrophic events or declines ordisruptions in industries that advertise heavily on the Internet and, as aresult, our revenue may decline.**

 

The advertising industry,including Internet advertising, is sensitive to both general economic andbusiness conditions and to specific events, such as acts of terrorism. Inaddition, Internet advertising spending can be affected by the condition ofindustries that advertise heavily on the Internet such as the travel, financialservices, education, telecommunications, retail and entertainment industries.Some of these industries tend to be sensitive to event-driven disruptions suchas government regulation, war, terrorism, disease, natural disasters and othersignificant events. A general decline in economic conditions or disruptions inspecific industries characterized by heavy spending on Internet advertisingcould cause a decline in Internet advertising expenditures, which could in turncause a decline in our revenue.

 

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**Changes tofinancial accounting standards and new exchange rules could make it moreexpensive to issue stock options to employees, which will increase ourcompensation costs and may cause us to change our business practices.**

 

We prepare our financialstatements in conformance with GAAP in the United States. These accountingprinciples are subject to interpretation by the Public Company AccountingOversight Board, the SEC and various other bodies. A change in those policiescould have a significant effect on our reported results and may affect our reportingof transactions completed before a change is announced. For example, we haveused stock options and other long-term equity incentives as a component of ouremployee compensation packages. We believe that stock options and otherlong-term equity incentives directly motivate our employees to maximizelong-term stockholder value and, through the use of vesting, encourageemployees to remain with us. Several regulatory agencies and entities areconsidering regulatory changes that could make it more difficult or expensivefor us to grant stock options to employees. In December 2004, theFinancial Accounting Standards Board issued a final standard that requires usto record a charge to earnings for employee stock option grants. This standardwill be effective for annual periods beginning after June 15, 2005. Wecould adopt the standard in one of two ways—the modified prospective transitionmethod or the modified retrospective transition method—and we have notconcluded how we will adopt the new standard. In addition, regulationsimplemented by The Nasdaq National Market generally require stockholderapproval for all stock option plans, which could make it more difficult orexpensive for us to grant stock options to employees. We will, as a result ofthese changes, incur increased compensation costs, which could be material andwe may change our equity compensation strategy or find it difficult to attract,retain and motivate employees.

 

**We rely onbandwidth and data center providers, and other third parties for key aspects ofthe process of providing products and services to our advertisers andpublishers, and any failure or interruption in the services and productsprovided by these third parties could disrupt our business and cause us to loseadvertisers and advertising space.**

 

We rely on third-partyvendors, including data center and bandwidth providers. Any disruption in thenetwork access or co-location services, which are the services that house andprovide Internet access to our servers, provided by these third-party providersor any failure of these third-party providers to handle current or highervolumes of use could significantly harm our business. Any financial or otherdifficulties our providers face may have negative effects on our business, thenature and extent of which we cannot predict. We exercise little control overthese third-party vendors, which increases our vulnerability to problems withthe services they provide. We license technology and related databases fromthird parties to facilitate aspects of our campaign reporting, analysis andstorage of data, and delivery of ads across our network. We have experiencedand expect to continue to experience interruptions and delays in service andavailability for such elements. Any errors, failures, interruptions or delaysexperienced in connection with these third-party technologies and informationservices could negatively impact our relationship with our advertisers andpublishers and adversely affect our brand and our business and could expose usto liabilities to third parties.

 

Our systems also heavilydepend on the availability of electricity, which also comes from third-partyproviders. If we were to experience a major power outage, we would have to relyon back-up generators. These back-up generators may not operate properlythrough a major power outage and their fuel supply could also be inadequateduring a major power outage. Information systems such as ours may be disruptedby even brief power outages, or by the fluctuations in power resulting fromswitches to and from backup generators. This could disrupt our business andcause us to lose advertisers and advertising space.

 

**We haverecently implemented new financial and accounting systems which may not work asexpected.**

 

We have recently implementednew financial and accounting software and continue to refine the software’sprocess and financial reporting features. Additionally, we are in the processof upgrading certain of our other information systems and internal controls.These systems are critical to our operations and involve sensitive interactionsbetween us and our advertisers and our website publishers. If we fail tosuccessfully implement and integrate these new financial reporting andaccounting systems, or we are not able to scale these systems to our growth, wemay not have adequate, accurate or timely financial information. Failure tohave adequate, accurate or timely financial information could result inadvertiser or publisher dissatisfaction, disrupt our operations and

 

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adversely affect our resultsof operations and effect our ability to prepare financial information inaccordance with GAAP.

 

**If we failto maintain an effective system of internal controls, we may not be able to accuratelyreport our financial results or prevent fraud. As a result, current andpotential stockholders could lose confidence in our financial reporting, whichwould harm our business and the trading price of our stock.**

 

Effective internal controlsare necessary for us to provide reliable financial reports and effectivelyprevent fraud. We have in the past discovered, and may in the future discover,areas of our internal controls that need improvement. For example, our auditorshave identified the need to hire additional financial employees and upgrade ouraccounting system. In addition, Section 404 of the Sarbanes-Oxley Act of2002 will require us to evaluate and report on our internal controls overfinancial reporting and have our independent auditors attest to our evaluation,beginning with our Annual Report on Form 10-K for the fiscal year ending December 31,2006. We have prepared an internal plan of action for compliance with Section 404and strengthening and testing our system of internal controls to provide thebasis for our report. The process of strengthening our internal controls andcomplying with Section 404 will be expensive and time consuming, and willrequire significant attention of management. Although we believe our recentefforts will strengthen our internal controls we are continuing to work toimprove our internal controls, including in the areas of our accounting system.We cannot be certain that these measures will ensure that we implement andmaintain adequate controls over our financial processes and reporting in thefuture. Failure to implement required new or improved controls, or difficultiesencountered in their implementation, could harm our operating results or causeus to fail to meet our reporting obligations. If we or our auditors discover amaterial weakness, the disclosure of that fact, even if quickly remedied, wouldreduce the market’s confidence in our financial statements and harm our stockprice. In addition, a delay in compliance with Section 404 could subjectus to a variety of administrative sanctions, including the suspension ordelisting of our common stock from The Nasdaq National Market and the inabilityof registered broker-dealers to make a market in our common stock, which wouldfurther reduce our stock price.

 

***Risks Related to Ownershipof Our Common Stock***

 

**Sales of a substantial number ofshares of common stock in the public market may adversely affect the marketprice for our common stock.**

 

Immediately following the consummation of our initialpublic offering on April 6, 2005, we had 19,382,880 shares of common stockoutstanding, of which the 6,500,000 shares sold in that offering, are freelytradable without restriction or further registration under the Securities Act,unless purchased by our “affiliates,” as such term is defined under theSecurities Act, in which case such shares will be subject to the resalelimitations but not the holding period requirements of Rule 144 under theSecurities Act. We and our executive officers and directors, the selling stockholdersand substantially all of our other stockholders and option holders, haveentered into 180-day lock-up agreements with the underwriters. Holders of285,360 shares (or shares issuable upon the exercise of outstanding options),in the aggregate, are not subject to a lock-up agreement.  The lock-up agreements prohibit each of usfrom selling or otherwise disposing of our shares of common stock except inlimited circumstances. The lock-up agreements are contractual agreements, andCredit Suisse First Boston LLC and Citigroup Global Markets Inc., at theirdiscretion, can waive the restrictions of any lock-up agreement at an earliertime without prior notice or announcement and allow the sale of shares of ourcommon stock. If the restrictions in the lock-up agreements are waived, sharesof our common stock will be available for sale into the public market, subjectto applicable securities laws, which could reduce the market price for sharesof our common stock.

 

Under our investors’ rights agreement, dated September 27,2004, some of our stockholders have customary demand and piggyback registrationrights. In addition, on May 13, 2005 we filed a registrationstatement on Form S-8 under the Securities Act to register an aggregate ofup to 4,000,000 shares of our common stock reserved for issuance under our 2005Equity Incentive Plan. These shares, when issued in accordance with the plans,will be eligible for immediate sale in the public market, subject to the 180-daylock-up restriction described above and Rule 144 resale volume limitationsif held by affiliates. We may also issue our common stock in connection withacquisitions or investments. The sale of any additional shares of our commonstock, or the perception of investors that such a sale could take place, coulddepress the market price for our common stock.

 

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**Our stock price may be volatile, andyou may not be able to resell shares of our common stock at or above the priceyou paid or at all.**

 

Our common stock has been traded publicly for only ashort period of time. We cannot predict the extent to which a trading marketwill develop or how liquid that market might become. The trading price of ourcommon stock could be subject to wide fluctuations due to the factors discussedin this “Management’s Discussion and Analysis of Financial Condition and Resultsof Operations—Factors That May Affect Results of Operations” section andelsewhere in this report. In addition, the stock market in general, and TheNasdaq National Market and technology companies in particular, have experiencedextreme price and volume fluctuations. Current trading prices and valuationsmay not be sustainable. Investor sentiment towards the market and our industrymay adversely affect the market price of our common stock, regardless of ouractual operating performance. In addition, in the past, following periods ofvolatility in the overall market and the market price of a company’ssecurities, securities class action litigation has often been institutedagainst such companies. This litigation, if instituted against us, could resultin substantial costs and a diversion of our management’s attention andresources.

 

**If securities or industry analysts donot publish research or reports about our business or if they downgrade theirrecommendations regarding our common stock, our stock price and trading volumecould decline.**

 

The trading market for our common stock is influencedby the research and reports that industry or securities analysts publish aboutus or our business. If any of the analysts who cover us downgrade our commonstock, our common stock price would likely decline. If analysts cease coverageof us or fail to regularly publish reports on us, we could lose visibility inthe financial markets, which in turn could cause our common stock price ortrading volume to decline and our common stock to be less liquid.

 

**Concentration of ownership among ourexisting executive officers, directors and principal stockholders may preventnew investors from influencing significant corporate decisions and may resultin a lower trading price for our common stock than if ownership of our commonstock was less concentrated.**

 

Our executive officers, directors and holders of 5% ormore of our common stock and their affiliates beneficially owned, in theaggregate, approximately 52% of our outstanding common stock as of July 31,2005. As a result, these stockholders, acting together, could have the abilityto exert substantial influence over all matters requiring approval by ourstockholders, including the election and removal of directors and any proposedmerger, consolidation or sale of all or substantially all of our assets andother corporate transactions. This concentration of control could be disadvantageousto other stockholders with interests different from those of our executiveofficers, directors and principal stockholders. For example, our executiveofficers, directors and principal stockholders could delay or prevent anacquisition or merger even if the transaction would benefit other stockholders.In addition, this significant concentration of common stock ownership mayadversely affect the market price for our common stock because investors oftenperceive disadvantages in owning stock in companies with a concentration ofownership in a few stockholders.

 

**We do not intend to pay any cashdividends in the foreseeable future and unless and until we pay cash dividendson our common stock, any gains from your investment in our common stock mustcome from an increase in its market price.**

 

We do not anticipate declaring or paying any cashdividends in the foreseeable future. We intend to reinvest any earnings in thegrowth of our business. Payments of future dividends, if any, will be at thediscretion of our board of directors after taking into account various factors,including our business, operating results and financial condition, current andanticipated cash needs, plans for expansion and any legal or contractuallimitations on our ability to pay dividends. Therefore, unless and until we paycash dividends on our common stock, any gains from your investment in ourcommon stock must come from an increase in its market price.

 

**We have and will continue to incurincreased costs as a public company, which could decrease our margins andnegatively affect our results of operations.**

 

As a public company, we have and will continue to incursignificant legal, accounting and other expenses that we did not incur as aprivate company. In addition, the Sarbanes-Oxley Act of 2002, as well as new rules

 

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subsequently implemented by the SEC and The NasdaqNational Market, have required changes in corporate governance practices ofpublic companies. We expect these new rules and regulations to increaseour legal and financial compliance costs and to make some activities moretime-consuming and costly. For example, as a result of being a public company,we are required to create additional board committees and adopt policiesregarding internal controls and disclosure controls and procedures. Inaddition, we have and will continue to incur additional costs associated withour public company reporting requirements. We also expect these new rules andregulations to make it more difficult and more expensive for us to obtaindirector and officer liability insurance and we may be required to acceptreduced policy limits and coverage or incur substantially higher costs toobtain the same or similar coverage. As a result, it may be more difficult forus to attract and retain qualified individuals to serve on our board ofdirectors or as executive officers. We are currently evaluating and monitoringdevelopments with respect to these new rules, but we cannot predict or estimatethe amount of additional costs we may incur or the timing of such costs.

 

**Provisions in our charter documentsand under Delaware law could discourage a takeover that stockholders mayconsider favorable.**

 

Provisions in our certificate of incorporation andbylaws may have the effect of delaying or preventing a change of control orchanges in our management. These provisions include the following:

 

•                  Vacancies created by the expansion of the board of directors, or theresignation, death or removal of a director may be filled only by a majority ofthe remaining directors, even though less than a quorum, or by a sole remainingdirector, and not by the stockholders.

 

•                  Our certificate of incorporation does not provide for cumulative voting inthe election of directors. This limits the ability of minority stockholders toelect director candidates. Members of the board of directors may only beremoved for cause and upon the affirmative vote of the holders of a majority ofour capital stock entitled to vote.

 

•                  Our certificate of incorporation provides for the board of directors to bedivided into three classes, each with staggered three-year terms. As a result,only one class of directors will be elected at each annual meeting ofstockholders, and each of the two other classes of directors will continue toserve for the remainder of their respective three-year term, limiting theability of stockholders to reconstitute the board of directors.

 

•                  Our bylaws provide that the holders of a majority of our capital stockentitled to vote constitute a quorum for the conduct of business at a meetingof stockholders. However, the holders of at least two-thirds of our outstandingvoting stock must approve any amendments to the protective provisions of ourcertificate of incorporation and bylaws, which include the requirements thatactions by stockholders be taken at duly called meetings and not by writtenconsent, and that our board of directors be divided into three classes withstaggered terms.

 

•                  Our bylaws provide that special meetings of the stockholders can be calledonly by the board of directors, the chairman of the board or the president, andnot by any stockholder. Our bylaws also prohibit the conduct of any businessother than as specified in the notice of special meeting or as otherwisebrought before the meeting by the board of directors. These provisions maydiscourage or deter a potential acquirer from conducting a solicitation ofproxies to elect the acquirer’s own slate of directors or otherwise attemptingto obtain control of us.

 

•                  Our board of directors may issue, without stockholder approval, shares ofpreferred stock with rights, preferences and privileges determined by the boardof directors. The ability to authorize and issue preferred stock with voting orother rights or preferences makes it possible for our board of directors toissue preferred stock with super voting, special approval, dividend or otherrights or preferences on a discriminatory basis that could impede the successof any attempt to acquire us.

 

•                  We are subject to certain Delaware anti-takeover provisions. Under Delawarelaw, a corporation may not engage in a business combination with any holder of15 percent or more of its capital stock unless the holder has held thestock for three years or, among other things, the board of directors hasapproved the

 

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transaction in which such person became such an interested stockholder. Ourboard of directors could rely on Delaware law to prevent or delay an acquisitionof us.

 

ITEM3.  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK

 

**InterestRate Risk**

 

Our exposure to market risksfor changes in interest rates relates primarily to our investment portfolio. Asof June 30, 2005, our short-term investments consisted of highly-liquidauction rate securities, U.S. and Canadian corporate notes, and U.S. governmentsecurities.  Due to the short-term natureof our investment portfolio, we do not believe that an immediate 10% increaseinterest rates would have a material effect on the fair market value of ourinvestment portfolio. We believe that we have the ability to liquidate thisportfolio in short order and we do not expect our operating results or cashflows to be materially affected to any significant degree by a sudden change inmarket interest rates on our investment portfolio.

 

**ForeignCurrency Risk**

 

Our exposure to adversemovements in foreign currency exchange rates is primarily related to nominalpayments to international website publishers. A hypothetical change of 10% inforeign currency exchange rates would not have a material impact on ourfinancial statements or results of operations. All of our sales are denominatedin U.S. dollars.

 

ITEM 4.  CONTROLS AND PROCEDURES

 

***QuarterlyControls Evaluation and Related CEO and CFO Certifications***

 

Our Chief Executive Officer,Kurt Johnson, and Chief Financial Officer, Fred Krupica, with the participationof our management, evaluated the effectiveness of the design and operation ofour disclosure controls and procedures as of the end of the period covered bythis quarterly report. Based upon that evaluation, the Chief Executive Officerand the Chief Financial Officer believe that, as of the end of the periodcovered by this report, the Company’s disclosure controls and procedures areeffective in timely making known to them material information relating to theCompany required to be included in this report.

 

Attached as exhibits to thisquarterly report are certifications of the Chief Executive Officer and the ChiefFinancial Officer, which are required in accordance with Rule 13a-14 ofthe Exchange Act. This “Controls and Procedures” section includes theinformation concerning the controls evaluation referred to in the certificationsand it should be read in conjunction with the certifications for a morecomplete understanding of the topics presented.

 

***Definition ofDisclosure Controls and Procedures***

 

Disclosure controls andprocedures are methods designed to reasonably assure that information requiredto be disclosed in our reports filed under the Exchange Act, such as thisquarterly report, is recorded, processed, summarized and reported within thetime periods specified in the Securities and Exchange Commission’s rules andforms. Disclosure controls and procedures are also designed to reasonablyassure that such information is accumulated and communicated to our management,including the Chief Executive Officer and Chief Financial Officer, asappropriate, to allow timely decisions regarding required disclosure.

 

***Limitations onthe Effectiveness of Disclosure Controls and Procedures.***

 

Disclosure controls andprocedures, no matter how well designed and implemented, can provide onlyreasonable assurance of achieving a company’s disclosure objectives. Thelikelihood of achieving such objectives is affected by limitations inherent indisclosure controls and procedures. These include the fact that human judgmentin decision-making can be faulty and that breakdowns in internal control canoccur because of human failures such as simple errors, mistakes or intentionalcircumvention of the established processes.

 

***Changes inInternal Control over Financial Reporting***

 

There was no change in theCompany’s internal control over financial reporting, known to the ChiefExecutive Officer or the Chief Financial Officer, which occurred during theperiod covered by this quarterly report that has

 

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materially affected, or isreasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

**PART II.  OTHER INFORMATION**

 

ITEM1.  LEGAL PROCEEDINGS

 

Not applicable.

 

ITEM2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

 

**Recent Sales of UnregisteredSecurities**

 

During the quarter ended June 30,2005, we issued an aggregate of 134,500 shares of common stock upon exercise ofstock options for aggregate consideration of $0.2 million.  We issued these shares of common stock intransactions exempt from registration under the Securities Act pursuant to Rule 701promulgated thereunder.

 

**Use of Proceeds**

 

We completed our initialpublic offering on April 6, 2005.  Themanaging underwriters of the public offering were Credit Suisse First Boston andCitigroup. In the offering, we sold an aggregate of 5,649,860 shares of ourcommon stock at a price to the public of $12.00 per share.  Also in the offering, our stockholders sold 850,140shares for their own accounts also at a price to the public of $12.00 pershare; we received none of the proceeds of those sales.

 

The aggregate proceeds were $78.0million, of which the aggregate gross proceeds to us were approximately $67.8million. We paid expenses of approximately $7.3 million, of which approximately$4.7 million represented underwriting discounts and commissions andapproximately $2.6 million represented expenses related to the offering. Netproceeds from the offering to us were approximately $63.1 million. Weclassified the net proceeds of the offering as common stock subscribed andclassified the other offering costs incurred of approximately $2,667,000 as areduction to additional paid-in capital in the accompanying unaudited balancesheet as of June 30, 2005.  In connection with the closing of theoffering, each of the Company’s 2,131,285 shares of redeemable convertible preferredstock converted into five shares of common stock, or 10,656,425 shares ofcommon stock.  As a result, upon theclosing of the offering, we had 19,464,280 shares of common stock issued andoutstanding with no exercise by the underwriters of their over-allotmentoption.  As of June 30, 2005,substantially all of the net proceeds were invested in short-term,interest-bearing, investment grade securities, U.S. and Canadian corporatenotes, and U.S. government securities.

 

None of the net proceedsreceived by us from the initial public offering were paid directly orindirectly to any director or officer of Fastclick, or to any person owning 10%or more of any class of equity securities of Fastclick. We expect that our useof proceeds from the offering will conform to the intended use of proceedsdescribed in our final initial public offering prospectus dated March 31,2005.

 

ITEM 3.   DEFAULTS UPON SENIORSECURITIES.

 

Not applicable.

 

ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

 

There were no matters submitted to a vote ofsecurity holders during the quarter ended June 30, 2005.

 

ITEM 5.   OTHER INFORMATION.

 

Not applicable.

 

ITEM 6.   EXHIBITS.

 

The exhibits to this report are listed in the Exhibit Indexon page 41 of this report.

 

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**SIGNATURES**

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 
| Date: August 12, 2005 |                      |
|----------------------------|---------------------------|
|                       |                      |
|                       |                      |
|                       | FASTCLICK, INC.           |
|                       |                      |
|                       |                      |
|                       | /s/ Kurt A. Johnson       |
|                       | Kurt A. Johnson           |
| * *                   | *Chief Executive Officer* |
| * *                   | * *                  |
| * *                   | * *                  |
|                       | /s/ Fred J. Krupica       |
|                       | Fred J. Krupica           |
| * *                   | *Chief Financial Officer* |

 

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**EXHIBIT INDEX**

 
| **Exhibit  Number**** ** | ** ** | **Description of Exhibit **                                                                                                                                                                |
|-------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                          |       |                                                                                                                                                                                            |
| 31.1                          |       | Certification of Chief Executive Officer Pursuant to  Rule 13a-14(a) of the Securities Exchange Act of 1934, Adopted  Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|                          |       |                                                                                                                                                                                            |
| 31.2                          |       | Certification of Chief Financial Officer Pursuant to  Rule 13a-14(a) of the Securities Exchange Act of 1934, Adopted  Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|                          |       |                                                                                                                                                                                            |
| 32                            |       | Certification Pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                              |

 

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