**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 MARCH 31, 2005**                                                                                                                                                |
|                                                                                                                                                                                                   |       |                                                                                                |
| **Or**                                                                                                                                                                                                 |
|                                                                                                                                                                                                   |       |                                                                                                |
| **o**                                                                                                                                                                                                  | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|                                                                                                                                                                                                   |       |                                                                                                |
| **For the  transition period from                 to              ** |
|                                                                                                                                                                                                   |       |                                                                                                |
| **Commission  file number 000-51226**                                                                                                                                                                  |

 

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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 Olive  Street**                                            |
| **Santa  Barbara, California 93101**                             |
| (Address of principal  executive offices, including zip code)    |
|                                                             |       |                                  |
| **(805) 568-5334**                                               |
| (Registrant’s telephone  number, including area code)       |

 

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Indicate by check mark whether the registrant:(1) has filed all reports required to be filed by Section 13 or 15(d)of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past90 days: Yes  o  No  ý

 

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

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date.

 
| **Class**                                | ** ** | **Outstanding at May 11, 2005** |
|------------------------------------------|------------|---------------------------------|
| Common Stock, Par Value $0.001 per share |       | 19,598,780 shares               |

 

 

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**FASTCLICK, INC.**

**INDEX TOFORM 10-Q FOR THE**

**QUARTERLYPERIOD ENDED MARCH 31, 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.     |       | Changes  in 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  and Reports on Form 8-K                                                           |       |
|         |       | Signature                                                                                   |       |
|         |       | Exhibit Index                                                                               |       |

 

1

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**PARTI.  FINANCIALINFORMATION**

ITEM1.  FINANCIALSTATEMENTS

 

**FASTCLICK, INC.BALANCE SHEETS(Dollars in thousands, except share and per share data)**

** **
| ** **                                                                                                                                                                                                                                                         | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                                         | ** ** | **(unaudited)**     | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                         |       |                |       |                        |       |
| Current assets:                                                                                                                                                                                                                                                    |       |                |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                                                                                          |       | $                   | 10,480     |                        | $          | 12,397 |   |
| Short-term investments                                                                                                                                                                                                                                             |       | 8,000               |       | 7,954                       |       |
| Accounts receivable, net of allowance of  $771 (2005) and $591 (2004)                                                                                                                                                                                              |       | 10,568              |       | 9,003                       |       |
| Prepaid expenses and other current assets                                                                                                                                                                                                                          |       | 443                 |       | 232                         |       |
|                                                                                                                                                                                                                                                               |       |                |       |                        |       |
| Total current assets                                                                                                                                                                                                                                               |       | 29,491              |       | 29,586                      |       |
|                                                                                                                                                                                                                                                               |       |                |       |                        |       |
| Property and equipment, net                                                                                                                                                                                                                                        |       | 2,317               |       | 2,078                       |       |
| Other assets                                                                                                                                                                                                                                                       |       | 2,036               |       | 2,219                       |       |
|                                                                                                                                                                                                                                                               |       |                |       |                        |       |
| Total assets                                                                                                                                                                                                                                                       |       | $                   | 33,844     |                        | $          | 33,883 |   |
|                                                                                                                                                                                                                                                               |       |                |       |                        |       |
| **LIABILITIES  AND STOCKHOLDERS’  EQUITY (DEFICIT)**                                                                                                                                                                                                          |       |                |       |                        |       |
| Current liabilities:                                                                                                                                                                                                                                               |       |                |       |                        |       |
| Accounts payable                                                                                                                                                                                                                                                   |       | $                   | 6,520      |                        | $          | 5,695 |   |
| Deferred revenue                                                                                                                                                                                                                                                   |       | 687                 |       | 738                         |       |
| Accrued payroll                                                                                                                                                                                                                                                    |       | 1,360               |       | 2,048                       |       |
| Accrued other liabilities                                                                                                                                                                                                                                          |       | 1,068               |       | 410                         |       |
| Income taxes payable                                                                                                                                                                                                                                               |       | 288                 |       | 77                          |       |
| Current portion of loans payable                                                                                                                                                                                                                                   |       | —              |       | 46                          |       |
| Deferred income taxes                                                                                                                                                                                                                                              |       | 307                 |       | 500                         |       |
|                                                                                                                                                                                                                                                               |       |                |       |                        |       |
| Total current liabilities                                                                                                                                                                                                                                          |       | 10,230              |       | 9,514                       |       |
|                                                                                                                                                                                                                                                               |       |                |       |                        |       |
| Long-term portion of loans payable, net of  current portion                                                                                                                                                                                                        |       | —              |       | 75                          |       |
| Deferred tax liabilities                                                                                                                                                                                                                                           |       | 951                 |       | 806                         |       |
|                                                                                                                                                                                                                                                               |       |                |       |                        |       |
| Total long-term liabilities                                                                                                                                                                                                                                        |       | 951                 |       | 881                         |       |
|                                                                                                                                                                                                                                                               |       |                |       |                        |       |
| Total liabilities                                                                                                                                                                                                                                                  |       | 11,181              |       | 10,395                      |       |
|                                                                                                                                                                                                                                                               |       |                |       |                        |       |
| Commitments and contingencies                                                                                                                                                                                                                                      |       |                |       |                        |       |
| Redeemable convertible preferred stock, no  par value; 0 shares authorized, issued or outstanding at March 31, 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 March  31, 2005, 0 shares authorized, issued and outstanding as of December 31, 2004                                                                    |       | —              |       | —                      |       |
| Common stock; $0.001 par value, 100,000,000  shares authorized, 19,464,280 shares issued and outstanding as of March 31,  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 |       | 19                  |       | 8,395                       |       |
| Common stock subscribed                                                                                                                                                                                                                                            |       | (63,052             | )          | —                      |       |
| Additional paid-in capital                                                                                                                                                                                                                                         |       | 87,300              |       | —                      |       |
| Deferred compensation                                                                                                                                                                                                                                              |       | (5,767              | )          | (7,249                      | )          |
| Treasury stock                                                                                                                                                                                                                                                     |       | —              |       | (54,386                     | )          |
| Retained earnings                                                                                                                                                                                                                                                  |       | 4,163               |       | 3,312                       |       |
|                                                                                                                                                                                                                                                               |       |                |       |                        |       |
| Total stockholders’ equity (deficit)                                                                                                                                                                                                                          |       | 22,663              |       | (49,928                     | )          |
|                                                                                                                                                                                                                                                               |       |                |       |                        |       |
| Total liabilities and stockholders’ equity  (deficit)                                                                                                                                                                                                         |       | $                   | 33,844     |                        | $          | 33,883 |   |

 

See accompanying notes.

 

2

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**FASTCLICK, INC.STATEMENTS OF INCOME(in thousands, except per share amounts)**

 
| ** **                                  | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------------|------------|-----------------------------------|------------|
| ** **                                  | ** ** | **2005**                          | ** ** | **2004** | ** ** |
| ** **                                  | ** ** | **(unaudited)**                   | ** ** |
| ** **                                  | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Revenue                                     |       | $                                 | 19,623     |   | $ | 10,922 |   |
| Cost of revenue (a)                         |       | 12,851                            |       | 7,380 |   |
|                                        |       |                              |       |   |   |
| Gross profit                                |       | 6,772                             |       | 3,542 |   |
| Operating costs:                            |       |                              |       |   |   |
| Sales and marketing                         |       | 2,462                             |       | 893 |   |
| Technology                                  |       | 613                               |       | 373 |   |
| General and administrative                  |       | 1,576                             |       | 404 |   |
| Stock-based compensation (b)                |       | 731                               |       | — |   |
|                                        |       |                              |       |   |   |
| Total operating costs                       |       | 5,382                             |       | 1,670 |   |
|                                        |       |                              |       |   |   |
| Operating income                            |       | 1,390                             |       | 1,872 |   |
| Interest and dividend income                |       | 98                                |       | 6 |   |
| Interest expense                            |       | (1                                | )          | (2 | ) |
|                                        |       |                              |       |   |   |
| Income before provision for income taxes    |       | 1,487                             |       | 1,876 |   |
| Provision for income taxes                  |       | 636                               |       | 43 |   |
|                                        |       |                              |       |   |   |
| Net income                                  |       | $                                 | 851        |   | $ | 1,833 |   |
|                                        |       |                              |       |   |   |
| Earnings per share:                         |       |                              |       |   |   |
| Basic                                       |       | $                                 | 0.26       |   | $ | 0.17 |   |
| Fully diluted                               |       | $                                 | 0.06       |   | $ | 0.17 |   |
|                                        |       |                              |       |   |   |
| Weighted average common shares outstanding: |       |                              |       |   |   |
| Basic                                       |       | 3,317                             |       | 10,748 |   |
| Fully diluted                               |       | 14,456                            |       | 11,065 |   |

 

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(a)Stock-based compensation charges are included in the following statement ofincome category:

 
| Cost of revenue |   | $ | 10 |   | $ | — |   |
|-----------------|--------|---|----|--------|---|--------|--------|

 

(b)Stock-based compensation charges are excluded from the following statement ofincome categories:

 
| Sales and marketing        |   | $   | 391    |   | $      | — |   |
|----------------------------|--------|-----|--------|--------|--------|--------|--------|
| Technology                 |   | 124 |   | — |   |
| General and administrative |   | 216 |   | — |   |
|                       |   | $   | 731    |   | $      | — |   |

 

See accompanying notes.

 

3

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**FASTCLICK, INC.STATEMENTS OF CASH FLOWS(in thousands)**

 
| ** **                                                                         | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| ** **                                                                         | ** ** | **(unaudited)**                        | ** ** |
|                                                                               |       |                                   |       |   |   |
| **Cash flow from operating activities:**                                           |       |                                   |       |   |   |
| Net income                                                                         |       | $                                      | 851        |   | $ | 1,833 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities: |       |                                   |       |   |   |
| Amortization of deferred compensation                                              |       | 741                                    |       | — |   |
| Depreciation and amortization                                                      |       | 294                                    |       | 82 |   |
| Deferred income taxes                                                              |       | (48                                    | )          | — |   |
| Changes in operating assets and liabilities:                                       |       |                                   |       |   |   |
| Accounts receivable                                                                |       | (1,565                                 | )          | (930 | ) |
| Prepaid expenses and other current assets                                          |       | (211                                   | )          | (28 | ) |
| Other assets                                                                       |       | —                                 |       | 4 |   |
| Accounts payable                                                                   |       | (38                                    | )          | 1,816 |   |
| Deferred revenue                                                                   |       | (51                                    | )          | 155 |   |
| Accrued payroll                                                                    |       | (688                                   | )          | 172 |   |
| Accrued other liabilities                                                          |       | 515                                    |       | (68 | ) |
| Income taxes payable                                                               |       | 211                                    |       | 43 |   |
|                                                                               |       |                                   |       |   |   |
| Net cash provided by operating activities                                          |       | 11                                     |       | 3,079 |   |
|                                                                               |       |                                   |       |   |   |
| **Cash flow from investing activities:**                                           |       |                                   |       |   |   |
| Purchase of short-term investments                                                 |       | (46                                    | )          | — |   |
| Purchase of property and equipment                                                 |       | (476                                   | )          | (92 | ) |
| Purchase of domain names                                                           |       | —                                 |       | (63 | ) |
| Software development costs                                                         |       | (670                                   | )          | — |   |
|                                                                               |       |                                   |       |   |   |
| Net cash used in investing activities                                              |       | (1,192                                 | )          | (155 | ) |
|                                                                               |       |                                   |       |   |   |
| **Cash flow from financing activities:**                                           |       |                                   |       |   |   |
| Financing services                                                                 |       | (737                                   | )          | (25 | ) |
| Net borrowings under loans payable                                                 |       | (121                                   | )          | (7 | ) |
| Proceeds from sale of common stock                                                 |       | 122                                    |       | 9 |   |
| Distributions to shareholders                                                      |       | —                                 |       | (1,706 | ) |
|                                                                               |       |                                   |       |   |   |
| Net cash used in financing activities                                              |       | (736                                   | )          | (1,729 | ) |
|                                                                               |       |                                   |       |   |   |
| Increase (decrease) in cash and cash  equivalents                                  |       | (1,917                                 | )          | 1,195 |   |
| Cash and cash equivalents, beginning of  period                                    |       | 12,397                                 |       | 1,657 |   |
|                                                                               |       |                                   |       |   |   |
| Cash and cash equivalents, end of period                                           |       | $                                      | 10,480     |   | $ | 2,852 |   |
|                                                                               |       |                                   |       |   |   |
| Supplemental disclosures to the statements of cash flows were as  follows:         |       |                                   |       |   |   |
|                                                                               |       |                                   |       |   |   |
| Cash paid for income taxes                                                         |       | $                                      | 472        |   | $ | — |   |
|                                                                               |       |                                   |       |   |   |
| Supplemental disclosure of cash flow  information:                                 |       |                                   |       |   |   |
| Conversion of preferred stock to common  stock                                     |       | $                                      | 73,416     |   | $ | — |   |
| Initial public offering, net of costs of  issuance                                 |       | $                                      | 60,513     |   | $ | — |   |
| Common stock subscribed                                                            |       | $                                      | (63,052    | ) | $ | — |   |
| Retirement of treasury stock                                                       |       | $                                      | 54,386     |   | $ | — |   |
| Conversion of no par value common stock to  $0.001 par value common stock          |       | $                                      | (7,776     | ) | $ | — |   |
| Deferred compensation, net                                                         |       | $                                      | (740       | ) | $ | — |   |

 

See accompanying notes.

 

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**FASTCLICK, INC.NOTES TO FINANCIAL STATEMENTS(All interim information relating to the three monthsended March 31, 2005 and 2004 is unaudited)**

 

**1. TheCompany 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.

 

Fastclickwas incorporated on March 31, 2000 under the laws of California, and on March29, 2005 reincorporated under the laws of Delaware. The Company’s headquartersare 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 is not necessarily indicative of results to be expected for theentire year.

 

Thesefinancial statements have been prepared in accordance with the rules andregulations 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 oromitted pursuant to such rules and regulations. These financial statements should be read in conjunction with thefinancial statements and the notes thereto included in the Company’sRegistration Statement on Form S-1 initially filed on December 22, 2004,as subsequently amended (the “Registration Statement”) (FileNo. 333-121528).

 

OnMarch 29, 2005, the Company completed a five-for-one stock split of itsoutstanding common stock.  All share and per share amounts for all periodspresented in this report reflect this split.  Prior to the consummation ofthe Company’s initial public offering on April 6, 2005, the Company amended andrestated its certificate of incorporation to authorize 100,000,000 sharescommon stock, $0.001 par value, and 10,000,000 shares of preferred stock,$0.001 par value, and retire all of its 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 subchapter Scorporation 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 September28, 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 quarter ended March 31, 2004. Under state laws,certain taxes (net of available tax credits) are imposed upon subchapter Scorporations and are provided for in the accompanying financial statements. Asa subchapter S corporation, the Company’s policy was to disburse the necessaryamount of funds to satisfy the stockholders’ estimate of income tax liabilitiesbased upon the Company’s taxable income.

 

Asa C corporation, the Company is taxed at statutory corporate rates. Deferredtax assets and liabilities are recognized for the tax consequences attributableto differences between the financial statement carrying amounts of existingassets and liabilities and their respective tax bases. Deferred tax assets andliabilities are measured using

 

5

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enactedtax rates expected to apply to taxable income in the years in which thosetemporary differences are expected to be recovered or settled. A deferred taxasset valuation allowance will be recorded if it is more likely than not thatall or a portion of the recorded deferred tax assets will not be realized.

 

*Earnings per*share—Basicearnings per share is calculated using the weighted average common sharesoutstanding for the period, and excludes dilutive securities. Diluted earningsper share reflects the dilution to earnings that would occur if employee stockoptions and other dilutive securities resulted in the issuance of common stock.The weighted average number of shares used for basic and diluted earnings pershare were as follows (in thousands, except per share amounts):

** **
| ** **                                               | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                               | ** ** | **2005**                          | ** ** | **2004** | ** ** |
| ** **                                               | ** ** | **(unaudited)**                   | ** ** |
| Numerator:                                               | ** ** | ** **                        | ** ** | ** ** | ** ** |
| ** **                                               | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Net income                                               |       | $                                 | 851        |   | $ | 1,833 |   |
|                                                     |       |                              |       |   |   |
| Denominator:                                             |       |                              |       |   |   |
| Weighted average common shares  outstanding—basic   |       | 3,317                             |       | 10,748 |   |
| Effect of dilutive securities:                           |       |                              |       |   |   |
| Employee stock options                                   |       | 622                               |       | 317 |   |
| Redeemable convertible preferred stock                   |       | 10,538                            |       | — |   |
|                                                     |       |                              |       |   |   |
| Weighted average common shares  outstanding—diluted |       | 14,477                            |       | 11,065 |   |
|                                                     |       |                              |       |   |   |
| Basic earnings per share                                 |       | $                                 | 0.26       |   | $ | 0.17 |   |
|                                                     |       |                              |       |   |   |
| Diluted earnings per share                               |       | $                                 | 0.06       |   | $ | 0.17 |   |

 

*Recent Accounting Pronouncements*—On December 16, 2004, the FinancialAccounting Standards Board (FASB) issued its final standard on accounting forShare-Based Payment in FASB Standard 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 interim orannual reporting period of the registrant’s first fiscal year beginning on orafter June 15, 2005. The Company intends to adopt the standard in the quarterending March 31, 2006, or earlier, and could adopt the new standard in one oftwo ways-the modified prospective transition method or the modifiedretrospective transition method.

 

**2.Commitments and Contingencies**

 

InApril 2005, the Company began leasing office space in Los Angeles, Californiafor sales and marketing purposes.  Thelease term is through November 2010.  Ascollateral for performance by the Company of its obligations under the 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 throughApril 2006.

 

TheCompany has existing legal claims against it and may encounter future legalclaims in the normal course of business. In the opinion of the Company, the resolution of the existing legalclaims is not expected to have a material impact on the Company’s financialposition, results of operations or cash flows. During the three months ended March 31, 2005 the Company recorded acharge to operations of approximately $95,000 for the settlement of one ofthese claims.

 

**3.Deferred Compensation**

 

TheCompany accounts for stock options using the intrinsic-value method under APBNo. 25. Accordingly, the Company has recorded deferred compensation of$5,767,000 through March 31, 2005 for the difference between the originalexercise price per share determined by the Board of Directors and the estimatedfair value per share of the underlying common stock at the options’ respectivegrant dates, net of amortization and reversals upon employee terminations.  Deferred compensation is recognized andamortized on a straight-line basis over the vesting period of

 

6

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therelated options, generally four years. The Company recorded no deferredcompensation or compensation expense under APB No. 25 prior to the thirdquarter of 2004 as the exercise prices of all option grants in those periodswere at the deemed fair value of the underlying common stock. Compensationexpense under APB No. 25 related to stock options granted to the Company’semployees was $741,000 and $0 for the three months ended March 31, 2005 and2004, respectively.

 

Hadthe Company recognized employee stock option related compensation expense inaccordance with SFAS No. 123 and used the minimum-value method for determiningthe weighted average fair value of options granted, the net income would havebeen as follows (in thousands, except per share amounts):

 
| ** **                                                                                  | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                  | ** ** | **2005**                          | ** ** | **2004** | ** ** |
| ** **                                                                                  | ** ** | **(unaudited)**                   | ** ** |
| ** **                                                                                  | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Net income as reported                                                                      |       | $                                 | 851        |   | $ | 1,833 |   |
| Less: Deferred stock-based compensation as  if the fair value method was used               |       | 94                                |       | — |   |
| Pro forma net income                                                                        |       | $                                 | 757        |   | $ | 1,833 |   |
|                                                                                        |       |                              |       |   |   |
| Basic earnings per share as reported                                                        |       | $                                 | 0.26       |   | $ | 0.17 |   |
| Per share effect of deferred stock-based  compensation as if the fair value method was used |       | (0.03                             | )          | — |   |
| Pro forma basic earnings per share                                                          |       | $                                 | 0.23       |   | $ | 0.17 |   |
|                                                                                        |       |                              |       |   |   |
| Fully diluted earnings per share as  reported                                               |       | $                                 | 0.06       |   | $ | 0.17 |   |
| Per share effect of deferred stock-based  compensation as if the fair value method was used |       | (0.01                             | )          | — |   |
| Pro forma fully diluted earnings per share                                                  |       | $                                 | 0.05       |   | $ | 0.17 |   |

 

Thecompensation portion of the Company’s stock option grants was estimated at thedate of the grant using the minimum-value option-pricing model with thefollowing assumptions:

 
| ** **                   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|------------------------------|------------|------------|------------|------------|------------|
| ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Risk-free interest rate      |       | 4.07       | %          | 3.38       | %          |
| Expected option life (years) |       | 5.00       |       | 5.00       |       |
| Dividend yield               |       | 0.00       | %          | 0.00       | %          |

 

Forpurposes of pro forma disclosures, the estimated fair value of the options isamortized ratably over the option’s vesting period. The pro forma effect on netincome for the periods presented is not representative of the pro forma effecton net income in future periods because compensation expense in future periods couldreflect the amortization of a greater or lesser number of stock options grantedin succeeding periods. Stock-based awards granted after the Company’s initialpublic offering of its common stock are valued using the Black-Scholes optionpricing model. In addition to the factors used to estimate the fair value ofstock options issued using the minimum-value method, the Black-Scholes modelconsiders the expected volatility of the Company’s stock price, determined inaccordance with SFAS 123, in arriving at an estimated fair value. Theminimum-value method does not consider stock price volatility.

 

**4. Initial Public Offering**

 

On March 31, 2005 the Company agreed to sell5,649,860 shares of common stock at a price of $12.00 per share in its initialpublic offering.  On April 6, 2005 theCompany received proceeds from the offering of $63,052,000, net of underwritingdiscounts and commissions.  Accordingly,the net proceeds of the offering are classified as common stock subscribed andthe other offering costs incurred of approximately $2,539,000 are classified asa reduction to additional paid-in capital in the accompanying unaudited balancesheet as of March 31, 2005.  In connection with the closing of theoffering, each of the Company’s 2,131,285 shares of redeemable convertiblepreferred stock converted into five shares of common stock, or 10,656,425shares of common stock in total.  As aresult, upon the closing of the offering, there were 19,464,280 shares ofcommon stock issued and outstanding.

 

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

 

**Special Note Regarding Forward-Looking Statements**

 

This report contains “forward-looking statements”within the meaning of Section 27A of the Securities Act of 1933, asamended, and Section 21E of the Securities Exchange Act of 1934, asamended. In making such statements, we must rely on estimates and assumptionsdrawn in light of our experience and our perception of historical trends,current conditions and expected future developments, as well as other factorswe believe are appropriate under the circumstances. These estimates andassumptions are inherently subject to significant business, economic andcompetitive uncertainties, many of which are beyond our control. Theseuncertainties and contingencies could affect actual results and could causeactual results to differ materially from those expressed or implied in anyforward-looking statements made by us, or on our behalf.

 

In particular, the words “expect,” “anticipate,” “estimate,”“may,” “will,” “should,” “intend,” “believe,” and similar expressions areintended to identify forward-looking statements. In light of the risks anduncertainties inherent in all forward-looking statements, you should notconsider the inclusion of forward-looking statements in this report to be a representationby us or any other person that our objectives or plans will be achieved.

 

Risks and uncertainties that could cause actualresults to differ from our forward-looking statements include those discussedunder the caption “Management’s Discussion and Analysis of Financial Conditionand Results of Operations—Factors That May Affect Future Results ofOperations” and elsewhere in this report.

 

We undertake no obligation to update ourforward-looking statements to reflect events or circumstances after the date ofthis report or to reflect the occurrence of unanticipated events.

 

The “Fastclick” family of related marks, images andsymbols are our properties, trademarks and service marks. All other tradenames, trademarks and service marks appearing in this report are the propertyof their respective owners.  Referencesto “Fastclick” “we,” “us,” “our,” or similar terms refer to Fastclick, Inc.

 

**General**

 

We are a provider of performance-based Internetadvertising technologies and services to advertisers and website owners, orpublishers. Our technologies and services, including our proprietaryOptimization Engine, Internet ad placement bidding system, and reporting andcampaign management tools, are designed to improve the effectiveness ofInternet ad campaigns and provide advertisers with an increased return on theiradvertising expenditures. We believe our technologies and services also enhancethe value of Internet advertising space available on our network of third-partywebsites.

 

Ouradvertisers include direct response marketers, brand marketers and advertisingagencies. We represent advertisers in a variety of industries, includingtravel, financial services, education, telecommunications, retail, automotive,entertainment, finance, pharmaceutical and health and information technology,either directly or indirectly through an advertising agency.  Our publishers include publishers of brandedwebsites that offer large amounts of advertising space as well as a substantialnumber of websites that reach Internet users with highly-targeted demographicsand interests.

 

**Overview**

 

***Our History***

 

We were founded inMarch 2000 and engaged primarily in the development of our proprietarytechnologies throughout 2000. We began generating revenue in 2000, and havesince 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.

 

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Our early operationswere financed with $0.4 million of equity financing in March 2000.Thereafter, we financed our operations primarily through internally generatedfunds through September 2004. On September 28, 2004, we sold 2,131,285shares of our preferred stock, (which converted into 10,656,425 shares ofcommon stock prior to the completion of our initial public offering) at a priceper share of $35.19, for total proceeds of approximately $75 million.Approximately $55 million of these proceeds were used to repurchase1,562,944 shares (on a pre-split basis, or 7,814,720 shares after giving effectto our five-for-one stock split) of our common stock held by our founders,employees and investors at $35.19 per share. We made a final cash distributionto our former subchapter S corporation stockholders of approximately$3.2 million on December 16, 2004. Approximately $18.5 million of our net proceeds from the sale ofour preferred stock remains on our balance sheet as cash, cash equivalents andshort-term investments and we expect to use these funds to finance our futuregrowth. On April 6, 2005,we completed our initial public offering of 5,649,860 shares of common stock ata price of $12.00 per share, and received proceeds of $63,052,000, net ofunderwriting discounts and commissions.

 

From our inception toDecember 31, 2001, we operated as a C corporation. EffectiveJanuary 1, 2002, we elected to be taxed as a subchapter S corporationfor federal and state income tax purposes. For the years ended December 31,2002 and 2003 and the period from January 1, 2004 throughSeptember 27, 2004, we did not incur any provision for federal incometaxes as the income, deductions, gains, losses, tax credits and other taxattributes of the corporation for these periods passed through and were taxeddirectly to the stockholders. We were subject to a 1.5% California subchapterS corporation income tax during these periods. We made distributions toour stockholders of $0.6 million, $4.4 million and $7.1 millionfor the years ended December 31, 2002, 2003 and 2004, respectively. Oursubchapter S corporation status was revoked on September 27, 2004 inconnection with the issuance of our preferred stock and we now operate as aC corporation and are subject to federal and state tax in the UnitedStates.

 

We have grown ouremployee base from three employees at inception to 103 employees as of March31, 2005. While we have increased the number of our employees in all areas, ourhighest growth has been in our sales and marketing departments. We expect ourheadcount to continue to grow as our business expands. We have two officelocations in Santa Barbara, California, including our corporate headquarters,and in April 2005, beganleasing office space in Los Angeles, California. We currentlyhave sales and marketing employees in San Francisco, Los Angeles and New YorkCity. We lease server space in San Jose, California and Ashburn, Virginia.

 

***Our Business Model***

 

We generate revenue primarily from the sale ofInternet advertising space across our network of websites. Advertising space onthis network of websites is priced through our ad placement bidding system,which values advertising space based on market demand by matching theadvertisers bidding the highest price for the advertising space that meetstheir campaign objectives with the websites able to supply that space, subjectto certain rules that may be set by us, our advertisers or our publishers.

 

We offer advertisers multiple pricing options toachieve their desired results. These alternatives include:

 

•                  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.

 

Whilewe allow advertisers to purchase website advertising space based on acost-per-action, cost-per-click or cost-per-thousand impressions pricing model,we pay for a majority of our publishers’ website advertising space on acost-per-thousand impressions basis. This allows our publishers to be paid forthe impressions they serve and our advertisers to receive the performance-basedpricing model they desire for their advertising campaigns.

 

Our standardadvertising contract covers both campaign management and ad delivery. Wegenerally bill advertisers on a 30-day, net basis, although a portion of ouradvertisers prepay us for their campaigns. Our

 

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advertising contractsare terminable at any time by the advertiser or us with no penalty upon one businessday prior notice. Our standard publishers’ agreement covers the provision anduse of Internet advertising campaigns and the related payments. We typicallypay our publishers within 25 business days after the end of the monthunder the revenue-sharing provisions of our publisher’s agreement. Under theseagreements we generally pay them up to 65% of the advertising revenue wegenerate from ads placed on their websites. We can terminate our publisher’sagreement at any time without penalty.

 

**Componentsof Gross Margin**

 

***Sources of Revenue***

 

We principally deriverevenue from the sale of Internet advertising space across our network ofwebsites. With respect to the Internet advertising services we provide toadvertisers, we recognize revenue when the advertising impression is served(for cost-per-thousand impressions contracts) or when the specified click orother 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. Our revenuerecognition policy is discussed in more detail in the section below entitled “CriticalAccounting Policies and the Use of Estimates—Revenue Recognition.”

 

***Cost of Revenue***

 

Cost of revenueconsists primarily of amounts we incur and pay to our publishers for theirshare of revenue we derive from the sale of their website advertising spaceand, to a lesser extent, the cost of maintaining the computer systemsinfrastructure which supports our proprietary technologies, the salaries andbenefits of network operations personnel, bandwidth and communications costs,depreciation of network infrastructure equipment and the cost of databasemaintenance and support.

 

**Componentsof our Operating Costs and Other Items**

 

The following describescertain line items in our statement of operations:

 

***Operating Costs***

 

Our operating costsinclude sales and marketing, technology, general and administrative andstock-based compensation. Since we expect the growth of our operating expensesto be driven, in part, by the growth of our business, we are currently unableto accurately estimate the anticipated increases in these costs.

 

*Salesand marketing.*    Oursales and marketing expenses primarily consist of the compensation andassociated costs for sales and marketing personnel, marketing and advertising,public relations and other promotional activities, general business developmentactivities, publisher acquisition and product development expenses. We expectsales and marketing expenses to increase in absolute terms with the growth ofour business as we expand our sales and marketing workforce and further promoteour products and services.

 

*Technology.*    Technology costs include expenses for the researchand development of new technologies designed to enhance our Internetadvertising services and costs associated with the maintenance andadministrative support of our technology team, including the salaries andrelated expenses for our research and development, as well as costs forcontracted 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.

 

*Generaland administrative.*    Ourgeneral and administrative expenses primarily consist of the compensation andassociated costs for general and administrative personnel and facility costs.We expect that general and administrative expenses will increase in absoluteterms as we hire additional personnel and incur costs related to theanticipated growth of our business and our operation as a public company.

 

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*Stock-basedcompensation.*    Wehave recorded stock-based compensation expense for some of our equity awardsprovided to employees and non-employee directors. Our accounting policy forrecognizing stock-based compensation expense is described in the section belowentitled “Critical Accounting Policies and the Use of Estimates—Accounting forStock-Based Compensation.” As of March 31, 2005, we had an aggregate of $5.8million of deferred stock-based compensation expense, which will be recognizedover the next four years as the related awards vest.

 

We expect sales andmarketing, technology and general and administrative operating expenses toincrease quarter over quarter commensurate with our expected revenue growthover the same periods. The largest impact on these expenses relate to publiccompany costs, which we estimate to be approximately $2 million for 2005.We expect to fund the increase in these expenses by future cash flow from operations,our current cash position and funds generated by our initial public offering.

 

***Income Taxes***

 

Accounting for incometaxes is discussed in more detail in the section below entitled “CriticalAccounting Policies and Use of Estimates—Accounting for Income Taxes.”

 

**Trendsthat Affect our Business**

 

Our business has grownrapidly since our inception in March 2000, and we expect that it willcontinue to grow; however, we anticipate that our growth rate will slow as ourrevenue base increases. We expect that some of the historical trends orpatterns in our business will change over time, and in managing and evaluatingour 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 in loweroverall revenue for us. In addition, to the extent that the lower priced adformats do not have a correspondingly lower revenue share payment, they couldresult 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, both as a percentage of revenue, and in absolute dollars, willincrease. In addition, as we continue to grow, we expect to hire additionaltechnology personnel and expand to new facilities.

 

•*General and administrative*.    Weanticipate that our general and administrative expenses will increase over thenext several quarters as we incur expenses related to being a public company,including increased legal, accounting and insurance expenses. We estimateincreased expenses related to public company costs of approximately$2 million for 2005. In addition, as we continue to grow, we expect tohire additional senior management personnel and expand to new facilities.

 

•*Seasonality and cyclicality*.    Webelieve that our business is subject to seasonal and cyclical fluctuations.Generally, our advertisers and advertising agencies place more ads in thefourth calendar quarter and fewer ads in the first calendar quarter of eachyear. Overall Internet usage generally declines during the summer months,resulting in lower inventories in our website network and lower revenue for us.In addition, domestic advertising spending generally is cyclical in reaction tooverall conditions in the United States economy. Our rapid historical growthrate has masked the impact of seasonality on our business. As our growth rateslows, however, we expect the seasonal pattern of our business to become morepronounced.

 

•*Volume of advertising space*.    Overthe past several years our website network and advertising space volume haveincreased significantly. In order to continue to grow our revenue we mustincrease the volume of advertising space that we are able to sell toadvertisers. We anticipate that our ability to grow advertising space volumewill be influenced by a number of factors including the size of our websitenetwork and Internet advertising market dynamics such as sector consolidation.

 

•*Provision for income taxes.*    Fromour inception to December 31, 2001 we operated as a C corporation.From January 1, 2002 through September 27, 2004 we operated as a subchapterS corporation. In connection with the issuance of our preferred stock oursubchapter S corporation status was revoked and we now operate as aC corporation. During the period we were a subchapter S corporation,we did not incur any provision for federal income taxes and we were subject toa 1.5% California income tax. As a C corporation, we will now payC corporation income taxes. We currently anticipate our effective tax rateto be approximately 43%, excluding the effects of any future tax credits.

 

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**Results ofOperations**

 

The following table sets forth the items in ourstatements of income for the periods indicated as a percentage of revenue: 

 
| ** **                   | ** ** | **Three Months Ended  March 31** | ** ** |
|------------------------------|------------|----------------------------------|------------|
| ** **                   | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| ** **                   | ** ** | **(unaudited)**                  | ** ** |
| ** **                   | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Revenue                      |       | 100.0                            | %          | 100.0 | % |
| Cost of revenue              |       | 65.5                             |       | 67.6 |   |
|                         |       |                             |       |   |   |
| Gross profit                 |       | 34.5                             |       | 32.4 |   |
| Operating costs:             |       |                             |       |   |   |
| Sales and marketing          |       | 12.6                             |       | 8.2 |   |
| Technology                   |       | 3.1                              |       | 3.4 |   |
| General and administrative   |       | 8.0                              |       | 3.7 |   |
| Stock-based compensation     |       | 3.7                              |       | — |   |
|                         |       |                             |       |   |   |
| Total operating costs        |       | 27.4                             |       | 15.3 |   |
|                         |       |                             |       |   |   |
| Operating income             |       | 7.1                              |       | 17.1 |   |
| Interest and dividend income |       | 0.5                              |       | — |   |
| Interest expense             |       | —                           |       | — |   |
|                         |       |                             |       |   |   |
| Income before income taxes   |       | 7.6                              |       | 17.1 |   |
| Provision for income taxes   |       | 3.3                              |       | 0.4 |   |
|                         |       |                             |       |   |   |
| Net income                   |       | 4.3                              | %          | 16.7 | % |

 

***Comparison of the Quarters EndedMarch 31, 2005 and 2004***

 

*Revenue.    *Revenue increased to $19.6 million inthe first quarter of 2005 from $10.9 million in the first quarter of 2004,a 79.7% increase. This increase was primarily due to an increase in the numberof paid ads delivered across our website network offset partially by a slightdecrease in the average price of existing ad formats as compared to the prioryear period and by a shift in mix toward new, lower priced advertising formats.We expect revenue to continue to increase during 2005 and, 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.

 

*Cost of revenue.*    Cost of revenueincreased to $12.9 million, or 65.5% of revenue, in the first quarter of 2005from $7.4 million, or 67.6% of revenue, in the first quarter of 2004.  This increase in absolute dollars was primarilydue to an increase in the volume of advertising sold to advertisers resultingin increased publisher revenue-share costs. The percentage of revenue we sharedwith publishers declined slightly which resulted in improved gross margins in2005 as we continued to pay our publishers primarily on a cost-per thousandimpressions basis while continuing our shift to cost-per-action andcost-per-click priced advertising campaigns. We anticipate that our cost ofrevenue will increase in absolute terms as our revenue increases, and willdecrease slightly as a percentage of revenue as advertisers continue to shiftto cost-per-action and cost-per-click based pricing models.

 

*Sales and marketing.*     Sales and marketingexpenses increased to $2.5 million, or 12.6% of revenue, in the first quarterof 2005 from $0.9 million, or 8.2% of revenue, in the first quarter of 2004.This increase in sales and marketing expenses was primarily the result ofhiring additional sales and marketing personnel, combined with expanded marketingand advertising costs. We anticipate that our sales and marketing expenses willincrease over the next several quarters as we expect to hire additional salesand marketing personnel and expand to new facilities to accommodate our growingsales and marketing team.

 

*Technology.*    Technology expensesincreased to $0.6 million, or 3.1% of revenue, in the first quarter of 2005from $0.4 million, or 3.4% of revenue, in the first quarter of 2004.  This increase in our technology expenses

 

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primarilyresulted from the employment costs of additional personnel. We expect ourtechnology expenses to increase slightly in absolute terms as we grow andcontinue to invest in new technologies and hire additional personnel.

 

*General and administrative.*     General andadministrative expenses increased to $1.6 million, or 8.0% of revenue, in thefirst quarter of 2005 from $0.4 million, or 3.7% of revenue, in the firstquarter of 2004. This increase in general and administrative expenses wasprimarily due to the employment cost of additional administrative personnel toprepare us for operation as a public company and to support growth of thecompany, and an increased allowance for doubtful accounts. We expect that generaland administrative expenses will increase in absolute terms during theremainder of 2005 as we bear the increased insurance and compliance costs ofoperating as a public company.

 

*Stock-based compensation.*    We have recordeddeferred stock-based compensation for some of our equity awards provided toemployees and non-employee directors. Stock-based compensation expenseincreased to $0.7 million, or 3.7% of revenue, in the first quarter of 2005from $0 in 2004. The increase in stock-based compensation was primarily aresult of recognizing the intrinsic value of our stock option grants during theperiod. As of March 31, 2005, we had an aggregate of $5.8 million ofdeferred compensation, which will be recognized over the next four years as therelated awards vest.  During the first quarter of 2005, we recorded deferred stock-basedcompensation to stockholders equity of $1.0 million related to the finalremeasurement of the grant of options.  We reversed $1.7 million ofdeferred stock-based compensation during the first quarter of 2005 upon theresignation of an employee.

 

*Interest and dividend income andinterest expense.*    Interestand dividend income when offset by interest expense increased to $0.1 million,or 0.5% of revenue, in the first quarter of 2005, from $4,000 in the firstquarter of 2004. The change was primarily a result of increasing averagebalances in our money market account and short term investments.  We expect interest and dividend income toincrease during the remainder of 2005 as we invest the cash proceeds from ourinitial public offering.

 

*Provision for income taxes.*    Provision for incometaxes increased to $0.7 million, an effective tax rate of 42.8%, in the firstquarter of 2005 from $43,000, an effective tax rate of 2.3%, in 2004. Duringall of 2003 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 the issuance of our preferred stock and we now operate as aC corporation and are subject to federal and state income tax in theUnited States.  We currently expect oureffective tax rate to be approximately 43% during the remainder of 2005,excluding the effects of any future tax credits.

 

**Liquidity and Capital Resources**

 

We have financed our operations principally throughinternally generated funds as well as private sales of equity securities andour initial public offering.

 

Our principal sources of liquidity are our cash,cash equivalents and short-term investments as well as the cash flow that wegenerate from our operations. Short-term investments consist of highly liquidauction rate securities as of March 31, 2005.

 

Our net cash provided by operating activities was$11,000 in the first quarter of 2005, as compared to $3.1 million in thefirst quarter of 2004. Net cash provided by operating activities during thefirst quarter of 2005 was primarily due to our net income before deductingamortization of deferred compensation and depreciation and amortization, andgrowth in accrued other liabilities and income taxes payable, offset by increasesin accounts receivable and accrued payroll.

 

Accounts receivable from our advertisers hasincreased with our revenue growth. Our accounts receivable balance increased by$1.6 million during the first quarter of 2005 and by $0.9 millionduring the first quarter of 2004.  Thegrowth in accounts receivable is anticipated to continue if our revenuecontinues to increase and this will continue to have a significant impact onour cash flows from operations.  Ouraccounts payable balance increased by $1.8 million during the first quarter of2004, due to the timing of payments to our publishers.

 

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Our net cash used in investing activities was$1.2 million in the first quarter of 2005 compared to $0.2 million inthe first quarter of 2004. During the first quarter of 2005, we invested $0.7million in software development and $0.5 million in property andequipment, including capital expenditures to enhance our server infrastructure.We expect to continue to invest in our facilities and technology to support ouroperations and remain competitive and expect to spend approximately $1.5million to $2.0 million in capital expenditures in the remainder of 2005.

 

Our net cash used in financing activities was$0.7 million in the first quarter of 2005 and $1.7 million in the firstquarter of 2004. During the first quarter of 2005, we paid $0.7 million of the$2.5 million of costs of our initial public offering.  Cash used in financing activities during thefirst quarter of 2004 was for distributions to stockholders during the timeperiod that we elected to be treated as a subchapter 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 operationsare to make the required payments to our website publishers, as well as tocover operating expenses and meet future tax obligations. We expect that ourfuture cash 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 flow from operations has generated sufficient cash tocover our operations and meet obligations. Although our historical cash flowsare not a predictor of future cash flows, we expect that future revenues andrelated collections should be sufficient to meet our anticipated obligationsand we believe our current cash, cash equivalent and short-term investmentposition is sufficient to cover any disparity in timing between receipt of ourrevenues and payment of our expenses. Factors which impact the timing of ourreceipt of revenue include competitive conditions in our industry for extendingcredit to customers, the financial health of our customers and their ability tomake payments to us in accordance with the credit terms we established withthem. The timing of payments for our expenses are dependent on the amounts andtiming of services and obligations contracted for, however, we currentlyanticipate no material change in the timing of payments we make to ourpublishers.  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 March 31, 2005,we had no outstanding debt securities, material contingent liabilities ormaterial mortgages or liens.

 

**Critical Accounting Policies and the 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 underdifferent assumptions 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.

 

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***Revenue Recognition***

 

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 for Stock-Based Compensation***

 

We account for stock-based employee compensationarrangements in accordance with the provisions of Accounting Principles Board,or APB, Opinion No. 25, “Accounting for Stock Issued to Employees” andrelated interpretations, and comply with the disclosure requirements of SFASNo. 123, “Accounting for Stock-Based Compensation.” Under APB OpinionNo. 25, compensation cost, if any, is recognized over the respectivevesting period based on the difference between the deemed fair value of ourcommon stock and the exercise price on the date of grant. We account fornon-employee stock-based awards, in which goods or services are theconsideration received for the equity instruments issued, in accordance withthe provisions of SFAS No. 123 and related interpretations. We haverecorded 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.

 

Duringthe first quarter of 2005, we granted stock options with exercise pricesranging from $5.00 per share to $12.00 per share resulting in deferredstock-based compensation of $1.0 million for the three month period endedMarch 31, 2005.  We reversed $1.7 millionof deferred stock-based compensation during the first quarter of 2005 upon theresignation of an employee. All stock options granted to our employees,officers and directors under our equity plans were intended to be exercisableat a price per share not less than the deemed fair value of the shares of ourcommon stock underlying those options or awards on their respective dates ofgrant. Because there has not been a public market for our shares prior to ourinitial public offering, our board of directors determined these exerciseprices in good faith, based on the best information available to the board andour management at the time of grant.

 

We recognizecompensation expense as we amortize the deferred stock-based compensationamounts on a straight-line basis over the related vesting periods, generallyover three to four years.  See “—Results of Operations—Stock-BasedCompensation.”

 

During 2004 and thethree months ended March 31, 2005, we recorded deferred stock-basedcompensation to stockholders equity of $7.9 million and $1.0 million,respectively, related to the final remeasurement of the grant of options.  Wereversed $1.7 million of deferred stock-based compensation during the firstquarter of 2005 upon the resignation of an employee.

 

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

 

We perform ongoingcredit evaluations of our customers and adjust credit limits based upon paymenthistory and the customer’s current credit worthiness, as determined by a reviewof their current credit information. We regularly monitor collections andpayments from our customers and maintain a provision for estimated creditlosses based upon historical experience and any specific customer collectionissues that have been identified. While such credit losses have historicallybeen within our expectations and the provisions established, we cannot guaranteethat we will continue to experience the same credit loss rates that have beenexperienced in the past.

 

The allowance fordoubtful accounts for estimated losses results from the inability of ourcustomers to make required payments. If the financial condition of ourcustomers were to deteriorate, resulting in an impairment of their ability tomake payments, additional allowances may be required.

 

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***Short-Term Investments***

 

We record an impairmentcharge when we believe our short-term investments have experienced a decline invalue that is other than temporary. Future adverse changes in market conditionsor poor operating results of underlying investments could result in losses oran inability to recover the carrying value of the investments that may not bereflected in an investment’s current carrying value, thereby possibly requiringan impairment charge in the future. As of March 31, 2005, our short-term investments consisted ofhighly-liquid auction rate securities.

 

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

 

In accordance with SOP98-1, “Accounting for the Costs of Computer Software Developed or Obtained forInternal Use,” we capitalize and amortize over the expected life of a softwareasset the costs incurred during the application development stage including thefollowing: (1) external direct costs of materials and services consumed indeveloping or obtaining software, (2) payroll and payroll-related costsfor employees who are directly associated with and who devote time to theproject, and (3) interest costs incurred, when material. We expense thecosts of research, during the preliminary project stage and costs incurred fortraining and maintenance.

 

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

 

We assess impairment ofour other long-lived assets in accordance with the provisions of SFASNo. 144, “Accounting for the Impairment or Disposal of Long-lived Assets.”An impairment review is performed whenever events or changes in circumstancesindicate that the carrying value may not be recoverable. Factors considered byus 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 thatthe carrying value of a long-lived asset may not be recoverable based upon theexistence of one or more of the above indicators of impairment, we estimate thefuture undiscounted cash flows expected to result from the use of the asset andits eventual disposition. If the sum of the expected future undiscounted cashflows and eventual disposition is less than the carrying amount of the asset,we recognize an impairment loss. We report an impairment loss in the amount bywhich the carrying amount of the asset exceeds the fair value of the asset,based on the fair market value if available, or discounted cash flows if not.To date, we have not had an impairment of long-lived assets.

 

***Accounting for Income 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 consequences of temporary differences between thecarrying 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 March 31, 2005 there wasno valuation allowance against net deferred tax assets. If we determine in thefuture that it is more likely than not that we will realize any future deferredtax assets for which we previously provided a valuation allowance, we wouldreduce the existing valuation allowance and recognize income in the amount ofthe reduction. Conversely, if we determine that we would not be able to realizeany future recorded net deferred tax asset, we would increase the valuationallowance and recognize the increase as a charge to our results of operationsin 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 thecorporation pass through were taxed directly to the stockholders for 2002, 2003and the period from January 1, 2004 through September 27, 2004. OnSeptember 27, 2004, we revoked our subchapter S corporation statusand we now operate as a C corporation. Under SFAS 109, in connectionwith the revocation of

 

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subchapterS, we recognized both a federal and state income tax provision in the amount of$1.2 million and $0.2 million, respectively, arising from the changefrom non-taxable subchapter S to taxable entity status as aC corporation.

 

Inaddition, we operate within multiple domestic taxing jurisdictions and aresubject to audit in those jurisdictions. These audits can involve complexissues, which may require an extended period of time for resolution. Althoughwe believe that our financial statements reflect a reasonable assessment of ourincome tax liability, it is possible that the ultimate resolution of theseissues could significantly differ from our original estimates.

 

***Contingencies and Litigation***

 

We evaluate contingentliabilities including threatened or pending litigation in accordance with SFASNo. 5, “Accounting for Contingencies” and record accruals when the outcomeof these matters is deemed probable and the liability is reasonably estimable.We make these assessments based on the facts and circumstances and in someinstances based in part on the advice of outside legal counsel.

 

***Proceeds of Initial Public Offering***

 

On March 31, 2005, we agreed to sell 5,649,860shares of common stock at a price to the public of $12.00 per share in ourinitial public offering.  The aggregategross proceeds to us from the public offering were approximately $67.8 million.We incurred expenses of approximately $7.2 million, of which approximately $4.7million represented underwriting discounts and commissions and approximately$2.5 million represented expenses related to the offering. Net proceeds to usfrom the offering were $63.1 million. We classified the net proceeds of theoffering as common stock subscribed and classified the other offering costsincurred of approximately $2,539,000 as a reduction to additional paid-incapital in the accompanying unaudited balance sheet as of March 31, 2005. In connection 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 April 15, 2005, substantially all ofthe net proceeds were invested in money market funds or highly-liquidauction rate securities.

 

The principal purposes for our initial publicoffering are to increase our working capital, create a public market for ourcommon stock, facilitate our future access to the public capital markets andincrease our visibility in our markets. We intend to use the net proceeds fromour offering for working capital, expansion of our operations, investment innew product development and strategic initiatives, including spending anestimated $1.5 million to $2.0 million in capital expenditures in the remainderof 2005. We may use a portion of the net proceeds to partially fund theanticipated increase in our sales and marketing, technology and general andadministrative operating expenses, including an estimated $2 million inexpenses in 2005 related to public company costs. We may also use a portion ofthe net proceeds to pursue acquisition candidates to grow our advertising andpublishing base and access technology and talent. However, we have no presentunderstandings, commitments or agreements with respect to the acquisition ofother 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 expenditures willvary depending on the amount of cash generated by our operations, competitiveand technological developments and the rate of growth, if any, of our business.Accordingly, our management will have broad discretion in applying the netproceeds from our offering. Pending the uses described above, we intend toinvest the net proceeds from our offering in short-term, interest-bearing,investment-grade securities.

 

**Off-Balance Sheet Arrangements**

 

We do not have any outstanding derivative financialinstruments, off-balance sheet guarantees, interest rate swap transactions orforeign currency forward contracts, or any other off-balance sheetarrangements.

 

**Factors That May Affect Future Results of Operations**

 

*You should consider carefully thefollowing risks described below, together with the other information containedin this quarterly report and in our other public filings in evaluating ourbusiness. If any of the following risks actually occurs, our business,financial condition, results of operations and future growth prospects would*

 

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*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 inMarch 2000 and began offering Internet advertising technologies andservices in September 2000. Accordingly, we have a limited operatinghistory, and as a result, we have limited financial data that you can use toevaluate our business and prospects. In addition, we derive nearly all of ourrevenue from Internet advertising, which is an immature industry that hasundergone rapid and dramatic changes in its short history. Our business modelis also evolving, is distinct from other companies in our industry, and may notbe successful. As a result of these factors, the future revenue and incomepotential of our business is uncertain. Although we have experiencedsignificant revenue growth in recent periods, we may not be able to sustainthis growth. Any evaluation of our business and our prospects must beconsidered in light of these factors and the risks and uncertainties oftenencountered by companies in our stage of development. Some of these risks and uncertaintiesrelate 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 meet anticipatedgrowth 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.

 

**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;

 

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•                  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. For example, our chief marketingofficer, whom we hired in December 2004, recently resigned. In addition,the vesting of some of the stock options granted to two of our seniorexecutives, Mr. Krupica and Mr. Aviani, accelerated upon theconsummation of our initial public offering. 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 hire additional members of seniormanagement to adequately manage our growing business. We may not be able toidentify and attract additional qualified senior management. Competition forsenior management in our industry is intense. Qualified individuals are in highdemand, and we may incur significant costs to attract them. Volatility or lackof performance in our stock price may also affect our ability to attract andretain senior management. If we are unable to attract and retain qualifiedsenior management, we may not be able to implement our business strategyeffectively and our revenue may decline.

 

**We need to hire additionalqualified personnel to grow and manage our business. If we are unable to retainour existing personnel or attract qualified new personnel, we may not be ableto grow our business or effectively compete in our industry.**

 

Our performance depends on the talents and effortsof our employees. Our future success will depend on our ability to retain andmotivate our existing personnel and attract, retain and motivate additional,highly skilled personnel in all areas of our organization and, in particular,in our technology, finance, and sales and marketing teams. We plan to continueto grow our business and will need to hire additional personnel to support thisgrowth. We have experienced difficulties in attracting and retaining qualifiedpersonnel in the past, particularly in the Santa Barbara, California area whereour headquarters are located. If we experience difficulties attracting newqualified personnel in the future, our growth may be hindered. If we were tolose our existing personnel, our business would be harmed. Qualifiedindividuals are in high demand, and we may incur significant costs to attractthem. Some of our employees have also become, or will soon become,substantially vested in their stock option grants. Employees may be more likelyto leave us if the shares underlying their options have significantlyappreciated in value relative to the option exercise price. If we are unable toretain our existing personnel and attract and retain the additional personnelwe need to succeed, we may not be able to grow our business or effectivelycompete in our industry.

 

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**Our operating results havefluctuated in the past and may do so in the future, which could make ourresults of operations difficult to predict or cause them to fall short ofexpectations.**

 

Our prior operating results have fluctuated due tochanges in our business and the Internet advertising industry. Similarly, ourfuture operating results may vary significantly from quarter to quarter due toa variety of factors, many of which are beyond our control and could cause ourresults to be below investors’ expectations, causing the price of our commonstock to fall. Because our business is changing and evolving, our historicaloperating results may not be useful to you in predicting our future operatingresults. Factors that may increase the volatility of our operating resultsinclude 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, advertising spending has historicallybeen cyclical in nature, reflecting overall economic conditions as well asbudgeting and buying patterns. Our rapid growth has historically masked thecyclicality and seasonality of our business. As our rate of growth slows, weexpect that the cyclicality and seasonality in our business may become morepronounced and may in the future cause our operating results to fluctuate.

 

**If we fail to compete effectivelyagainst other Internet advertising companies, we could lose advertisers oradvertising space and our revenue may decline.**

 

The market for Internet advertising technologies andservices is intensely competitive. We expect this competition to continue toincrease because there are no significant barriers to entry into our market. Wecompete both for advertisers and for the high quality advertising space that isavailable through websites. We compete for advertisers on the basis of a numberof factors, including price, return on advertising expenditures, volume ofavailable advertising space and customer service.

 

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Our primary current and potential competitorsinclude:

 

•                  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 large Internet companies andtraditional media for a share of advertisers’ overall marketing 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 among websites, search engines,Internet service providers, or ISPs, as well as competition with traditionalmedia companies, could result in significant price pressure, declining margins,reductions in advertising revenue and loss of our market share. In addition, aswe continue to expand the scope of our services, we may compete with a greaternumber of websites, advertisers and traditional media companies across anincreasing range of different services, including in vertical markets wherecompetitors may have advantages in expertise, brand recognition and otherareas. Large websites with brand recognition, such as Yahoo!, AOL, Google andMSN, have direct sales personnel and substantial proprietary advertising spacethat provides a significant competitive advantage compared to our network ofwebsites and have significant impact on pricing for Internet advertising. Manyof our current and potential competitors also enjoy other competitiveadvantages over us, such as longer operating histories, larger advertiserbases, greater access to advertising space on high-traffic websites, andsignificantly greater financial, technical and marketing resources. As aresult, we may not be able to compete successfully. If we fail to deliveradvertising results that are superior to those that advertisers or websitescould achieve directly or through the use of our competitors, we could loseadvertisers or advertising space and revenue may decline.

 

**We depend on websites foradvertising space, and any decline in the supply of advertising space availablethrough our network could cause our revenue to decline or the cost to acquireadvertising space to increase.**

 

We generate a significant portion of our revenuefrom the advertising space provided by a limited number of websites. Expensesfor our top ten website publishers accounted for 21% and 26% of our publisherexpenses for the first quarter of 2005 and 2004, respectively. In mostinstances, website publishers can change the amount of advertising space theymake available to us at any time and therefore impact our revenue. In addition,website publishers may place significant restrictions on our use of theiradvertising space. These restrictions may prohibit ads from specificadvertisers or specific industries, or restrict the use of certain creativecontent or format. If a website publisher decides not to make advertising spaceavailable to us, or decides to demand a higher revenue share or placessignificant restrictions on the use of such advertising space, we may not beable to replace the space with advertising space from other websites thatsatisfy our requirements in a timely and cost-effective manner. In addition,the number of competing Internet advertising networks that acquire space fromwebsites continues to increase. We cannot assure you that we will be able toacquire advertising space that meets our advertisers’ performance, price andquality requirements. If any of these things occur, our revenue could decline orour cost of acquiring advertising space may increase.

 

**If we offer new technologies andservices that compete with products or services offered by our advertisers orwebsite publishers, we could lose advertisers or advertising space and ourrevenue could decrease.**

 

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We intend to expand the scope of our services anddevelop new technologies and services. As we do so, we will compete with agreater number of advertisers, website publishers and other media companiesacross an increasing range of markets, which may include advertisers orpublishers to whom we currently provide technologies and services. For example,we are currently developing a search engine advertising technology, which isdesigned to help advertisers manage their advertising campaigns across multiplethird-party Internet search engines, including bids for search terms. We arealso developing an Internet user targeting technology, which is designed togather, store and distribute to advertisers targeted Internet user contact andother information. 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.

 

**A substantial portion of ourrevenue is generated from a limited number of advertisers, and if we lose amajor advertiser our revenue could decrease.**

 

A substantial portion of our revenue is generatedfrom a limited number of advertisers and advertising agencies. Our advertiserscan generally terminate their contracts with us at any time, with no penaltyupon one business day prior notice. Our top ten advertisers accounted for 54%and 50% of our advertising revenue for the first quarter of 2005 and 2004,respectively. We expect that a limited number of advertisers may continue toaccount for a significant percentage of our revenue, and the loss of ormaterial reduction in their advertising purchases could decrease our revenueand harm our business.

 

**Because our advertiser contractsgenerally can be cancelled by the advertiser with no penalty upon one businessday prior notice, the cancellation of one or more contracts could result in animmediate decline in our revenue.**

 

We derive substantially all of our revenue fromInternet advertising campaigns under short-term contracts, most of which arecancelable with one business day prior notice. In addition, these contracts donot contain penalty provisions for cancellation before the end of the contractterm. The non-renewal, renegotiation, cancellation or deferral of largecontracts, or a number of contracts that in the aggregate account for asignificant amount of revenue, is difficult to anticipate and could result inan immediate decline in our revenue.

 

**We may pursue the acquisition ofother businesses in order to grow our advertiser and website base and accesstechnology and talent, which may not achieve the desired results or couldresult in operating difficulties, dilution and other harmful consequences.**

 

A component of our strategy is to acquire otherbusinesses in order to grow our advertiser and website base and accesstechnology and talent. However, suitable acquisition candidates may not beavailable on terms and conditions we find acceptable. In pursuing acquisitions,we will compete with other companies, many of which have greater financial andother resources than we do. Further, if we do succeed in consummatingacquisitions, these acquisitions could be material to our business, operatingresults and financial condition. Any future acquisition or investment mayrequire 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. In addition,acquisitions involve numerous risks, any of which could harm our business,including:

 

•                  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 business relationshipsand the reputations of the acquired businesses;

 

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•                  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 the acquisition of businessesoutside the United States. Foreign acquisitions involve unique risks inaddition to those mentioned above, including those related to integration ofoperations across different cultures and languages, currency risks and theparticular economic, political and regulatory risks associated with specificcountries.

 

**Interruption or failure of ourinformation technology and communications systems could impair our ability toeffectively deliver our technologies and services, which could cause us to loseadvertisers or advertising space and harm our operating results.**

 

Our delivery of technologies and services depends onthe continuing operation of our technology infrastructure and systems. Anydamage to or failure of our systems could result in interruptions in ourability to deliver ads quickly and accurately and to process users’ responses toads. Interruptions in our service could reduce our revenue and profits, and ourreputation could be damaged if people believe our system is unreliable. Oursystems are vulnerable to damage or interruption from earthquakes, terroristattacks, floods, fires, power loss, telecommunications failures, computerviruses or other attempts to harm our systems, and similar events. We havecritical systems in our Santa Barbara, California headquarters and lease serverspace in San Jose, California and Ashburn, Virginia. Our California facilitiesare located in areas with a high risk of major earthquakes. Our facilities arealso subject to break-ins, sabotage and intentional acts of vandalism, and topotential disruptions if the operators of these facilities have financialdifficulties. Some of our systems are not fully redundant, and our disasterrecovery planning cannot account for all eventualities. The occurrence of anatural disaster, a decision to close a facility we are using without adequatenotice for financial reasons or other unanticipated problems at our facilitiescould result in lengthy interruptions in our service.

 

We have experienced limited system failures in thepast and may in the future. Any unscheduled interruption in our service puts aburden on our entire organization and results in an immediate loss of revenue.If we experience frequent or persistent system failures, the attractiveness ofour technologies and services to advertisers and website publishers could bepermanently harmed. Our insurance policies may not adequately compensate us forany losses that occur due to failure in our systems. The steps we have taken toincrease the reliability and redundancy of our systems are expensive, reduceour operating margin and may not be successful in reducing the frequency orduration of unscheduled interruptions.

 

**Any constraints on the capacity ofour technology infrastructure could delay the effectiveness of our operationsor result in system failures, which could result in the loss of advertisers anda decline in our revenue.**

 

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Our future success depends in part on the efficientperformance of our software and technology infrastructure. As the numbers ofwebsites and Internet users increase, our technology infrastructure may not beable to meet the increased demand. A sudden and unexpected increase in thevolume of ads delivered by us or in user responses could strain the capacity ofour technology infrastructure. Any capacity constraints we experience couldlead to slower response times or system failures and adversely affect theavailability of ads, the number of ads delivered and the level of userresponses received, which could result in the loss of advertisers and a declinein our revenue.

 

**Our Internet advertisingtechnologies and services incorporate multiple proprietary technologies and ourintellectual property rights are key to the success of our business. If we donot adequately protect our intellectual property rights, our competitive positionmay suffer.**

 

We rely on a combination of patent, copyright,trademark and trade secret laws of the United States and other countries, andconfidentiality procedures to protect our intellectual property rights. Despiteour efforts to protect our intellectual property rights, unauthorized partiesmay attempt to copy or otherwise obtain and use our proprietary technology. Theuse of our intellectual property rights by others could reduce any competitiveadvantage we have developed and cause us to lose advertisers or websites orotherwise harm our business. We have from time to time become aware of thirdparties who we believe may have infringed on our intellectual property rights.The steps we currently take to monitor the unauthorized use of our proprietarytechnology are difficult and costly, and we cannot be certain that the steps wehave taken and continue to take will prevent unauthorized distribution and useof our proprietary technology, particularly in foreign countries, where thelaws may not protect our intellectual property rights as fully as in the UnitedStates. In addition, in the future it may become necessary for us to resort tolitigation to protect these rights, and any proceedings could be burdensome andcostly and we may not prevail.

 

**Third parties may sue us for ouruse of Internet advertising technologies or other intellectual property andallege that we have infringed on their intellectual property rights. Ifsuccessful, these lawsuits could require us to pay significant damage awards orcurtail our technology or service offerings.**

 

From time to time third parties have alleged that wehave infringed their intellectual property rights. We cannot be certain that wedo not and will not infringe the intellectual property rights of others and wemay be subject to legal proceedings and claims in the ordinary course of ourbusiness, including suits for intellectual property infringement or proceedingsto invalidate our intellectual property. Any intellectual property claims,whether or not meritorious, could result in costly litigation and could divertmanagement resources and attention. Moreover, should we be found liable forinfringement, we may be required to enter into licensing agreements (ifavailable on acceptable terms or at all), pay damages or limit or curtail ourproduct or service offerings. We may also need to redesign some of our productsor processes to avoid future infringement liability. Any of the foregoing couldprevent us from competing effectively and increase our costs.

 

**Our proprietary technologies,including our Optimization Engine, may include design or performance defectsand may not achieve their intended results, any of which could impair ourfuture revenue growth.**

 

Our Optimization Engine and other proprietarytechnologies are relatively new, and they may contain design or performancedefects that are not yet apparent. We cannot assure you that the use of ourproprietary technologies will achieve the intended results as effectively asother technologies that exist now or may be introduced by our competitors, inwhich case our business could be harmed.

 

In addition, we recently have spent significantresources developing our search engine advertising technology and Internet usertargeting technology which we currently intend to launch in the third quarterof 2005. If these technologies do not achieve the results we desire, ourexpected growth in future revenue and margins may not materialize. Our successalso depends on our ability to develop and introduce new proprietary technologiesthat address our advertisers’ and website publishers’ changing needs. Any newproducts that we develop may not achieve significant market acceptance. Ourcompetitors may introduce new products that compete with our proprietarytechnologies and render our proprietary technologies unmarketable. Developingnew technologies and services requires a significant commitment of technologyand other resources. If revenue generated from the use of our proprietarytechnologies does not cover our development costs, our results of operationsmay be harmed.

 

**If we are unable to accuratelyprice advertising space on our network, our margins and revenue may decline.**

 

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Our advertisers can purchase advertising space onour 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 advertiser pays for space, wepay the vast majority of our website publishers on a cost-per-thousandimpressions basis. However, the number of impressions it actually takes toachieve an action can be far greater than the number we anticipate. This canresult in us paying a higher price to our publishers for advertising space thanour advertisers pay us for that space. If we are unable to accurately convertadvertising campaigns that are priced on a cost-per-action or cost-per-clickbasis to an effective cost-per-thousand impressions based price that reflectsthe actual amount of impressions it takes to achieve an action or click, ourresults of operations will suffer. During the first quarter of 2005,approximately 36% of the advertising space on our network was purchased on acost-per-action basis and we paid the vast majority of our website publishersdisplaying these ads on a cost-per-thousand impressions basis. We expect thatadvertising purchased based on this pricing will increase over time.

 

**Any decrease in demand for ourtechnologies and services could substantially reduce our revenue.**

 

To date, substantially all of our revenue has beenderived from Internet advertising. We expect that Internet advertising willcontinue to account for substantially all our revenue in the future. However,our revenue from Internet advertising may decrease in the future for a numberof 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 advertising market is characterized byrapidly changing technologies, evolving industry standards, frequent newproduct and service introductions and changing user demands. The introductionof new products and services embodying new technologies and the emergence ofnew industry standards and practices can render existing products and servicesobsolete and unmarketable or require unanticipated investments in technology.Our future success will depend on our ability to adapt to rapidly changingadvertising formats and other technologies. 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 weintroduce are not ultimately

 

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successful,the time and resources we devoted to their development may be wasted. Wecurrently intend to launch our search engine advertising technology and ourInternet user targeting technology in the second or third quarter of 2005. Wehave spent significant resources developing these new technologies and expecttheir results to be material to our future growth. If we do not successfullyintroduce new technologies and services or if we fail to keep pace withtechnological developments and the introduction of new industry and technologystandards on a cost-effective basis, we could lose advertisers and advertisingspace and our revenue may decline.

 

**Changes in government regulationand industry standards applicable to the Internet could decrease demand for ourtechnologies and services or increase our costs.**

 

Laws and regulations that apply to Internetcommunications, commerce and advertising are becoming more prevalent. Theseregulations could affect the costs of communicating on the Internet and coulddecrease demand for our technologies and services or increase our costs.

 

In the United States, federal and state laws havebeen enacted regarding children’s privacy, copyrights, sending of unsolicitedcommercial email, user privacy, search engines, Internet tracking technologies,direct marketing, data security, pricing, sweepstakes, promotions, intellectualproperty ownership and infringement, trade secrets, export of encryptiontechnology, taxation and acceptable content and quality of goods. The EuropeanUnion has also adopted directives that may affect our ability to collect anduse information regarding Internet users in Europe. Other laws and regulationsmay be adopted in the future. This legislation could hinder growth in the useof the Internet generally, and decrease the acceptance of the Internet as acommunications, commercial and advertising medium.

 

Several recent federal laws could have an impact onour business. The Digital Millennium Copyright Act is intended, in part, tolimit the liability of eligible Internet service providers for listing orlinking to third-party websites that include materials that infringe copyrightsor other rights of others. The Children’s Online Protection Act and theChildren’s Online Privacy Protection Act are intended to restrict thedistribution of certain materials deemed harmful to children and imposeadditional restrictions on the ability of Internet services to collect userinformation 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 the Internet remain largelyunsettled, even in areas where there has been some legislative action. We arenot certain how our business might be affected by the application of existinglaws governing issues such as property ownership, copyrights, encryption andother intellectual property issues, libel, obscenity and export or importmatters to the Internet advertising industry. The vast majority of such lawswere adopted prior to the advent of the Internet. As a result, they do notcontemplate or address the unique issues of the Internet and relatedtechnologies. Changes in laws intended to address such issues could createuncertainty in the Internet market. It may take years to determine how existinglaws apply to the Internet and Internet advertising. Such uncertainty can makeit difficult to predict costs and could reduce demand for our technologies andservices or increase the cost of doing business as a result of litigation costsor increased service delivery costs.

 

The growth and development of the market forInternet commerce may prompt calls for more stringent laws and regulationsgoverning the Internet, both in the United States and abroad, which may imposeadditional burdens on companies conducting business over the Internet. Inaddition to governmental regulation, privacy advocacy groups and theadvertising, 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, regulations or industry guidelines relating to theInternet, or the application of existing laws to the Internet or Internet-basedadvertising.

 

**We may be subject to regulationsand taxes in locations from which our transmissions do not originate and we maynot accurately determine our tax liabilities, either of which could materiallyaffect our financial results.**

 

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Due to the global nature of the Internet, it ispossible that, although our transmissions originate in Santa Barbara,California, San Jose, California and Ashburn, Virginia, the governments ofother states or foreign countries might attempt to regulate our transmissionsor levy sales or other taxes relating to our activities. For example, we filetax returns in the states where we are required to by law, based on principlesapplicable to traditional businesses. However, one or more states could seek toimpose additional income tax obligations or sales tax collection obligations onout-of-state companies, such as us, that engage in or facilitate electroniccommerce. A number of proposals have been made at state and local levels thatcould impose such taxes on the sale of products and services through theInternet or the income derived from such sales. If adopted, these proposalscould substantially impair the growth of electronic commerce and seriously harmour profitability.

 

Thedetermination of our provision for income taxes and other tax liabilitiesrequires significant judgment and, in the ordinary course of our business,there are many transactions and calculations where the ultimate taxdetermination is uncertain. Although we believe our estimates are reasonable,the ultimate tax outcome may differ from the amounts recorded in our financialstatements and may materially affect our financial results in the period orperiods for which such determination is made.

 

**If the technology that we currentlyuse to target the delivery of Internet advertisements and to prevent fraud onour network is restricted by or becomes subject to regulation, our expensescould increase and we could lose advertisers or advertising space.**

 

Websites typically place small files ofnon-personalized, or anonymous, information, commonly known as cookies andaction tags, on an Internet user’s hard drive, generally without the user’sknowledge or consent. Cookies generally collect aggregate information aboutusers on a non-personalized basis to enable websites to provide users with amore customized experience. Cookie information is passed to the website throughan Internet user’s browser software. We use cookies to collect informationregarding the ads we deliver to Internet users and their interaction with theseads. An action tag functions similarly to a banner ad, except that the actiontag is not visible. Action tags may be placed on certain pages of a website,which enables us to measure an advertising campaign’s effectiveness in drivingInternet users to take specific actions. We use this information to identifyInternet users who have received our ads in the past and to monitor and preventpotentially fraudulent activity. In addition, our proprietary technologies usethis information to monitor the performance of ongoing advertising campaignsand plan future campaigns. Most currently available Internet browsers allowInternet users to modify their browser settings to prevent cookies from beingstored on their hard drives, and some users currently do so. Internet users canalso delete cookies from their hard drives at any time. Recently, technologieshave been developed, like the Platform for Privacy Preferences Project, or P3P,which limit the collection of cookie and action tag information. Finally, thirdparties have brought class action lawsuits against other companies relating tothe use of cookies, and we may be subject to similar lawsuits in the future.The use of such technologies or the results of such lawsuits could limit oreliminate our ability to use cookies and action tags.

 

Some Internet commentators and privacy advocateshave suggested limiting or eliminating the use of cookies and certain softwareprograms which allow the monitoring of Internet users’ activities without theirconsent; these programs are commonly known as “spyware.” Legislation has beenpassed or is pending in several states and in the United States Congress thatrestricts the use of certain of these types of technologies. For example, inCalifornia, the Consumer Protection Against Computer Spyware Act was passed andtook effect on January 1, 2005. In Utah, the Spyware Control Act took effect in2004, and regulates certain types of advertising software.   In March and April of 2005, Virginia’sgovernor signed the Computer Crimes Act, which provides criminal penalties forthe malicious, unauthorized installation of software on the computer ofanother, and the Arizona, Arkansas, Georgia and Washington state legislaturesall 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 Principles Yielding Better Levels of Consumer Knowledge, orSPY BLOCK Act, which would overlap significantly with the SPY Act.  In addition, the European Union has adopted adirective requiring that when cookies are used, the user must be informedregarding the use and purpose of cookies and provided instructions on how toremove cookies. The State Attorney General of New York has recently filed asuit alleging that use of spyware or adware violate state statutes againstfalse advertising and deceptive business practices and that it constitutes atrespass under New York common law.  Aconsumer class action case has also been filed in Illinois seeking damages andalleging that a marketing software for tracking web users and sending them popup ads and which is bundled with other free

 

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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 our publishers and advertisersto adhere to advertising standards that are designed to protect Internet users’privacy, including prohibitions against the use of spyware, and we monitor ournetwork to ensure compliance with these standards, it is unclear how newregulations and standards of business conduct will affect our 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.

 

Anyone or more of these occurrences could result in increased costs, require us tochange our business practices or divert management’s attention.

 

**New technologies could block ourability to serve advertisements, and may reduce demand for our technologies andservices.**

 

During the quarters ended March 31, 2005 and 2004,we derived approximately 40% and 55%, respectively, of our revenue from ourdeployment of pop-under ads across our network. Technologies have beendeveloped and distributed that are designed to block the appearance of pop-upand pop-under ads on website pages viewed by Internet users. These ad- blockingtechnologies may become more effective and their use may become morewidespread, and they may block the display of other current or future formatsthat we may use to deploy our ads. Substantially all of our revenue is derivedfrom fees paid to us by advertisers in connection with the display of ads onwebsites. As a result, ad-blocking technology could reduce demand for ourtechnologies and services and harm our business.

 

**Disputes with advertisers orwebsite publishers over our measurement of Internet user impressions, clicks oractions may cause us to lose advertisers and publishers.**

 

We earn advertising revenue and make payments towebsite publishers based on the number of impressions, clicks and actions fromads delivered on our network of websites. Advertisers’ and publishers’willingness to use our services and join our network will depend on the extentto which they perceive our measurements to be accurate and reliable.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.

 

**If our pricing models are notaccepted by our advertisers, we could lose advertisers and our revenue coulddecrease.**

 

Many of our technologies and services are offered toadvertisers based on cost-per-action or cost-per-click pricing models, underwhich advertisers only pay us if the user takes a specific action in responseto the ad, such as clicking on it or registering on a website. Theseperformance-based pricing models differ from the fixed-rate pricing model usedby many Internet advertising companies, under which these companies are paidbased on the number of times the ad is shown without regard to effectiveness.Our ability to generate significant revenue from advertisers will depend, inpart, on our ability to demonstrate the effectiveness of our primary pricingmodels to advertisers, who may be more accustomed to a fixed-rate pricingmodel. Furthermore, intense competition among websites and other Internet advertisingproviders has led to the development of a number of alternative pricing modelsfor Internet

 

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advertising.The proliferation of multiple pricing alternatives may confuse advertisers andmake it more difficult for them to differentiate among these alternatives. Inaddition, it is possible that new pricing models may be developed and gainwidespread acceptance that are not compatible with our business model or ourtechnologies. These alternatives, and the likelihood that additional pricingmodels will be introduced, make it difficult for us to project the levels ofadvertising revenue or the margins that we, or the Internet advertisingindustry in general, will realize in the future. If advertisers do notunderstand the benefits of our pricing models, then the market for our servicesmay decline or develop more slowly than we expect, which may limit our abilityto grow our revenue or cause our revenue to decline.

 

**Limitations on our ability to collectand use data derived from advertising campaigns could significantly diminishthe value of our technologies and services and cause us to lose advertisers andrevenue.**

 

When a user visits the websites on our network, weuse technologies, including cookies, to collect information such as the user’sIP address, ads delivered by us that have been previously viewed by the userand responses by the user to those ads. In order to determine the effectivenessof an advertising campaign by one of our advertisers and to determine how tomodify the campaign, we need to access and analyze this information. Certain ofour advertisers and publishers prohibit or limit our collection or use of thisdata. Interruptions, failures or defects in our data collection systems, aswell as privacy concerns regarding the collection of user data, could alsolimit our ability to analyze data from our advertisers’ advertising campaigns.If that happens, we may be unable to provide effective technologies andservices to advertisers and we may lose advertisers.

 

**We could lose advertisers if wefail to detect click-through fraud on advertisements in a manner that isacceptable to our advertisers.**

 

We are exposed to the risk of fraudulent clicks onour ads by individuals seeking to increase the advertising fees paid to ourwebsite publishers. We may in the future have to refund revenue that ouradvertisers have paid to us and that was later attributed to click-throughfraud. Click-through fraud occurs when an individual clicks on an ad displayedon a website for the sole intent of generating the revenue share payment to thepublisher rather than to view the underlying content. From time to time we haveexperienced fraudulent clicks on our network and we do not charge ouradvertisers for such fraudulent clicks. This negatively affects ourprofitability, and this type of fraudulent act could hurt our brand. Iffraudulent clicks are not detected, the affected advertisers may experience areduced return on their investment in our advertising programs, which couldlead the advertisers to become dissatisfied with our advertising campaigns, andin turn, lead to loss of advertisers and the related revenue.

 

**Consolidation of website publishersmay impair our ability to provide marketing services and acquire advertisingspace at favorable rates.**

 

The consolidation of Internet advertising networksand website publishers could eventually lead to a concentration of desirableadvertising space on a small number of networks and large websites. Suchconcentration could:

 

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

 

•                  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 of our advertisers areunable to pay for our technologies and services, we will lose the revenuerelated to the technologies and services we provided.**

 

Some of our advertisers have limited operatinghistories, are unprofitable and may not be able to pay for our services. In thepast we have lost advertisers, or have had difficulty collecting payments fromadvertisers, who could

 

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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 be liable for contentdisplayed on our network of websites which could increase our expenses.**

 

We may be liable to third parties for content in theads we deliver if the artwork, text or other content included in the adsviolates copyright, trademark, or other intellectual property rights of thirdparties or if the content is defamatory. From time to time we have receivednotice from third parties alleging that the content displayed on our networkinfringes their intellectual property rights. In the event any of theseallegations result in claims or counterclaims, it could be time-consuming,result in costly litigation and divert management’s attention.

 

**If the market for Internetadvertising fails to continue to develop, our future growth may be limited andour revenue may decrease.**

 

Our future success is highly dependent on thecontinued use and growth of the Internet as an advertising medium. The Internetadvertising market is relatively new and rapidly evolving, and it usesdifferent measurements than traditional media to gauge its effectiveness. As aresult, demand for and market acceptance of Internet advertising services isuncertain. Many of our current or potential advertisers have little or noexperience using the Internet for advertising purposes and have allocated onlylimited portions of their advertising budgets to the Internet. The adoption ofInternet advertising, particularly by those entities that have historicallyrelied upon traditional media for advertising, requires the acceptance of a newway of conducting business, exchanging information, measuring success andevaluating new advertising products and services. Such advertisers may findInternet advertising to be less effective for promoting their products andservices than traditional advertising media. They may never adopt Internetadvertising or cease using it. We cannot assure you that the market forInternet advertising will continue to grow or become sustainable. If the marketfor Internet advertising fails to continue to develop or develops more slowlythan we anticipate, our ability to grow may be limited and our revenue maydecrease.

 

**The advertising industry, includingInternet advertising, could be adversely affected by general economicdownturns, catastrophic events or declines or disruptions in industries thatadvertise heavily on the Internet and, as a result, our revenue may decline.**

 

The advertising industry, including Internetadvertising, is sensitive to both general economic and business conditions andto specific events, such as acts of terrorism. In addition, Internetadvertising spending can be affected by the condition of industries thatadvertise heavily on the Internet such as the travel, financial services,education, telecommunications, retail and entertainment industries. Some ofthese industries tend to be sensitive to event-driven disruptions such asgovernment 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.

 

**Changes to financial accountingstandards and new exchange rules could make it more expensive to issue stockoptions to employees, which will increase our compensation costs and may causeus to change our business practices.**

 

We prepare our financial statements to conform withGAAP in the United States. These accounting principles are subject tointerpretation by the Public Company Accounting Oversight Board, the SEC andvarious other bodies. A change in those policies could have a significanteffect on our reported results and may affect our reporting of transactionscompleted before a change is announced. For example, we have used stock optionsand other long-term equity incentives as a component of our employeecompensation packages. We believe that stock options and other long-term equityincentives directly motivate our employees to maximize long-term stockholdervalue and, through the use of vesting, encourage employees to remain with us.Several regulatory agencies and entities are considering regulatory changesthat could make it more difficult or expensive for us to grant stock options toemployees. In December 2004, the Financial Accounting Standards Boardissued a final standard that requires us to record a

 

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chargeto earnings for employee stock option grants. This standard will be effectivefor annual periods beginning after June 15, 2005. We could adopt thestandard in one of two ways—the modified prospective transition method or themodified retrospective transition method—and we have not concluded how we willadopt the new standard. In addition, regulations implemented by The NasdaqNational Market generally require stockholder approval for all stock optionplans, which could make it more difficult or expensive for us to grant stockoptions to employees. We will, as a result of these changes, incur increasedcompensation costs, which could be material and we may change our equitycompensation strategy or find it difficult to attract, retain and motivateemployees.

 

**We rely on bandwidth and datacenter providers, and other third parties for key aspects of the process ofproviding products and services to our advertisers and publishers, and anyfailure or interruption in the services and products provided by these thirdparties could disrupt our business and cause us to lose advertisers andadvertising space.**

 

We rely on third-party vendors, including datacenter and bandwidth providers. Any disruption in the network access orco-location services, which are the services that house and provide Internetaccess to our servers, provided by these third-party providers or any failureof these third-party providers to handle current or higher volumes of use couldsignificantly harm our business. Any financial or other difficulties ourproviders face may have negative effects on our business, the nature and extentof which we cannot predict. We exercise little control over these third-partyvendors, which increases our vulnerability to problems with the services theyprovide. We license technology and related databases from third parties tofacilitate aspects of our campaign reporting, analysis and storage of data, anddelivery of ads across our network. We have experienced and expect to continueto experience interruptions and delays in service and availability for suchelements. Any errors, failures, interruptions or delays experienced inconnection with these third-party technologies and information services couldnegatively impact our relationship with our advertisers and publishers andadversely affect our brand and our business and could expose us to liabilitiesto third parties.

 

Our systems also heavily depend on the availabilityof electricity, which also comes from third-party providers. If we were toexperience a major power outage, we would have to rely on back-up generators.These back-up generators may not operate properly through a major power outageand their fuel supply could also be inadequate during a major power outage.Information systems such as ours may be disrupted by even brief power outages,or by the fluctuations in power resulting from switches to and from backupgenerators. This could disrupt our business and cause us to lose advertisersand advertising space.

 

**We have recently implemented newfinancial and accounting systems which may not work as expected.**

 

We have recently implemented new financial andaccounting software and continue to refine the software’s process and financialreporting features. Additionally, we are in the process of upgrading certain ofour other information systems and internal controls. These systems are criticalto our operations and involve sensitive interactions between us and ouradvertisers and our website publishers. If we fail to successfully implementand integrate these new financial reporting and accounting systems, or we arenot able to scale these systems to our growth, we may not have adequate,accurate or timely financial information. Failure to have adequate, accurate ortimely financial information could result in advertiser or publisherdissatisfaction, disrupt our operations and adversely affect our results ofoperations and effect our ability to prepare financial information inaccordance with GAAP.

 

**If we fail to maintain an effectivesystem of internal controls, we may not be able to accurately report ourfinancial results or prevent fraud. As a result, current and potentialstockholders could lose confidence in our financial reporting, which would harmour business and the trading price of our stock.**

 

Effective internal controls are necessary for us toprovide reliable financial reports and effectively prevent fraud. We have inthe past discovered, and may in the future discover, areas of our internalcontrols that need improvement. For example, our auditors have identified theneed to hire additional financial employees and upgrade our accounting system.In addition, Section 404 of the Sarbanes-Oxley Act of 2002 will require usto evaluate and report on our internal controls over financial reporting andhave our independent auditors attest to our evaluation, beginning with ourAnnual 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

 

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Section 404will be expensive and time consuming, and will require significant attention ofmanagement. Although we believe our recent efforts will strengthen our internalcontrols we are continuing to work to improve our internal controls, includingin the areas of our accounting system. We cannot be certain that these measureswill ensure that we implement and maintain adequate controls over our financialprocesses and reporting in the future. Failure to implement required new orimproved controls, or difficulties encountered in their implementation, couldharm our operating results or cause us to fail to meet our reportingobligations. If we or our auditors discover a material weakness, the disclosureof that fact, even if quickly remedied, would reduce the market’s confidence inour financial statements and harm our stock price. In addition, a delay incompliance with Section 404 could subject us to a variety ofadministrative sanctions, including the suspension or delisting of our commonstock from The Nasdaq National Market and the inability of registeredbroker-dealers to make a market in our common stock, which would further reduceour stock price.

 

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

 

**Salesof a substantial number of shares of common stock in the public market may adverselyaffect the market price for our common stock.**

 

Immediately followingthe consummation of our initial public offering on April 6, 2005, we had19,382,880 shares of common stock outstanding, of which the 6,500,000 sharessold in that offering, are freely tradable without restriction or furtherregistration under the Securities Act, unless purchased by our “affiliates,” assuch term is defined under the Securities Act, in which case such shares willbe subject to the resale limitations but not the holding period requirements ofRule 144 under the Securities Act. We and our executive officers anddirectors, the selling stockholders and substantially all of our otherstockholders and option holders, have entered into 180-day lock-up agreementswith the underwriters. Holders of 285,360 shares (or shares issuable upon theexercise of outstanding options), in the aggregate, are not subject to alock-up agreement.  The lock-upagreements prohibit each of us from selling or otherwise disposing of ourshares of common stock except in limited circumstances. The lock-up agreementsare contractual agreements, and Credit Suisse First Boston LLC and CitigroupGlobal Markets Inc., at their discretion, can waive the restrictions ofany lock-up agreement at an earlier time without prior notice or announcementand allow the sale of shares of our common stock. If the restrictions in thelock-up agreements are waived, shares of our common stock will be available forsale into the public market, subject to applicable securities laws, which couldreduce the market price for shares of our common stock.

 

Under our investors’rights agreement, dated September 27, 2004, some of our stockholders havecustomary demand and piggyback registration rights. In addition, we intend tofile a registration statement under the Securities Act to register anaggregate of up to 4,000,000 shares of our common stock reserved for issuanceunder our 2005 Equity Incentive Plan. These shares, when issued in accordancewith the plans, will be eligible for immediate sale in the public market,subject to the 180-day lock-up restriction described above and Rule 144resale volume limitations if held by affiliates. We may also issue our commonstock in connection with acquisitions or investments. The sale of anyadditional shares of our common stock, or the perception of investors that sucha sale could take place, could depress the market price for our common stock.

 

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**Ourstock price may be volatile, and you may not be able to resell shares of ourcommon stock at or above the price you paid or at all.**

 

Our common stock hasbeen traded publicly for only a short period of time. We cannot predict theextent to which a trading market will develop or how liquid that market mightbecome. The trading price of our common stock could be subject to widefluctuations due to the factors discussed in this “Management’s Discussion andAnalysis of Financial Condition and Results of Operations—Factors That MayAffect Results of Operations” section and elsewhere in this report. Inaddition, the stock market in general, and The Nasdaq National Market andtechnology companies in particular, have experienced extreme price and volumefluctuations. Current trading prices and valuations may not be sustainable.Investor sentiment towards the market and our industry may adversely affect themarket price of our common stock, regardless of our actual operatingperformance. In addition, in the past, following periods of volatility in theoverall market and the market price of a company’s securities, securities classaction litigation has often been instituted against such companies. Thislitigation, if instituted against us, could result in substantial costs and adiversion of our management’s attention and resources.

 

**Ifsecurities or industry analysts do not publish research or reports about ourbusiness, or if they downgrade their recommendations regarding our commonstock, our stock price and trading volume could decline.**

 

The trading market forour common stock is influenced by the research and reports that industry orsecurities analysts publish about us or our business. If any of the analystswho cover us downgrade our common stock, our common stock price would likelydecline. If analysts cease coverage of us or fail to regularly publish reportson us, we could lose visibility in the financial markets, which in turn couldcause our common stock price or trading volume to decline and our common stockto be less liquid.

 

**Concentrationof ownership among our existing executive officers, directors and principalstockholders may prevent new investors from influencing significant corporatedecisions and may result in a lower trading price for our common stock than ifownership of our common stock was less concentrated.**

 

Our executive officers,directors and holders of 5% or more of our common stock and their affiliatesbeneficially owned, in the aggregate, approximately 52% of our outstandingcommon stock as of April 30, 2005. As a result, these stockholders, actingtogether, could have the ability to exert substantial influence over allmatters requiring approval by our stockholders, including the election andremoval of directors and any proposed merger, consolidation or sale of all orsubstantially all of our assets and other corporate transactions. Thisconcentration of control could be disadvantageous to other stockholders withinterests different from those of our executive officers, directors andprincipal stockholders. For example, our executive officers, directors andprincipal stockholders could delay or prevent an acquisition or merger even ifthe transaction would benefit other stockholders. In addition, this significantconcentration of common stock ownership may adversely affect the market pricefor our common stock because investors often perceive disadvantages in owningstock in companies with a concentration of ownership in a few stockholders.

 

**Wedo not intend to pay any cash dividends in the foreseeable future and unlessand until we pay cash dividends on our common stock, any gains from yourinvestment in our common stock must come from an increase in its market price.**

 

We do not anticipatedeclaring or paying any cash dividends in the foreseeable future. We intend toreinvest any earnings in the growth of our business. Payments of futuredividends, if any, will be at the discretion of our board of directors aftertaking into account various factors, including our business, operating resultsand financial condition, current and anticipated cash needs, plans forexpansion and any legal or contractual limitations on our ability to paydividends. Therefore, unless and until we pay cash dividends on our commonstock, any gains from your investment in our common stock must come from an increasein its market price.

 

**Wehave and will continue to incur increased costs as a public company, whichcould decrease our margins and negatively affect our results of operations.**

 

As a public company, wehave and will continue to incur significant legal, accounting and otherexpenses that we did not incur as a private company. In addition, theSarbanes-Oxley Act of 2002, as well as new rules

 

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subsequentlyimplemented by the SEC and The Nasdaq National Market, have required changes incorporate governance practices of public companies. We expect these new rulesand regulations to increase our legal and financial compliance costs and tomake some activities more time-consuming and costly. For example, as a resultof being a public company, we are required to create additional boardcommittees and adopt policies regarding internal controls and disclosurecontrols and procedures. In addition, we have and will continue to incuradditional costs associated with our public company reporting requirements. Wealso expect these new rules and regulations to make it more difficult and moreexpensive for us to obtain director and officer liability insurance and we maybe required to accept reduced policy limits and coverage or incur substantiallyhigher costs to obtain the same or similar coverage. As a result, it may bemore difficult for us to attract and retain qualified individuals to serve onour board of directors or as executive officers. We are currently evaluatingand monitoring developments with respect to these new rules, but we cannotpredict or estimate the amount of additional costs we may incur or the timingof such costs.

 

**Provisionsin our charter documents and under Delaware law could discourage a takeoverthat stockholders may consider favorable.**

 

Provisions in ourcertificate of incorporation and bylaws may have the effect of delaying orpreventing a change of control or changes in our management. These provisionsinclude 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. UnderDelaware law, a corporation may not engage in a business combination with anyholder of 15 percent or more of its capital stock unless the holder hasheld the stock for three years or, among other things, the board of directorshas approved the

 

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transaction in whichsuch person became such an interested stockholder. Our board of directors couldrely on Delaware law to prevent or delay an acquisition of us.

 

ITEM3.  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK

 

**Interest Rate Risk**

 

Our exposure to market risks for changes in interestrates relates primarily to our investment portfolio. As of March 31, 2005, ourcash equivalents and short-term investments consisted of money market funds andhighly-liquid auction rate securities. Due to the short-term nature of ourinvestment portfolio, we do not believe that an immediate 10% increase interestrates would have a material effect on the fair market value of our investmentportfolio. We believe that we have the ability to liquidate this portfolio inshort order and we do not expect our operating results or cash flows to bematerially affected to any significant degree by a sudden change in marketinterest rates on our investment portfolio.

 

**Foreign Currency Risk**

 

Our exposure to adverse movements in foreigncurrency exchange rates is primarily related to nominal payments tointernational website publishers. A hypothetical change of 10% in foreigncurrency exchange rates would not have a material impact on our financialstatements or results of operations. All of our sales are denominated in U.S.Dollars.

 

ITEM4.  CONTROLSAND PROCEDURES

 

***Quarterly Controls Evaluation and RelatedCEO and CFO Certifications***

 

Our Chief Executive Officer, Kurt Johnson, and ChiefFinancial Officer, Fred Krupica, with the participation of our management,evaluated the effectiveness of the design and operation of our disclosurecontrols and procedures as of the end of the period covered by this quarterlyreport. Based upon that evaluation, the Chief Executive Officer and the ChiefFinancial Officer believe that, as of the end of the period covered by thisreport, the Company’s disclosure controls and procedures are effective intimely making known to them material information relating to the Companyrequired to be included in this report.

 

Attached as exhibits to this quarterly report arecertifications of the Chief Executive Officer and the Chief Financial Officer,which are required in accordance with Rule 13a-14 of the SecuritiesExchange Act of 1934, as amended (“Exchange Act”). This “Controls andProcedures” section includes the information concerning the controls evaluationreferred to in the certifications, and it should be read in conjunction withthe certifications for a more complete understanding of the topics presented.

 

***Definition ofDisclosure Controls and Procedures***

 

Disclosure controls and procedures are methodsdesigned to reasonably assure that information required to be disclosed in ourreports filed under the Exchange Act, such as this quarterly report, isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms. Disclosurecontrols and procedures are also designed to reasonably assure that suchinformation is accumulated and communicated to our management, including theChief Executive Officer and Chief Financial Officer, as appropriate, to allowtimely decisions regarding required disclosure.

 

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

 

Disclosure controls and procedures, no matter how welldesigned and implemented, can provide only reasonable assurance of achieving acompany’s disclosure objectives. The likelihood of achieving such objectives isaffected by limitations inherent in disclosure controls and procedures. Theseinclude the fact that human judgment in decision-making can be faulty and thatbreakdowns in internal control can occur because of human failures such assimple errors, mistakes or intentional circumvention of the establishedprocesses.

 

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

 

There was no change in the Company’s internalcontrol over financial reporting, known to the Chief Executive Officer or theChief Financial Officer, which occurred during the period covered by thisquarterly report that has

 

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materiallyaffected, or is reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

 

**PART II.  OTHER INFORMATION**

 

ITEM1.  LEGALPROCEEDINGS

 

Notapplicable.

 

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

 

**Recent Sales of Unregistered Securities**

 

During the quarter ended March 31, 2005, we madestock option grants to certain of our employees and members of our board ofdirectors under our 2004 Stock Incentive Plan covering an aggregate of 246,250shares of common stock, at a weighted average exercise price of $8.36 pershare. During this period, we also issued an aggregate of 81,400 shares ofcommon stock upon exercise of stock options for aggregate consideration of $0.5million.  We issued these stock optionsand shares of common stock in transactions exempt from registration under theSecurities Act of 1933, as amended, pursuant to Rule 701 promulgatedthereunder.

 

**Use of Proceeds**

 

We completed our initial public offering on April 6,2005.  The managing underwriters of thepublic offering were Credit Suisse First Boston and Citigroup. In the offering,we sold an aggregate of 5,649,860 shares of our common stock at a price to thepublic of $12.00 per share.  Also in theoffering, our stockholders sold 850,140 shares for their own accounts also at aprice to the public of $12.00 per share; we received none of the proceeds ofthose sales.

 

The aggregate proceeds were $78.0 million, of whichthe aggregate gross proceeds to us were approximately $67.8 million. We paidexpenses of approximately $7.2 million, of which approximately $4.7 millionrepresented underwriting discounts and commissions and approximately $2.5million represented expenses related to the offering. Net proceeds from theoffering to us were approximately $63.1 million. We classified the net proceedsof the offering as common stock subscribed and classified the other offeringcosts incurred of approximately $2,539,000 as a reduction to additional paid-incapital in the accompanying unaudited balance sheet as of March 31, 2005. In connection 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 withno exercise by the underwriters of their over-allotment option.  As of April 15, 2005, substantially all ofthe net proceeds were invested in short-term, interest-bearing, investmentgrade securities.

 

None of the net proceeds received by us from theinitial public offering were paid directly or indirectly to any director orofficer of Fastclick, or to any person owning 10% or more of any class ofequity securities of Fastclick. We expect that our use of proceeds from theoffering will conform to the intended use of proceeds described in our finalinitial public offering prospectus dated March 31, 2005.

 

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES.

 

Not applicable.

 

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

 

On March 14, 2005, we sent a written consent tocertain of our stockholders requesting approval of the following matters inconnection with our initial public offering: (1) the reincorporation ofthe Company in Delaware, (2) the amendment of our certificate of incorporationeffecting a 5 for 1 stock split of our common stock that became effective onMarch 29, 2005, (3) the amendment and restatement of our certificate ofincorporation to implement certain changes with respect to the adoption ofprotective measures that may impede or hinder an unsolicited attempt to acquirecontrol of the Company that became effective immediately prior to the closingof our initial public offering on April 6, 2005, (4) the amendment andrestatement of our bylaws to provide for certain changes consistent with ourbecoming a public company that became effective immediately prior to theeffectiveness of the Registration Statement, (5) the approval of our 2005Equity Incentive Plan and the reservation of 4,000,000 shares of our commonstock thereunder, and (6) the issuance and sale by us of shares of common stockand our facilitation

 

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of the sale by the selling stockholders of shares ofcommon stock pursuant to the Registration Statement. All such actions wereeffected pursuant to an action by written consent of our stockholders pursuantto Section 228 of the Delaware General Corporation Law. A total of11,555,090 shares of our stock out of 13,814,420 shares issued and outstanding(on an as-converted to common stock basis, and reflecting the 5 for 1 stocksplit of our common stock that was effected prior to the consummation of ourinitial public offering) voted in favor of these matters.

 

On March 24, 2005, wesent written waivers to our preferred stockholders requesting that, inconnection with our initial public offering, they agree to treat the initialpublic offering as a “Qualified Public Offering” as defined in theRecapitalization Agreement, dated September 9, 2004, and the Investors’ RightsAgreement, dated September 27, 2004, and that they voluntarily convert all oftheir shares of preferred stock into common stock prior to the consummation ofour initial public offering. All of the preferred stockholders, constituting atotal of 10,656,425 shares (on an as-converted to common stock basis), waivedthese rights as requested and voluntarily converted all of their shares ofpreferred stock into common stock prior to the consummation of our initialpublic offering.

 

ITEM 5.  OTHERINFORMATION.

 

Not applicable.

 

ITEM6.  EXHIBITS.

 

The exhibits to thisreport are listed in the Exhibit Index on page 40 of this report.

 

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**SIGNATURE****S**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
| Date: May 13, 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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