**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 
| **(Mark  One)**                                      |                                                                                                     |
|------------------------------------------------------|----------------------------------------------------------------------------------------------------------|
|                                                 |                                                                                                     |
| **ý**                                           | **QUARTERLY REPORT PURSUANT TO SECTION 13  OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**  |
|                                                 |                                                                                                     |
| **For the quarterly period ended May 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 0-27046**

 

**TRAFFIX****, INC.**

(Exact name of registrant as specified in its charter)

 
| **Delaware**                             | ** ** | **22-3322277**      |
|------------------------------------------|------------|---------------------|
| (State or other jurisdiction of          |       | (I.R.S. Employer    |
| incorporation or organization)           |       | Identification No.) |
|                                     |       |                |
| **One Blue Hill Plaza**                  |       |                |
| **Pearl River, New York**                |       | **10965**           |
| (Address of principal executive offices) |       | (Zip Code)          |

 

**(845) 620-1212**

Registrant’s telephone number, including area code:

 

Indicateby check mark whether the Registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theRegistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.

 

Yes   ý   No   o

 

Indicate by check mark whether the Registrantis an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 

Yes   o   No   ý

 

Thenumber of shares outstanding of the Registrant’s common stock is 14,100,907 (asof 07/14/05).

 

 

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**TRAFFIX****, INC.**

**INDEX TO QUARTERLY REPORT ON FORM 10-Q**

**FILED WITH THE SECURITIES AND EXCHANGECOMMISSION**

**QUARTER ENDED MAY 31, 2005**

 

**ITEMS IN FORM 10-Q**

 
| **Part I**  | **Financial Information**                                                                   |   |
|------------------|---------------------------------------------------------------------------------------------|--------|
|             |                                                                                        |   |
| Item 1.          | Financial Statements                                                                        |   |
|             |                                                                                        |   |
| Item 2.          | Management’s Discussion and Analysis of  Financial Condition and Results of Operations | 35     |
|             |                                                                                        |   |
| Item 3.          | Quantitative and Qualitative Disclosures About Market Risk                                  |   |
|             |                                                                                        |   |
| Item 4.          | Controls and Procedures                                                                     | 83     |
|             |                                                                                        |   |
| **Part II** | **Other Information**                                                                       | 85     |
|             |                                                                                        |   |
| Item 1.          | Legal Proceedings                                                                           | 85     |
|             |                                                                                        |   |
| Item 2.          | Unregistered Sales of Equity Securities and Use of Proceeds                                 |   |
|             |                                                                                        |   |
| Item 3.          | Defaults Upon Senior Securities                                                             |   |
|             |                                                                                        |   |
| Item 4.          | Submission of Matters to a Vote of Security Holders                                         |   |
|             |                                                                                        |   |
| Item 5.          | Other Information                                                                           |   |
|             |                                                                                        |   |
| Item  6.         | Exhibits                                                                                    | 88     |

 

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**Signatures**

 

FORWARD LOOKING INFORMATION

 

ThisQuarterly Report on Form 10-Q includes “forward-looking statements” withinthe meaning of Section 27A of the Securities Act of 1933 and Section 21Eof the Securities Exchange Act of 1934. When used herein, words like “intend”, “anticipate”, “believe”, “estimate”,“plan”, or “expect”, as they relate to us, are intended to identifyforward-looking statements.  We believethat the assumptions and expectations reflected in such forward-lookingstatements are reasonable, based on information available to us in the date ofthis Quarterly Report, but no assurances can be given that these assumptionsand expectations will prove to have been correct or that we will take anyaction that we may presently be planning. We are not undertaking to publicly update or revise any forward-lookingstatement if we obtain new information or upon the occurrence of future eventsor otherwise.

 

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**TRAFFIX****, INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                   | ** ** | **May 31,** | ** ** | **November 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|-----------------------|------------|
| ** **                                                                                                                                   | ** ** | **2005**         | ** ** | **2004**              | ** ** |
| ** **                                                                                                                                   | ** ** | **(Unaudited)**  | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                   | ** ** | ** **       | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                              | ** ** | ** **       | ** ** | ** **            | ** ** |
| Cash and cash equivalents                                                                                                                    |       | $                | 7,283,691  |                  | $          | 7,553,285 |   |
| Marketable securities                                                                                                                        |       | 23,354,021       |       | 28,251,348            |       |
| Accounts receivable, trade, net of  allowance for doubtful accounts of $840,367 at May 31, 2005 and $691,229  at November 30, 2004 |       | 9,498,405        |       | 4,744,220             |       |
| Deferred income taxes                                                                                                                        |       | 982,195          |       | 1,206,096             |       |
| Prepaid expenses and other current assets                                                                                                    |       | 689,253          |       | 923,069               |       |
| **Total  current assets**                                                                                                                    |       | 41,807,565       |       | 42,678,018            |       |
| Property and equipment, net                                                                                                                  |       | 2,087,874        |       | 2,381,364             |       |
| Goodwill                                                                                                                                     |       | 6,333,770        |       | 4,231,054             |       |
| Other intangibles, net                                                                                                                       |       | 3,226,810        |       | 2,371,411             |       |
| Deferred income taxes                                                                                                                        |       | 296,663          |       | 296,663               |       |
| **Total  assets**                                                                                                                            |       | $                | 53,752,682 |                  | $          | 51,958,510 |   |
| **Liabilities**                                                                                                                              |       |             |       |                  |       |
| Current liabilities:                                                                                                                         |       |             |       |                  |       |
| Accounts payable                                                                                                                             |       | $                | 3,816,057  |                  | $          | 3,673,789 |   |
| Accrued expenses                                                                                                                             |       | 3,728,175        |       | 3,450,798             |       |
| Reserve for customer chargebacks                                                                                                             |       | 318,955          |       | 377,535               |       |
| Due to related parties                                                                                                                       |       | 369,337          |       | 311,341               |       |
| Income taxes payable                                                                                                                         |       | 408,650          |       | 306,333               |       |
| **Total  current liabilities**                                                                                                               |       | 8,641,174        |       | 8,119,796             |       |
| Deferred income taxes                                                                                                                        |       | 316,279          |       | 316,279               |       |
| **Total  liabilities**                                                                                                                       |       | 8,957,453        |       | 8,436,075             |       |
| Minority interest                                                                                                                            |       | 169,278          |       | —                |       |
| Commitments and contingencies (Notes 2 and  7)                                                                                               |       |             |       |                  |       |
| **Shareholders’  equity**                                                                                                               |       |             |       |                  |       |
| Preferred stock - $.001 par value;  1,000,000 shares authorized; none issued and outstanding                                                 |       | —           |       | —                |       |
| Common stock - $.001 par value; authorized  50,000,000 shares; issued 14,061,174 shares and 13,510,605 shares,  respectively                 |       | 14,061           |       | 13,510                |       |
| Additional paid-in capital                                                                                                                   |       | 43,853,379       |       | 41,309,652            |       |
| Retained earnings                                                                                                                            |       | 179,214          |       | 1,052,277             |       |
| Accumulated other comprehensive income                                                                                                       |       | 579,297          |       | 1,146,996             |       |
| **Total  shareholders’ equity**                                                                                                         |       | 44,625,951       |       | 43,522,435            |       |
| **Total  liabilities and shareholders’ equity**                                                                                         |       | $                | 53,752,682 |                  | $          | 51,958,510 |   |

 

The acompanying notes are an integral part ofthese financial statements

 

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**TRAFFIX****, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF INCOME**

**(UNAUDITED)**

 
| ** **                                        | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                        | ** ** | **May 31,**       | ** ** | **May 31,**     | ** ** | **May 31,** | ** ** | **May 31,** | ** ** |
| ** **                                        | ** ** | **2005**               | ** ** | **2004**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                        | ** ** | ** **             | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net revenue                                       |       | $                      | 16,610,569 |                 | $          | 9,139,855 |   | $ | 29,886,385 |   | $ | 16,310,149 |   |
| Cost of sales                                     |       | 10,526,749             |       | 5,137,014            |       | 18,941,119 |   | 8,942,968 |   |
| **GROSS  PROFIT**                                 |       | 6,083,820              |       | 4,002,841            |       | 10,945,266 |   | 7,367,181 |   |
|                                              |       |                   |       |                 |       |   |   |   |   |
| Selling expenses                                  |       | 974,120                |       | 515,158              |       | 1,791,295 |   | 963,088 |   |
| General and administrative expenses               |       | 3,914,134              |       | 3,147,860            |       | 7,675,379 |   | 6,007,437 |   |
| Bad debt expense                                  |       | 80,382                 |       | (65,656              | )          | 165,607 |   | (112,113 | ) |
| **INCOME  FROM OPERATIONS**                       |       | 1,115,184              |       | 405,479              |       | 1,312,985 |   | 508,769 |   |
|                                              |       |                   |       |                 |       |   |   |   |   |
| Other income (expense):                           |       |                   |       |                 |       |   |   |   |   |
|                                              |       |                   |       |                 |       |   |   |   |   |
| Interest income and dividends                     |       | 237,514                |       | 113,989              |       | 425,337 |   | 222,721 |   |
| Realized (losses) gains on marketable  securities |       | (11,218                | )          | 11,647               |       | 574,050 |   | 22,670 |   |
| Realized gain on sale of subsidiary               |       | —                 |       | 199,900              |       | 195,000 |   | 394,900 |   |
| Other non-operating income (expense)              |       | 2,326                  |       | 292,694              |       | (6,384 | ) | 338,887 |   |
| Minority interest in income of subsidiary         |       | (150,529               | )          | —               |       | (248,174 | ) | — |   |
|                                              |       |                   |       |                 |       |   |   |   |   |
| **INCOME  BEFORE PROVISION FOR INCOME TAXES**     |       | 1,193,277              |       | 1,023,709            |       | 2,252,814 |   | 1,487,947 |   |
|                                              |       |                   |       |                 |       |   |   |   |   |
| Provision for income taxes                        |       | 485,593                |       | 358,917              |       | 921,849 |   | 470,264 |   |
|                                              |       |                   |       |                 |       |   |   |   |   |
| **NET  INCOME**                                   |       | $                      | 707,684    |                 | $          | 664,792 |   | $ | 1,330,965 |   | $ | 1,017,683 |   |
|                                              |       |                   |       |                 |       |   |   |   |   |
| Basic income per share (Note 3):                  |       |                   |       |                 |       |   |   |   |   |
| Net income                                        |       | $                      | 0.05       |                 | $          | 0.05 |   | $ | 0.10 |   | $ | 0.08 |   |
| Weighted average shares outstanding               |       | 13,986,127             |       | 13,100,188           |       | 13,794,009 |   | 13,030,529 |   |
|                                              |       |                   |       |                 |       |   |   |   |   |
| Diluted income per share (Note 3):                |       |                   |       |                 |       |   |   |   |   |
| Net income                                        |       | $                      | 0.05       |                 | $          | 0.04 |   | $ | 0.09 |   | $ | 0.07 |   |
| Weighted average shares outstanding               |       | 14,233,711             |       | 13,765,499           |       | 14,245,027 |   | 13,659,127 |   |
| Cash dividends per common share                   |       | $                      | 0.16       |                 | $          | 0.08 |   | $ | 0.16 |   | $ | 0.16 |   |

 

Theaccompanying notes are an integral part of these financial statements

 

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**TRAFFIX****, INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(UNAUDITED)**

 
| ** **                                                                                   | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                   | ** ** | **May 31,**     | ** ** | **May 31,** | ** ** |
| ** **                                                                                   | ** ** | **2005**             | ** ** | **2004** | ** ** |
| Cash flows from operating activities:                                                        |       |                 |       |   |   |
| Net income                                                                                   |       | $                    | 1,330,965  |   | $ | 1,017,683 |   |
| Adjustments to reconcile net income to net  cash (used in) provided by operating activities: |       |                 |       |   |   |
| Depreciation and amortization                                                                |       | 1,098,170            |       | 635,095 |   |
| Reserve for customer chargebacks                                                             |       | (58,580              | )          | 165,763 |   |
| Provision for uncollectible accounts                                                         |       | 165,607              |       | (112,113 | ) |
| Deferred income taxes                                                                        |       | 448,585              |       | 130,105 |   |
| Net gains on sale of marketable securities                                                   |       | (574,050             | )          | (22,671 | ) |
| Gain on sale of subsidiary                                                                   |       | (195,000             | )          | (394,900 | ) |
| Minority interest                                                                            |       | 248,174              |       | — |   |
| Changes in assets and liabilities of  business, net of assets and liabilities acquired:      |       |                 |       |   |   |
| Accounts receivable                                                                          |       | (4,919,792           | )          | (1,213,092 | ) |
| Prepaid expenses and other current assets                                                    |       | 233,816              |       | 574,102 |   |
| Accounts payable                                                                             |       | 100,691              |       | 689,476 |   |
| Income taxes payable                                                                         |       | 443,193              |       | 281,243 |   |
| Due (from)/to related parties                                                                |       | (30,635              | )          | 98,229 |   |
| Other, principally accrued expenses                                                          |       | 257,381              |       | (577,932 | ) |
| **Net cash  (used in) provided by operating activities**                                     |       | (1,451,470           | )          | 1,270,988 |   |
| Cash flows from investing activities:                                                        |       |                 |       |   |   |
| Purchases of securities                                                                      |       | (116,093,328         | )          | (146,393,022 | ) |
| Proceeds from sales of securities                                                            |       | 120,919,416          |       | 144,689,766 |   |
| Proceeds from the sale of a subsidiary                                                       |       | 195,000              |       | 394,900 |   |
| Payment for asset acquisition, net of cash  received                                         |       | (2,931,424           | )          | — |   |
| Cash payment for intangible asset - license  agreement                                       |       | —               |       | (65,000 | ) |
| Capital expenditures                                                                         |       | (69,582              | )          | (18,253 | ) |
| **Net cash  provided by (used in) investing activities**                                     |       | 2,020,082            |       | (1,391,609 | ) |
| Cash flows from financing activities:                                                        |       |                 |       |   |   |
| Dividends paid                                                                               |       | (2,204,028           | )          | (2,097,404 | ) |
| Distribution to minority interest holder                                                     |       | (78,896              | )          | — |   |
| Proceeds from stock options exercised                                                        |       | 1,521,117            |       | 1,376,658 |   |
| **Net cash  used in financing activities**                                                   |       | (761,807             | )          | (720,746 | ) |
| Effect of exchange rate changes on cash and  cash equivalents                                |       | (76,399              | )          | (33,055 | ) |
| Net decrease in cash and cash equivalents                                                    |       | (269,594             | )          | (874,422 | ) |
| Cash and cash equivalents, beginning of  period                                              |       | 7,553,285            |       | 9,939,657 |   |
| **Cash and  cash equivalents, end of period**                                                |       | $                    | 7,283,691  |   | $ | 9,065,235 |   |

 

See Notes 2 and 7 for a summary of noncashinvesting activities.

 

The accompanying notes arean integral part of these financial statements

 

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**TRAFFIX****, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY**

**FOR THE SIX MONTHS ENDED MAY 31, 2005**

**(UNAUDITED)**

 
| ** **                                                                               | ** ** | ** **       | ** ** | ** **  | ** ** | ** **     | ** ** | ** **        | ** ** | **Accumulated**        | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------------------|------------|------------------|------------|-------------|------------|----------------|------------|-------------------|------------|------------------------|------------|------------|------------|
| ** **                                                                               | ** ** | ** **       | ** ** | ** **  | ** ** | **Additional** | ** ** | ** **        | ** ** | **Other**              | ** ** | **Total**  | ** ** |
| ** **                                                                               | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Retained**   | ** ** | **Comprehensive** | ** ** | **Shareholders’** | ** ** |
| ** **                                                                               | ** ** | **Shares**       | ** ** | **Amounts** | ** ** | **Capital**    | ** ** | **Earnings**      | ** ** | **Income(Loss)**       | ** ** | **Equity** | ** ** |
| ** **                                                                               | ** ** | ** **       | ** ** | ** **  | ** ** | ** **     | ** ** | ** **        | ** ** | ** **             | ** ** | ** ** | ** ** |
| **Balance, November 30, 2004**                                                      |       | 13,510,605       |       | $           | 13,510     |           | $          | 41,309,652        |       | $                      | 1,052,277  |       | $          | 1,146,996 |   | $ | 43,522,435 |   |
|                                                                                     |       |             |       |        |       |           |       |              |       |                   |       |       |       |
| Net income for the six months ended May 31,  2005                                   |       |             |       |        |       |           |       | 1,330,965         |       |                   |       | 1,330,965  |       |
|                                                                                     |       |             |       |        |       |           |       |              |       |                   |       |       |       |
| Unrealized losses on available-for-sale  securities, net of income tax expense           |       |             |       |        |       |           |       |              |       | (60,024                | )          | (60,024    | )          |
| Reclassification adjustment for gains realized  in net income, net of income tax expense |       |             |       |        |       |           |       |              |       | (360,584               | )          | (360,584   | )          |
| Foreign Currency Translation adjustment                                                  |       |             |       |        |       |           |       |              |       | (147,091               | )          | (147,091   | )          |
| Dividends declared                                                                       |       |             |       |        |       |           |       | (2,204,028        | )          |                   |       | (2,204,028 | )          |
| Stock option exercises                                                                   |       | 436,748          |       | 437         |       | 1,520,680      |       |              |       |                   |       | 1,521,117  |       |
| Tax benefit from exercise of stock options                                               |       |             |       |        |       | 340,881        |       |              |       |                   |       | 340,881    |       |
| Common stock issued in connection with  asset acquisition                                |       | 113,821          |       | 114         |       | 682,166        |       |              |       |                   |       | 682,280    |       |
|                                                                                     |       |             |       |        |       |           |       |              |       |                   |       |       |       |
| **Balance,  May 31, 2005**                                                          |       | 14,061,174       |       | $           | 14,061     |           | $          | 43,853,379        |       | $                      | 179,214    |       | $          | 579,297 |   | $ | 44,625,951 |   |

 

**TRAFFIX****, INC. AND SUBSIDIARIES**

**NOTES TO FINANCIAL STATEMENTS (UNAUDITED)**

 

**1.  GENERAL**

 

The accompanying consolidated financial statements of Traffix, Inc. and its subsidiaries (the “Company”) are unaudited; however, in the opinion of management, thesefinancial statements are presented in conformity with accounting principlesgenerally accepted in the United States of America. The accompanying unaudited consolidated financial statements reflect alladjustments which are, in the opinion of management, necessary for a fairpresentation of the financial position and operating results for the interimperiods presented and are of a normal and recurring nature. In the preparationof these financial statements, management is 

 

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required to make estimates and assumptions thataffect the reported amounts of assets, liabilities, revenues, expenses anddisclosures at the date of, and for the interim periods presented. Actual resultscould differ from those estimates. Significant estimates include accruals forfulfillment redemptions, reserves for uncollectible receivables, reserves for dataqualification allowances, recoverability of long-lived assets, and the realizability of deferred tax assets. Additionally, theCompany has potential exposure resulting from pending and/or threatenedlitigation for which the Company currently does not provide a loss provision. Management’sestimates and assumptions are continually reviewed against actual results withthe effects of any revisions being reflected in the results of operations atthat time. The accompanying unaudited consolidatedfinancial statements should be read in conjunction with the auditedconsolidated financial statements and notes thereto, together with management’sdiscussion and analysis of financial condition and results of operations,contained in the Company’s Annual Report on Form 10-K for the fiscal yearended November 30, 2004. The results of operations for the three and sixmonth periods ended May 31, 2005 are not necessarily indicative of theresults to be expected for the subsequent quarters or the full fiscal yearending November 30, 2005. Certain prior year amounts in the unaudited consolidated financial statements have beenreclassified to conform with the current yearpresentation.

 

During the six months ended May 31, 2005 and 2004, options for 436,748 shares and 327,857 shares of the Company’s common stock, respectively, were exercised by its employees and directors. Tax benefits of $340,881 and $256,878 in the six months ended May 31, 2005 and 2004, respectively, resulting from the exercise of these options, were recorded as an increase to additional paid-in capital and a reduction of income taxes currently payable.

 

# **RecentAccounting Pronouncements**

# ** **

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and ErrorCorrections, which replaces APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes inInterim Financial Statements. Opinion No. 20 had required that changes inaccounting principles be 

 

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recognized by including the cumulativeeffect of the change in the period in which the new accounting principle wasadopted. SFAS No. 154 requires retrospectiveapplication of the change to prior periods’ financial statements, unless it isimpracticable to determine the period-specific effects of the change. The FASB identified the reason for the issuance of SFAS No. 154 to be part of a broader attempt toeliminate differences with the International Accounting Standards Board (IASB). The Statement is effective for fiscal yearsbeginning after December 15, 2005. The Company does not believe theadoption of this statement will have a material impact on its financialstatements.

 

In December 2004, the FASB issued SFAS No. 123 (R), Share Based Payments, which replacesSFAS 123, Accounting for Stock-Based Compensation,and supersedes APB Opinion No. 25, Accounting for Stock Issued toEmployees, and amends SFAS No. 95, Statement ofCash Flows. SFAS No. 123 (R) requires allshare-based payments to employees, including grants of employee stock options,to be recognized in the income statement based on their fair values. As such,pro forma disclosure in lieu of expensing is no longer an alternative. The newstandard is effective for the first annual reporting period beginning after June 15,2005. The Company is currently assessing the impact that the Statement may haveon its financial statements.

 

In December 2004, the FASB issued SFAS 153, Exchanges of NonmonetaryAssets, which amends APB Opinion No. 29. The guidance in APB 29,Accounting for Nonmonetary Transactions, is based onthe principle that exchanges of nonmonetary assetsshould be measured based on the fair value of the assets exchanged. Theamendment made by SFAS 153 eliminates the exceptionfor exchanges of similar productive assets and replaces it with a broaderexception for exchanges of nonmonetary assets that donot have commercial substance. The provisions of the statement are effectivefor exchanges taking 

 

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place in fiscal periods beginning after June 15,2005. The Company does not believe the adoption of this Statement will have amaterial impact on its financial statements.

 

**2.  SIGNIFICANT ACCOUNTING POLICIES**

 

**Revenue Recognition, Variable Costs, Allowances, AccountsReceivable and Bad Debts**

 

*Revenue*

 

TheCompany currently earns the material portion of its revenue from the E-commercesegment. This revenue primarily results from marketing agreements with theCompany’s marketing partners and corporate customers. These marketingagreements satisfy the “existence of pervasive evidence of an arrangement”required under the current revenue recognition rules under StaffAccounting Bulletin (SAB)104.The provisions of each agreement determine the (a) pricing characteristicsof the revenue generating activity, the specific type of revenue activity (i.e.on-line dating membership, website advertising activity, email marketingpromotion and terms of LEC recurring billedproducts), and (b) the method of the Company’s delivery obligations to,and acceptance obligations of, its clients and customers, with (a) and (b) satisfyingthe criterion of SAB 104, that “sales price is fixedor determinable” and “delivery has occurred”. As a function of the Company’sclient and customer acceptance process, the Company reviews bank and creditreferences, business financial statements and personal financial statementsand/or obtain corporate officer guarantees (if appropriate), all of whichsatisfy the SAB 104 criteria, “collectibility is reasonably assured”. Based on the revenuerecognition criterion discussed above, the Company believes it recognizesrevenue when it is realizable and earned.

 

*Deferred Revenue*

 

TheCompany’s on-line dating service is a membership based arrangement,

 

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with membership offerings ranging from one monthsubscriptions to plans with annual terms. The one month membership plans formthe bulk of the Company’s subscription sales. Deferred revenue is recorded netof estimated cancellations and is amortized over the life of the membership asit is earned.

 

*Contra revenue*

 

Atthe time revenue is recognized, the Company provides for an estimate forcontractually specified data qualification allowances, when required under thegoverning marketing agreement. Such data qualification allowances may includeallowances for data duplications, invalid addresses, age and country of originrestrictions, and are recorded in a contra-revenue account.

 

*Cost of Sales*

 

Certainrevenue related obligations are recorded at the time revenue is recognized.They include costs payable to other on-line, as well as off-line, mediacompanies for generating registered users and consumer data for the Company,database fee sharing costs under third-party database use agreements, emailmessage delivery costs, contingent-based prize indemnification coverage (i.e.,sweepstakes payout indemnification), estimated premium fulfillment costsrelated to the respective promotion (if applicable), representing all variablecosts directly associated with completing the Company’s obligations relative tothe revenue being recognized, all of which satisfy the criteria regarding theconcept of “other than a perfunctory, or inconsequential ongoing obligation”,as specified in SAB 104.

 

*Accounts Receivable and Bad Debt Allowances*

 

Revenuerecognition is also subject to provisions based on the probability ofcollection of the related trade accounts receivable. The Company continuouslyevaluates the potential of the collectibility oftrade accounts receivable by reviewing such factors as deterioration in theoperating results, financial condition, or bankruptcy filings of its customers.As a result of this review process, the Company records bad debt provisions toadjust the related receivable carrying amount to an estimated realizable value.

 

11

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Provisionsfor bad debts are also recorded due to the review of other factors, includingthe length of time the account receivables are past due, historical experienceand other factors obtained during the conduct of collection efforts. Ifcircumstances change regarding the Company’s specific customers on anindividual basis, or if demand for Internet direct marketing softens, or if theU.S. economy stumbles, the Company’s estimates for bad debt provisions could befurther increased, which could adversely affect its operating margins,profitability, cash flows and capital resources.

 

Accounts receivable consist of trade accountsreceivable from the Company’s corporate customer base, credit card merchantsand third party billing companies, with extension of credit varying between 30to 90 days, with the majority at 30 days, and as such, do not bear interest.Corporate customers with credit balances, generally resulting from prepayments,are classified as deferred revenue, and included in “Accrued expenses” on theCompany’s balance sheets. 

 

Accounts Receivable by major category consisted of the following at May 31,2005 and 2004

 
| ** **                                                                                                         | ** ** | **May 31, 2005** | ** ** | **May 31, 2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| Accounts Receivable from:                                                                                          |       |                  |       |                  |       |
| Corporate Clients                                                                                                  |       | $                     | 8,624,371  |                  | $          | 3,961,064 |   |
|                                                                                                               |       |                  |       |                  |       |
| Consumers via Credit Card Merchant  arrangements, Third Party Billing companies and Local Exchange Carriers (LECs) |       | 874,034               |       | 1,441,088             |       |
|                                                                                                               |       |                  |       |                  |       |
| Total Accounts Receivable                                                                                          |       | $                     | 9,498,405  |                  | $          | 5,402,152 |   |

 

Followingare the changes in the allowance for doubtful accounts for the six months endedMay 31, 2005 and 2004:

 

12

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| ** ** | ** ** | **Beginning  Balance** | ** ** | **Net   additions(reductions)   to allowance** | ** ** | **Write-offs   net of   recoveries** | ** ** | **Ending   Balance** | ** ** |
|------------|------------|------------------------|------------|------------------------------------------------|------------|--------------------------------------|------------|----------------------|------------|
| 2005       |       | $                      | 691,230    |                                           | 165,607    |                                 | (16,470    | )                    | $          | 840,367 |   |
| 2004       |       | $                      | 872,605    |                                           | (112,113   | )                                    | —     |                 | $          | 760,492 |   |

 

**Transactions with Major Customers and other Revenue Concentrations**

 

During the three and six month periods ended May 31, 2005, one customer in the Company’s E-commerce segment accounted for approximately $2.2 and $3.2 million, or 13.2% and 10.8% of consolidated net revenues, respectively. With respect to the balance of the Company’s current customer base, no single customer had net revenues that equaled or exceeded 5.4% and 3.9% of consolidated net revenues for the three and six month periods ended May 31, 2005, respectively. During the three and six month period ended May 31,2004, the Company had one customer in its E-commerce segment accounting for approximately $1.1 and $2 million, or 11.8% and 12.6% of consolidated net revenues, respectively.

 

In the three and six months ended May 31, 2005, 15.9% and 16.5% of the Company’s revenue was derived from its proprietary products (13.8% and 14.1% from iMatchUp.com, the Company’s online dating site, and 2.1% and 2.4% from its LEC Billed Product segment’s proprietary products).

 

13

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**Goodwill, long lived assets and other purchased intangible assets**

 

**Statementof Financial Accounting Standards No. 142, “Goodwill and Other IntangibleAssets” (SFAS 142), requires goodwill to be testedfor impairment on an annual basis, and more frequently under certaincircumstances. Under SFAS 142, the Company isrequired to perform a two step process in its impairment assessment. Step oneis to test for the potential of goodwill impairment. If the potential forimpairment is identified by step one, then step two isundertaken to measure the amount of impairment loss. The Company conducts thetests described above annually during its quarter ending August 31. Duringthe six month period ended May 31, 2005, the Company did not identify anycircumstances that would warrant impairment testing of goodwill.**

** **

**In theperformance of its annual impairment testing, the Company uses estimates of thefair value of its aggregated goodwill using internal analysis, externaleconomic and financial data and external market valuations, all of whichincorporate valuation applications derived from revenue multiples, capitalizedearnings and discounted cash flow models, and other comparable marketvaluations methods deemed relevant at that time.**

** **

SFAS 144,Accounting for Impairment or Disposal of Long Lived Assets, requires long-livedassets to be reviewed for impairment if, or when, events or changes incircumstances indicate that their carrying amounts may not be recoverable.Determination of long-lived asset recoverability is based on estimated futurecash flows expected to result from the use of such asset over its remaininguseful life and the potential cash flows realizable from its possibledisposition.  If the sum of the expectedfuture cash flows (undiscounted and without interest charges) is less than thecarrying amount of the long-lived asset, an impairment loss is measured as adifference between carrying amount and the future discounted cash flows.

 

See Note 8, “Goodwill and Identifiable Intangible Assets”.

 

14

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###### **Stock–based Compensation**

###### ** **

**Pursuantto Statement of Financial Accounting Standard (“SFAS”)No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, the Company will continue to use theintrinsic value method of accounting for its employee and director stock-basedcompensation awards until its adoption of SFAS 123R. Accordingly,the Company has not recognized compensation expense for its noncompensatoryemployee and director stock option awards. As recommended by SFAS No. 123, the fair values of options wereestimated using the Black-Scholes option-pricingmodel. Option vesting periods have historically been three years, except forgrants to non-employee members of the Board of directors, which fully vest atthe time of grant. Additionally, options have been granted to management that vest upon the attainment of specified financial performancehurdles. The Company’s adjusted net income and adjusted earnings per share, hadit elected to adopt the fair value approach of SFAS No. 123in the current fiscal year, which charges earnings for the estimated differencebetween the strike price and the fair value of the stock options, would havebeen as follows:**

 
| ** **                                                                                                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                                                         | ** ** | **May 31,**       | ** ** | **May 31,**     | ** ** | **May 31,** | ** ** | **May 31,** | ** ** |
| ** **                                                                                                         | ** ** | **2005**               | ** ** | **2004**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income:                                                                                                        |       |                   |       |                 |       |   |   |   |   |
| As reported                                                                                                        |       | $                      | 707,684    |                 | $          | 664,792 |   | $ | 1,330,965 |   | $ | 1,017,683 |   |
| Less: Total stock-based compensation  expense determined under fair value based method, net of related tax effects |       | (148,244               | )          | (70,967              | )          | (266,534 | ) | (143,573 | ) |
| Pro forma                                                                                                          |       | $                      | 559,440    |                 | $          | 593,825 |   | $ | 1,064,431 |   | $ | 874,110 |   |
| Basic net income per share:                                                                                        |       |                   |       |                 |       |   |   |   |   |
| As reported                                                                                                        |       | $                      | 0.05       |                 | $          | 0.05 |   | $ | 0.10 |   | $ | 0.08 |   |
| Pro forma                                                                                                          |       | $                      | 0.04       |                 | $          | 0.05 |   | $ | 0.08 |   | $ | 0.07 |   |
| Diluted net income per share:                                                                                      |       |                   |       |                 |       |   |   |   |   |
| As reported                                                                                                        |       | $                      | 0.05       |                 | $          | 0.04 |   | $ | 0.09 |   | $ | 0.07 |   |
| Pro forma                                                                                                          |       | $                      | 0.04       |                 | $          | 0.04 |   | $ | 0.07 |   | $ | 0.06 |   |

 

15

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Thepro forma amounts shown above, regarding stock based compensation, are notnecessarily representative of the impact on net income in future periods.

 

**IncomeTaxes**

 

Quarterly income taxes are calculated in accordancewith the interim financial reporting requirements as set forth in theAccounting Principal Board’s Opinion 28. Such Opinion considers interimquarterly periods as an integral part of the annual period, with interimquarterly tax periods reflecting the estimated annual effective tax rate. TheCompany believes that it has adequately provided for tax-related matters. TheCompany is subject to examination by taxing authorities in variousjurisdictions. Matters raised upon audit may involve substantial amounts.Management considers it unlikely that resolution of any such matters would havea material adverse effect upon the Company’s consolidated financial statements.

 

###### **Non-cash Investing and Financing Activities**

###### ** **

Non-cash investing and financing activities areexcluded from the consolidated statement of cash flows. For the six monthsended May 31, 2005, non-cash activities included the following items:

 

**Investing Activities:**

 

**Asset Acquisition of Hot Rocket (Also see notes 7 and8)**

 
| Stock Issued in connection with acquisition |   | $ | 682,280 |   |
|---------------------------------------------|--------|---|---------|--------|

 

16

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**License Acquisitions**

 

In May 2005, the Company entered into a license agreement with Alliant Cooperative Data Solutions, LLC. The agreement allows for the use of an Alliant product which ranks and scores lists of consumers who register on our websites, allowing the Company to project the response rate of ordering a product after receiving an offer and the rate of payment given a response. The total cost of the license was $38,000, payable in three installments due in June, July and October 2005. The full liability was recognized at May 31, 2005 and the license agreement is being amortized on a straight line basis over a three year period.

 

On March 24, 2004, the Company entered into a license agreementwith LiveOnTheNet.com Inc. The agreement allows theCompany to market to consumers under its own brand name (Click Help), asoftware program, which enables home PC users to access customer serviceoperators who provide real-time support for questions related to their personalcomputers. The total cost of the software license was $200,000, payable by a$35,000 down payment and eleven monthly installments of $15,000, due on thefirst of the month, commencing April 1, 2004. As of May 31, 2005, theCompany had fully satisfied its payment obligations under this licenseagreement, which is being amortized on the straight-line basis over a five yearperiod.

 

**3.  Earnings Per Share**

 

The following table sets forth the reconciliation of the weighted average shares used for basic and diluted earnings per share:

 

17

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| ** **                                                                   | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                   | ** ** | **May 31,**       | ** ** | **May 31,**     | ** ** | **May 31,** | ** ** | **May 31,** | ** ** |
| ** **                                                                   | ** ** | **2005**               | ** ** | **2004**             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Denominator:                                                                 |       |                   |       |                 |       |   |   |   |   |
| Denominator for basic earnings per  share-weighted average shares            |       | 13,986,127             |       | 13,100,188           |       | 13,794,009 |   | 13,030,529 |   |
| Effect of dilutive securities:                                               |       |                   |       |                 |       |   |   |   |   |
| Stock options                                                                |       | 247,584                |       | 665,311              |       | 451,018 |   | 628,598 |   |
| Denominator for diluted earnings per  share-adjusted weighted average shares |       | 14,233,711             |       | 13,765,499           |       | 14,245,027 |   | 13,659,127 |   |

 

Options to purchase 2,135,401 and 595,050 shares of common stock for the three months ended May 31, 2005 and 2004, respectively, and 2,082,401 and 800,900 for the six months ended May 31, 2005 and 2004, respectively, were outstanding but were not included in the computation of diluted earnings per share because their effect would be anti-dilutive.

 

**4.****             ****Comprehensive Income (Loss)**

 

The Company presents foreign currency translation adjustments and unrealized gains and losses on its marketable securities (net of tax, when applicable) as a component of “comprehensive income (loss)” and are presented below: 

 
| ** **                                                                                                          | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                                                          | ** ** | **May 31,**       | ** ** | **May 31,**     | ** ** | **May 31,** | ** ** | **May 31,** | ** ** |
| ** **                                                                                                          | ** ** | **2005**               | ** ** | **2004**             | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                                                |       |                   |       |                 |       |   |   |   |   |
| Net income                                                                                                          |       | $                      | 707,684    |                 | $          | 664,792 |   | $ | 1,330,965 |   | $ | 1,017,683 |   |
|                                                                                                                |       |                   |       |                 |       |   |   |   |   |
| Other comprehensive income (loss), net of  tax:                                                                     |       |                   |       |                 |       |   |   |   |   |
| Foreign currency translation adjustment                                                                             |       | (51,152                | )          | (59,121              | )          | (147,091 | ) | 174,391 |   |
| Unrealized gain (loss) from  available-for-sale securities, arising during the period, net of income taxes  of $-0- |       | (18,410                | )          | (46,774              | )          | (60,024 | ) | (168,712 | ) |
|                                                                                                                |       |                   |       |                 |       |   |   |   |   |
| Add: reclassification adjustment for gains  realized in net income, net of tax effect of $224,684                   |       | —                 |       | —               |       | (360,584 | ) |   |   |
|                                                                                                                |       |                   |       |                 |       |   |   |   |   |
| Comprehensive income                                                                                                |       | $                      | 638,122    |                 | $          | 558,897 |   | $ | 763,266 |   | $ | 1,023,362 |   |

 

18

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**5.****             ****Advertising and Marketing**

 

The Company’s advertising and marketing costs, incurred in the advertising and marketing of the Company’s and its clients’ products, services and promotional offers, have historically been comprised of (1) costs associated with the transmission of email marketing messages, both from internal sources and external third-party vendors, (2) costs associated with the purchase of on-line consumer data (including registered users to the Company’s websites, and its clients’ websites), and (3) email and website program promotional and creative development costs. During the six months ended May 31, 2005, the Company included the costs of Internet media arbitrage purchases resulting from the January 21, 2005 acquisition of Hot Rocket Marketing, Inc.  During the year ended November 30, 2004, as a result of the acquisition of SendTraffic.com,Inc., the Company included the costs of its search engine marketing activities in its advertising and marketing cost accounts. During the fiscal periods prior to these acquisitions, the Company incurred immaterial search engine marketing costs and did not participate in Internet media arbitrage activities.

 

Advertising and marketing costs are charged to operations (1) at the time of the email transmission, (2) upon receipt of the qualified consumer data, (3) at the time the promotional and creative services are provided, (4) at the time the search engine marketing media purchases are incurred, and/or 

 

19

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(5) at the time the Company purchase the underlying Internet media, respectively, and are included as a component of cost of sales.

 

Total advertising and marketing costs included in cost of sales for the three months ended May 31, 2005 and 2004 were approximately $10,311,000 and $4,259,000, respectively, and for the six months ended May 31, 2005 and 2004 were approximately $18,490,000 and $7,693,000, respectively.

 

**6.****             ****Segment Information**

 

Segments are defined as components of an enterprise for which separatefinancial information is available that is evaluated regularly by the chiefoperating decision maker(s) in deciding how to allocate resources and inassessing performance.  Disclosure isalso required about products and services, geographic areas and majorcustomers. The Company’s segments operate principally in the United States witha presence in Canada. The Canadian presence contributed an immaterial amount toconsolidated net revenue and net income. The Company’s two operating segmentsare: (a) E-commerce and (b) LEC BilledProducts. This business segment delineation is consistent with the Company’smanagement and financial reporting structure based on products and services.The Company evaluates performance based on many factors, with the primarycriteria being each segment’s adjusted EBITDA, whichis defined as net income excluding (i) specialcharges, (ii) interest expense, (iii) interest and dividend income, (iv) netgains (losses) on the sale of marketable securities, (v) permanent impairmentcharges to long-lived assets, (vi) other nonoperating income, (vii) minorityinterest (income)loss, (viii)

 

20

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depreciation, (ix) amortization and(x) income taxes. The Company shares a common workforce and officeheadquarters, which precludes an allocation of all overhead components.Overhead items that are specifically identifiable to a particular segment areapplied to such segment and all other overhead costs are included in Corporate.The following tables set forth the Company’s financial results, by management’sperformance criteria, by operating segment. All presented revenues are from nonintersegment sources, and, therefore no intersegment elimination applies.

 

***Segment Data - Net Revenue***

 
| ** **               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------|------------|------------------------|------------|----------------------|------------|
| ** **               | ** ** | **May 31,**       | ** ** | **May 31,**     | ** ** | **May 31,** | ** ** | **May 31,** | ** ** |
| ** **               | ** ** | **2005**               | ** ** | **2004**             | ** ** | **2005** | ** ** | **2004** | ** ** |
|                     |       |                   |       |                 |       |   |   |   |   |
| E-commerce               |       | $                      | 16,257,112 |                 | $          | 8,062,505 |   | $ | 29,182,043 |   | $ | 15,109,206 |   |
| LEC  Billed Products     |       | 353,457                |       | 1,077,350            |       | 704,342 |   | 1,200,943 |   |
|                     |       |                   |       |                 |       |   |   |   |   |
| **Consolidated  totals** |       | $                      | 16,610,569 |                 | $          | 9,139,855 |   | $ | 29,886,385 |   | $ | 16,310,149 |   |

 

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***Segment Data - Adjusted EBITDA****

 
| ** **               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------|------------|------------------------|------------|----------------------|------------|
| ** **               | ** ** | **May 31,**       | ** ** | **May 31,**     | ** ** | **May 31,** | ** ** | **May 31,** | ** ** |
| ** **               | ** ** | **2005**               | ** ** | **2004**             | ** ** | **2005** | ** ** | **2004** | ** ** |
|                     |       |                   |       |                 |       |   |   |   |   |
| E-commerce               |       | $                      | 2,491,245  |                 | $          | 1,429,024 |   | $ | 3,971,313 |   | $ | 2,984,490 |   |
|                     |       |                   |       |                 |       |   |   |   |   |
| LEC  Billed Products     |       | 165,407                |       | 186,132              |       | 316,065 |   | (94,746 | ) |
|                     |       |                   |       |                 |       |   |   |   |   |
| **Consolidated  totals** |       | $                      | 2,656,652  |                 | $          | 1,615,156 |   | $ | 4,287,378 |   | $ | 2,889,744 |   |

 

----

* Adjusted EBITDA is net income excludingcorporate level general and administrative costs (including the exclusion ofCorporate level depreciation and amortization), special charges, interestexpense, interest and dividend income, net gains (losses) on the sale ofmarketable securities, realized gains on subsidiary sales, permanent impairmentcharges to long lived assets, other nonoperatingincome (expense), minority interest (income) loss, depreciation, amortizationand income taxes.

 

***Segment Data - Depreciation and Amortization***

 
| ** ** | ** **               | **Three Months Ended** | ** **       | **Six Months Ended** | ** **       |
|------------|--------------------------|------------------------|------------------|----------------------|------------------|
| ** ** | ** **               | ** **             | **May 31,** | ** **           | **May 31,** | ** ** | **May 31,** | ** ** | **May 31,** | ** ** |
| ** ** | ** **               | ** **             | **2005**         | ** **           | **2004**         | ** ** | **2005** | ** ** | **2004** | ** ** |
|       |                     |                   |             |                 |             |   |   |   |   |   |
|       | E-commerce               |                   | $                | 619,649              |             | $ | 261,777 |   | $ | 1,035,762 |   | $ | 530,732 |   |
|       |                     |                   |             |                 |             |   |   |   |   |   |
| ** ** | **Consolidated  totals** |                   | $                | 619,649              |             | $ | 261,777 |   | $ | 1,035,762 |   | $ | 530,732 |   |

 

22

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***Segment Data - Reconciliation of Reportablesegment’s Adjusted EBITDA to***

***consolidated******income before taxes***

 
| ** **                                                                             | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                             | ** ** | **May 31,**       | ** ** | **May 31,**     | ** ** | **May 31,** | ** ** | **May 31,** | ** ** |
| ** **                                                                             | ** ** | **2005**               | ** ** | **2004**             | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                   |       |                   |       |                 |       |   |   |   |   |
| ***Adjusted EBITDA  - by segment***                                                    |       |                   |       |                 |       |   |   |   |   |
| E-commerce                                                                             |       | $                      | 2,491,245  |                 | $          | 1,429,024 |   | $ | 3,971,313 |   | $ | 2,984,490 |   |
|                                                                                   |       |                   |       |                 |       |   |   |   |   |
| LEC  Billed Products                                                                   |       | 165,407                |       | 186,132              |       | 316,065 |   | (94,746 | ) |
|                                                                                   |       |                   |       |                 |       |   |   |   |   |
| **Total  Adjusted EBIDTA**                                                             |       | $                      | 2,656,652  |                 | 1,615,156  |   | $ | 4,287,378 |   | 2,889,744 |   |
|                                                                                   |       |                   |       |                 |       |   |   |   |   |
| ***Items effecting Adjusted EBITDA in arriving at  consolidated income before taxes*** |       |                   |       |                 |       |
| Corporate (expense)                                                                    |       | (921,819               | )          | (947,900             | )          | (1,938,631 | ) | (1,850,243 | ) |
| Depreciation and amortization (expense)                                                |       | (619,649               | )          | (261,777             | )          | (1,035,762 | ) | (530,732 | ) |
| Interest income and dividends                                                          |       | 237,514                |       | 113,989              |       | 425,337 |   | 222,721 |   |
| Realized (losses) gains on marketable  securities                                      |       | (11,218                | )          | 11,647               |       | 574,050 |   | 22,670 |   |
| Realized gain on sale of subsidiary                                                    |       | —                 |       | 199,900              |       | 195,000 |   | 394,900 |   |
| Other non-operating income (expense)                                                   |       | 2,326                  |       | 292,694              |       | (6,384 | ) | 338,887 |   |
| Minority interest in income of subsidiary                                              |       | (150,529               | )          | —               |       | (248,174 | ) | — |   |
| **Total  items effecting Adjusted EBITDA**                                             |       | (1,463,375             | )          | (591,447             | )          | (2,034,564 | ) | (1,401,797 | ) |
|                                                                                   |       |                   |       |                 |       |   |   |   |   |
| **Consolidated  income before taxes**                                                  |       | $                      | 1,193,277  |                 | $          | 1,023,709 |   | $ | 2,252,814 |   | $ | 1,487,947 |   |

 

**7.  Asset Acquisitions and AssetDispositions**

 

# **Acquisition**

# ** **

On January 21, 2005, the Company, through its wholly ownedsubsidiary, Hot Rocket Acquisition Corp., acquired all of the intangible assetsof Hot Rocket Marketing Inc. and Clockwork Advertising Inc. (collectively “HotRocket”), corporations in the business of buying and selling performance basedon-line advertising space for third parties. The acquisition was accounted forin accordance with SFAS 141, Business Combinations.The Company believes that

 

23

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the Hot Rocket acquisition broadens itsreach into the Internet direct marketing arena, potentially allowing forexpanded client relationships and various other synergistic possibilities, suchas adding value to the Company’s core operations by the enhancement of itscurrent and developing marketing programs.

 

The purchase price was approximately $3.7 millionand was comprised of $2.9 million in cash, $0.7 million (or 113,821 shares) ofthe Company’s common stock and transaction fees approximating $0.1 million.Based on an internal preliminary valuation, the reported purchase priceincludes approximately $2.1 million of goodwill and $1.5 million ofidentifiable intangibles The Company is currently having the valuation being prepared.

 

Under SFAS No.142, “Goodwill &Intangible Assets”, goodwill is not amortized, but it is reviewed forimpairment on an annual basis. The identifiable intangibles acquired from HotRocket consist of employment contracts and internally developed software, whichwill be amortized on a straight-line basis over estimated useful lives of fiveand three years, respectively. It is expected that the entire goodwill valuewill be deductible for tax purposes based on the nature of the assetacquisition. The entire amount of the identifiable intangibles and goodwill area component of the Company’s E-commerce segment.

 

In addition to the initial cost of the acquisition, we agreed to payHot Rocket a contingent purchase price of up to $12.5 million if Hot Rocketgenerates an aggregate of $27 million in EBITDA (asquantified in the Agreement) over the four year period following the closing. Thecontingent purchase price, if any, will be accounted for as additional purchaseprice in accordance with EITF 95-8, “Accounting for ContingentConsideration Paid to the Shareholders of an Enterprise in a Purchase Business Combination”. At May 31, 2005, the Company hasdetermined that at the current rate of growth recognized by Hot Rocket, it is notprobable that the first tier of contingent payment will be attained within thefirst measurement period, which ends February 28, 2006.  The first tier contingent payment commences uponthe attainment of EBITDA of $1.5 million for theperiod February 1, 2005 to January 31, 2006, and is capped at $4 million.

 

24

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As of May 31, 2005, the Company is not liable for any contingentpayments and, therefore, has not accrued any at this time. The Company willcontinue to asses its liability under the Hot Rocket contingent paymentarrangement in each successive quarter, and will record additional purchaseprice through increased goodwill, if and when a liability is realized. For anyinterim period accrual of additional purchase price arising out of thecontingent arrangement, the Company presently deems that it will be settled incash, but retains the right to settle the final payment with a blend of cashand stock, with stock not to exceed 50% of the total payment and to make asmuch of such payment in cash as is necessary to keep all share issuances to HotRocket at a maximum of 19.9% of the Company’s outstanding stock.

 

**Hot Rocket Pro Forma Information**

 

The Hot Rocket acquisitionclosed on January 21, 2005 and, as such, the results of its operations areincluded in the Company’s consolidated results from that date through May 31,2005. The first pro forma disclosure set forth below provides the details asthough the business combination had been completed as of January 1, 2005.The pro forma adjustments serve to: (1) eliminate intercompanytransactions during the pre-acquisition period; (2) record amortization expensefor the pre-acquisition period; (3) provide for income tax expense at Traffix’s marginal tax rate as applicable to the six-monthperiod ended May 31, 2005, applied to Hot Rocket’s adjusted pre tax income;and (4) increase the weighted average shares outstanding as if theacquisition shares were issued on December 1, 2004.

 
| ** **                                  | ** ** | **Pro forma**   | ** ** |
|---------------------------------------------|------------|-----------------|------------|
| ** **                                  | ** ** | **Traffix**     | ** ** |
| ** **                                  | ** ** | **12-01-04 to** | ** ** |
| ** **                                  | ** ** | **05-31-05**    | ** ** |
|                                        |       |            |       |
| Net revenue                                 |       | $               | 31,150,875 |   |
| Income from operations                      |       | 1,573,377       |       |
| Income before provision for income taxes    |       | 2,513,206       |       |
| Net income                                  |       | 1,492,408       |       |
| Diluted income per share                    |       | $               | 0.10       |   |
| Diluted weighted average shares outstanding |       | 14,309,526      |       |

 

25

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The pro forma disclosureset forth below provides the details as though the business combination hadbeen completed as of the beginning of the six month period commencing January 1,2004. The Hot Rocket entity had a natural business year which ended December 31.Both the month of December 2003, and the period January 1, 2004 to June 30,2004, did not include any material, or non-recurring items requiring separatedisclosure in the pro forma information. The pro forma adjustments serve to: (1) eliminate intercompanytransactions; (2) record amortization expense for the six months ended June 30,2004; (3) provide for income tax expense at Traffix’ marginal tax rate asapplicable to the six-month period ended May 31, 2004, applied to HotRocket’s adjusted pre tax income; and (4) increase the weighted averageshares outstanding as if the acquisition shares were issued on December 1,2003.

 
| ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Proforma**    | ** ** |
|---------------------------------------------|------------|------------|------------|------------|------------|------------|------------|-----------------|------------|
| ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Traffix**     | ** ** |
| ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **12-01-03 to** | ** ** |
| ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **05-31-04**    | ** ** |
|                                        |       |       |       |       |       |       |       |            |       |
| Net revenue                                 |       |       |       |       |       |       |       |            |       |   | $ | 21,889,433 |   |
| Income from operations                      |       |       |       |       |       |       |       | 2,553,522       |       |
| Income before provision for income taxes    |       |       |       |       |       |       |       | 3,536,836       |       |
| Net income                                  |       |       |       |       |       |       |       |            | 2,287,994  |   |
| Diluted income per share                    |       |       |       |       |       |       |       |            | $          | 0.17 |   |
| Diluted weighted average shares outstanding |       |       |       |       |       |       |       | 13,772,948      |       |
|                                             |            |            |            |            |            |            |            |                 |            |  |  |  |  |

 

26

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**Fiscalyear ended November 30, 2004 Asset Acquisitions**

 

During the fiscal year ended November 30, 2004, the Companyentered into an Asset Acquisition Agreement for the acquisition of the assetsof SendTraffic.com, Inc. (Send Traffic). The acquisition was accounted forin accordance with SFAS 141, Business Combinations. Send Traffic warranted thatcertain financial information contained in its unaudited June 30, 2004balance sheet was accurate, and if such financial information ultimately provedpost-closing to have been inaccurate, Send Traffic would return to the Companyany shortfall.  In order to ensurecompliance with such warranty, the Company retained in escrow $250,000 of thepurchase price.  On November 24,2004, the Company signed an Adjustment Agreement with Greg Byrnes and CraigHandelman, the principals of Send Traffic (the “ST Stockholders”), regardingthe final determination of the June 30, 2004 balance sheet. In accordancewith the Adjustment Agreement’s “Cash Adjustment” clause, the Company received$300,000 in cash from the ST Stockholders, $250,000 of which came from theescrow withheld at closing, and an additional $50,000 of which was received on November 30,2004. Additionally, under the Adjustment Agreement’s “Share Adjustment” clause,the ST Stockholders returned 57,142 shares to the Company, which served toreduce the total shares issued in the asset acquisition to 176,799 shares, ascompared to the original issuance of 233,941 shares.

 

Upon the consummation of the Send Trafficacquisition, each of the ST Stockholders entered into five-year employmentcontracts with the Company’s wholly-owned subsidiary.  Included in each of those contracts wererestrictive covenants prohibiting the ST Stockholders from competing with the Companyduring the term of their employment and for a period of time thereafter (the “RestrictiveCovenants”).

 

At the time of the Send Traffic acquisition, theCompany allocated $665,000 (of the approximately $5.43 million purchase price)to the Restrictive Covenants, which the Company amortized over a five-yearperiod, or through June 30, 2009.

 

On April 6, 2005, the employmentrelationship between the ST Stockholders and the Company terminated.  The Company maintains that the STStockholders resigned from their positions voluntarily and without good reasonunder the terms of their respective employment contracts, in which event thecontracts provide that the Restrictive Covenants would continue in effect untilJune 30, 2007.  Accordingly, theCompany is reducing the period over which it is amortizing the remainingunamortized portion of the purchase price allocated to the RestrictiveCovenants to the period ending June 30, 2007.  As a result of shortening the life of the RestrictiveCovenants, the increased risk of competition and the reduced future revenuesthat may flow therefrom, the remaining carrying value of the RestrictiveCovenants as of May 31, 2005 (or $539,000) was re-evaluated in accordance withSFAS No. 144 and deemed to be impaired by approximately $137,000. Thisimpairment loss is included in depreciation and amortization expense in the“administrative expense” caption of the Company’s income statement for thethree and six month periods ended May 31, 2005. The impairment loss isallocated to the Company’s E-commerce segment.

 

The ST Stockholders have contended that theiremployment contracts were either terminated without Cause (as that term isdefined in their respective employment contracts) by the Company, or that theywere entitled to terminate the agreements as a result of actions taken by theCompany with respect to the scope of their duties and responsibilities.  If it were determined that the STStockholders’ employment was terminated by the Company without Cause, then,under their employment contracts, each would have been entitled to severance ofnot less than 6 months’ and up to 12 months’ base salary (such amountdetermined by the Company in its discretion) and the Restrictive Covenantswould have continued during the severance period. The remaining unamortizedportion of the purchase price allocated to the Restrictive Covenants would beamortized over such period, which would have ended no earlier than November 6,2005 and no later than April 6, 2006, as determined by the Company, and,in accordance with SFAS 144, the remaining carrying value of the RestrictiveCovenants would be re-evaluated, with the Company taking an impairment loss at thetime of re-evaluation.  If, however, itwere determined that the ST Stockholders were entitled to terminate theiremployment agreements with good reason as a result of actions taken by theCompany, then the Restrictive Covenants would have ended on April 6, 2005,the date of termination, and, in accordance with SFAS 144, the remainingunamortized portion of the purchase price allocated to the RestrictiveCovenants would be an expense in the current period.  Should it become necessary, the Company willdefend its position vigorously and use whatever means available to enforce theRestrictive Covenants.  The Company isconfident that, notwithstanding the departure of the ST Stockholders, theCompany’s extensive and experienced workforce will allow it to grow the Send Trafficbusiness and expand its contributions to the Company’s overall operations.

 

As of May 31, 2005, the unamortizedbalance remaining relating to the Restrictive Covenants is $402,000 and isincluded in other intangibles.  Noamounts have been accrued relating to any severance.

 
| **Details  of Acqusition**    | ** ** | **SendTraffic.com** | ** ** |
|-------------------------------|------------|---------------------|------------|
|                          |       |                |       |
| Fair Value of assets acquired |       | $                   | 6,043,206  |   |
| Liabilities assumed           |       | (1,240,788          | )          |
| Stock issued                  |       | (1,107,953          | )          |
| Cash paid                     |       |                | 3,694,465  |   |
| Less: cash acquired           |       | (196,812            | )          |
|                          |       |                |       |
| Net cash paid for acquisition |       | $                   | 3,497,653  |   |

 

27

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**8. Goodwill and Identifiable Intangibles Assets**

 

Thegross carrying value of goodwill and the gross carrying value and accumulatedamortization of other intangibles are as follows:

 
| ** **                                | ** ** | **As  of May 31, 2005** | ** ** | **As  of November 30, 2004** | ** ** |
|-------------------------------------------|------------|------------------------------|------------|-----------------------------------|------------|
| ** **                                | ** ** | **Gross**                    | ** ** | ** **                        | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                                | ** ** | **Carrying**                 | ** ** | **Accumulated**                   | ** ** | **Carrying** | ** ** | **Accumulated** | ** ** |
| ** **                                | ** ** | **Amount**                   | ** ** | **Amortization**                  | ** ** | **Amount** | ** ** | **Amortization** | ** ** |
|                                      |       |                         |       |                              |       |   |   |   |   |
| Amortizable intangible assets:            |       |                         |       |                              |       |   |   |   |   |
| *GroupLotto  identifiable intangibles:*   |       |                         |       |                              |       |   |   |   |   |
| GroupLotto Site Brand  Recognition        |       | $                            | 722,922    |                              | $          | 558,517 |   | $ | 722,922 |   | $ | 486,225 |   |
| GroupLotto Database                       |       | 433,754                      |       | 335,110                           |       | 433,754 |   | 291,735 |   |
| Intellectual Property Assets              |       | 289,169                      |       | 223,406                           |       | 289,169 |   | 194,490 |   |
| Licenses                                  |       | 238,000                      |       | 50,528                            |       | 200,000 |   | 30,000 |   |
|                                      |       |                         |       |                              |       |   |   |   |   |
| *Infiknowledge identifiable intangibles:* |       |                         |       |                              |       |   |   |   |   |
| Internet Game Suite                       |       | 245,525                      |       | 169,320                           |       | 258,109 |   | 152,328 |   |
| Intellectual Property Assets              |       | 184,144                      |       | 126,990                           |       | 193,582 |   | 114,246 |   |
| Market Position Acquired                  |       | 204,605                      |       | 141,100                           |       | 215,091 |   | 126,940 |   |
|                                      |       |                         |       |                              |       |   |   |   |   |
| *Thanksmuch identifiable intangibles:*    |       |                         |       |                              |       |   |   |   |   |
| Profiled customer data                    |       | 50,000                       |       | 50,000                            |       | 50,000 |   | 44,305 |   |
| Restrictive Covenants                     |       | 10,000                       |       | 7,878                             |       | 10,000 |   | 6,878 |   |
|                                      |       |                         |       |                              |       |   |   |   |   |
| *SendTraffic identifiable intangibles:*   |       |                         |       |                              |       |   |   |   |   |
| Employment Contracts                      |       | 660,592                      |       | 258,592                           |       | 660,592 |   | 55,049 |   |
| Software                                  |       | 963,951                      |       | 271,841                           |       | 963,951 |   | 123,564 |   |
|                                      |       |                         |       |                              |       |   |   |   |   |
| *Hot Rocket identifiable intangibles*     |       |                         |       |                              |       |   |   |   |   |
| Employment Contracts                      |       | 569,394                      |       | 41,439                            |       | — |   | — |   |
| Software                                  |       | 1,012,257                    |       | 122,782                           |       | — |   | — |   |
|                                      |       |                         |       |                              |       |   |   |   |   |
| Total amortizable intangible  assets      |       | $                            | 5,584,313  |                              | $          | 2,357,503 |   | $ | 3,997,170 |   | $ | 1,625,761 |   |
|                                      |       |                         |       |                              |       |   |   |   |   |
| Unamortized intangible assets:            |       |                         |       |                              |       |   |   |   |   |
| *Goodwill – Infiknowledge - (1)*     |       | $                            | 810,594    |                              |       |   | $ | 852,138 |   |   |   |
| *Goodwill - SendTraffic*                  |       | 3,097,091                    |       |                              |       | 3,089,180 |   |   |   |
| *Goodwill - Hot Rocket*                   |       | 2,136,349                    |       |                              |       |   |   |   |   |
| *Goodwill - Thanksmuch*                   |       | 289,736                      |       |                              |       | 289,736 |   |   |   |
|                                      |       |                         |       |                              |       |   |   |   |   |
| Total Goodwill                            |       | $                            | 6,333,770  |                              |       |   | $ | 4,231,054 |   |   |   |

 

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**(1)**                                 The Infiknowledge identifiable intangiblesand unamortizable goodwill carrying value changes as a result of the effects offoreign currency exchange translation.

 

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The amortizable intangibles listed above are deemed to have a finitelife of five years, or less, from the date of acquisition with the weighted average life being 3.9 years.The straight-line method of amortization has been applied to such assets incalculating their respective amortization. The Internet and E-commerceindustries, within which the Company conducts the majority of its business andhas extensive experience, are dynamic and constantly evolving business arenas.

 

Theamortization expense related to acquired amortizable indentifiable intangibles assetshas been recorded from the dates of the respective acquisitions.

 

Thefuture intangible amortization expense for the next five fiscal years isestimated to be as follows:

 

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| ** **                                             | ** ** | **2005** | ** ** | **2006** | ** ** | **2007**  | ** ** | **2008** | ** ** | **2009** | ** ** |
|--------------------------------------------------------|------------|----------|------------|----------|------------|-----------|------------|----------|------------|----------|------------|
|                                                   |       |     |       |     |       |      |       |     |       |     |       |
| *GroupLotto  Identifiable intangible amortization:*    |       |     |       |     |       |      |       |     |       |     |       |
| GroupLotto  Site Brand Recognition                     |       | $        | 140,892    |     | $          | 89,744    |       | $        | —     |     | $          | — |   | $ | — |   |
| GroupLotto  Database                                   |       | 84,535   |       | 53,847   |       |      |       | —   |       |     |       |
| Intellectual  Property Assets                          |       | 56,357   |       | 35,898   |       |      |       | —   |       |     |       |
| Licenses                                               |       | 46,861   |       | 52,667   |       | 52,667    |       | 45,805   |       | 10,000   |       |
| *Total  Group’s amortization*                     |       |     | 328,645    |     |       | 232,156   |       |     | 52,667     |     |       | 45,805 |   |   | 10,000 |   |
|                                                   |       |     |       |     |       |      |       |     |       |     |       |
| *Infiknowledge  Identifiable intangible amortization:* |       |     |       |     |       |      |       |     |       |     |       |
| Cost  allocated                                        |       |     |       |     |       |      |       |     |       |     |       |
| Internet Game  Suite                                   |       |     | 49,105     |     |       | 49,105    |       |     | 1,581      |     |       | 464 |   |   | 369 |   |
| Intellectual  Property Assets                          |       | 36,829   |       | 36,829   |       | 1,186     |       | 348      |       | 277      |       |
| Market  Position Acquired                              |       | 40,921   |       | 40,921   |       | 1,317     |       | 387      |       | 307      |       |
| *Total  Group’s amortization*                     |       |     | 126,855    |     |       | 126,855   |       |     | 4,084      |     |       | 1,199 |   |   | 952 |   |
|                                                   |       |     |       |     |       |      |       |     |       |     |       |
| *ThanksMuch  Identifiable intangible amortization:*    |       |     |       |     |       |      |       |     |       |     |       |
| Profiled  customer data                                |       |     | 5,695      |     |       | —    |       |     | —     |     |       | — |   |   | — |   |
| Restrictive  Covenants                                 |       | 2,000    |       | 1,122    |       | —    |       | —   |       | —   |       |
| *Total  Group’s amortization*                     |       |     | 7,695      |     |       | 1,122     |       |     | —     |     |       | — |   |   | — |   |
|                                                   |       |     |       |     |       |      |       |     |       |     |       |
| *SendTraffic  identifiable intangible amortization:*   |       |     |       |     |       |      |       |     |       |     |       |
| Employment  Contracts                                  |       |     | 304,043    |     |       | 201,000   |       |     | 100,500    |     |       | — |   |   | — |   |
| Software                                               |       |     | 296,554    |     |       | 296,554   |       |     | 234,897    |     |       | 12,382 |   |   | — |   |
|                                                   |       |     | 600,597    |     |       | 497,554   |       |     | 335,397    |     |       | 12,382 |   |   | — |   |
|                                                   |       |     |       |     |       |      |       |     |       |     |       |
| *Hot  Rocket identifiable intangible amortization*     |       |     |       |     |       |      |       |     |       |     |       |
| Employment  Contracts                                  |       |     | 97,746     |     |       | 113,879   |       |     | 113,879    |     |       | 113,879 |   |   | 113,879 |   |
| Software                                               |       |     | 289,618    |     |       | 337,419   |       |     | 337,419    |     |       | 47,801 |   |   | — |   |
|                                                   |       |     | 387,364    |     |       | 451,298   |       |     | 451,298    |     |       | 161,680 |   |   | 113,879 |   |
|                                                   |       |     |       |     |       |      |       |     |       |     |       |
| **Summary**                                            |       |     |       |     |       |      |       |     |       |     |       |
| *GroupLotto  Identifiable intangibles:*                |       |     | 328,645    |     |       | 232,156   |       |     | 52,667     |     |       | 45,805 |   |   | 10,000 |   |
| *Infiknowledge  Identifiable intangibles:*             |       | 126,855  |       | 126,855  |       | 4,084     |       | 1,199    |       | 952      |       |
| *ThanksMuch  Identifiable intangibles:*                |       | 7,695    |       | 1,122    |       | —    |       | —   |       | —   |       |
| *Hot  Rocket Identifiable intangibles:*                |       | 387,364  |       | 451,298  |       | 451,298   |       | 161,680  |       | 113,879  |       |
| *SendTraffic  identifiable intangibles:*               |       | 600,597  |       | 497,554  |       | 335,397   |       | 12,382   |       | —   |       |
| * *                                               |       |     |       |     |       |      |       |     |       |     |       |
| *Total  identifiable intangible amortization*          |       | $        | 1,451,156  |     | $          | 1,308,985 |       | $        | 843,445    |     | $          | 221,065 |   | $ | 124,831 |   |

 

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**9. Income Taxes**

 

TheCompany’s income tax provision for the three and six months ended May 31,2005 was approximately $486,000 and $922,000, respectively, and includes $439,000and $829,000 of expense related to the current year’s three and six month operationsand approximately $47,000 and $93,000 of period expenses related to an increasein the Company’s estimates related to tax audits.

 

Theeffective income tax rates for the three and six months ended May 31, 2005was 40.7% and 40.9%, respectively. This differs from the Company’s estimatedannual effective income tax rate of 39.9% described below, due primarily to projectedconsistent tax liability adjustments made to a projected increasing pre-taxincome environment.

 

*Estimated Annual Effective Income Tax Rate.*The estimated annual effective income taxrate for 2005 differs from the U.S. federal statutory income tax rate of 34% asfollows:

 
| ** **                                         | ** ** | **Fiscal Year 2005 (1)** | ** ** | **Fiscal Year   2004 (2)** | ** ** |
|----------------------------------------------------|------------|-----------------------------------------|------------|--------------------------------------|------------|
| Income tax expense at U.S. federal  statutory rate |       | 34.0                                    | %          | 34.0                                 | %          |
| State income taxes, net of U.S. federal  impact    |       | 2.2                                     |       | 2.2                                  |       |
| Impact of foreign operations                       |       | 1.3                                     |       | 1.2                                  |       |
| Change in contingent tax liabilities               |       | (0.3                                    | )          | (8.4                                 | )          |
| Other, including non-deductible expenses           |       | 2.7                                     |       | 2.6                                  |       |
|                                               |       |                                    |       |                                 |       |
|                                               |       | 39.9%                                   |       | 31.6                                 | %          |

 

----

| (1)    | Estimated  annual effective income tax rate for Fiscal 2005.                                  |
|--------|-----------------------------------------------------------------------------------------------|
|   |                                                                                          |   |
| (2)    | Projected  annual effective income tax rate used for the six months ended May 31,  2004. |

 

The“State income taxes, net of U.S. federal impact” item above primarily reflectsfranchise tax and minimum tax expense, net of related federal benefit, whichthe Company expects for the year. The Company currently has a significantvaluation allowance against state net operating loss carryforwards, and a fullvaluation allowance against capital loss 

 

31

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carryforwards.The annual estimated effective tax rate for 2005 does not include anyanticipated benefit from additional current year state tax losses, nor does itanticipate any benefit from the use of capital loss carryovers.

 

**10. Litigation**

 

Weare subject to legal proceedings, lawsuits and other claims, brought by: (1) consumersof our products and services; (2) our clients; (3) consumers of ourclients’ products and services; and (4) others bringing claims that arisein the normal course of our business. Legal proceedings are subject to numerousuncertainties rendering the prediction of their outcome difficult. As a resultof such uncertainty, we are unable to estimate the ultimate outcome of any ofthe following claims, and, accordingly, no provision for loss has beenrecorded. We believe that individually, and in the aggregate, the ultimatesettlement of the following claims will not have a material adverse effect onour consolidated financial position, results of operations or cash flows.

 

*Qwest*

 

Qwest Communications, Inc. notified us of an indemnification claimrelating to a class action filed against Qwest in Minnesota, *Bindner v. LCI International Telecom Corp. et al.*,District Court of Minnesota, County of Sibley, Case No. C0-00-242 (the “Class Action”).In that action, plaintiffs claimed that from September 1998 to July 1999,they were misled when they were solicited to change their long distance carrierto Qwest. They asserted that they were not told that they would have to stay atcertain hotels and pay their regular rates as part of a promotion involving freeairline tickets. We introduced the promotion (“Fly Free America”) to Qwest, andwere retained by Qwest to operate the telemarketing campaign pursuant to ourAgreement. In or about May 2000, we and Qwest entered into an agreementterminating the Agreement and settling the amount due us (the “May 2000Agreement”). The Agreement and the May 2000 Agreement contain languagethat Qwest claims obligates us to indemnify Qwest for the losses it sustainedby reason of this class action. We maintain that we have no liability in thematter.

 

Fraud claims in the Class Action were dismissed, leaving breach ofcontract and false advertising claims. The court certified the class and Qwest,without our consent, agreed to settle the Class Action. The court approvedthe settlement agreement, stated that there was no finding of any liability 

 

32

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against Qwest, and approved the attorneys’ fees for plaintiffs’counsel. No appeal was taken so that the Class Action has been concluded.

 

In November 2002, we commenced an arbitration against Qwest torecover certain amounts held in escrow that were due us pursuant to the May 2000Agreement. In December 2002, Qwest filed counterclaims in the arbitrationrelating to the Fly Free America program. Qwest asserts that in connection withthe Class Action, we must indemnify it for $3.4 million in Qwestattorneys’ fees; $600,000 in fees for counsel to the plaintiffs in the Class Action;and $500,000 in settlement payments to Class members. Qwest also soughtreimbursement of approximately $3.1 million it paid us pursuant to the May 2000Agreement.  Initially, Qwest also soughtto recover approximately $1.5 million of fines and penalties it claimed itpaid to various attorneys general; Qwest has now withdrawn that claim.

 

A panel of arbitrators was appointed in December 2003. The panelestablished a schedule for substantive motions and for hearings in June 2004.The arbitrators also provided for exchanges of information in the arbitrationsubject to Qwest’s right to seek to prevent such exchanges. Qwest moved toprevent exchanges of information and this application was granted. Qwest movedfor summary judgment with respect to its indemnification counterclaim. Thatmotion was denied.  We believe that thereis no merit to Qwest’s counterclaims and intend vigorously to defend against them,as well as to pursue our claims for payments due to us under the May 2000Agreement.  The arbitration was heardduring the week of June 20, 2005, at this time the Company is still awaitingthe arbitrators decision.

 

*Columbia House/Rydel*

 

In or about August 2002, Columbia House, one of our clients,notified us of an indemnification claim relating to a class action filedagainst Columbia House, among others, in Illinois, *Rydel v. Comtrad Industries, Inc. et al.*, Circuit Courtof Cook County, Illinois, No. 02 CH 13269. In that action, plaintiffclaims to have received unsolicited commercial e-mail from, among others,Columbia House, in violation of Illinois law, and asserts two basic claimsagainst Columbia House, one for violation of Illinois’ Consumers Fraud Statute,the second for violation of Illinois’ Electronic Mail Act. Columbia Houseadvised us that it believes that the email in question was not approved byColumbia House when it was sent, and asserted a claim for indemnificationagainst us pursuant to our contract. We and Columbia House agreed to deferresolution of the indemnification claim (and reserved each of our respective

 

33

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rights). Columbia House is defending against the class action. Itsmotion to dismiss was granted as to the Consumer Fraud claim, but denied as tothe Electronic Mail Act claim. The plaintiff has appealed the partialdismissal.

 

In or about January 2003, we were named as a defendant in the *Rydel* class action. In an additional countin the complaint, the plaintiff asserted that we violated the Illinois ConsumerFraud and Deceptive Business Practices Act by providing to a co-defendant alist of consumers who had consented to receive commercial e-mails when, thecomplaint alleges, they had not. The complaint sought injunctive relief andunspecified damages. Our motion to dismiss the claim as against us was grantedin June 2003, and the plaintiff filed an appeal.

 

In late 2004, the appellate court affirmed the decision below, so thatthe claim against us is dismissed; the Consumer Fraud claim against ColumbiaHouse is dismissed; and the Electronic Mail Act claim against Columbia Houseremains. The plaintiff asked the appellate court to reconsider its decision,and the court denied that request on April 14, 2005.

 

We evaluate contingent liabilities including threatened or pendinglitigation in accordance with SFAS No. 5, *Accounting forContingencies*, and record accruals when the outcome of these mattersis deemed probable and the liability is reasonably estimable. We make theseassessments based on the facts and circumstances and in some instances based inpart on the advice of outside legal counsel. Accordingly, and as stated above,we are unable to determine the ultimate outcomes of any of the foregoing claimsor demands, and, accordingly, no provision for loss has been recorded in thefinancial statements included in this Report.

 

**11.  Subsequent Events**

 

On July 12, 2005, the Board of Directors declared a dividend from theCompany’s retained earnings of $0.08 per share on the outstanding shares of itscommon stock for the quarter ended May 31, 2005. Such dividend is payableon or about August 10, 2005 to holders of record of such shares at theclose of business on August 1, 2005.  TheCompany can give no assurance that its Board will declare any dividends infuture fiscal periods. Any further declarations will depend upon the Company’sperformance, the level of its then current and retained earnings, if any,available capital and projected capital requirements necessary for operations,and other pertinent factors. You should not rely on any prior approvals of theBoard as an indicator of its intent to approve the 

 

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declaration of any dividends in the future.

 

**ITEM 2****.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

The matters discussed in the following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements and information relating to the Company that are based on the current beliefs, expectations and estimations of Management, as well as assumptions made by and information currently available to the Company. When used in this Management’s Discussion and Analysis, and elsewhere in this Form 10-Q, the words “anticipate”, “believe”, “estimate”, “continue”, and “expect”, and variations of such words and similar expressions, as they relate to the Company, are intended to identify forward-looking statements. Such statements are not guarantees of future performance, but reflect the current views of the Company’s management with respect to future events and are subject to certain risks, uncertainties and assumptions, which could cause the actual results to differ materially from those reflected in the forward-looking statements. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.

 

**Overview**

 

Weare a leading Internet media and marketing company that uses our on-line medianetwork to generate leads and sales for our corporate clients. We providecomplete end-to-end marketing solutions for companies seeking to increase salesand customers through on-line marketing programs. The services we offer includethe development of a complete creative promotion to be used to market theclient’s product to consumers, broadcasting a promotion on-line in order togenerate new customers for the client, delivery of data files from the resultsof campaigns, creating and hosting the customized websites or web pages necessaryto effect the consumer transaction that drives the client’s 

 

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salesand generating comprehensive reporting in order for the client to analyze theeffectiveness of a promotion. We use the media of our websites, as well asemail, search engines and other on-line media to generate the customers, salesand leads for our clients, and for our own product and service offers. We arepaid by our clients primarily on a success-based model, in that we receive afee for every lead, customer or sale generated for the client.

 

In addition to our third party client-based revenue, we generaterevenue directly from consumers from our own products and services. In Fiscal2003, we expanded our line of direct-to-consumer products and services toinclude Internet based services, such as iMatchUp.com, our on-line datingservice included in our E-commerce segment, which revenues are included in ourE-commerce segment, and TXNet/WorldWebAccess, our ISP, VOIP and email products,which comprise our LEC Billed Products segment. During Fiscal 2004, we introducedClick-Help, an addition to our LEC Billed Product suite that offers 24/7technical assistance to the home PC user, under a recurring monthly billingplan. We discontinued new customer acquisitions for our LEC Billed Products segmentduring the fourth quarter of Fiscal 2004. We continue to expend effort to effectivelyseek out other products that fit the LEC billing mode that exhibit thepotential for acceptable economic returns. LEC Billed Products do not have anylong-lived assets associated with the segment. These “direct to consumer”generated products and services accounted for approximately $0.4 million and $0.7million, or 2.1% and 2.4 %, respectively, of our revenue during the three andsix month periods ended May 31, 2005, as compared to $1.1 million and $1.2million, or 12% and 7% for the three and six month periods ended May 31,2004.

 

Wealso generate revenues from the sales and rentals (for use both on-line andoff-line) of our proprietary, profiled databases, which are included in ourE-commerce segment.

 

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**Background**

 

Fromour inception in 1993 (under the name “Quintel Communications, Inc.”)through 1999, we generated the bulk of our revenue from direct marketing usingthe traditional media of television, postal mail and telemarketing. In 2000, werepositioned our direct marketing business to the on-line media of the Web.Applying the direct marketing disciplines honed from our years of operating inthe “off-line” media arena, we have been able to provide enhancedresponse-based results in a cost-efficient and scaleable manner via on-linemarketing.

 

##### **On-Line Marketing**

##### ** **

Weown and operate a variety of Internet websites featuring specialized contentsuch as downloadable music, recipes, greeting cards, automobile information,DVD promotions, and on-line dating. We generate traffic to our websites fromadvertising on third party Internet media (i.e., search engines, email andbanner advertisements) and through cross-marketing within our own on-line media.Our Web properties and our marketing activities are designed to generatereal-time response-based marketing results for our corporate clients. Whenvisiting our on-line properties, consumers are given the opportunity topurchase, sign-up for, ask to be contacted regarding, or simply indicate aninterest in, hundreds of offers for various products and services.Specifically, through these interactive Web properties we generate a variety oftransactional results ranging from (a) Web traffic, (b) inboundtelemarketing calls, (c) outbound telemarketing leads, (d) demographically/psychographicallyprofiled lists of consumers, (e) highly-targeted customized response-basedleads, (f) completed applications for products, and (g) sales ofproducts and services.

 

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*Websites.  *We own and operate a variety of websites with a broad range of content.  Virtually all of our websites generaterevenue from client advertisements.  Theadvertisements are served across all of our websites using ourinternally-developed technology that serves ads to website visitors using analgorithm that takes into account a number of factors, including informationsupplied by the visitor upon registration (e.g, gender, age and zip code), aswell as the price paid by our customer to serve the ad.

 

The websites feature content ranging from music for downloads tosweepstakes.  We recently launchedEZ-Tracks.com, a site that features over thirty thousand songs available forfree and legal downloading, as well as other content such as musical greetingcards and a downloadable version of the Bible in audio format.  We have a games website that offers a varietyof free parlor-style games, such as backgammon and checkers.  We also recently launched a website thatfeatures thousands of cooking recipes, reciperewards.com.

 

Our PrizeDistributors, Inc. sponsored group of websitesoffers consumers the opportunity to win up to $1 million daily in our free,on-line sweepstakes. The sweepstakes prizes are indemnified by an independent,third-party agency. In order to play, each consumer must provide complete andaccurate registration information and agree to receive (“opt-in”) marketingmessages from us and our marketing partners.

 

Weown and operate several other websites such as AtlasCreditGroup.com,TheBargainSpot.com, AltasAutomotiveGroup.com, Take 1 Entertainment.com,prizecade.com and jewelclaimcenter.com. Each of these sites is designed toappeal to a specific consumer interest category that we matched with clientpromotions that appeal to such interest category.

 

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*Email Marketing.* Each program that we market for our clientscan be implemented not only through the websites, but also, and often, through emailmarketing. We currently market to a vast database, which includes consumer datathat is either owned by us or is managed by us under our revenue sharearrangements whereby we recognize the gross revenue as earned and bear thepayment obligation to the list owner, irrespective of receipt of payment fromour clients.

 

*ResultsAnalysis.* Even aftercampaigns are fully implemented, we continually analyze the marketing resultsto gauge whether the campaigns are continuing to generate adequate results forthe client, whether the media is being utilized cost-efficiently, and todetermine whether new and different copy is yielding better overall results.These are traditional direct-marketing disciplines that we apply, and that webelieve, distinguish us from many of our competitors in the on-line marketingindustry.

 

*Syndication.* After we develop a campaign that worksefficiently on our own media, we sometimes “syndicate” the program tothird-party media. Typically, we have expended time, media and other costs indeveloping certain campaigns. In exchange for this invested effort, we obtainthe right to market those campaigns to other on-line media companies. Webelieve that with syndicated offers we can leverage campaigns we have developedso that in future fiscal periods we can generate additional revenue withreduced costs and risks associated with such business extension.

 

**PRODUCTS AND SERVICES**

 

We introduced several new businesses during Fiscal 2003, and furtherexpanded those new business units in Fiscal 2004, including an on-line datingprogram (“iMatchup.com”) included in our E-commerce segment, and Internet-

 

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based service products such as a PC home user technical supportservice, an ISP service and email accounts that are LEC billed (“Click-Help”, “TxNET”and “WorldWideAccess, Inc.”). These new business units are designed asmonthly recurring billing programs, such as membership to iMatchUp.com. Revenuefrom these businesses is generated primarily from billing consumersdirectly.  Imatchup.com became asignificant source of revenue for us in 2004, and continues to be a significantsource of revenue as represented by its approximate $2.3 million, or 14 %contribution to consolidated net revenue for the three months ended May 31,2005, as compared to $1.6 million, or 18% contribution during the comparableprior year fiscal period. During the six month period ended May 31, 2005,Imatchup contributed $4.2 million, or 14% of consolidated net revenue ascompared to $3.0 million, or 18% in the prior year’s comparable prior fiscalperiod.

 

Ourexpansion in, and dependence on, our on-line direct marketing efforts, coupledwith the potential for state and/or federal legislation limiting our ability tocontact consumers on-line should all be considered when referring to ourcurrent fiscal year’s results, as well as prior years’ historical results, inevaluating the potential for our future operations, cash flows, and financialposition.

 

**GOVERNMENT REGULATION**

 

As a direct-to-consumer marketing company we aresubject to a variety of federal, state and local laws and regulations designedto protect consumers that govern certain of our marketing practices.

 

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Federal legislation was signed into law, effective January 1,2004, pre-empting all existing and pending state e-mail marketing legislation.The CAN-SPAM Act of 2003 requires that certain “opt-out” procedures, including,but not limited to, a functioning return e-mail address (and a time limit often (10) days to comply with all opt-out requests sent by consumers), beincluded in commercial e-mail marketing. The CAN-SPAM Act prohibits the sendingof e-mail containing false, deceptive or misleading subject lines, routing information,headers and/or return address information. The CAN-SPAM Act does not permitconsumers to file suit against e-mail marketers for violation of such Act. Webelieve that this may benefit us, as individuals will be more limited in theirability to file frivolous suits against us, as they have in the past. TheFederal Trade Commission (“FTC”) is empowered by the CAN-SPAM Act to enactregulations that would implement certain provisions of the CAN-SPAM Act such asstandardized subject line labeling, a “bounty” system to compensate consumersfor being the first to report a spammer and a potential “do-not-spam registry.”Under its subject line labeling authority, the FTC has required sexuallyoriented material to include the warning “Sexually-Explicit.” On December 16,2004, the FTC adopted rule provisions, effective March 28, 2005, toassist in determining whether the purpose of an e-mail is commercial. Onlycommercial and transactional messages are regulated by the CAN-SPAM Act.Generally, if the recipient of the e-mail would interpret the subject line orbody of the e-mail to be primarily commercial, then the e-mail is subject tothe CAN-SPAM Act and its implementing regulations. If any subsequentregulations are promulgated by the FTC that limit our ability to market ouroffers, we could potentially realize a material adverse impact in future fiscalperiod net revenue growth, and, therefore, profitability and cash flows couldbe adversely affected.

 

Under its rule-making authority, the FederalCommunications Commission (“FCC”) in August 2004 adopted rules prohibitingsending of unsolicited commercial e-mails to wireless phones and pagers. Toassist in compliance with the rules, the FCC published on February 7, 2005a list of mail domain names associated with wireless devices. Senders weregiven thirty (30) days to come into compliance. Thereafter, it has becomeillegal to send unsolicited commercial e-mail to a domain address on the listunless the subscriber has given prior express authorization. The effect ofthese rules is to create a “double opt-in” requirement for each sender ofmail (advertiser and publisher). The practical consequence of theserequirements on senders of commercial e-mail is that conducting compliantcampaigns will necessitate the suppression of the domains listed in the FCC’slist. In short, we, in order to

 

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complywith the latest regulations, are required to suppress the domains listed in theFCC’s list of wireless domains. Additionally, since domain suppression is nowrequired as a practical matter by law, any campaigns that have domainsuppression lists will have those lists included with the regular e-mailsuppression lists. Our publishers will be required to suppress the domain listsassociated with each campaign in the same manner that they already suppress thee-mail address lists. Although these new regulations do not have a materialadverse impact on our current operations, there can be no assurance that theywill not have a material adverse impact on our future operations.

 

Under its rule-making authority, in May 2005, theDepartment of Justice adopted rules that amend the record keeping andinspection requirements for producers of sexually explicit performances.  Codified in 18 U.S.C. 2257 of the federalcriminal code, Section 2257 (as it is known colloquially), as amended,went into effect on June 23, 2005 and requires a class referred to as “secondaryproducers” to comply with the record keeping and inspection requirements thatapply to primary producers.  At present,litigation is pending that challenges, among other things, the extent to whichwebmasters and/or web sites fall under the definition of “secondary producers”under the new Section 2257 regulations. There is the risk that the definition of “secondary producer” may bebroadly interpreted. As we may therefore be required to block certain contentand/or make changes in our future record keeping practices, this interpretationof Section 2257 may have a material adverse impact on a segment of ourcurrent operations.

 

Legislation has been passed at the state level(currently, only the California and Utah bills have been signed into law) andcompeting bills are pending at the federal level which are intended to regulate“spyware” and, to a limited extent, the use of “cookies.” “Spyware” has notbeen precisely defined in existing and pending legislation, but is generallyconsidered to include software which is installed on consumers’ computers anddesigned to track consumers’ activities and collect and possibly disseminateinformation, including personally identifiable information, about thoseconsumers without their knowledge and consent. We do not provide or use “spyware”in our marketing practices, but there is the risk that the definition ofspyware may be broadly interpreted to include legitimate ad-serving softwareand/or cookie technology that is currently provided or used by us. Anti-spywarelegislation has: 1) generally included a limited exemption for the use of cookies;and 2) focused on providing consumers with notification and the option toaccept or 

 

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decline the installation of spyware software.  However, there can be no assurance thatfuture legislation will not incorporate more burdensome standards by which theuse of cookies will not be exempted and software downloading onto consumers’computers will not be more strictly enforced. If more restrictive legislationis adopted, we may be required to develop new technology and/or methods toprovide our services or discontinue services in some jurisdictions altogether.

 

Legislation has also been passed at the state level(currently, only the California bill has been signed into law, but the New Yorkbill has been passed by the State Legislature and awaits the review of thatState’s Governor, George Pataki) and competing bills are pending at the federallevel which are intended to require that businesses and institutions providenotice to consumers of any potential theft or loss of sensitive consumerinformation then in possession of the applicable business or institution.  Under its enforcement authority, the FTC in2005 filed a complaint against BJ’s Wholesale Club, Inc. (“BJ’s”) forviolation of the FTC Act in connection with the theft of consumer credit/debitcard information which was then in BJ’s possession.  The FTC alleged that BJ’sfailure to secure customers’ sensitive information was an unfair practice underthe FTC Act because it caused substantial injury that was not reasonablyavoidable by consumers and not outweighed by offsetting benefits to consumersor competition. BJ’s agreed to a settlement that requires BJ’s to establish andmaintain a comprehensive information security program that includes administrative,technical and physical safeguards.  Although we donot anticipate that this interpretation of the FTC Act, nor the legislationrequiring notice of theft or loss of sensitive consumer information, will havea material adverse impact on our current operations, there can be no assurancethat they will not have an adverse impact on our current or future operations.We could potentially be subject to regulatory proceedings for past and currentpractices in connection with the storage and security of sensitive consumerinformation and notice of such sensitive consumer information’s theft orloss.  In addition, we may be required tomake changes in our future practices relating to the storage, security andprovision of notice in connection with sensitive consumer information.

 

At present, the laws and regulations governing theInternet remain largely unsettled, even in areas where there has beenlegislative and/or regulatory action. It is uncertain as to how long it willtake to determine the extent to which existing laws including, but not limitedto, those 

 

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relatingto intellectual property, advertising, sweepstakes and privacy, apply to theInternet and Internet marketing. Recently, however, growing public concernregarding privacy and the collection, distribution and use of Internet userinformation has led to increased federal and state scrutiny, as well asregulatory activity concerning data collection, record keeping, storage,security, notification of data theft, and associated use practices. The application of existing laws, theadoption or modification of laws or regulations in the future, together withincreased regulatory scrutiny on issues such as advertising, sweepstakes, datacollection, record keeping, storage, security, notification of data theft andprivacy, could materially and adversely affect our business, prospects, resultsof operations and financial condition and could potentially expose us and/orour clients to fines, litigation, cease and desist orders and civil andcriminal liability.

 

**TRANSACTIONS WITH MAJOR CUSTOMERS**

 

Transactionswith major customers and related economic dependence information is set forth (1) followingour discussion of Liquidity and Capital Resources, (2) in our discussionof Critical Accounting Policy and Accounting Estimate Discussion (immediatelyfollowing (1) previously mentioned) and (3) under the heading “Transactionswith Major Customers” in Note 2 to the Consolidated Financial Statementsincluded herein.

 

**SEGMENT INFORMATION**

 

Duringthe three and six month periods ended May 31, 2005 and 2004, we generatedrevenue from the following segments: E-Commerce and LEC Billed Products. TheE-Commerce segment currently represents the core of our business 

 

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operations.Revenue in the E-commerce segment is generated primarily from marketing ofthird-party products and services on our websites, through email, and throughour two recently acquired subsidiaries from search engine optimization servicesand from Internet advertising agency revenue. The LEC Billed Products segmentconsists of our proprietary LEC billed products, marketed under the brandsClick-Help, TXNet ISP and WorldWebAccess, Inc. These products were introducedduring Fiscal 2003 and 2004.

 

Segment information is set forth in Note 6 to the ConsolidatedFinancial Statements referred to in the Financial Statements and SupplementaryData section included herein.

 

**RESULTS OF OPERATIONS**

 

The following is a discussion of our results of operations for the three and six month periods ended May 31, 2005 and 2004. It should be read in conjunction with our Form 10-K as filed for the year ended November 30, 2004, the notes thereto and other financial information included elsewhere in this report.

 

THREE MONTHS ENDED MAY 31, 2005 AND 2004

 

Our net revenues, on a segmental basis, and with disclosure of the components of the individual segments, for each of the three-month periods ended May 31, 2005 and 2004, are detailed in the following tables:

 

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SEGMENT DATA - NETREVENUES, BY SEGMENT, BY COMPONENT

 
| ** **                             | ** ** | **Three  Months Ended** | ** ** | **Change**       | ** ** | **Change**   | ** ** |
|----------------------------------------|------------|-------------------------|------------|------------------|------------|--------------|------------|
| ** **                             | ** ** | **May 31,**        | ** ** | **May 31,** | ** ** | **Inc(Dec)** | ** ** | **Inc(Dec)** | ** ** |
| ** **                             | ** ** | **2005**                | ** ** | **2004**         | ** ** | **$$$**      | ** ** | **%%%** | ** ** |
| ** **                             | ** ** | ** **              | ** ** | ** **       | ** ** | ** **   | ** ** | ** ** | ** ** |
| **E-Commerce components**              |       |                    |       |             |       |         |       |   |   |
| iMatchUp.com dating sites              |       | $                       | 2,285,301  |             | $          | 1,603,282    |       | $ | 682,019 |   | 43 | % |
| Website advertising                    |       | 6,241,188               |       | 4,348,017        |       | 1,893,171    |       | 44 | % |
| Search Engine Marketing                |       | 2,188,640               |       | —           |       | 2,188,640    |       | 100 | % |
| Internet Advertising Agency            |       | 2,003,980               |       | —           |       | 2,003,980    |       | 100 | % |
| Email marketing programs               |       | 2,477,564               |       | 1,618,311        |       | 859,253      |       | 53 | % |
| Data sales and rentals                 |       | 301,957                 |       | 332,245          |       | (30,288      | )          | -9 | % |
| Sales of jewelry and gifts             |       | 14,427                  |       | 96,705           |       | (82,278      | )          | -85 | % |
| Internet game development and other    |       | 744,055                 |       | 63,945           |       | 680,110      |       | 1064 | % |
|                                   |       |                    |       |             |       |         |       |   |   |
| **Total E-commerce**                   |       | 16,257,112              |       | 8,062,505        |       | 8,194,607    |       | 102 | % |
|                                   |       |                    |       |             |       |         |       |   |   |
| **LEC Billed Product components**      |       |                    |       |             |       |         |       |   |   |
| Click-Help, WWA and TXNet LEC Products |       | 353,457                 |       | 1,077,350        |       | (723,893     | )          | -67 | % |
|                                   |       |                    |       |             |       |         |       |   |   |
| **Total LEC Billed Products**          |       | 353,457                 |       | 1,077,350        |       | (723,893     | )          | -67 | % |
|                                   |       |                    |       |             |       |         |       |   |   |
| **Total Consolidated Net Revenue**     |       | $                       | 16,610,569 |             | $          | 9,139,855    |       | $ | 7,470,714 |   | 82 | % |

 

Net Revenue increased approximately $7.5 million, or 82%, to $16.6 million for the three months ended May 31, 2005, from $9.1 million in the prior year’s comparable period. The E-commerce segment’s core business grew organically, primarily driven by an expansion in our customer base, and accounted for approximately $4.0 million of the consolidated revenue increase. Supplementing the core E-commerce growth was $2.2 million in revenue earned from our July 1, 2004 SendTraffic acquisition and $2.0 million in revenue earned from our January 21, 2005 Hot Rocket acquisition. Both search engine revenue (SendTraffic) and sales of performance based on-line advertising space (Hot Rocket) are shown after intercompany eliminations. Sales in our LEC 

 

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Billed Product segment decreased by $0.7 million, or 67%, to $0.4 million for the three months ended May 31, 2005, from $1.1 million in the prior year’s comparable period. The comparable period of 2004 saw increased marketing and enrollment in our WWA email service and the launch of our Click-Help LEC product. This marketing strategy was curtailed in the fourth quarter of Fiscal 2004 and such change is reflected in the reduced sales for the three months when compared to the prior year’s three month period.

 

Our cost of sales during the three months ended May 31, 2005 and 2004 were comprised of (1) direct and indirect marketing costs associated with the acquisition and retention of consumers for our marketing programs, including direct response email marketing costs, website registrations, customer profiles, other customer acquisition costs (such as outbound telemarketing), search engine marketing costs, promotional and creative costs, and premium fulfillment costs, and (2) the related contingent-based sweepstakes indemnification expense, billing and collection fees and customer service costs.

 

Our cost of sales, on a segmental basis, and with disclosure of the components of the individual segments, for each of the three-month periods ended May 31, 2005 and 2004, are set forth below:

 

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**Consolidated Cost of Sales, by Segment, by Component**

 
| ** **                                                                                         | ** ** | **Three Months Ended** | ** ** | **Change**       | ** ** | **Change**   | ** ** |
|----------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------------|------------|--------------|------------|
| ** **                                                                                         | ** ** | **May 31,**       | ** ** | **May 31,** | ** ** | **Inc(Dec)** | ** ** | **Inc(Dec)** | ** ** |
| ** **                                                                                         | ** ** | **2005**               | ** ** | **2004**         | ** ** | **$$$**      | ** ** | **%%%** | ** ** |
| **E-commerce**                                                                                     |       |                   |       |             |       |         |       |   |   |
| **Advertising,  promotion and fulfillment costs**                                                  |       |                   |       |             |       |         |       |   |   |
| Email marketing and related delivery costs                                                         |       | $                      | 1,325,269  |             | $          | 986,955      |       | $ | 338,314 |   | 34 | % |
| Website registrations, customer profiles,  search and all other related customer acquisition costs |       | 7,421,830              |       | 3,205,072        |       | 4,216,758    |       | 132 | % |
| Promotional, creative and other costs                                                              |       | 112,761                |       | 67,202           |       | 45,559       |       | 68 | % |
| Purchases of on-line advertising space                                                             |       | 1,451,026              |       | —           |       | 1,451,026    |       | 100 | % |
|                                                                                               |       |                   |       |             |       |         |       |   |   |
| **Total  E-commerce Advertising**                                                                  |       |                   | 10,310,886 |             |       | 4,259,229    |       |   | 6,051,657 |   | 142 | % |
| ** **                                                                                         |       |                   |       |             |       |         |       |   |   |   |   |   |
| **Service  Bureau fees**                                                                           |       |                   |       |             |       |         |       |   |   |
| Contingent based prize indemnification  costs                                                      |       | 51,956                 |       | 83,803           |       | (31,847      | )          | -38 | % |
|                                                                                               |       |                   |       |             |       |         |       |   |   |
| **Total  E-commerce Cost of Sales**                                                                |       |                   | 10,362,842 |             |       | 4,343,032    |       |   | 6,019,810 |   | 139 | % |
|                                                                                               |       |                   |       |             |       |         |       |   |   |
| **LEC  Billed Product****Components**                                                              |       |                   |       |             |       |         |       |   |   |
|                                                                                               |       |                   |       |             |       |         |       |   |   |
| **Service  Bureau fees**                                                                           |       |                   |       |             |       |         |       |   |   |
| Service provision, billing and collection  fees                                                    |       | 163,907                |       | 793,982          |       | (630,075     | )          | -79 | % |
|                                                                                               |       |                   |       |             |       |         |       |   |   |
| **Total  LEC Billed Cost of Sales**                                                                |       |                   | 163,907    |             |       | 793,982      |       |   | (630,075 | ) | -79 | % |
|                                                                                               |       |                   |       |             |       |         |       |   |   |
| **Consolidated  Cost of Sales**                                                                    |       | $                      | 10,526,749 |             | $          | 5,137,014    |       | $ | 5,389,735 |   | 105 | % |

 

Cost of sales on a consolidated basis increased $5.4 million, or 105%, to $10.5 million for the three months ended May 31, 2005 from $5.1 million in the comparable prior year’s period.

 

Theprimary factor contributing to the increase in consolidated costs of sales wasrelated to a net increase of approximately $6.1 million in costs incurred byour E-commerce segment in the generation of its increased revenues. TheE-commerce segment recognized an increase of $4.2 million, or 

 

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132%in its media purchases, which included website registrations, customerprofiles, search engine costs and all other on-line customer procurement costs.The specific increase in search engine marketing costs amounted toapproximately $1.4 million, and did not have a comparable cost in the priorfiscal period. During the three months ended May 31, 2005, cost of revenuealso included approximately $1.4 million in direct purchases of on-lineadvertising space, which is resold on a performance return basis by our HotRocket subsidiary, which was acquired on January 21, 2005.

 

Theincrease in E-commerce cost of sales further resulted from an increase of $0.3million, or 34%, in email marketing costs (which includes certain operatingcosts necessary to handle the email operations business of our Infiknowledgesubsidiary) to promote the segment’s revenue generating opportunities directlyrelated to email promotions and to cause potential (as well as repeat)customers to visit our websites, and, once there, to register and becomecustomer profiles available to be marketed in current and future fiscalperiods. See “-Consolidated Gross Profit, by Segment” for a discussion ofanticipated future revenue recognition as a result of current period costsincurred.

 

Thecost of sales related to our LEC Billed Product segment declined approximately$0.6 million, or 79%, when compared to the prior year’s comparable period. LECcosts are principally comprised of billing, collection and customer servicecosts. We terminated our marketing efforts during the fourth quarter of Fiscal2004 regarding the acquisition of new LEC Billed Product segment customerswhich is the reason for the comparative period decline in LEC Billed Productsegment cost of revenues.

 

Ourgross profit in terms of dollars, on a segmental basis, and our gross profitpercentage, on a segmental basis, for each of the three-month periods ended May 31,2005 and 2004, are set forth below:

 

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***ConsolidatedGross Profit, by Segment***

 
| ** **              | ** ** | **Three  Months Ended** | ** ** | **Change**       | ** ** | **Change**   | ** ** |
|-------------------------|------------|-------------------------|------------|------------------|------------|--------------|------------|
| ** **              | ** ** | **May 31,**        | ** ** | **May 31,** | ** ** | **inc(dec)** | ** ** | **inc(dec)** | ** ** |
| ** **              | ** ** | **2005**                | ** ** | **2004**         | ** ** | **$$$**      | ** ** | **%%%** | ** ** |
| E-commerce              |       | $                       | 5,894,270  |             | $          | 3,719,473    |       | $ | 2,174,797 |   | 58 | % |
|                    |       |                    |       |             |       |         |       |   |   |
| LEC  Billed products    |       | 189,550                 |       | 283,368          |       | (93,818      | )          | 33 | % |
|                    |       |                    |       |             |       |         |       |   |   |
| **CONSOLIDATED TOTALS** |       | $                       | 6,083,820  |             | $          | 4,002,841    |       | $ | 2,080,979 |   | 52 | % |

 

***ConsolidatedGross Profit Percentages, by Segment***

 
| ** **                               | ** ** | ** **              | ** ** | **Absolute**     | ** ** | **Relative**   | ** ** |
|------------------------------------------|------------|-------------------------|------------|------------------|------------|----------------|------------|
| ** **                               | ** ** | **Three  Months Ended** | ** ** | **percentage**   | ** ** | **percentage** | ** ** |
| ** **                               | ** ** | **May  31,**            | ** ** | **May 31,** | ** ** | **change**     | ** ** | **change** | ** ** |
| ** **                               | ** ** | **2005**                | ** ** | **2004**         | ** ** | **inc(dec)**   | ** ** | **inc(dec)** | ** ** |
| E-commerce                               |       | 36.3                    | %          | 46.1             | %          | -9.8           | %          | -21.3 | % |
|                                     |       |                    |       |             |       |           |       |   |   |
| LEC  Billed products                     |       | 53.6                    | %          | 26.3             | %          | 27.3           | %          | 103.8 | % |
|                                     |       |                    |       |             |       |           |       |   |   |
| **CONSOLIDATED GROSS PROFIT PERCENTAGE** |       | 36.6                    | %          | 43.8             | %          | -7.2           | %          | -16.4 | % |

 

Consolidated Gross Profit (“Gross Margin”) as apercentage of net revenue was 36.6% during the three months ended May 31,2005, compared to 43.8% in the prior year’s comparable period, representing anabsolute 

 

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percentage point decrease of 7.2%, or a 16.4%decrease on a relative basis.

 

The decline in gross profit percentage isprimarily attributable to three factors: 

 

(1)           Increasedwebsite registration, customer profile, search engine marketing and other thirdparty online customer acquisition costs for our websites. All such costs are charged to operationswhen incurred, with such outlays generating revenue in future fiscal periods.

 

(2)           Theimpact on gross profit from our iMatchUp.com dating sites resulting from our expensingof our significant customer acquisitionramp up during the period in the acquisition of free iMatchUp.com membershipaccounts. The recognition of that revenue is dependent upon whether or not thefree account converts to a paying membership. The period that a free accountmay convert to a billable account typically ranges from one week afteracquisition to as long as two years after its initial month of acquisition,based on available historical conversion to billable experience. Therefore,predicated on stabilized acquisition costs in future fiscal periods, we expectthat the future conversions of free membership acquisitions to billablemembers, as well as anticipated renewal revenues from such acquired customers,should allow us to report improved gross profit margins attributable to suchmemberships in our E-commerce segment in future fiscal periods.

 

(3)           Toa lesser degree, our shift in resource allocation in response to regulatorychanges whereby we migrated a portion of our marketing efforts from highermargin email revenue to lower margin site based revenue.

 

Our Selling Expenses for each of the three monthsended May 31, 2005 and 2004 are presented, on a segmental basis, and withthe components of the individual segments, in the tables set forth below:

 

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**Segment Data - Consolidated Selling Expenses, bysegment, by component**

 
| ** **                             | ** ** | **Three  Months Ended** | ** ** | **Change  -**    | ** ** | **Change  -** | ** ** |
|----------------------------------------|------------|-------------------------|------------|------------------|------------|---------------|------------|
| ** **                             | ** ** | **May 31,**        | ** ** | **May 31,** | ** ** | **inc(dec)**  | ** ** | **inc(dec)** | ** ** |
| ** **                             | ** ** | **2005**                | ** ** | **2004**         | ** ** | **$$$**       | ** ** | **%%%** | ** ** |
|                                   |       |                    |       |             |       |          |       |   |   |
| **E-commerce**                         |       |                    |       |             |       |          |       |   |   |
| Fee  share commissions                 |       | $                       | 568,283    |             | $          | 295,119       |       | $ | 273,164 |   | 93 | % |
|                                   |       |                    |       |             |       |          |       |   |   |
| Selling  salaries and related expenses |       | 361,828                 |       | 185,726          |       | 176,102       |       | 95 | % |
|                                   |       |                    |       |             |       |          |       |   |   |
| Travel  and entertainment              |       | 44,009                  |       | 34,313           |       | 9,696         |       | 28 | % |
| **TOTAL Selling - E-commerce segment** |       |                    | 974,120    |             |       | 515,158       |       |   | 458,962 |   | 89 | % |
|                                   |       |                    |       |             |       |          |       |   |   |
| **Consolidated Totals**                |       | $                       | 974,120    |             | $          | 515,158       |       | $ | 458,962 |   | 89 | % |

 

Selling expenses, on a consolidatedbasis, increased approximately $0.5 million, or 89%, to $1.0 million during thethree months ended May 31, 2005 from $0.5 million during the three monthsended May 31, 2004. The increase resulted from (a) an approximate$0.3 million increase in fee share commissions and correlates to our increasedemail revenue and the related use of third-party databases in our emailmarketing programs to produce a portion of such revenue (as we are the primaryobligor to the list owner and bear the responsibility of payment to the listowner regardless of whether our client pays us), and (b) an approximate$0.2 million increase in selling salaries, with such increase relatingpartially to the expansion of our sales force, coupled with increased salescommission expense resulting from our increased revenue earned during the threemonths ended May 31, 2005 when compared to the three months ended May 31,2004.

 

Our general and administrative expenses (“G&A”) are principally comprised of (i) compensation costs and related expenses for executive, finance, information technology and operation systems, and general administration personnel, (ii) professional fees (which include legal; audit, accounting and tax; Sarbanes-Oxley compliance costs; public relations; 

 

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database management and consulting; and public company related printing and filing costs), (iii) insurance costs, (iv) occupancy and other equipment rental costs, (v) site development, maintenance and modification costs related to our various active segments, and (vi) all other general and miscellaneous corporate expense items.

 

Our General and Administrative Expenses for the three months ended May 31, 2005 and 2004 are presented, on a segmental basis, and with the components of the individual segments, in the tables set forth below:

 

**Consolidated General and Administrative Expenses, bysegment, by component**

 
| ** **                                       | ** ** | **Three  Months Ended** | ** ** | **Change  -**    | ** ** | **Change  -** | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|------------------|------------|---------------|------------|
| ** **                                       | ** ** | **May 31,**        | ** ** | **May 31,** | ** ** | **inc(dec)**  | ** ** | **inc(dec)** | ** ** |
| ** **                                       | ** ** | **2005**                | ** ** | **2004**         | ** ** | **$$$**       | ** ** | **%%%** | ** ** |
|                                             |       |                    |       |             |       |          |       |   |   |
| **E-commerce**                                   |       |                    |       |             |       |          |       |   |   |
| Compensation  costs and related expenses         |       | $                       | 1,632,072  |             | $          | 973,708       |       | $ | 658,364 |   | 68 | % |
| Professional  fees                               |       |                    | 138,324    |             |       | 295,824       |       | (157,500 | ) | -53 | % |
| Insurance  costs                                 |       |                    | 117,729    |             |       | 136,882       |       | (19,153 | ) | -14 | % |
| Occupancy  and equipment costs                   |       |                    | 92,154     |             |       | 82,355        |       | 9,799 |   | 12 | % |
| Site  development, maintenance and modifications |       |                    | 342,266    |             |       | 343,707       |       | (1,441 | ) | 0 | % |
| All  other G&A expenses                      |       |                    | 645,628    |             |       | 270,249       |       | 375,379 |   | 139 | % |
| **TOTAL G&A - E-commerce segment**           |       |                    | 2,968,173  |             |       | 2,102,725     |       |   | 865,448 |   | 41 | % |
|                                             |       |                    |       |             |       |          |       |   |   |
| **LEC Billed Product Components**                |       |                    |       |             |       |          |       |   |   |
| Compensation  costs and related expenses         |       |                    | 14,312     |             |       | 56,563        |       |   | (42,250 | ) | -75 | % |
| Insurance  costs                                 |       |                    | 4,937      |             |       | 18,886        |       | (13,949 | ) | -74 | % |
| Occupancy  and equipment costs                   |       |                    | 2,283      |             |       | 13,752        |       | (11,469 | ) | -83 | % |
| All  other G&A expenses                      |       |                    | 2,611      |             |       | 8,035         |       | (5,425 | ) | -68 | % |
| **TOTAL G&A - LEC segment**                  |       |                    | 24,143     |             |       | 97,236        |       |   | (73,093 | ) | -75 | % |
|                                             |       |                    |       |             |       |          |       |   |   |
| **Corporate**                                    |       |                    |       |             |       |          |       |   |   |
| Compensation  costs and related expenses         |       |                    | 440,108    |             |       | 501,488       |       |   | (61,379 | ) | -12 | % |
| Professional  fees                               |       |                    | 241,907    |             |       | 169,975       |       | 71,932 |   | 42 | % |
| Insurance  costs                                 |       |                    | 111,861    |             |       | 123,768       |       | (11,907 | ) | -10 | % |
| All  other G&A expenses                      |       |                    | 127,942    |             |       | 152,668       |       | (24,727 | ) | -16 | % |
| **TOTAL G&A - Corporate**                    |       |                    | 921,818    |             |       | 947,899       |       |   | (26,081 | ) | -3 | % |
|                                             |       |                    |       |             |       |          |       |   |   |
| **Consolidated Totals**                          |       | $                       | 3,914,134  |             | $          | 3,147,860     |       | $ | 766,274 |   | 24 | % |

 

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General and Administrative expenses (“G&A”)on a consolidated basis increased approximately $0.8 million, or 24%, whencomparing G&A of $3.9 million for the three months ended May 31, 2005to G&A of $3.1 million incurred during the three months ended May 31,2004. The net increase was attributable to an increase in E-commerce segment($0.9 million), offset by a decline in the LEC Billed Product segment of ($0.1million). The significant increase in E-commerce expenses was attributable tothe operating overhead incurred from our two recently acquired subsidiaries. Incombination, such subsidiaries overhead amounted to approximately $1.0 millionduring the three months ended May 31, 2005. Neither subsidiary had been organizedduring the prior year’s comparable period. Specifically, during the threemonths ended May 31, 2005, the subsidiaries combined compensation costsand related expenses amounted to approximately $0.7 million, which representedthe significant portion of the increase in E-commerce compensation costs. Thesubsidiaries also contributed to overhead as follows: office rent and relatedoffice expense of approximately $0.1 and other G&A of approximately $0.2million. Included in the other G&A was amortization expense ofapproximately $0.1 from the Send Traffic acquisition, and approximately $0.1million from the Hot Rocket acquisition. As described in Note 7 to the financial statements, the Company incurredan impairment loss of $137,000 on identifiable intangible, relating to the SendTraffic acquisition.

 

Feder, Kaszovitz, Issacson, Weber, Skala, Bass andRhine LLP (“FKIWSBR”) provides general legal services to us in the ordinarycourse of business and litigation services in defense of actions arising from suchbusiness activities. Murray L. Skala, a partner in such firm, has been a memberof our 

 

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Board of Directors since inception. Weincurred approximately $146,000 in legal fees (exclusive of disbursements) fromFKIWSBR during the three months ended May 31, 2005, of the $146,000;$80,000 were incremental cost incurred in the Hot Rocket marketing AssetAcquisition and were capitalized as purchase price goodwill; the balance of$66,000 were charged to operations.  Weincurred approximately $194,000 in legal fees (exclusive of disbursements) fromFKIWSBR during the three months ended May 31, 2004.

 

**Consolidated -Bad Debt Expense, by Segment**

 
| ** **              | ** ** | **Three  Months Ended** | ** ** | **Change**       | ** ** | **Change**   | ** ** |
|-------------------------|------------|-------------------------|------------|------------------|------------|--------------|------------|
| ** **              | ** ** | **May 31,**        | ** ** | **May 31,** | ** ** | **Inc(Dec)** | ** ** | **Inc(Dec)** | ** ** |
| ** **              | ** ** | **2005**                | ** ** | **2004**         | ** ** | **$$$**      | ** ** | **%%%** | ** ** |
| ** **              | ** ** | ** **              | ** ** | ** **       | ** ** | ** **   | ** ** | ** ** | ** ** |
| E-commerce              |       | $                       | 80,382     |             | $          | (65,656      | )          | $ | 146,038 |   | 222 | % |
|                    |       |                    |       |             |       |         |       |   |   |
| **Consolidated Totals** |       | $                       | 80,382     |             | $          | (65,656      | )          | $ | 146,038 |   | 222 | % |

 

Bad Debt expense increased approximately $0.1million, or 222%, from bad debt recapture of $65,656 in the three months ended May 31,2004 to bad debt expense of $80,382 in the three months ended May 31,2005. Our allowance for bad debts results from our assessment of the risk ofcollection embedded in our customer base as described below.

 

We continuously evaluate the potential of thecollectibility of trade receivables by reviewing such factors as deteriorationin the operating results, financial condition or bankruptcy filings of ourcustomers. As a result of this review process, we record adjustments to baddebt provisions/(recaptures) to reflect the related receivables’ carryingamount to amounts that estimate their probable realizable value. Provisions forbad debts are also recorded resulting from the review of other factors,including (a) length of time the receivables are past due and (b) historicalexperience 

 

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and other factors obtained during collectionefforts. If circumstances related to specific customers change, our estimatesfor bad debt provision/(recaptures) could be further increased or decreased infuture fiscal periods.

 

**OTHER INCOME (EXPENSE)**

 

The components of our “Other income (expense)” areset forth below:

 
| ** **                                                | ** ** | **Three  Months Ended** | ** ** | **change**       | ** ** | **change**   | ** ** |
|-----------------------------------------------------------|------------|-------------------------|------------|------------------|------------|--------------|------------|
| ** **                                                | ** ** | **May 31,**        | ** ** | **May 31,** | ** ** | **inc(dec)** | ** ** | **inc(dec)** | ** ** |
| ** **                                                | ** ** | **2005**                | ** ** | **2004**         | ** ** | **$$$**      | ** ** | **%%%** | ** ** |
|                                                      |       |                    |       |             |       |         |       |   |   |
| Interest  income and dividends                            |       | $                       | 237,514    |             | $          | 113,989      |       | $ | 123,525 |   | 108 | % |
| Realized  (losses) gains on sale of marketable securities |       | (11,218                 | )          | 11,647           |       | (22,865      | )          | -196 | % |
| Realized  gain on sale of subsidiary                      |       | —                  |       | 199,900          |       | (199,900     | )          | -100 | % |
| Other  non-operating income:                              |       |                    |       |             |       |         |       |   |   |
| Other  miscellaneous income(expense)                      |       | 6,957                   |       | (6,414           | )          | 13,371       |       | 208 | % |
| Vendor  settlement on prior year marketing fee            |       | —                  |       | 350,000          |       | (350,000     | )          | -100 | % |
| Foreign  Currency Exchange Rate Fees and interest         |       | (4,631                  | )          | (3,102           | )          | (1,529       | )          | 49 | % |
| Interest  and penalties - Florida tax settlement          |       | —                  |       | (47,790          | )          | 47,790       |       | -100 | % |
| Reduction  of prior year’s LEC reserve               |       | —                  |       | —           |       | —       |       | 0 | % |
| Minority  interest (income) loss                          |       | (150,529                | )          | —           |       | (150,529     | )          | 100 | % |
|                                                      |       |                    |       |             |       |         |       |   |   |
| Total  Consolidated Other Income (Expense)                |       | $                       | 78,093     |             | $          | 618,230      |       | $ | (540,137 | ) | -87 | % |

 

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Consolidated Other Income (Expense) decreasedapproximately $540,000, from approximately $618,000 for the three months ended May 31,2004, to approximately $78,000 for the three months ended May 31, 2005.

 

The material factors contributing to the netdecrease as set forth in the above table are as follows:

 

(1)                                  The three months ended May 31, 2004included $199,900 in installment payments from a prior year sale of asubsidiary. The installment payments were completed in the first quarter of thecurrent fiscal year. Therefore, the three months ended May 31, 2005 didnot include comparable payments.

 

(2)                                  The three month period ended May 31, 2004 includeda collection of $350,000 in settlement of a prior year’s marketing agreementdispute. No comparable amount is reflected in the three month period ended May 31,2005.

 

(3)                                  Interest income increased approximately$124,000 as the result of increased interest rates earned on our short-term investments.

 

(4)                                  Minority Interest resulting from our EZTracks partnership with Madacy Entertainment amounted to $151,000. Thepartnership agreement was entered into on January 12, 2005 and, as such,the three month period ended May 31, 2004 included no comparable amount.

 

**PROVISION FOR INCOME TAXES**

 

Quarterly income taxes are calculated in accordancewith the interim financial reporting requirements as set forth in theAccounting Principal Board’s Opinion 28. Such Opinion considers interimquarterly periods as an integral part of the annual period, with interimquarterly tax periods reflecting the estimated annual effective tax rate. Webelieve that we have 

 

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adequately provided fortax-related matters. We are subject to examination by taxing authorities invarious jurisdictions. Management considers it unlikely that resolution of anyopen audits would have a material adverse effect upon our consolidatedfinancial statements.

 

The results for the three months ended May 28,2005 include a tax expense of approximately $486,000 on pre-tax income of $1,193,277.The effective rate relationship of 40.7% differs immaterially from ourhistorically recognized effective tax rate of approximately 39%. The balance ofthe rate reconciliation is attributable to potential tax liabilities related toexaminations by taxing authorities.

 

SIXMONTHS ENDED MAY 31, 2005 AND MAY 31, 2004

 

Our net revenues, on a segmental basis, and with disclosure of the components of the individual segments, for each of the six-month periods ended May 31, 2005 and 2004, are detailed in the following tables:

 

SEGMENT DATA - NET REVENUES, BY SEGMENT, BYCOMPONENT

 
| ** **                              | ** ** | **Six  Months Ended** | ** ** | **Change**       | ** ** | **Change**   | ** ** |
|-----------------------------------------|------------|-----------------------|------------|------------------|------------|--------------|------------|
| ** **                              | ** ** | **May 31,**      | ** ** | **May 31,** | ** ** | **Inc(Dec)** | ** ** | **Inc(Dec)** | ** ** |
| ** **                              | ** ** | **2005**              | ** ** | **2004**         | ** ** | **$$$**      | ** ** | **%%%** | ** ** |
| ** **                              | ** ** | ** **            | ** ** | ** **       | ** ** | ** **   | ** ** | ** ** | ** ** |
| **E-Commerce components**               |       |                  |       |             |       |         |       |   |   |
| iMatchUp.com  dating sites              |       | $                     | 4,218,815  |             | $          | 2,999,893    |       | $ | 1,218,922 |   | 41 | % |
| Website  advertising                    |       | 11,905,442            |       | 7,937,739        |       | 3,967,703    |       | 50 | % |
| Search  Engine Marketing                |       | 3,643,289             |       | —           |       | 3,643,289    |       | 100 | % |
| Internet  Advertising Agency            |       | 2,858,509             |       | —           |       | 2,858,509    |       | 100 | % |
| Email  marketing programs               |       | 4,626,973             |       | 3,019,632        |       | 1,607,341    |       | 53 | % |
| Data  sales and rentals                 |       | 690,893               |       | 691,656          |       | (763         | )          | 0 | % |
| Sales  of jewelry and gifts             |       | 39,206                |       | 197,560          |       | (158,354     | )          | -80 | % |
| Internet  game development and other    |       | 1,198,916             |       | 262,726          |       | 936,190      |       | 356 | % |
|                                    |       |                  |       |             |       |         |       |   |   |
| **Total E-commerce**                    |       | 29,182,043            |       | 15,109,206       |       | 14,072,837   |       | 93 | % |
|                                    |       |                  |       |             |       |         |       |   |   |
| **LEC Billed Product components**       |       |                  |       |             |       |         |       |   |   |
| Click-Help,  WWA and TXNet LEC Products |       | 704,342               |       | 1,200,943        |       | (496,601     | )          | -41 | % |
|                                    |       |                  |       |             |       |         |       |   |   |
| **Total LEC Billed Products**           |       | 704,342               |       | 1,200,943        |       | (496,601     | )          | -41 | % |
|                                    |       |                  |       |             |       |         |       |   |   |
| **Total Consolidated Net Revenue**      |       | $                     | 29,886,385 |             | $          | 16,310,149   |       | $ | 13,576,236 |   | 83 | % |

 

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Net Revenue increased approximately $13.6 million, or 83%, to $29.9 million for the six months ended May 31, 2005, from $16.3 million in the prior year’s comparable period. The E-commerce segment’s core business grew organically, primarily driven by an expansion in our customer base, and accounted for approximately $7.6 million of the consolidated revenue increase. Supplementing the core E-commerce growth was $3.6 million in revenue earned from our July 1, 2004 SendTraffic acquisition and $2.9 million in revenue earned from our January 21, 2005 Hot Rocket acquisition. Both search engine revenue (SendTraffic) and sales of performance based on-line advertising space (Hot Rocket) are shown after intercompany eliminations. Internet game development and other increased 356%, with the significant portion of such increase being attributable to our generating revenue from our users under third party list management agreements. Sales in our LEC Billed Product segment decreased by $0.5 million during the six months ended May 31, 2005. The comparable period of 2004 saw increased marketing and enrollment in our WWA email service and the launch of our Click-Help LEC product. This 

 

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marketing strategy ended in the fourth quarter of Fiscal 2004 and such change is reflected in the reduced sales for the current six months when compared to the prior year’s six month period.

 

                                                Our cost of sales during the six months ended May 31, 2005 and 2004 were comprised of (1) direct and indirect marketing costs associated with the acquisition and retention of consumers for our marketing programs, including direct response email marketing costs, website registrations, customer profiles, other customer acquisition costs (such as outbound telemarketing), search engine marketing costs, promotional and creative costs, and premium fulfillment costs, and (2) the related contingent-based sweepstakes indemnification expense, billing and collection fees and customer service costs.

 

Our cost of sales, on a segmental basis, and with disclosure of the components of the individual segments, for each of the six month periods ended May 31, 2005 and 2004, are set forth below:

 

CONSOLIDATED COST OF SALES, BY SEGMENT, BYCOMPONENT

 
| ** **                                                                                         | ** ** | **Six Months Ended** | ** ** | **Change**       | ** ** | **Change**   | ** ** |
|----------------------------------------------------------------------------------------------------|------------|----------------------|------------|------------------|------------|--------------|------------|
| ** **                                                                                         | ** ** | **May 31,**     | ** ** | **May 31,** | ** ** | **Inc(Dec)** | ** ** | **Inc(Dec)** | ** ** |
| ** **                                                                                         | ** ** | **2005**             | ** ** | **2004**         | ** ** | **$$$**      | ** ** | **%%%** | ** ** |
| **E-commerce**                                                                                     |       |                 |       |             |       |         |       |   |   |
| **Advertising, promotion and fulfillment  costs**                                                  |       |                 |       |             |       |         |       |   |   |
| Email marketing and related delivery costs                                                         |       | $                    | 2,523,106  |             | $          | 1,861,646    |       | $ | 661,460 |   | 36 | % |
| Website registrations, customer profiles,  search and all other related customer acquisition costs |       | 13,840,260           |       | 5,707,620        |       | 8,132,640    |       | 142 | % |
| Promotional, creative and other costs                                                              |       | 211,545              |       | 123,434          |       | 88,111       |       | 71 | % |
| Purchases of on-line advertising space                                                             |       | 1,914,810            |       | —           |       | 1,914,810    |       | 100 | % |
|                                                                                               |       |                 |       |             |       |         |       |   |   |
| **Total  E-commerce Advertising**                                                                  |       |                 | 18,489,721 |             |       | 7,692,700    |       |   | 10,797,021 |   | 140 | % |
|                                                                                               |       |                 |       |             |       |         |       |   |   |
| **Service Bureau fees**                                                                            |       |                 |       |             |       |         |       |   |   |
| Contingent based prize indemnification  costs                                                      |       |                 | 112,411    |             |       | 146,316      |       | (33,905 | ) | -23 | % |
|                                                                                               |       |                 |       |             |       |         |       |   |   |
| **Total  E-commerce Cost of Sales**                                                                |       |                 | 18,602,132 |             |       | 7,839,016    |       |   | 10,763,116 |   | 137 | % |
|                                                                                               |       |                 |       |             |       |         |       |   |   |
| **LEC Billed Product****Components**                                                               |       |                 |       |             |       |         |       |   |   |
|                                                                                               |       |                 |       |             |       |         |       |   |   |
| **Service Bureau fees**                                                                            |       |                 |       |             |       |         |       |   |   |
| Service provision, billing and collection  fees                                                    |       |                 | 338,987    |             |       | 1,103,952    |       | (764,965 | ) | -69 | % |
|                                                                                               |       |                 |       |             |       |         |       |   |   |
| **Total  LEC Billed Cost of Sales**                                                                |       |                 | 338,987    |             |       | 1,103,952    |       |   | (764,965 | ) | -69 | % |
|                                                                                               |       |                 |       |             |       |         |       |   |   |
| **Consolidated  Cost of Sales**                                                                    |       | $                    | 18,941,119 |             | $          | 8,942,968    |       | $ | 9,998,151 |   | 112 | % |

 

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Cost of sales on a consolidated basis increased $10 million, or 112%, to $18.9 million for the six months ended May 31, 2005 from $8.9 million in the comparable prior year period.

 

The reason for this increase in consolidated costsof sales was related to a net increase of approximately $10.8 million in costsincurred by our E-commerce segment in the generation of its increased revenues.This E-commerce segment recognized an increase of $8.1 million, or 142% in itsmedia purchases, which includes website registrations, customer profiles,search engine costs and all other on-line customer procurement costs. Thespecific increase in search engine marketing costs amounted to approximately$2.5 million, and did not have a comparable cost in the prior year’s comparableperiod. During the six months ended May 31, 2005, cost of revenue alsoincluded approximately $ 1.9 million in direct purchases of on-line advertisingspace, which is resold on a performance return basis by our Hot Rocketsubsidiary, which was acquired on January 21, 2005.

 

Additionally, the increase in E-commerce cost ofsales further

 

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resulted from an increase of $0.7 million, or36%, in email marketing costs (which includes certain operating costs necessaryto handle the email operations business of our Infiknowledge subsidiary) topromote the segment’s revenue generating opportunities directly related toemail promotions and to cause potential (as well as repeat) customers to visit ourwebsites, and, once there, to register and become customer profiles availableto be marketed in current and future fiscal periods. See “-Consolidated GrossProfit, by Segment” for a discussion of anticipated future revenue recognitionas a result of current period costs incurred.

 

The cost of sales related to our LEC Billed Productsegment declined approximately $0.8 million, or 69%, when compared to the prioryear’s comparable period. LEC costs are principally comprised of billing,collection and customer service costs. We terminated our marketing effortsduring the fourth quarter of Fiscal 2004 regarding the acquisition of new LEC BilledProduct segment customers, which is the reason for the comparative perioddecline in LEC Billed Product segment cost of revenues.

 

Our gross profit in terms of dollars, on a segmentalbasis, and our gross profit percentage, on a segmental basis, for each of thesix month periods ended May 31, 2005 and 2004, are set forth below:

 

***ConsolidatedGross Profit, by Segment***

 
| ** **              | ** ** | **For  the  Six Months Ended** | ** ** | **Change**       | ** ** | **Change**   | ** ** |
|-------------------------|------------|--------------------------------|------------|------------------|------------|--------------|------------|
| ** **              | ** ** | **May 31,**               | ** ** | **May 31,** | ** ** | **inc(dec)** | ** ** | **inc(dec)** | ** ** |
| ** **              | ** ** | **2005**                       | ** ** | **2004**         | ** ** | **$$$**      | ** ** | **%%%** | ** ** |
| E-commerce              |       | $                              | 10,579,911 |             | $          | 7,270,190    |       | $ | 3,309,721 |   | 46 | % |
|                    |       |                           |       |             |       |         |       |   |   |
| LEC  Billed products    |       | 365,355                        |       | 96,991           |       | 268,364      |       | 277 | % |
|                    |       |                           |       |             |       |         |       |   |   |
| **CONSOLIDATED TOTALS** |       | $                              | 10,945,266 |             | $          | 7,367,181    |       | $ | 3,578,085 |   | 49 | % |
|                         |            |                                |            |                  |            |              |            |  |  |  |  |  |  |  |  |

 

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***ConsolidatedGross Profit Percentages, by Segment***

 
| ** **                               | ** ** | **For  the**          | ** ** | **Absolute**     | ** ** | **Relative**   | ** ** |
|------------------------------------------|------------|-----------------------|------------|------------------|------------|----------------|------------|
| ** **                               | ** ** | **Six  Months Ended** | ** ** | **percentage**   | ** ** | **percentage** | ** ** |
| ** **                               | ** ** | **May 31,**      | ** ** | **May 31,** | ** ** | **change**     | ** ** | **change** | ** ** |
| ** **                               | ** ** | **2005**              | ** ** | **2004**         | ** ** | **inc(dec)**   | ** ** | **inc(dec)** | ** ** |
| E-commerce                               |       | 36.3                  | %          | 48.1             | %          | -11.8          | %          | -24.6 | % |
|                                     |       |                  |       |             |       |           |       |   |   |
| LEC  Billed products                     |       | 51.9                  | %          | 8.1              | %          | 43.8           | %          | 540.7 | % |
|                                     |       |                  |       |             |       |           |       |   |   |
| **CONSOLIDATED GROSS PROFIT PERCENTAGE** |       | 36.6                  | %          | 45.2             | %          | -8.6           | %          | -19.0 | % |

 

Consolidated Gross Profit (“Gross Margin”) as apercentage of net revenue was 36.6% during the six months ended May 31,2005, compared to 45.2% in the prior year’s comparable period, representing anabsolute percentage point decrease of -8.6%, or a 19.0% decrease on a relativebasis.

 

The decline in gross profit percentage isprimarily attributable to three factors: 

 

(1)           Increasedwebsite registration, customer profile, search engine marketing and other thirdparty online customer acquisition costs for our websites. All such costs are charged to operationswhen incurred, with such outlays generating revenue in future fiscal periods.

 

(2)           Theimpact on gross profit from our iMatchUp.com dating sites resulting from ourexpensing of customer acquisition costs during the period we acquire a freeiMatchUp.com membership account.  Therecognition of that revenue is dependent upon whether or not the free accountconverts to a paying membership. The period that a free account may convert toa billable account typically ranges from one week after acquisition to as longas two years after its initial month of acquisition, based on available historicalconversion to billable 

 

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experience.Therefore, predicated on stabilized acquisition costs in future fiscal periods,we expect that the future conversions of free membership acquisitions tobillable members, as well as anticipated renewal revenues from such acquiredcustomers, should allow us to report improved gross profit margins attributableto such memberships in our E-commerce segment in future fiscal periods.

 

(3)           Toa lesser degree, our shift in resource allocation in response to regulatorychanges whereby we migrated a portion of our marketing efforts from highermargin email revenue to lower margin site based revenue.

 

Our Selling Expenses for each of the six monthsended May 31, 2005 and 2004 are presented, on a segmental basis, and withthe components of the individual segments, in the tables set forth belowimpactul our gross profit percentage:

 

**Segment Data - Consolidated Selling Expenses, bysegment, by component**

 
| ** **                             | ** ** | **Six  Months Ended** | ** ** | **Change  -**    | ** ** | **Change  -** | ** ** |
|----------------------------------------|------------|-----------------------|------------|------------------|------------|---------------|------------|
| ** **                             | ** ** | **May 31,**      | ** ** | **May 31,** | ** ** | **inc(dec)**  | ** ** | **inc(dec)** | ** ** |
| ** **                             | ** ** | **2005**              | ** ** | **2004**         | ** ** | **$$$**       | ** ** | **%%%** | ** ** |
|                                   |       |                  |       |             |       |          |       |   |   |
| **E-commerce**                         |       |                  |       |             |       |          |       |   |   |
| Fee  share commissions                 |       | $                     | 1,036,204  |             | $          | 508,216       |       | $ | 527,988 |   | 104 | % |
| Selling  salaries and related expenses |       | 677,969               |       | 387,692          |       | 290,277       |       | 75 | % |
| Travel  and entertainment              |       | 77,122                |       | 67,180           |       | 9,942         |       | 15 | % |
| **TOTAL Selling - E-commerce segment** |       |                  | 1,791,295  |             |       | 963,088       |       |   | 828,207 |   | 86 | % |
|                                   |       |                  |       |             |       |          |       |   |   |
| **Consolidated Totals**                |       | $                     | 1,791,295  |             | $          | 963,088       |       | $ | 828,207 |   | 86 | % |

 

Selling expenses, on a consolidatedbasis, increased approximately $0.8 million, or 86%, to $1.8 million during thesix months ended May 31, 2005 from $1.0 million during the three monthsended May 31, 2004. The increase resulted from (a) an approximate$0.5 million increase in fee share commissions and 

 

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correlatesto our increased email revenue and the related use of third-party databases inour email marketing programs to produce a portion of such revenue (as we arethe primary obligor to the list owner and bear the responsibility of payment tothe list owner regardless of whether our client pays us), and (b) anapproximate $0.3 million increase in selling salaries, with such increaserelating partially to the expansion of our sales force, coupled with increasedsales commission expense resulting from our increased revenue earned during thesix months ended May 31, 2005 when compared to the six months ended May 31,2004.

 

Our General and Administrative Expenses for the six months ended May 31, 2005 and 2004 are presented, on a segmental basis, and with the components of the individual segments, in the tables set forth below:

 

**Consolidated General and Administrative Expenses, bysegment, by component**

 
| ** **                                       | ** ** | **Six  Months Ended** | ** ** | **Change  -**    | ** ** | **Change  -** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|------------------|------------|---------------|------------|
| ** **                                       | ** ** | **May 31,**      | ** ** | **May 31,** | ** ** | **inc(dec)**  | ** ** | **inc(dec)** | ** ** |
| ** **                                       | ** ** | **2005**              | ** ** | **2004**         | ** ** | **$$$**       | ** ** | **%%%** | ** ** |
|                                             |       |                  |       |             |       |          |       |   |   |
| **E-commerce**                                   |       |                  |       |             |       |          |       |   |   |
| Compensation  costs and related expenses         |       | $                     | 3,139,368  |             | $          | 1,866,807     |       | $ | 1,272,561 |   | 68 | % |
| Professional  fees                               |       | 317,494               |       | 516,437          |       | (198,943      | )          | -39 | % |
| Insurance  costs                                 |       | 235,254               |       | 278,641          |       | (43,387       | )          | -16 | % |
| Occupancy  and equipment costs                   |       | 192,909               |       | 123,348          |       | 69,561        |       | 56 | % |
| Site  development, maintenance and modifications |       | 683,574               |       | 696,489          |       | (12,915       | )          | -2 | % |
| All  other G&A expenses                      |       | 1,118,859             |       | 483,736          |       | 635,123       |       | 131 | % |
| **TOTAL G&A - E-commerce segment**           |       | 5,687,458             |       | 3,965,458        |       | 1,722,000     |       | 43 | % |
|                                             |       |                  |       |             |       |          |       |   |   |
| **LEC Billed Product Components**                |       |                  |       |             |       |          |       |   |   |
| Compensation  costs and related expenses         |       | 28,625                |       | 113,125          |       | (84,500       | )          | -75 | % |
| Insurance  costs                                 |       | 10,655                |       | 36,774           |       | (26,119       | )          | -71 | % |
| Occupancy  and equipment costs                   |       | 4,615                 |       | 27,686           |       | (23,071       | )          | -83 | % |
| All  other G&A expenses                      |       | 5,395                 |       | 14,152           |       | (8,757        | )          | -62 | % |
| **TOTAL G&A - LEC segment**                  |       | 49,290                |       | 191,737          |       | (142,447      | )          | -74 | % |
|                                             |       |                  |       |             |       |          |       |   |   |
| **Corporate**                                    |       |                  |       |             |       |          |       |   |   |
| Compensation  costs and related expenses         |       | 926,052               |       | 1,001,227        |       | (75,175       | )          | -8 | % |
| Professional  fees                               |       | 522,071               |       | 330,968          |       | 191,103       |       | 58 | % |
| Insurance  costs                                 |       | 226,139               |       | 249,178          |       | (23,039       | )          | -9 | % |
| All  other G&A expenses                      |       | 264,369               |       | 268,869          |       | (4,500        | )          | -2 | % |
| **TOTAL G&A – Corporate**               |       | 1,938,631             |       | 1,850,242        |       | 88,389        |       | 5 | % |
|                                             |       |                  |       |             |       |          |       |   |   |
| **Consolidated Totals**                          |       | $                     | 7,675,379  |             | $          | 6,007,437     |       | $ | 1,667,942 |   | 28 | % |

 

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General and Administrative expenses (“G&A”)on a consolidated basis increased approximately $1.7 million, or 28%, whencomparing G&A of $7.7 million for the six months ended May 31, 2005 toG&A of $6.0 million incurred during the six months ended May 31, 2004.The net increase was attributable to an increase in E-commerce segment ($1.7million) and Corporate ($0.1 million), offset by a decline in the LEC BilledProduct segment of ($0.1 million). The significant increase in E-commerceexpenses was attributable to the operating overhead incurred from our tworecently acquired subsidiaries; in combination such subsidiaries overheadamounted to approximately $1.8 million during the six months ended May 31,2005. Neither subsidiary had been organized during the prior year’s comparableperiod. Specifically, during the six months ended May 31, 2005 thesubsidiaries combined compensation costs and related expenses amounted toapproximately $1.2 million. The subsidiaries also contributed to overhead asfollows: office rent and related office expense of approximately $0.1 million andother G&A of approximately $0.4 million. Included in other G&A wasamortization expense of approximately $0.2 million from the Send Trafficacquisition and approximately $0.2 million from the Hot Rocket acquisition.

 

Feder, Kaszovitz, Issacson, Weber, Skala, Bass and RhineLLP (“FKIWSBR”) provides general legal services to us in the ordinary course ofbusiness and litigation services in defense of actions arising from suchbusiness activities. Murray L. Skala, a partner in such firm, has been a memberof our Board of Directors since inception. We incurred approximately $391,000in legal fees (exclusive of disbursements) from FKIWSBR during the six monthsended May 31, 2005, of which $222,000 was expensed, and $169,000 was 

 

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capitalized in the Hot Rocket acquisition. Weincurred approximately $296,000 in legal fees (exclusive of disbursements) fromFKIWSBR during the six months ended May 31, 2004.

 

**Consolidated -Bad Debt Expense, by Segment**

 
| ** **              | ** ** | **Six  Months Ended** | ** ** | **Change**       | ** ** | **Change**   | ** ** |
|-------------------------|------------|-----------------------|------------|------------------|------------|--------------|------------|
| ** **              | ** ** | **May 31,**      | ** ** | **May 31,** | ** ** | **Inc(Dec)** | ** ** | **Inc(Dec)** | ** ** |
| **For the periods:**    | ** ** | **2005**              | ** ** | **2004**         | ** ** | **$$$**      | ** ** | **%%%** | ** ** |
| ** **              | ** ** | ** **            | ** ** | ** **       | ** ** | ** **   | ** ** | ** ** | ** ** |
| E-commerce              |       | $                     | 165,607    |             | $          | (112,113     | )          | $ | 277,720 |   | 248 | % |
|                    |       |                  |       |             |       |         |       |   |   |
| **Consolidated Totals** |       | $                     | 165,607    |             | $          | (112,113     | )          | $ | 277,720 |   | 248 | % |

 

Bad Debt expense increased approximately $0.3million, or 248%, from bad debt recapture of $112,113 in the six months ended May 31,2004 to bad debt expense of $165,607 in the six months ended May 31, 2005.Our allowance for bad debts results from our assessment of the risk ofcollection embedded in our customer base as described below.

 

We continuously evaluate the potential of thecollectibility of trade receivables by reviewing such factors as deteriorationin the operating results, financial condition or bankruptcy filings of ourcustomers. As a result of this review process, we record adjustments to baddebt provisions/(recaptures) to reflect the related receivables’ carryingamount to amounts that estimate their probable realizable value. Provisions forbad debts are also recorded resulting from the review of other factors,including (a) length of time the receivables are past due, and(b)historical experience and other factors obtained during collection efforts.If circumstances related to specific customers change, our estimates for baddebt provision/(recaptures) could be further increased or decreased in future 

 

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fiscal periods.

 

**OTHER INCOME (EXPENSE)**

 

The components of our “Other income (expense)” areset forth below:

 
| ** **                                        | ** ** | **Six  Months Ended** | ** ** | **change**       | ** ** | **change**   | ** ** |
|---------------------------------------------------|------------|-----------------------|------------|------------------|------------|--------------|------------|
| ** **                                        | ** ** | **May 31,**      | ** ** | **May 31,** | ** ** | **inc(dec)** | ** ** | **inc(dec)** | ** ** |
| ** **                                        | ** ** | **2005**              | ** ** | **2004**         | ** ** | **$$$**      | ** ** | **%%%** | ** ** |
| ** **                                        | ** ** | ** **            | ** ** | ** **       | ** ** | ** **   | ** ** | ** ** | ** ** |
| Interest  income and dividends                    |       | $                     | 425,337    |             | $          | 222,721      |       | $ | 202,616 |   | 91 | % |
| Realized  gains on sale of marketable securities  |       | 574,050               |       |             | 22,670     |         | 551,380    |   | 2432 | % |
| Realized  gain on sale of subsidiary              |       | 195,000               |       |             | 394,900    |         | (199,900   | ) | -51 | % |
| Other  non-operating income:                      |       |                  |       |             |       |         |       |   |   |
| Other  miscellaneous income(expense)              |       | 6,918                 |       |             | 9,921      |         | (3,003     | ) | -30 | % |
| Vendor  settlement on prior year marketing fee    |       | —                |       |             | 350,000    |         | (350,000   | ) | -100 | % |
| Foreign  Currency Exchange Rate Fees and interest |       | (13,302               | )          | (7,425           | )          | (5,877       | )          | 79 | % |
| Interest  and penalties - Florida tax settlement  |       | —                |       | (47,790          | )          | 47,790       |       | 100 | % |
| Reduction  of prior year’s LEC reserve       |       | —                |       | 34,181           |       | (34,181      | )          | -100 | % |
| Minority  interest (income) loss                  |       | (248,174              | )          | —           |       | (248,174     | )          | -100 | % |
|                                              |       |                  |       |             |       |         |       |   |   |
| Total  Consolidated Other Income (Expense)        |       | $                     | 939,829    |             | $          | 979,178      |       | $ | (39,349 | ) | -4 | % |

 

Consolidated Other Income (Expense) decreasedapproximately $39,000, from approximately $979,000 for the six months ended May 31,2004, to approximately $940,000 for the six months ended May 31, 2005.

 

The material factors contributing to the netincrease as set forth in the above table are as follows:

 

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(1)          Realized gains on the sale of marketable securities increased by$551,000 over the prior year’s comparable three month period. This resultedfrom our decision to recognize unrealized capital gains on our equity securityportfolio enabling us to utilize the federal tax benefit of capital losscarryforwards.

 

(2)          The six months ended May 31, 2004included $394,900 in installment payments from a prior year sale of asubsidiary, compared to $195,000 in the current six month period. The declinewas the result of the installment agreement having been completed in February,2005.

 

(3)          The six month period ended May 31, 2004included a collection of $350,000 in settlement of a prior year’s marketingagreement dispute. No comparable amount is reflected in the six month periodended May 31, 2005.

 

(4)          Minority Interest resulting from our EZTracks partnership with Madacy Entertainment amounted to $248,000. Thepartnership agreement was entered into on January 12, 2005 and, as such,the six month period ended May 31, 2004 included no comparable amount.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

As of May 31, 2005, we had aggregate workingcapital of $33.2 million compared to aggregate working capital of $34.6 millionas of November 30, 2004. We had available cash, cash equivalents, equitiesand readily available marketable debt securities of $30.6 million as of May 31,2005, compared to available cash, cash equivalents, equities and readilyavailable marketable debt securities of $35.8 million as of November 30,2004. The equity component 

 

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of our marketable securities was $1.6 millionat May 31, 2005, compared to $1.8 million at November 30, 2004.

 

Cash used in operating activities was approximately$1.5 million for the six months ended May 31, 2005, compared toapproximately $1.3 million in cash provided by operating activities in the sixmonths ended May 31, 2004, representing an approximate $2.8 milliondecrease in cash provided by operating activities. The primary factor givingrise to the decrease in cash provided by operating activities was attributableto an increase in accounts receivable of approximately $3.7 million (see “-day-sales-outstanding”below).

 

 Cash providedby investing activities was approximately $2 million during the six monthsended May 31, 2005, compared to $1.4 million used in investing activitiesduring the prior year’s comparable quarter. The primary use of cash ininvesting activities in the six months ended May 31, 2005 related to netcash of approximately $2.9 million expended in the Hot Rocket asset acquisitionon January 21, 2005. This was more than offset by net proceeds from salesof securities providing cash of approximately $4.8 million.

 

Cash used in financing activities was approximately$0.8 million for the six months ended May 31, 2005, compared to $0.7million used by financing activities for the six months ended May 31,2004. Proceeds from stock option exercises were $1.5 million for the six monthsended May 31, 2005, compared to $1.4 million collected during thecomparable prior year period. Dividend payments totaled $2.2 million for thesix months ended May 31, 2005, compared to $2.1 million in the comparableprior period.

 

Our days-sales-outstanding (“DSO”) in accountsreceivable at May 31, 2005 was 58 days, compared to 44 days at February 28,2005, 42 days at November 30, 

 

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2004, 55 days at August 31, 2004, and 60days at May 31, 2004. The 14 day increase in the current quarter’s DSOcompared to the fourth quarter of the prior fiscal year relates to increases inE-commerce accounts receivable, based on newly acquired subsidiaries andincreased core operations, offset by reductions in the LEC Billed Productsegment accounts receivable of $4.8 million (when comparing the May 31,2005 combined accounts receivable balance of $9.5 million with accountsreceivable at November 30, 2004 of approximately $4.7 million).

 

The majority of our customers are extended 30-daycredit terms. In limited instances, customer credit is extended to rangesapproximating 90 days. Our LEC Billed Products segment collection cycle is afunction of the terms of the billing and collection agreements governing suchactivity, which collection cycles can exceed 90 days.  We continually monitor customer adherence tocredit terms and constantly strive to improve the effectiveness of ourcollection efforts with the goal of achieving a DSO in the 40-day range. Futurefiscal periods might not reflect this goal of a 40-day DSO, and might exceedthe 58-day DSO recognized in the three-month period ended May 31, 2005.

 

Historically, our primary cash requirements havebeen used to fund the cost of advertising and promotion and test-marketing newproducts, services and promotions, with additional funds having been used inthe purchasing of equipment and services in connection with the commencement ofnew business lines, further development of businesses being test marketed andfor the development of the equipment infrastructure of subsidiaries.

 

In Fiscal 2000, we executed our on-line directmarketing strategy. Our future plans and business strategy may continue to callfor our Internet-based E-commerce segment to be our primary operating focus,with such segment generating the material portion of our revenues for the sixand three month periods ended May 31, 2005. In Fiscal 2002 and 2003, weexpended approximately 

 

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$1.9 and $1.5 million, respectively, forcapital expenditures to support our E-commerce business. In Fiscal 2004,capital expenditures declined to approximately $141,000 as a result of theprior two year’s of capital expenditures, which yielded excess capacity. Forthe six months ended May 31, 2005, capital expenditures totaledapproximately $70,000. We believe that our current infrastructure is adequateto support our E-commerce growth plan, and therefore do not contemplatesignificant capital expenditure requirements in the near future.

 

If our operations fail to generate sufficientrevenue, we could realize a material adverse impact on our capital andliquidity resources resulting from expenditures necessary to generate suchrevenue, including, but not limited to, expenditures for (a) marketingcampaigns, including media costs and other costs of customer acquisitioninformation, (b) product development costs, (c) site development andmaintenance and related technology based costs, (d) potential on-line,and/or off-line, business acquisitions, (e) costs associated withdeveloping alternative means of email promotion delivery, or (f) otherunexpected and/or currently unidentifiable costs.

 

On January 21, 2005, we acquired the intangibleassets of Hot Rocket, a privately-held on-line media and marketing agency. Thepurchase price was approximately $3.7 million, comprised of $0.7 million inshares of our common stock (or 113,821 shares) and $2.9 million in cash. Inaddition, we agreed to pay Hot Rocket a contingent purchase price of up to$12.5 million upon the generation of certain EBITDA thresholds over the fouryear period following the closing.

 

On June 30, 2004, we consummated theacquisition of the assets of SendTraffic.com, Inc. and its affiliatedentity, The Traffic Group, LLC, privately held search engine marketing companies based in New York. Theoriginal purchase price agreement was for approximately $5.0 million, comprisedof $3.5 million 

 

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in cash and 233,941 shares of Traffix commonstock. The asset acquisition agreement calls for contingent earn-out paymentsbased on the post closing attainment of certain earnings before interest,taxes, depreciation and amortization (EBITDA) thresholds during the thirty-sixmonth period following the transaction.

 

Additionally in the agreement, Send Trafficwarranted that certain financial information contained in its unaudited June 30,2004 balance sheet, which was used to determine the original purchase price,was accurate, and if such financial information ultimately proved post-closingto have been inaccurate, Send Traffic would return to us any shortfall.  In order to ensure compliance with suchwarranty, we retained in escrow $250,000 of the purchase price.  On November 24, 2004, we signed an AdjustmentAgreement with Greg Byrnes and Craig Handelman, the principals of SendTraffic (the “STStockholders”), regarding the final determination of the June 30,2004 balance sheet. In accordance with the Adjustment Agreement’s “CashAdjustment” clause, we received $300,000 in cash from the STStockholders, $250,000 of which camefrom the escrow withheld at closing, and an additional $50,000 of which wasreceived on November 30, 2004. Additionally, under the AdjustmentAgreement’s “Share Adjustment” clause, the ST Stockholders returned 57,142 shares to us, which servedto reduce the total shares issued in the asset acquisition to 176,799 shares,as compared to the original issuance of 233,941 shares.

 

Upon theconsummation of the Send Traffic acquisition, each of the ST Stockholdersentered into five-year employment contracts with our wholly-ownedsubsidiary.  Included in each of thosecontracts were restrictive covenants prohibiting the ST Stockholders fromcompeting with us during the term of their employment and for a period of timethereafter (the “Restrictive Covenants”).

 

At the time ofthe Send Traffic acquisition, we allocated $665,000 (of the approximately $5.43million purchase price) to the Restrictive Covenants, which we amortized over afive-year period, or through June 30, 2009.

 

On April 6,2005, the employment relationship between the ST Stockholders and usterminated.  We maintain that the STStockholders resigned from their positions voluntarily and without good reasonunder the terms of their respective employment contracts, in which event thecontracts provide that the Restrictive Covenants would continue in effect untilJune 30, 2007.  Accordingly, we arereducing the period over which we are amortizing the remaining unamortizedportion of the purchase price allocated to the Restrictive Covenants to theperiod ending June 30, 2007.  SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets,” requirescertain disclosures in the financial statements which include the recognitionof any impairment loss.  As a result ofshortening the life of the Restrictive Covenants, the increased risk ofcompetition and the reduced future revenues that may flow therefrom, theremaining carrying value of the Restrictive Covenants as of May 31, 2005 (or $539,000)was re-evaluated in accordance with SFAS No. 144 and deemed to be impairedby approximately $137,000 to $402,000. This impairment loss is included indepreciation and amortization expense and the “administrative expense” caption ofour income statement for the three and six month periods ended May 31,2005. The impairment loss is allocated to our E-commerce segment.

 

The STStockholders have contended that their employment contracts were eitherterminated without Cause (as that term is defined in their respectiveemployment contracts) by us, or that they were entitled to terminate theagreements as a result of actions taken by us with respect to the scope oftheir duties and responsibilities.   If itwere determined that the ST Stockholders’ employment was terminated by uswithout Cause, then, under their employment contracts, each would have beenentitled to severance of not less than 6 months’ and up to 12 months’ basesalary (such amount determined by us in our discretion) and the RestrictiveCovenants would have continued for such period. The remaining unamortizedportion of the purchase price allocated to the Restrictive Covenants would beamortized over such period, which would have ended no earlier than November 6,2005 and no later than April 6, 2006, as determined by us, and, inaccordance with SFAS 144, the remaining carrying value of the RestrictiveConvenants would be re-evaluated, with us taking an impairment loss at thattime.  If, however, it were determinedthat the ST Stockholders were entitled to terminate their employment agreementswith good reason as a result of actions taken by us, then the RestrictiveCovenants would have ended on April 6, 2005, the date of termination, and,in accordance with SFAS 144, the remaining unamortized portion of the purchaseprice allocated to the Restrictive Covenants would be an expense in the currentperiod.  Should it become necessary, wewill defend our position vigorously and use whatever means available to enforcethe Restrictive Covenants. We are confident that, notwithstanding the departureof the ST Stockholders, our extensive and experienced workforce will allow usto grow the Send Traffic business and expand its contributions to our overalloperations.

 

As of May 31,2005, the unamortized balance remaining relating to the Restrictive Covenantsis $402,000 and is included in other intangibles.  No amounts have been accrued relating to anyseverance.

 

On April 1, 2004, we announced that wehad acquired an exclusive license for an operating platform created byLiveOnTheNet.com, Inc., a privately held company. We had announced in February 2004that we had entered into an agreement to acquire all of the assets of suchentity, but the asset acquisition plans were discarded in favor of a licenseagreement resulting from our final stages of due diligence. The licenseagreement called for a total payment of $200,000. A down payment of $35,000 andthe initial $15,000 installment was made at the time of signing the license,and 

 

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installments of $15,000 wererequired on the ten monthly anniversary dates following the signing. As of May 31,2005, all installments have been made in accordance with the terms of thelicense agreement.

 

In May 2005, we entered into a license agreement with Alliant Cooperative Data Solutions, LLC. The agreement allows for the use of an Alliant product which ranks and scores lists of consumers who register on our websites, allowing us to project the response rate of ordering a product after receiving an offer and the rate of payment given a response. The total cost of the license is $38,000, payable in three installments in June, July and October 2005. The full liability was recognized at May 31, 2005 and the license agreement is being amortized on a straight line basis over a three year period.

 

In March 2003, we sold our 51%majority-owned subsidiary, Montvale Management LLC (“Montvale”), to MortgageIndustry Consultants, LLC (“MIC”) for $1.6 million, plus our investment. We hadobtained our 51% interest in September 1999 through an initial investmentof approximately $50,000. The terms of the agreement included an initialpayment of $1 million (received in March 2003) followed by an additional$600,000 to be paid in 24 monthly installments of $25,000 each. As of May 31,2005, all required installments were received and recorded as realized gain onsale of subsidiary.

 

In May 2003, we received approximately$299,000, representing our GAAP basis capital account in such majority-ownedsubsidiary as at November 30, 2002, pursuant to the terms of theagreement. We also entered into a two-year Media Purchase Agreementwhereby we agreed to provide certain media lead generation and related servicesto the continuing owners of Montvale for consideration of $40,000 per monthover the term of the agreement. As of May 31, 2005, we have collected allof the requisite payments specified under the agreement.

 

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Under currently proposed operating plans andassumptions, management believes that projected cash flows from operations andavailable cash resources and working capital, as described above, will besufficient to satisfy our anticipated cash requirements for at least the nexttwelve months.

 

Additionally, as we seek to further extend our reachinto the E-commerce and LEC Billed Product arenas, as well as identifying newand other consumer oriented products and services in the off-line arena, we mayuse existing cash reserves, enter into long-term financing arrangements,acquire the assets of privately-held companies, or employ other means tofinance such diversification, none of which is specifically identifiable ormeasurable at this time.

 

###### **OBLIGATIONSAND COMMITMENTS**

###### ** **

We are not aware of any specific factors,outside of those described in the following table, and those “potential factors”described in the “Critical 

 

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Accounting Policy and Accounting Estimate Discussion” which is setforth below, that are reasonably likely to cause a material impact, eitherpositive or negative, on our liquidity trends. Additionally, we do not have off-balance sheet arrangements, other thanthose described in the following table, and do not engage in trading activitiesinvolving non-exchange traded contracts.

 

A summary table of future contractualcommitments, for future minimum lease payments under non-cancelable operatingleases and employment contracts, and other contractually binding agreements, asof May 31, 2005, are set forth below: 

 
| ** ** | ** ** | ** **           | ** ** | ** **                | ** ** | ** **   | ** ** | ** **      | ** ** | ** **   | ** ** | **Total Contractual** | ** ** |
|------------|------------|----------------------|------------|---------------------------|------------|--------------|------------|-----------------|------------|--------------|------------|-----------------------|------------|
| ** ** | ** ** | **Operating Leases** | ** ** | **Employment agreements** | ** ** | **Other**    | ** ** | **Obligations** | ** ** |
| ** ** | ** ** | **Domestic**         | ** ** | **Foreign**               | ** ** | **Domestic** | ** ** | **Foreign**     | ** ** | **Domestic** | ** ** | **Domestic**          | ** ** | **Foreign** | ** ** |
|       |       |                 |       |                      |       |         |       |            |       |         |       |                  |       |   |   |
| 2005       |       | $                    | 194,425    |                      | $          | —       |       | $               | 932,250    |         | $          | 143,862               |       | $ | — |   | $ | 1,126,675 |   | $ | 143,862 |   |
| 2006       |       | 262,277              |       | —                    |       | 1,268,075    |       | 311,701         |       | —       |       | 1,530,352             |       | 311,701 |   |
| 2007       |       | 48,695               |       | —                    |       | 1,221,855    |       | 3,941           |       | —       |       | 1,270,550             |       | 3,941 |   |
| 2008       |       | 50,156               |       | —                    |       | 348,469      |       | —          |       | —       |       | 398,625               |       | — |   |
| 2009       |       | 16,883               |       | —                    |       | 196,200      |       | —          |       | —       |       | 213,083               |       | — |   |
| Thereafter |       | —               |       | —                    |       | 28,209       |       | —          |       | —       |       | 28,209                |       | — |   |
|       |       | $                    | 572,436    |                      | $          | —       |       | $               | 3,995,058  |         | $          | 459,504               |       | $ | — |   | $ | 4,567,494 |   | $ | 459,504 |   |
|            |            |                      |            |                           |            |              |            |                 |            |              |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

###### **RELATEDPARTIES**

###### ** **

Feder, Kaszovitz, Issacson, Weber, Skala, Bass andRhine LLP (“FKIWSBR”) provides general legal services to us in the ordinarycourse of business and litigation services in defense of actions arising fromsuch business activities. Murray L. Skala, a partner in such firm, has been amember of our 

 

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Boardof Directors since inception. FKIWSBR legal services are billed on an armslength transaction basis. We incurred approximately $391,000 in legal fees(exclusive of disbursements) from FKIWSBR during the six months ended May 31,2005, of which $222,000 was expensed, and $169,000 was capitalized in the HotRocket acquisition. We incurred approximately $296,000 in legal fees (exclusiveof disbursements) from FKIWSBR during the six months ended May 31, 2004.

 

**CRITICAL ACCOUNTING POLICY AND ACCOUNTING ESTIMATEDISCUSSION**

 

In accordance with the Commission’sRelease Nos. 33-8040 and 34-45149 and FR-60 issued in December 2001,referencing the Commission’s statement “regarding the selection and disclosureby public companies of critical accounting policies and practices”, we have setforth below what we believe to be the most pervasive accounting policies andestimates that could have a material effect on our Company’s results ofoperations and cash flows, if general business conditions or individualcustomer financial circumstances change in an adverse way relative to thepolicies and estimates used in the attached financial statements or in any “forwardlooking” statements contained herewith.

 

**Estimates**

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires our management tomake estimates 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 period. Actual results could differ from those estimates. Our mostsignificant estimates relate to the accruals for fulfillment redemptions,reserves for uncollectible receivables, reserves for data qualificationallowances, recoverability of long-lived assets, and the 

 

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realizabilityof deferred tax assets. Additionally, we have potential exposure resulting frompending and/or threatened litigation for which we currently assess immaterialrisk and, accordingly, do not provide for loss. Additionally, no provision forloss has been recorded for the potential of currently unknown actions naming usas defendant in future fiscal periods. Actual results could differ from ourestimates.

 

**FACTORS THAT COULD AFFECT FUTURE RESULTS**

 

**Historically High Levels of Volatility in Revenue and Cost Trends**

 

Our revenues and profitability from operations havehistorically varied. Our revenues, cost of providing revenues, profit marginsand overhead expenses have varied historically among segments, as well as on aconsolidated basis. The revenue allocation among our segments in future periodswill most probably be different than our current revenue allocation due toseveral factors, including consumer tastes, business opportunities, regulatoryissues that may exist in future periods, and other currently unknown factorsthat could impact our revenue generating cycle or cost structure. Therefore, itis difficult to predict revenue and gross margin trends, and theircorresponding impact on liquidity and capital resources. Actual trends maycause us to adjust our operating emphasis, which could result in continuedperiod-to-period fluctuations in our results of operations. Historically, wehave been able to rapidly react to changes in the business environment withinwhich we operate. Management responds to these changes as deemed appropriate atthe time of change, and as dictated by the nature of such changes. Management’sreaction to such changes could cover a broad range of business-relatedadjustments, ranging from product mix repositioning and staff reductions, toentire business model overhauls. Based on our current operations and marketingmethods, as well as the dynamic, ever changing status of the Internet marketingenvironment, it is conceivable that we would institute changes to our businesspractices in future fiscal periods. There can be no assurance 

 

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thatany such potential change would be successful in its implementation, and therecan be no assurance that any such implementation would benefit our operatingmargins, profitability, cash flows or capital resources.

 

**Revenue Recognition, Variable Costs and Bad Debts**

 

We currently earn the most significant portion ofour revenue from the E-commerce segment pursuant to marketing agreements withmarketing partners and corporate customers. The provisions of each agreementdetermine the type and timing of revenue to be recorded. We invoice ourcustomers in accordance with the terms of the underlying agreement. Revenue isrecognized at the time the marketing activity is delivered, or service isprovided, net of estimated contractually specified data qualificationallowances, when applicable. Such data qualification allowances may includeduplications, invalid addresses, and age restrictions, and are recorded ascontra-revenue. Our revenues are adjusted in later fiscal periods if actualallowances vary from amounts previously estimated. Historically, the variancebetween actual allowances and previously estimated allowances has beenimmaterial. If events were to occur that would cause actual allowances (whichare recorded as offsets against gross revenue, as contra-revenues, in arrivingat reported net revenue) to vary significantly from those originally estimatedand reflected in the financial statements, we could suffer materialdeterioration in future fiscal period gross margins, and, therefore, ourprofitability, cash flows and capital resources could be adversely affected.

 

Certain revenue related obligations are recorded atthe time revenue is recognized. They include costs payable to other on-line, aswell as off-line, media companies for generating registered users and consumerdata for us, 

 

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databasefee sharing costs under third-party database use agreements, email messagedelivery costs, contingent-based prize indemnification coverage (i.e.,sweepstakes payout indemnification), estimated premium fulfillment costsrelated to the respective promotion (if applicable) and all other variablecosts directly associated with completing our obligations relative to therevenue being recognized. Our actual premium fulfillment estimates have variedfrom that which were accrued at the time of recording the related revenue. Thisis deemed a change in management’s estimate, and we take the additional cost,or benefit, on the accrual adjustment in the fiscal period that the variance isdeterminable.

 

Should the Internet operating landscape changeresulting in (a) higher costs of acquiring consumer data and registeredusers for our websites; (b) higher costs of acquiring data for ourmarketing partners, compromising such marketing partners’ ability to maintainadequate sized databases to allow for continued third-party database useagreements; (c) the InfiKnowledge asset acquisition failing to maintain alower cost of our email delivery activities and web development and web hostingservice costs as compared to our competitors, or us being required to depend onthird-party emailing service bureaus, to a degree higher, and/or at a cost inexcess of our anticipated internally-generated costs, than that currentlyutilized during the six months ended May 31, 2005, or other currentlyunknown third party influences on our ability to deliver email messages to therecords in our databases, or the records in our marketing affiliates’databases; (d) our contingent-based prize indemnification premiums forindemnification coverage increasing due to an increase in the number of prizewinners at the sites, or as a result of the insurance industry in general; (e) ouraccruals for fulfillment obligations arising out of promotions proving to beless than the actual redemptions processed in subsequent fiscal periods; or (f) unpredictabletechnology changes or commercial technology applications; 

 

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then,if any one, or a combination, of the above factors were to materialize we couldsuffer material deterioration in future fiscal period revenue growth and grossmargins and, therefore, our profitability, cash flows and capital resourcescould be materially adversely affected.

 

Revenue recognition is also subject to provisionsbased on the probability of collection of the related trade accountsreceivable. We continuously evaluate the potential of the collectibility oftrade receivables by reviewing such factors as deterioration in the operatingresults, financial condition, or bankruptcy filings, of our customers. As aresult of this review process, we record bad debt provisions to adjust therelated receivables’ carrying amount to an estimated realizable value.Provisions for bad debts are also recorded due to the review of other factors,including the length of time the receivables are past due, historicalexperience and other factors obtained during the conduct of collection efforts.If circumstances change regarding our specific customers on an individualbasis, or if demand for Internet direct marketing softens, or if the U.S.economy stumbles, our estimates for bad debt provisions could be furtherincreased, which could adversely affect our operating margins, profitability,cash flows and capital resources.

 

**Major Customers and Disposition of Majority-ownedSubsidiary**

 

During the six month period ended May 31, 2005, we had 9 customers in our E-commerce segment accounting for approximately $10.2 million or 34.2% of consolidated net revenues and approximately $5.1 million, or 53.8% of consolidated net accounts receivable as of May 31, 2005. The 9 customers accounted for 10.8%, 3.9%, 2.9%, 2.8%, 2.8%, 2.5%, 2.4%, 2.0% and 2.0% of consolidated net revenue for that six month period.

 

During the six month period ended May 31, 2004, we had 7 customers in our E-commerce segment accounting for approximately $5.6 million or 34.6% of 

 

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consolidated net revenue and approximately $2.1 million or 38.7% of consolidated net accounts receivable as of May 31, 2004. The 7 customers accounted for 12.6%, 6.2%, 4.5%, 3.3%, 3.0%, 3.0% and 2.1% of consolidated net revenue for that six month period.

 

Regarding the balance of our customer base, no single customer had net revenues that equaled or exceeded 2.0% of consolidated net revenues for the six month period ended May 31, 2005 or for the six month period ended May 31, 2004. During the year ended November 30, 2003, our business model caused us to move away from significant single, or material multiple, customer reliance, and therefore minimized the risk regarding singular customer loss.

 

In the six months ended May 31, 2005, 16.5% of our revenue was derived from our proprietary products: 14.1% from iMatchUp.com, our online dating sites, and 2.4% from our LEC Billed Product segment’s proprietary products.

 

**Impairment of Goodwill, Other Intangibles andinvestment Portfolio Could Impact net Income**

 

We carry goodwill and other identifiable intangibleson our balance sheet arising from current and prior-year acquisitions, with allsuch goodwill and other identifiable intangibles being aggregated and allocatedto our E-commerce segment. We are required to review, at least annually,goodwill for any asset impairment. If the review of the aggregated goodwillrelated to the E-commerce segment determines that such goodwill is impaired,then we will be required to recognize an impairment charge on such goodwillnecessary to reduce the carrying value of the goodwill to its net realizablevalue. Should events occur that would give rise to such impairment charge, wewould recognize decreased profitability to the extent of such adjustment. Cashflows would not be directly affected by the impairment charge, but cash flowswould, most likely, have been adversely affected as a result of the facts andcircumstances that created the impairment charge.

 

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**Market Fluctuation and Debt Repayment Risk ofMarketable Securities Investment Portfolio**

 

We maintain an investment portfolio that is managedby prominent financial institutions. The portfolio includes high-gradecorporate commercial paper and auction rate securities, and common stockequities, all of which are held for varying periods of time, pursuant tomaturity dates, market conditions and other factors. The fair value of ourinvestments in the common stock of publicly traded companies as of May 31,2005 amounted to approximately $1.6 million. These investments are subject tomarket price volatility, in addition to the potential for business failure atthe company level. Moreover, due to the economic downturn and difficulties thatmay be faced by some of the companies in which we have investments, ourinvestment portfolio could be further impaired by the failure of such companiesto fulfill their responsibility of adhering to the repayment of principal uponmaturity. Additionally, our cash flows and interest income could be negativelyimpacted by Federal Reserve Bank interest rate reductions, if any.

 

**Item 4.****   ****CONTROLS AND PROCEDURES**

 

(a)           Evaluation of disclosure controls andprocedures.

 

Our Chief Executive Officer and ChiefFinancial Officer, after evaluating the effectiveness of our disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-15(e) and15d-15(e)) as of the end of the period covered by this Quarterly Report, haveconcluded that as of that date, our disclosure controls and procedures wereadequate and effective to ensure that information required to be disclosed byus in the reports we file or submit with the Securities and Exchange Commissionis recorded, processed, summarized and reported within the time periodsspecified in the Securities and Exchange Commission’s rules and forms.

 

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(b)           Changes in internal control over financialreporting.

 

There were no changes in our internal control overfinancial reporting identified in connection with the evaluation required byExchange Act Rules 13a-15(d) and 15d-15 that occurred during theperiod covered by this Quarterly Report that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

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**PART II**

 

**OTHER INFORMATION**

 

**Item1.**                    **Legal Proceedings**

 

We are subject to legal proceedings, lawsuits andother claims, brought by: (1) consumers of our products and services; (2) ourclients; (3) consumers of our clients’ products and services; and (4) othersbringing claims that arise in the normal course of our business. Legalproceedings are subject to numerous uncertainties rendering the prediction oftheir outcome difficult. As a result of such uncertainty, we are unable toestimate the ultimate outcome of any of the subsequently mentioned claims, and,accordingly, no provision for loss has been recorded. We believe thatindividually, and in the aggregate, the ultimate settlement of the subsequentlymentioned claims should not have a material adverse effect on our consolidatedfinancial position, results of operations or cash flows.

 

*Qwest*

 

Qwest Communications, Inc. notified usof an indemnification claim relating to a class action filed against Qwest inMinnesota, *Bindner v. LCI InternationalTelecom Corp. et al.*, District Court of Minnesota, County of Sibley,Case No. C0-00-242 (the “Class Action”). In that action, plaintiffsclaimed that from September 1998 to July 1999, they were misled whenthey were solicited to change their long distance carrier to Qwest. Theyasserted that they were not told that they would have to stay at certain hotelsand pay their regular rates as part of a promotion involving free airlinetickets. We introduced the promotion (“Fly Free America”) to Qwest, and wereretained by Qwest to operate the telemarketing campaign pursuant to ourAgreement. In or about May 2000, we and Qwest entered into an agreementterminating the Agreement and settling the amount due us (the “May 2000Agreement”). The Agreement and the May 2000 Agreement contain languagethat Qwest claims obligates us to indemnify Qwest for the losses it sustainedby reason of this class action. We maintain that we have no liability in thematter.

 

Fraud claims in the Class Action weredismissed, leaving breach of contract and false advertising claims. The courtcertified the class and Qwest, without our consent, agreed to settle the Class Action.The court approved the settlement agreement, stated that there was no findingof any liability 

 

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against Qwest, and approved the attorneys’ fees for plaintiffs’counsel. No appeal was taken so that the Class Action has been concluded.

 

In November 2002,we commenced an arbitration against Qwest to recover certain amounts held inescrow that were due us pursuant to the May 2000 Agreement. In December 2002,Qwest filed counterclaims in the arbitration relating to the Fly Free Americaprogram. Qwest asserts that in connection with the Class Action, we mustindemnify it for $3.4 million in Qwest attorneys’ fees; $600,000 in feesfor counsel to the plaintiffs in the Class Action; and $500,000 insettlement payments to Class members. Qwest also sought reimbursement ofapproximately $3.1 million it paid us pursuant to the May 2000Agreement.  Initially, Qwest also soughtto recover approximately $1.5 million of fines and penalties it claimed itpaid to various attorneys general; Qwest has now withdrawn that claim.

 

A panel of arbitrators was appointed in December 2003.The panel established a schedule for substantive motions and for hearingsin June 2004. The arbitrators also provided for exchanges of informationin the arbitration subject to Qwest’s right to seek to prevent such exchanges.Qwest moved to prevent exchanges of information and this application wasgranted. Qwest moved for summary judgment with respect to its indemnificationcounterclaim. That motion was denied.  Webelieve that there is no merit to Qwest’s counterclaims and intend vigorouslyto defend against them, as well as to pursue our claims for payments due to usunder the May 2000 Agreement. The arbitration hearing has been scheduledfor the week of June 20, 2005.

 

*Columbia House/Rydel*

 

In or about August 2002, Columbia House,one of our clients, notified us of an indemnification claim relating to a classaction filed against Columbia House, among others, in Illinois, *Rydel v. Comtrad Industries, Inc. et al.*,Circuit Court of Cook County, Illinois, No. 02 CH 13269. In that action,plaintiff claims to have received unsolicited commercial e-mail from, amongothers, Columbia House, in violation of Illinois law, and asserts two basicclaims against Columbia House, one for violation of Illinois’ Consumers FraudStatute, the second for violation of Illinois’ Electronic Mail Act. ColumbiaHouse advised us that it believes that the email in question was not approvedby Columbia House when it was sent, and asserted a claim for indemnificationagainst us pursuant to our contract. We and Columbia House agreed to deferresolution of the indemnification claim (and reserved each of our respective 

 

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rights). Columbia House is defending against the class action. Itsmotion to dismiss was granted as to the Consumer Fraud claim, but denied as tothe Electronic Mail Act claim. The plaintiff has appealed the partialdismissal.

 

In or about January 2003, we were namedas a defendant in the *Rydel* classaction. In an additional count in the complaint, the plaintiff asserted that weviolated the Illinois Consumer Fraud and Deceptive Business Practices Act byproviding to a co-defendant a list of consumers who had consented to receivecommercial e-mails when, the complaint alleges, they had not. The complaint soughtinjunctive relief and unspecified damages. Our motion to dismiss the claim asagainst us was granted in June 2003, and the plaintiff filed an appeal.

 

In late 2004, the appellate court affirmedthe decision below, so that the claim against us is dismissed; the ConsumerFraud claim against Columbia House is dismissed; and the Electronic Mail Actclaim against Columbia House remains. The plaintiff asked the appellate courtto reconsider its decision, and the court denied that request on April 14,2005.

 

As stated above, we are unable to determinethe ultimate outcomes of any of the foregoing claims or demands, and,accordingly, no provision for loss has been recorded in the financialstatements included in this Report.

 

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**Item6.****    Exhibits**

 
| **Exhibit** |       |                                                                           |
|-------------|------------|--------------------------------------------------------------------------------|
| **Number**  | ** ** | ** **                                                                     |
|        |       |                                                                           |
| 3.1.1       |       | Articles of Incorporation of the Company,  as amended (1)                      |
|        |       |                                                                           |
| 3.1.2       |       | Amendment to the Articles of Incorporation  of the Company (2)                 |
|        |       |                                                                           |
| 3.2         |       | By-Laws of  the Company (3)                                                    |
|        |       |                                                                           |
| 31.1        |       | Rule 13a-14(a)/15d-14(a) Certification  of Chief Executive Officer * |
|        |       |                                                                           |
| 31.2        |       | Rule 13a-14(a)/15d-14(a) Certification  of Chief Financial Officer * |
|        |       |                                                                           |
| 32.1        |       | Section 1350  Certification of Chief Executive Officer *                  |
|        |       |                                                                           |
| 32.2        |       | Section 1350  Certification of Chief Financial Officer *                  |

 

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*              Filed herewith.

 

(1)           Filedas an Exhibit to the Company’s Registration Statement on Form 8-A,dated October 23, 1995, and incorporated herein by reference.

 

(2)           Filedas an Exhibit to the Company’s Quarterly Report on Form 10-Q for thefiscal quarter ended August 31, 1998, and incorporated herein byreference.

 

(3)           Filedas an Exhibit to the Company’s Registration Statement on Form S-1(the “S-1 Registration Statement”), dated September 6, 1995 (File No. 33-96632),and incorporated herein by reference.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the Registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

 
|                                | TRAFFIX, INC.                     |
|-------------------------------------|-----------------------------------|
|                                |                              |   |
|                                |                              |   |
|                                | By:                               | /s/ Jeffrey L. Schwartz |   |
|                                | Jeffrey L. Schwartz               |
|                                | Chairman and CEO Chairman and CEO |
| Date:  July 15, 2005 | (Principal Executive Officer)     |
|                                     |                                   |  |  |  |

 

 
|                            | By:                           | /s/ Daniel Harvey |   |
|---------------------------------|-------------------------------|-------------------|--------|
|                            | Daniel Harvey                 |
|                            | Chief Financial Officer       |
| Date:   July 15, 2005 | (Principal Financial Officer) |

 

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Exhibit Index

 
| **Exhibit** |       |                                                                           |
|-------------|------------|--------------------------------------------------------------------------------|
| **Number**  | ** ** | ** **                                                                     |
|        |       |                                                                           |
| 3.1.1       |       | Articles of Incorporation of the Company,  as amended. (1)                     |
|        |       |                                                                           |
| 3.1.2       |       | Amendment to the Articles of Incorporation of  the Company. (2)                |
|        |       |                                                                           |
| 3.2         |       | By-Laws of  the Company. (3)                                                   |
|        |       |                                                                           |
| 31.1        |       | Rule 13a-14(a)/15d-14(a) Certification  of Chief Executive Officer * |
|        |       |                                                                           |
| 31.2        |       | Rule 13a-14(a)/15d-14(a) Certification  of Chief Financial Officer * |
|        |       |                                                                           |
| 32.1        |       | Section 1350  Certification of Chief Executive Officer *                  |
|        |       |                                                                           |
| 32.2        |       | Section 1350  Certification of Chief Financial Officer *                  |

 

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*              Filed herewith.

 

(1)           Filedas an Exhibit to the Company’s Registration Statement on Form 8-A,dated October 23, 1995, and incorporated herein by reference.

 

(2)           Filedas an Exhibit to the Company’s Quarterly Report on Form 10-Q for thefiscal quarter ended August 31, 1998, and incorporated herein byreference.

 

(3)           Filedas an Exhibit to the Company’s Registration Statement on Form S-1(the “S-1 Registration Statement”), dated September 6, 1995 (File No. 33-96632),and incorporated herein by reference.

 

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