**SECURITIESAND 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 February 29, 2004**                                         |
|                                                                                                                                                                                                                                                          |   |                                                                                          |
| **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  incorporation or organization) |   | (I.R.S. Employer  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 to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

Yes  ý    No  o

 

Indicate bycheck mark whether the Registrant is an accelerated filer (as defined in Rule12b-2 of the Exchange Act).

 

Yes  o    No  ý

 

Thenumber of shares outstanding of the Registrant’s common stock is12,991,202      (as of 04/12/04).

 

 

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**TRAFFIX, INC.**

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

**FILED WITH THE SECURITIES AND EXCHANGECOMMISSION**

**QUARTER ENDED FEBRUARY 29, 2004**

 

**ITEMS IN FORM 10-Q**

 
|           |                                                                                        | **Page** |
|----------------|---------------------------------------------------------------------------------------------|----------|
|           |                                                                                        |     |
| **Part I**     | **Financial Information**                                                                   |     |
|           |                                                                                        |     |
| Item 1.        | Financial Statements (Unaudited)                                                            | 3        |
|           |                                                                                        |     |
| Item 2.        | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 29       |
|           |                                                                                        |     |
| Item 3.        | Quantitative and Qualitative Disclosures About Market Risk                                  | None     |
|           |                                                                                        |     |
| Item 4.        | Controls and Procedures                                                                     | 59       |
|           |                                                                                        |     |
| **Part II**    | **Other Information**                                                                       | 61       |
|           |                                                                                        |     |
| Item 1.        | Legal Proceedings                                                                           | 61       |
|           |                                                                                        |     |
| Item 2.        | Changes in Securities and Use of Proceeds                                                   | None     |
|           |                                                                                        |     |
| Item 3.        | Defaults Upon Senior Securities                                                             | None     |
|           |                                                                                        |     |
| Item 4.        | Submission of Matters to a Vote of Security Holders                                         | None     |
|           |                                                                                        |     |
| Item 5.        | Other Information                                                                           | None     |
|           |                                                                                        |     |
| Item 6.        | Exhibits and Reports on Form 8-K                                                            | 66       |
|           |                                                                                        |     |
| **Signatures** | 68                                                                                          |

 

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**TRAFFIX, INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

 
|                                                                                                                                    |   | **February  29,  2004** |       | **November  30,  2003** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|------------|-------------------------|--------|
|                                                                                                                                    |   | **(Unaudited)**         |       |                    |   |
| **Assets**                                                                                                                              |   |                    |       |                    |   |
| Current assets:                                                                                                                         |   |                    |       |                    |   |
| Cash and cash equivalents                                                                                                               |   | $                       | 10,060,549 |                    | $      | 9,939,657 |   |
| Marketable securities                                                                                                                   |   | 28,521,661              |       | 28,272,520              |   |
| Accounts receivable, trade, net of  allowance for doubtful accounts of $826,148 at February 29, 2004 and $872,605  at November 30, 2003 |   | 4,144,478               |       | 4,076,947               |   |
| Deferred income taxes                                                                                                                   |   | 1,507,254               |       | 1,295,983               |   |
| Prepaid expenses and other current assets                                                                                               |   | 772,405                 |       | 1,065,580               |   |
| **Total current assets**                                                                                                                |   | 45,006,347              |       | 44,650,687              |   |
| Property and equipment, at cost, net of  accumulated depreciation                                                                       |   | 2,532,432               |       | 2,799,405               |   |
| Goodwill                                                                                                                                |   | 1,046,330               |       | 1,071,525               |   |
| Other intangibles, net                                                                                                                  |   | 1,039,063               |       | 1,157,176               |   |
| Deferred income taxes                                                                                                                   |   | 103,005                 |       | 271,744                 |   |
| **Total assets**                                                                                                                        |   | $                       | 49,727,177 |                    | $      | 49,950,537 |   |
| **Liabilities**                                                                                                                         |   |                    |       |                    |   |
| Current liabilities:                                                                                                                    |   |                    |       |                    |   |
| Accounts payable                                                                                                                        |   | $                       | 2,566,397  |                    | $      | 2,337,445 |   |
| Accrued expenses                                                                                                                        |   | 2,529,630               |       | 2,974,967               |   |
| Reserve for customer chargebacks                                                                                                        |   | 541,284                 |       | 406,352                 |   |
| Due to related parties                                                                                                                  |   | 451,180                 |       | 351,335                 |   |
| Income taxes payable                                                                                                                    |   | 450,101                 |       | 333,705                 |   |
| **Total current liabilities**                                                                                                           |   | 6,538,592               |       | 6,403,804               |   |
| Deferred income taxes                                                                                                                   |   | 207,820                 |       | 207,820                 |   |
| **Total liabilities**                                                                                                                   |   | 6,746,412               |       | 6,611,624               |   |
|                                                                                                                                    |   |                    |       |                    |   |
| **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 12,976,202 shares and 12,882,992 shares,  respectively            |   | 12,976                  |       | 12,882                  |   |
| Common stock issuable - $.001 par value;  -0- and 39,174 shares, respectively                                                           |   | —                  |       | 242,879                 |   |
| Additional paid-in capital                                                                                                              |   | 38,374,084              |       | 37,916,110              |   |
| Retained earnings                                                                                                                       |   | 3,634,444               |       | 4,319,356               |   |
| Accumulated other comprehensive income                                                                                                  |   | 959,261                 |       | 847,686                 |   |
| **Total shareholders’ equity**                                                                                                     |   | 42,980,765              |       | 43,338,913              |   |
| **Total liabilities and shareholders’ equity**                                                                                     |   | $                       | 49,727,177 |                    | $      | 49,950,537 |   |

 

The accompanyingnotes are an integral part of these financial statements

 

3

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**TRAFFIX, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF INCOME**

**(UNAUDITED)**

 
|                                                    |   | **Three  Months Ended** |      |
|---------------------------------------------------------|--------|-------------------------|-----------|
|                                                    |   | **February  29,  2004** |      | **February  28,  2003** |   |
|                                                    |   |                    |      |   |   |
| Net revenue                                             |   | $                       | 7,170,294 |   | $ | 9,117,229 |   |
| Cost of sales                                           |   | 3,805,954               |      | 2,245,930 |   |
| **Gross profit**                                        |   | 3,364,340               |      | 6,871,299 |   |
|                                                    |   |                    |      |   |   |
| Selling expenses                                        |   | 447,930                 |      | 2,319,559 |   |
| General and administrative expenses                     |   | 2,859,577               |      | 4,206,037 |   |
| Bad debt (recapture) expense                            |   | (46,457                 | )         | 336,188 |   |
| **Income from operations**                              |   | 103,290                 |      | 9,515 |   |
|                                                    |   |                    |      |   |   |
| Other income (expense):                                 |   |                    |      |   |   |
|                                                    |   |                    |      |   |   |
| Interest income and dividends                           |   | 108,732                 |      | 154,601 |   |
| Realized gains on marketable securities                 |   | 11,023                  |      | 738 |   |
| Realized gain on prior year sale of  subsidiary         |   | 195,000                 |      | — |   |
| Other non-operating income(expense)                     |   | 46,193                  |      | (14,038 | ) |
| Minority interest in income of subsidiary               |   | —                  |      | (120,328 | ) |
|                                                    |   |                    |      |   |   |
| **Income before provision (benefit) for  income taxes** |   | 464,238                 |      | 30,488 |   |
|                                                    |   |                    |      |   |   |
| Provision (benefit) for income taxes                    |   | 111,347                 |      | (401,000 | ) |
|                                                    |   |                    |      |   |   |
| **Net income**                                          |   | $                       | 352,891   |   | $ | 431,488 |   |
|                                                    |   |                    |      |   |   |
| Basic income per share (Note 3):                        |   |                    |      |   |   |
| Net income                                              |   | $                       | 0.03      |   | $ | 0.03 |   |
| Weighted average shares outstanding                     |   | 12,960,105              |      | 12,750,247 |   |
|                                                    |   |                    |      |   |   |
| Diluted income per share (Note 3):                      |   |                    |      |   |   |
| Net income                                              |   | $                       | 0.03      |   | $ | 0.03 |   |
| Weighted average shares outstanding                     |   | 13,551,989              |      | 13,096,590 |   |

 

The accompanying notes are an integral partof these financial statements

 

4

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**TRAFFIX, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(UNAUDITED)**

 
|                                                                                         |   | **Three  Months Ended** |       |
|----------------------------------------------------------------------------------------------|--------|-------------------------|------------|
|                                                                                         |   | **February  29,  2004** |       | **February  28,  2003** |   |
| Cash flows from operating activities:                                                        |   |                    |       |   |   |
| Net income                                                                                   |   | $                       | 352,891    |   | $ | 431,488 |   |
| Adjustments to reconcile net income to net  cash provided by (used in) operating activities: |   |                    |       |   |   |
| Depreciation and amortization                                                                |   | 322,638                 |       | 368,748 |   |
| Reserve for customer chargebacks                                                             |   | 134,932                 |       | 209,277 |   |
| Provision for uncollectible accounts                                                         |   | (46,457                 | )          | 336,188 |   |
| Deferred income taxes                                                                        |   | (42,532                 | )          | (360,791 | ) |
| Net (gains) on sale of marketable  securities                                                |   | (11,023                 | )          | (738 | ) |
| Gain on sale of subsidiary                                                                   |   | (195,000                | )          | — |   |
| Minority interest                                                                            |   | —                  |       | 98,777 |   |
| Changes in assets and liabilities of  business:                                              |   |                    |       |   |   |
| Accounts receivable                                                                          |   | (21,074                 | )          | (585,628 | ) |
| Prepaid expenses and other current assets                                                    |   | 293,175                 |       | 148,740 |   |
| Accounts payable                                                                             |   | 228,952                 |       | 409,286 |   |
| Prepaid/payable income taxes                                                                 |   | 153,416                 |       | 522,939 |   |
| Due from/to related parties                                                                  |   | 99,845                  |       | 53,263 |   |
| Other, principally accrued expenses                                                          |   | (445,337                | )          | (1,962,809 | ) |
| **Net cash provided by (used in) operating  activities**                                     |   | 824,426                 |       | (331,260 | ) |
| Cash flows from investing activities:                                                        |   |                    |       |   |   |
| Purchases of securities                                                                      |   | (74,608,242             | )          | (83,294,642 | ) |
| Proceeds from sales of securities                                                            |   | 74,591,290              |       | 69,002,477 |   |
| Proceeds from the sale of a subsidiary                                                       |   | 195,000                 |       | — |   |
| Capital expenditures                                                                         |   | (19,378                 | )          | (206,675 | ) |
| **Net cash provided by (used in) investing  activities**                                     |   | 158,670                 |       | (14,498,840 | ) |
| Cash flows from financing activities:                                                        |   |                    |       |   |   |
| Dividends paid                                                                               |   | (1,037,803              | )          | — |   |
| Proceeds from stock options exercised                                                        |   | 178,169                 |       | 26,267 |   |
| **Net cash (used in) provided by financing  activities**                                     |   | (859,634                | )          | 26,267 |   |
| Effect of exchange rate changes on cash and  cash equivalents                                |   | (2,570                  | )          | (17,482 | ) |
| Net increase(decrease) in cash and cash  equivalents                                         |   | 120,892                 |       | (14,821,315 | ) |
| Cash and cash equivalents, beginning of  period                                              |   | 9,939,657               |       | 23,136,341 |   |
| **Cash and cash equivalents, end of period**                                                 |   | $                       | 10,060,549 |   | $ | 8,315,026 |   |

 

The acompanying notes are an integral part ofthese financial statements

 

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**TRAFFIX,INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENT OF SHAREHOLDERS’ EQUITY**

**FOR THETHREE MONTHS ENDED FEBRUARY 29, 2004**

**(UNAUDITED)**
|                                                    |                |        |       | **Common  Stock********Issuable** |       | **Additional  Paid-in********Capital** |   | **Retained********Earnings** |   |    |       | **Accumulated  other  Comprehensive********Income(Loss)** |   | **Total  Shareholders’********Equity** |   |
|---------------------------------------------------------|---------------------|-------------|------------|-----------------------------------|------------|----------------------------------------|--------|------------------------------|--------|---------|------------|-----------------------------------------------------------|--------|---------------------------------------------|--------|
|                                                    |                |        |       |                              |       |                                   |   |                         |   |    |
| **Common  Stock**                                       | **Treasury  Stock** |
| **Shares**                                              |                | **Amounts** | **Shares** |                              | **Amount** |
|                                                    |                |        |       |                              |       |                                   |   |                         |   |    |       |                                                      |   |                                        |   |   |   |   |   |
| Balance, November 30, 2003                              |                | 12,882,992  |       | $                                 | 12,882     |                                   | $      | 242,879                      |   | $       | 37,916,110 |                                                      | $      | 4,319,356                                   |   | — |   | $ | — |   | $ | 847,686 |   | $ | 43,338,913 |   |
|                                                    |                |        |       |                              |       |                                   |   |                         |   |    |       |                                                      |   |                                        |   |   |   |   |   |
| Net income for the three months ended February 29, 2004 |                |        |       |                              |       |                                   |   |                         |   | 352,891 |       |                                                      |   |                                        |   |   |   | $ | 352,891 |   |
|                                                    |                |        |       |                              |       |                                   |   |                         |   |    |       |                                                      |   |                                        |   |   |   |   |   |
| Unrealized losses on available-for-sale securities      |                |        |       |                              |       |                                   |   |                         |   |    |       |                                                      |   |                                        |   | (109,590 | ) | $ | (109,590 | ) |
| Foreign Currency Translation adjustment                 |                |        |       |                              |       |                                   |   |                         |   |    |       |                                                      |   |                                        |   | 221,165 |   | $ | 221,165 |   |
| Comprehensive income (loss)                             |                |        |       |                              |       |                                   |   |                         |   |    |       |                                                      |   |                                        |   |   |   | $ | 464,466 |   |
| Dividends declared                                      |                |        |       |                              |       |                                   |   |                         |   | $       | (1,037,803 | )                                                         |   |                                        |   |   |   |   | $ | (1,037,803 | ) |
| Stock option exercises                                  |                | 54,036      |       | 55                                |       |                                   |   | 178,115                      |   |    |       |                                                      |   |                                        |   |   |   | $ | 178,170 |   |
| Tax benefit from exercise of stock options              |                |        |       |                              |       |                                   |   | 37,019                       |   |    |       |                                                      |   |                                        |   |   |   | $ | 37,019 |   |
| Purchase of common stock, held in treasury, at cost     |                |        |       |                              |       |                                   |   |                         |   |    |       |                                                      |   |                                        |   |   |   | $ | — |   |
| Common stock issued in connection with acquisition      |                | 39,174      |       | 39                                |       | (242,879                               | )      | 242,840                      |   |    |       |                                                      |   |                                        |   |   |   | $ | — |   |
|                                                    |                |        |       |                              |       |                                   |   |                         |   |    |       |                                                      |   |                                        |   |   |   |   |   |
| Balance, February 29, 2004                              |                | 12,976,202  |       | $                                 | 12,976     |                                   | $      | —                       |   | $       | 38,374,084 |                                                      | $      | 3,634,444                                   |   | — |   | $ | — |   | $ | 959,261 |   | $ | 42,980,765 |   |

** **
| The  accompanying notes are an integral part of these financial statements |   |
|----------------------------------------------------------------------------|--------|

 

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TRAFFIX, INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS (UNAUDITED)

 

1. GENERAL

 

The accompanying consolidated financialstatements are unaudited;however, in the opinion of management, these financialstatements are presentedin conformity with accounting principles generally accepted in the United States of America. Theaccompanying unaudited consolidated financial statements reflect all adjustments which are, in the opinion ofmanagement,  necessary for a fair presentation ofthe financial position and operating results for the interim periods presented. In the preparation ofthese financialstatements, management is required to make estimates and assumptions

 

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that affect the reported amounts of assets and liabilities anddisclosure ofcontingentassets and liabilities at the date of the financial statements and revenues and expenses during theinterim periods reported. Actual results could differ from those estimates. Principally, estimates areused in accounting forbad debts, data qualification allowances and sales allowances,  depreciationand amortization, income taxes and contingencies. Management’s estimates and assumptions arecontinually reviewed against actual results with the effects ofany revisions being reflected in the results of operations at that time.  Theaccompanying unaudited consolidated financial statements should be read inconjunction with the auditedconsolidated financial statements and notes thereto, together with management’s discussion and analysis offinancial condition andresults of operations, contained in the Company’s Annual Report on Form 10-K for the fiscal yearended November 30, 2003. The results of operations for the three-month period ended February 29, 2004are not necessarilyindicative of the results to be expected for the subsequent quarters orthe full fiscal year ending November 30, 2003. Certain prior year amounts inthe unaudited consolidated financial statements have been reclassified toconform with the current year presentation.

 

During thethree months ended February 29, 2004 and February 28, 2003, options for 53,036shares and 12,500 shares of the Company’s common stock, respectively, wereexercised by our employees. Tax benefits of $37,019 and $5,077 in the threemonths ended February 29, 2004 and February 28, 2003, respectively, wererecorded as an increase to additional paid-in capital and a reduction of incometaxes currently payable.

 

# **Recent Accounting Pronouncements**

 

In March 2004, the Financial AccountingStandards Board (“FASB”) issued an Exposure Document regarding the mandatoryexpensing of stock options

 

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beginning in 2005. The Exposure Draft is in its elemental stages andwill be replaced with the final guidance as issued by FASB.

 

In January 2003, the FASB issued FIN No. 46,Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51,Fin No. 46 requires certain variable interest entities to be consolidated bythe primary beneficiary of the entity if the equity investors in the entity donot have the characteristics of a controlling financial interest or do not havesufficient equity at risk for the entity to finance its activities withoutadditional subordinated financial support from other parties.  FIN No. 46 is effective immediately for allnew variable interest entities created or acquired after January 31, 2003.  For variable interest entities created oracquired prior to February 1, 2003, the provisions for Fin No. 46 must beapplied for the first interim or annual period ending after December 15, 2003.The adoption of this standard did not have a material impact on our financialposition and results of operations.

 

2. SIGNIFICANT ACCOUNTING POLICIES

 

Revenue Recognition

 

The Company currently earns the mostsignificant portion of its revenue from its E-commerce segment pursuant tomarketing agreements with marketing partners and corporate customers(collectively, “Corporate Customers”). The provisions of each agreementdetermine the type and timing of revenue to be recorded. The Company generatesits E-commerce revenue from the following eight basic categories: (1) deliveryof consumer traffic to the websites and inbound telemarketing call centers ofits Corporate Customers (e.g., click-thrus from the game banners on the Company’swebsites), (2) delivery of consumer data to Corporate Customers with respect tothe consumers who have registered for Corporate Customers’ products or services(e.g., a consumer who registered via the registration page of one of theCompany’s websites to receive on-line promotions from Corporate Customers), (3)delivery of pre-qualified consumer data to Corporate Customers as a result ofconsumers’ responses to targeted questions and surveys (e.g., receiving freegifts for

 

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yourchildren), (4) delivery of a sale or completed application for a CorporateCustomer’s product or service (e.g., a consumer who responds to a Traffix emailpromotion on behalf of a Corporate Customer by completing an on-line applicationfor a credit card or subscribing for a cellular phone service), (5) generatingrevenue from any of the foregoing categories by placing Corporate Customers’offers on the media of third parties with whom the Company has a marketingrelationship on a revenue share basis, (6) sales of inexpensive gift itemsdirectly to consumers, (7) rentals and sales of copies of specific segments ofthe Company’s databases to Corporate Customers for their proprietary marketingand database enhancements, and (8) sales of memberships to the Company’s onlinedating service, iMatchUp.com.

 

The Company invoices its customers inaccordance with the terms of their respective underlying agreement. Revenue isrecognized at the time the marketing activity is delivered, or service isprovided (normally, either daily or weekly), net of estimated contractuallyspecified data qualification allowances, when applicable. Such dataqualification allowances may include duplications, invalid addresses, agerestrictions and other allowances. Historically, the variance between actualallowances and previously estimated allowances has been immaterial. The Companyrecords all related obligations associated with the related net revenue at itspoint of recognition.

 

Membership revenue on the Company’s onlinedating service is currently billed to members in one-month, three-month andsix-month terms. The monthly memberships are recognized as revenue in the monthbilled (which is the same month as the services are provided). Three-month andsix-month memberships are deferred and recognized over the subscription term.

 

Revenue from the Company’s LEC BilledProduct and Service segment consists of Local Exchange Carrier (“LEC”) billedInternet based products. Such products include an Internet Service Provider(“ISP”) product, an email

 

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serviceproduct and a Voice Over Internet Protocol Long Distance product (VOIP). Therevenue from such services is recognized net of an estimated provision forrefunds, credits and adjustments subsequently granted to customers (“customerchargebacks”). Customer chargebacks are reflected as a contra-revenue accountwithin the Company’s statement of operations. Since the provision for customerchargebacks is established prior to the periods in which chargebacks areactually expended, the Company’s revenues are adjusted in later periods if theCompany’s incurred chargebacks vary from the amounts previously estimated.

 

Revenues from the Company’s off-linemarketing services segment included the revenue earned by Montvale Management,LLC which, prior to March 7, 2003, was a majority-owned subsidiary of theCompany. Montvale was sold to the other member thereof on March 7, 2003. SeeNote 7, “Sale of Majority Owned Subsidiary”. Such revenues representedapproximately $-0- and $2.2 million, or -0-% and 24%, respectively, of theCompany’s consolidated net revenues for the three-month periods ended February29, 2004 and February 28, 2003. Such revenue resulted from Montvale’s commissionearned for the provision of net branch services to a mortgage bankinginstitution. Under such arrangement, Montvale managed the branch offices andloan origination business of a single third party licensed mortgage banker.

 

With respect to capitalization and amortization of marketing costs, theCompany’s policy is to expense, as a cost of sale, database and customerprofile acquisition costs, and all other related marketing costs, at the timean obligation or expense is incurred.

 

**Revenue Related Accruals**

 

The Companyhas historically provided for the estimated cost to fulfill customer premiumobligations arising from certain of its customer acquisition services upon therecognition of the related revenue. Such reserves had been determined basedupon actual experience, estimates as to new premium offers

 

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resulting from actualexperience and managements’ historical industry experience. Such estimates weretrued up against actual results, with the variance being charged to operationsat that time. The Company currently does not employ premiums in the marketingof its services and products.

 

**Accounts receivableand allowance for doubtful accounts**

 

Accounts receivable consist of trade accountsreceivable from the Company’s Corporate Customer base, with extension of creditvarying between 30 to 90 days, with the majority at 30 days.  At February 29, 2004 we had one customerwith 90 day credit terms, such customer accounted for $0.9 million, or 21.6%,of our accounts receivable balance as of that date. Additionally, accountsreceivable from Local Exchange Carriers (LEC segment) and credit card companies(on-line dating service) are due to the Company. The Company’s customer base iscomprised of domestic entities with diverse demographics. The allowance fordoubtful accounts is based on management’s evaluation of the collectibility ofreceivables after giving consideration to current delinquency data, historicalloss experience and general economic conditions, both at the Company level andsector/industry level. The Company’s accounts receivable balances arecontinually reviewed by management and, when situations dictate, provisions forlosses are recorded. Additional allowances might be required if the originalestimates for loss prove to be inadequate.

 

**Accounts receivable and allowance forcontractually specified data qualifications**

 

The Company’saccounts receivable, as described above, is reported net of an allowance forcontractually specified data qualification allowances. Such data qualificationallowances are reflected as a reduction to accounts receivable, and as acontra-revenue account in arriving at the Company’s reported net revenue.Contractually specified data qualifications allowances are determined pursuantto the terms of the Company’s marketing agreements with its corporatecustomers. These allowances include reductions to the gross

 

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amount of records shipped to,accepted by, and invoiced to the Company’s corporate customers. The allowancerelates to data that fails to meet: (1) minimum age restrictions, (2) countryresidence restrictions, (3) pre-existing relationships of such data with therespective corporate customers, (4) duplications of names within the same filetransfer, and (5) other data qualifications specific to the terms of theunderlying marketing offer.  TheCompany’s methodology in determining the allowance for data qualifications isbased on the Company’s historical experience regarding data qualifications withexisting corporate clients, and the application of such experience to similarproducts in the case of new corporate clients whose marketing agreements callfor data qualification allowances.

 

**Transactionswith Major Customers and other Revenue Concentrations**

 

During thethree months ended February 29, 2004, we had one customer in our E-commercesegment accounting for approximately $1.0 million, or 13.5% of consolidated netrevenue. Approximately $0.4 million, or 9.5% of consolidated net accountsreceivable, was attributable to such major customer as of February 29, 2004.Regarding the balance of our customer base, no single customer had net revenuesthat equaled or exceeded 9% of consolidated net revenues for the three monthsended February 29, 2004. During the three months ended February 28, 2003, nosingle customer had net revenues that equaled or exceeded 8% of consolidatednet revenues for such period.

 

Currently, 21.2% of the Company’s revenue is derived from itsproprietary products: 19.5% from iMatchUp.com, the Company’s online datingsites, and 1.7% from its LEC segment’s proprietary products.

 

###### **Stock–based Compensation**

 

Pursuant to Statement of Financial Accounting Standard (“SFAS”) No.123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, theCompany will continue to use the intrinsic value method of accounting for itsemployee and director stock-based compensation awards. Accordingly, the

 

13

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Company has not recognizedcompensation expense for its noncompensatory employee and director stock optionawards. As recommended by SFAS No. 123, the fair values of options wereestimated using the Black-Scholes option-pricing model. Option vesting periodshave historically been three years, except grants to non-employee members ofthe Board of Directors, which fully vest at the time of grant. The Company’sadjusted net income and adjusted earnings per share, had it elected to adoptthe fair value approach of SFAS No. 123, which charges earnings for theestimated fair value of stock options, would have been as follows:

 
|                                                                                                               |   | **Three  months ended** |    |
|--------------------------------------------------------------------------------------------------------------------|--------|-------------------------|---------|
|                                                                                                               |   | **February  29, 2004**  |    | **February  28, 2003** |   |
|                                                                                                               |   |                    |    |   |   |
| Net income                                                                                                         |   | $                       | 352,891 |   | $ | 431,488 |   |
| Less: Total stock-based compensation expense  determined under fair value based method, net of related tax effects |   | (72,606                 | )       | (259,571 | ) |
| Pro forma Net income, as adjusted                                                                                  |   | $                       | 280,285 |   | $ | 171,917 |   |
| Basic net income per share:                                                                                        |   |                    |    |   |   |
| As reported                                                                                                        |   | $                       | 0.03    |   | $ | 0.03 |   |
| Pro forma                                                                                                          |   | $                       | 0.02    |   | $ | 0.01 |   |
| Diluted net income per share:                                                                                      |   |                    |    |   |   |
| As reported                                                                                                        |   | $                       | 0.03    |   | $ | 0.03 |   |
| Pro forma                                                                                                          |   | $                       | 0.02    |   | $ | 0.01 |   |

 

The pro forma amounts shown above are not necessarily representative ofthe impact on net income in future periods.

 

**3. Earnings Per Share**

 

The following table sets forth thereconciliation of the weightedaverage shares used for basic and diluted earnings per share:

 

14

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|                                                                         |   | **Three  Months Ended** |   |
|------------------------------------------------------------------------------|--------|-------------------------|--------|
|                                                                         |   | **February  29,  2004** |   | **February  28,  2003** |   |
|                                                                         |   |                    |   |   |   |
| Denominator:                                                                 |   |                    |   |   |   |
| Denominator for basic earnings per  share-weighted average shares            |   | 12,960,105              |   | 12,750,247 |   |
| Effect of dilutive securities:                                               |   |                    |   |   |   |
| Stock options                                                                |   | 591,884                 |   | 346,343 |   |
| Denominator for diluted earnings per  share-adjusted weighted average shares |   | 13,551,989              |   | 13,096,590 |   |

 

Options to purchase 981,750 and 1,687,831shares of common stock for the three months ended February 29, 2004 andFebruary 28, 2003, respectively, were outstanding but were not included in thecomputation of diluted earnings per share because their effect would beanti-dilutive.

 

**4.****                     ****ComprehensiveIncome (Loss)**

 

The Company presents foreign currencytranslation adjustments and unrealized gains and losses on its marketablesecurities (net of tax, when applicable) as a component of “Comprehensiveincome (loss)” and are presented below:

 
|                                                                                                                |   | **Three  Months Ended** |    |
|---------------------------------------------------------------------------------------------------------------------|--------|-------------------------|---------|
|                                                                                                                |   | **February  29,  2004** |    | **February  28,  2003** |   |
|                                                                                                                |   |                    |    |   |   |
| Net income                                                                                                          |   | $                       | 352,891 |   | $ | 431,488 |   |
|                                                                                                                |   |                    |    |   |   |
| Other comprehensive income (loss):  Foreign currency translation adjustment                                         |   | (109,590                | )       | 26,253 |   |
| Unrealized gain (loss) from  available-for-sale securities, arising during the period, net of income taxes  of $-0- |   | 221,165                 |    | (53,366 | ) |
|                                                                                                                |   |                    |    |   |   |
| Comprehensive income                                                                                                |   | $                       | 464,466 |   | $ | 404,375 |   |

 

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**5.  Advertising and Marketing**

 

The Company’sadvertising and marketing costs, incurred in the advertising and marketing ofthe Company’s, and its clients’, products, services and promotional offers,have historically been comprised of (1) costs associated with the transmissionof email marketing messages, both from internal sources and external thirdparty vendors, (2) costs associated with the purchase of on-line consumer data(including registered users to the Company’s websites), (3) costs associatedwith the fulfillment obligations relating to premiums offered in conjunctionwith the Company’s promotions, and (4) email, and website, program promotionaland creative development costs. Such costs are charged to operations (1) at thetime of the email transmission, (2) upon receipt of the qualified consumerdata, and/or (3) at the time the promotional and creative services areprovided, respectively, and are included as a component of cost of sales.

 

Total advertising and marketing costsincluded in cost of sales for the three months ended February 29, 2004 andFebruary 28, 2003 were approximately $3,433,000 and $2,038,000, respectively.

 

**6.Segment Information**

 

Segments are defined as components of anenterprise for which separate financial information is available that isevaluated regularly by the chief operating decision maker(s) in deciding how toallocate resources and in assessing performance.  Disclosure is also required about products and services,geographic areas and major customers. The Company’s segments operate principally in the United States with apresence in Canada; the Canadian presence contributed an immaterial amount toconsolidated net

 

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revenues and consolidated net income. The Company’s three principleoperating segments are: (a) E-commerce, (b) Off-line Marketing Services, and(c) LEC Billed Products and Services. The balance of the Company’s operations,immaterial individually and in the aggregate, are included as part ofCorporate. 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 (a) gross profit and (b) net income excluding (i)special charges, (ii) interest expense, (iii) interest and dividend income,(iv) net gains (losses) on the sale of marketable securities, (v) permanentimpairment charges to long-lived assets, (vi) other nonoperating income, (vii) minority interest (income)loss,(viii) depreciation, (ix) amortization and (x) income taxes. The Company sharesa common workforce and office headquarters, which precludes an allocation ofall overhead components. Overhead items that are specifically identifiable to aparticular segment are applied to such segment and all other overhead costs areincluded in Corporate and other. The following tables set forth the Company’sfinancial results, by management’s performance criteria, by operating segment.All revenues are from nonintersegment sources; therefore no intersegmentelimination applies.

 

***Segment Data – Net Revenue***

 
|                             |   | **Three  Months Ended** |      |
|----------------------------------|--------|-------------------------|-----------|
|                             |   | **February  29,  2004** |      | **February  28,  2003** |   |
|                             |   |                    |      |   |   |
| E-commerce                       |   | $                       | 7,046,701 |   | $ | 7,042,929 |   |
| Off-line Marketing Services      |   | —                  |      | 1,879,971 |   |
| LEC Billed Products and Services |   | 123,593                 |      | 194,329 |   |
|                             |   |                    |      |   |   |
| **Consolidated totals**          |   | $                       | 7,170,294 |   | $ | 9,117,229 |   |

 

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***Segment Data – Gross Profit***

 
|                             |   | **Three  Months Ended** |      |
|----------------------------------|--------|-------------------------|-----------|
|                             |   | **February  29,  2004** |      | **February  28,  2003** |   |
|                             |   |                    |      |   |   |
| E-commerce                       |   | $                       | 3,550,717 |   | $ | 5,123,528 |   |
| Off-line Marketing Services      |   | —                  |      | 1,691,931 |   |
| LEC Billed Products and Services |   | (186,377                | )         | 55,840 |   |
|                             |   |                    |      |   |   |
| **Consolidated totals**          |   | $                       | 3,364,340 |   | $ | 6,871,299 |   |

 

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

 
|                             |   | **Three  Months Ended** |      |
|----------------------------------|--------|-------------------------|-----------|
|                             |   | **February  29,  2004** |      | **February  28,  2003** |   |
|                             |   |                    |      |   |   |
| E-commerce                       |   | $                       | 1,555,466 |   | $ | 1,139,460 |   |
| Off-line Marketing Services      |   | —                  |      | 173,193 |   |
| LEC Billed Products and Services |   | (280,878                | )         | 55,840 |   |
|                             |   |                    |      |   |   |
| **Consolidated totals**          |   | $                       | 1,274,588 |   | $ | 1,368,493 |   |

 

----

* Adjusted EBITDA is net income excludingcorporate level general and administrative costs, 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 nonoperating income (expense), minorityinterest (income) loss, depreciation,

 

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amortization and income taxes.

 

***Segment Data– Depreciation and Amortization***

 
|                             |   | **Three  Months Ended** |    |
|----------------------------------|--------|-------------------------|---------|
|                             |   | **February  29,  2004** |    | **February  28,  2003** |   |
|                             |   |                    |    |   |   |
| E-commerce                       |   | $                       | 268,955 |   | $ | 288,693 |   |
| Off-line Marketing Services      |   | —                  |    | 6,877 |   |
| LEC Billed Products and Services |   | —                  |    | — |   |
|                             |   |                    |    |   |   |
| **Consolidated totals**          |   | $                       | 268,955 |   | $ | 295,570 |   |

 

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***Segment Data - Reconciliation of Reportable segment’s Adjusted EBITDAto consolidated income before taxes***

 
|                                                                                   |   | **Three  Months Ended** |      |
|----------------------------------------------------------------------------------------|--------|-------------------------|-----------|
|                                                                                   |   | **February  29,  2004** |      | **February  28,  2003** |   |
|                                                                                   |   |                    |      |   |   |
| ***Adjusted EBITDA -  by segment***                                                    |   |                    |      |   |   |
| E-commerce                                                                             |   | $                       | 1,555,466 |   | $ | 1,139,460 |   |
| Off-line Marketing Services                                                            |   | —                  |      | 173,193 |   |
| LEC Billed Products and Services                                                       |   | (280,878                | )         | 55,840 |   |
|                                                                                   |   |                    |      |   |   |
| **Total Adjusted EBIDTA**                                                              |   | $                       | 1,274,588 |   | $ | 1,368,493 |   |
|                                                                                   |   |                    |      |   |   |
| ***Items effecting  adjusted EBITDA in arriving at consolidated income before taxes*** |   |                    |      |   |   |
| Corporate (expense)                                                                    |   | $                       | (902,343  | ) | $ | (990,230 | ) |
| Depreciation and amortization (expense)                                                |   | (268,955                | )         | (368,748 | ) |
| Interest income and dividends                                                          |   | 108,732                 |      | 154,601 |   |
| Realized gains on marketable securities                                                |   | 11,023                  |      | 738 |   |
| Realized gain on sale of subsidiary                                                    |   | 195,000                 |      | — |   |
| Other non-operating income(expense)                                                    |   | 46,193                  |      | (14,038 | ) |
| Minority interest in income of subsidiary                                              |   | —                  |      | (120,328 | ) |
| **Total items effecting Adjusted EBITDA**                                              |   | $                       | (810,350  | ) | $ | (1,338,005 | ) |
|                                                                                   |   |                    |      |   |   |
| **Consolidated income before taxes**                                                   |   | $                       | 464,238   |   | $ | 30,488 |   |

 

**7. Asset Dispositions**

 

In March of Fiscal 2003, the Company sold its majority-ownedsubsidiary, Montvale Management LLC (“Montvale”) to Mortgage IndustryConsultants, LLC (“MIC”) for $1.6 million, plus its investment. Traffix hadobtained its 51% interest in September of 1999 through an initial investment ofapproximately $50,000. Pursuant to the terms of the sale, we received $1million in cash at closing on March 7, 2003. Additionally, we received a notefrom the Purchaser for $600,000, payable in 24 monthly installments of $25,000.As of April 1, 2004, fifteen installments were received under the note. TheCompany has also

 

20

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received approximately $299,000, representing its GAAP basis capitalaccount in such majority-owned subsidiary as at November 30, 2002.

 

Based on management’s assessment ofMontvale’s future cash flows, after taking into consideration Montvale’sincreased obligations with respect to the note obligations due the Company, theCompany has deemed it prudent to defer recognition of income on the unpaidportion of the note. Recognition will take place in future periods under thecost recovery method.

 

The Company also entered into a two-yearMedia Purchase Agreement whereby it agreed to provide certain media leadgeneration and related services to the continuing owners of Montvale forconsideration of $40,000 per month over the term of the agreement. As of April1, 2004, nine installments were received under the Media Purchase Agreement.

 

**8. Goodwill andIdentifiable Intangibles Assets**

 

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

 
|                                      |   | **As of  February 29, 2004** |      | **As of  November 30, 2003**  |   |
|-------------------------------------------|--------|------------------------------|-----------|-------------------------------|--------|
|                                      |   | **Gross  Carrying  Amount**  |      | **Accumulated  Amortization** |   | **Gross  Carrying  Amount** |   | **Accumulated  Amortization** |   |
|                                      |   |                         |      |                          |   |   |   |   |   |
| Amortizable  intangible assets:           |   |                         |      |                          |   |   |   |   |   |
| *GroupLotto identifiable intangibles:*    |   |                         |      |                          |   |   |   |   |   |
| GroupLotto  Site Brand Recognition        |   | $                            | 722,922   |                          | $      | 377,786 |   | $ | 722,922 |   | $ | 341,640 |   |
| GroupLotto  Database                      |   | 433,754                      |      | 226,672                       |   | 433,754 |   | 204,983 |   |
| Intellectual  Property Assets             |   | 289,169                      |      | 151,114                       |   | 289,169 |   | 136,656 |   |
| Marketing  Right License Fee              |   | 300,000                      |      | 300,000                       |   | 300,000 |   | 300,000 |   |
|                                      |   |                         |      |                          |   |   |   |   |   |
| *Infiknowledge identifiable intangibles:* |   |                         |      |                          |   |   |   |   |   |
| Internet  Game Suite                      |   | 227,293                      |      | 101,108                       |   | 231,543 |   | 91,438 |   |
| Intellectual  Property Assets             |   | 170,469                      |      | 75,832                        |   | 173,657 |   | 68,578 |   |
| Market Position  Acquired                 |   | 189,410                      |      | 84,258                        |   | 201,525 |   | 79,583 |   |
|                                      |   |                         |      |                          |   | — |   | — |   |
|                                      |   |                         |      |                          |   |   |   |   |   |
| *Thanksmuch identifiable intangibles:*    |   |                         |      |                          |   |   |   |   |   |
| Profiled  customer data                   |   | 50,000                       |      | 31,806                        |   | 50,000 |   | 28,209 |   |
| Restrictive  Covenants                    |   | 10,000                       |      | 5,378                         |   | 10,000 |   | 4,307 |   |
|                                      |   |                         |      |                          |   |   |   |   |   |
| Total  amortizable intangible assets      |   | $                            | 2,393,017 |                          | $      | 1,353,954 |   | $ | 2,412,570 |   | $ | 1,255,394 |   |
|                                      |   |                         |      |                          |   |   |   |   |   |
| Unamortized  intangible assets:           |   |                         |      |                          |   |   |   |   |   |
| *Goodwill - Infiknowledge*                |   | $                            | 756,594   |                          |   |   | $ | 781,789 |   |   |   |
|                                      |   |                         |      |                          |   | — |   |   |   |
|                                      |   |                         |      |                          |   |   |   |   |   |
| *Goodwill - Thanksmuch*                   |   | 289,736                      |      |                          |   | 289,736 |   |   |   |
|                                      |   |                         |      |                          |   |   |   |   |   |
| Total  Goodwill                           |   | $                            | 1,046,330 |                          |   |   | $ | 1,071,525 |   |   |   |

 

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

 

The Internetand E-commerce industries, within which the Company conducts the majority ofits business and has extensive experience, are dynamic and constantly evolvingbusiness arenas.  Based on itsexperience in these industries, the Company evaluated the nature of each of thecomponents of the identifiable intangible assets and determined that afive-year useful life, with corresponding straight-line amortization, was the mostaccurate available means of estimating such assets’ finite lives. In futurefiscal periods, if facts or circumstances arise that indicate the five-yearuseful life assigned to such assets was, in fact, inaccurate, the Company willmake the appropriate adjustments at that time.

 

Goodwill isnot amortized but is tested for impairment in the fourth quarter of each fiscalyear, or more frequently if events or circumstances indicate an impairment hasoccurred. Management’s estimation of implied fair value of goodwill is comparedto its carrying value in the assessment and determination of impairment, ifany.

 

The future intangible amortization expensefor the next five fiscal years is estimated to be as follows:

 

22

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|                                              |   | **2004** |    | **2005** |   | **2006** |   | **2007** |    | **2008** |   |
|---------------------------------------------------|--------|----------|---------|----------|--------|----------|--------|----------|---------|----------|--------|
|                                              |   |     |    |     |   |     |   |     |    |     |   |
| *GroupLotto Identifable intangible amortization:* |   |     |    |     |   |     |   |     |    |     |   |
| GroupLotto  Site Brand Recognition                |   | $        | 144,595 |     | $      | 144,595  |   | $        | 84,621  |     | $      | — |   | $ | — |   |
| GroupLotto  Database                              |   | 86,757   |    | 86,757   |   | 50,773   |   | —   |    | —   |   |
| Intellectual  Property Assets                     |   | 57,837   |    | 57,837   |   | 33,848   |   | —   |    | —   |   |
| Marketing  Right License Fee                      |   | —   |    | —   |   | —   |   | —   |    | —   |   |
|                                              |   |     |    |     |   |     |   |     |    |     |   |
| *Total Group’s amortization*                 |   | $        | 289,189 |     | $      | 289,189  |   | $        | 169,242 |     | $      | — |   | $ | — |   |
|                                              |   |     |    |     |   |     |   |     |    |     |   |
| *Infiknowledge Identifable intangibles:*          |   |     |    |     |   |     |   |     |    |     |   |
| Cost  allocated                                   |   |     |    |     |   |     |   |     |    |     |   |
| Internet  Game Suite                              |   | $        | 52,278  |     | $      | 52,278   |   | $        | 52,278  |     | $      | 898 |   | $ | — |   |
| Intellectual  Property Assets                     |   | 39,208   |    | 39,208   |   | 39,208   |   | 673      |    | —   |   |
| Market  Position Acquired                         |   | 45,500   |    | 45,500   |   | 45,500   |   | 781      |    | —   |   |
| *Total Group’s amortization*                 |   | $        | 136,986 |     | $      | 136,986  |   | $        | 136,986 |     | $      | 2,352 |   | $ | — |   |
|                                              |   |     |    |     |   |     |   |     |    |     |   |
| *ThanksMuch Identifable intangibles:*             |   |     |    |     |   |     |   |     |    |     |   |
| Profiled  customer data                           |   | $        | 10,000  |     | $      | 10,000   |   | $        | 10,000  |     | $      | 190 |   | $ | — |   |
| Restrictive  Covenants                            |   | 2,000    |    | 2,000    |   | 2,000    |   | 38       |    | —   |   |
| *Total Group’s amortization*                 |   | $        | 12,000  |     | $      | 12,000   |   | $        | 12,000  |     | $      | 228 |   | $ | — |   |
|                                              |   |     |    |     |   |     |   |     |    |     |   |
| **Summary**                                       |   |     |    |     |   |     |   |     |    |     |   |
| *GroupLotto Identifable intangibles:*             |   | $        | 289,189 |     | $      | 289,189  |   | $        | 169,242 |     | $      | — |   | $ | — |   |
| *Infiknowledge Identifable intangibles:*          |   | 136,986  |    | 136,986  |   | 136,986  |   | 2,352    |    | —   |   |
| *ThanksMuch Identifable intangibles:*             |   | 12,000   |    | 12,000   |   | 12,000   |   | 228      |    | —   |   |
|                                              |   |     |    |     |   |     |   |     |    |     |   |
| *Total identifiable intangible amortization*      |   | $        | 438,175 |     | $      | 438,175  |   | $        | 318,228 |     | $      | 2,580 |   | $ | — |   |

 

**9.Litigation**

 

The Securities Exchange Act of 1934, asamended (the “Exchange Act”), requires us to describe briefly any materialpending legal proceedings to which we are a party or of which any of ourproperty is subject. We believe that all of the claims made against us to dateare either without merit or will ultimately result in a judgment against us (ifat all) in an amount less than 10% of our current assets. Nevertheless, as theplaintiff in the *Wingler* actionis seeking damages in excess of 10% of our current assets, and as certain ofthe remaining legal claims made against us fail to specify an amount of damagesbeing sought by the plaintiff, and as there is a potential that the ultimatedamages awarded in a claim could exceed such 10% threshold,

 

23

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in compliance with the Exchange Act, we listed below the *Wingler* action, as well as all legalclaims made against us for which no amount of damages has been specified. The *Qwest* action seeks damages against us inan amount slightly less than 10% of our current assets.

 

*Mavies Wingler -*

 

On or about May 9, 2001, Mavies Winglercommenced an action against Group Lotto, Inc. (“GLI”), one of ourwholly-owned subsidiaries, in the Circuit Court of Logan County, West Virginia.Ms. Wingler claims to have picked the winning numbers entitling her to$10 million. On June 8, 2001, the action was removed to the UnitedStates District Court, Southern District of West Virginia, and is entitled *Wingler v. Grouplotto, Inc.*, DocketNumber 2:01—CV—518. At the end of 2002, Ms. Wingler’s attorney withdrew,and she is now representing herself. We and GLI have a contract ofindemnification with SCA Promotions, Inc. to be indemnified for prizespaid out to qualified winners. GLI winners are required to produce the GroupLotto Entry Notification form (“GLEN”) within a specified period of time aftermatching a drawing’s winning numbers in order to qualify for receipt of theappropriate prize winnings. We do not believe that there is any merit toMs. Wingler’s claim and intend to vigorously continue our defense thereof.

 

In March 2004, the Court granted ourmotion for summary judgment dismissing the complaint. Ms. Wingler has filed anappeal, which she must perfect by April 30, 2004. We intend to continue todefend against the claim.

 

*Plasmanet*

 

On November 21, 2002,Plasmanet, Inc., one of our competitors, commenced an action allegingpatent infringement and misappropriation of trade secrets entitled *Plasmanet, Inc. v. Apax Partners, Inc.,et al.,* Case No. 02 Civ 9290 (S.D.N.Y.). Plasmanetoperates a website, FreeLotto.com, which is similar to

 

24

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one operated by GLI. Plasmanet alleged that on September 24, 2002it obtained a patent for a “Free Remote Lottery System” and that we infringedthis patent. In addition, Plasmanet asserted that trade secrets were containedin a private placement memorandum and that we misappropriated these tradesecrets after we were allegedly shown such private placement memorandum by anagent of Plasmanet’s investment banker. The complaint sought injunctive reliefand unspecified money damages. We asserted counterclaims, inter alia, todeclare Plasmanet’s patent invalid. In December 2003, the complaint wasdismissed with prejudice with respect to Plasmanet’s patent infringement claimand our counterclaims, and without prejudice with respect to themisappropriation of trade secrets claim. Such misappropriation claim has beenreasserted by Plasmanet in New York court (Sup. Ct. N.Y. Co.,January 27, 2004, Index No. 60021-04). We believe there is no merit to thereasserted claim and have filed a motion to dismiss this claim, that motion iscurrently scheduled to be submitted on May [ - ], 2004. We intend to vigorouslydefend against this action.

 

*QwestCommunications*

 

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 ofSibley, Case No. C0-00-242. In that action, plaintiffs claim that fromSeptember 1998 to July 1999, they were misled when they were solicited tochange their long distance carrier to Qwest. They assert that they were nottold that they would have to stay at certain hotels and pay their regular ratesas part of a promotion, which offered them free airline tickets. We

 

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introduced the promotion (“Fly Free America”) to Qwest, and wereretained by Qwest to operate the telemarketing campaign. In or aboutMay 2000, we and Qwest entered into an agreement terminating our contractand settling the amount due us (the “May 2000 Agreement”). TheMay 2000 Agreement contained language which Qwest claims obligates us toindemnify Qwest for any loss it may sustain by reason of this class action. Wemaintain that we have no liability in the matter. Fraud claims in the classaction have been dismissed, leaving breach of contract and false advertisingclaims. The court has certified the class and Qwest is defending the action.

 

In November 2002, we commenced anarbitration against Qwest to recover certain amounts due us pursuant to theMay 2000 Agreement. In December 2002, Qwest filed counterclaims inthe arbitration relating to the Fly Free America program. Qwest asserts that wemust indemnify Qwest for, among other things, fines and penalties amounting toapproximately $1.5 million which Qwest claims it paid in connection with anumber of consent decrees it entered into with various state attorneys general,an unspecified amount of attorneys’ fees, and any and all expenses, penaltiesor other amounts Qwest becomes liable for in connection with the class action.Qwest also seeks reimbursement of approximately $3.1 million it paid uspursuant to the May 2000 Agreement. A panel of arbitrators was appointedin December 2003 and a preliminary conference was held inJanuary 2004. After the conference, a schedule was established forsubstantive motions and for hearings in June 2004. The arbitrators alsoprovided for exchanges of information in the arbitration subject to Qwest’sright to seek to prevent such exchanges. Qwest moved to prevent exchanges ofinformation and this application was granted. Qwest moved for summary judgmentwith respect to its indemnification counterclaim. We have opposed the motionand it is scheduled to be heard on April 20, 2004. We believe that there is nomerit to Qwest’s counterclaims and intend vigorously to defend against them, aswell as to pursue our claim.

 

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*ColumbiaHouse/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. Columbia House advised usthat it believes that the email in question was not approved by Columbia Housewhen it was sent, and asserted a claim for indemnification against us pursuantto our contract. We and Columbia House agreed to defer resolution of theindemnification claim (and reserved each of our respective rights). ColumbiaHouse is defending against the class action. Its motion to dismiss thecomplaint has been denied.

 

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 complaintsought injunctive relief and unspecified damages. Our motion to dismiss thecomplaint was granted in June 2003, and the plaintiff has filed an appeal.We believe that there is no merit to the claim, and, in the event the dismissalof the claim is reversed on appeal, we intend to vigorously defend against it.

 

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*MissouriCivil Investigative Demand*

 

On September 26, 2003, we were servedwith a Civil Investigative Demand by the Missouri Attorney General’s Officerequesting certain documents and inquiring into our Company’s merchandisingpractices in connection with games of chance available for entry atgrouplotto.com. We have responded to the document and information requests andawait a response from the Missouri Attorney General’s Office.

 

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.

 

**10. Subsequent Events**

 

On April 1, 2004, we announced that we hadacquired an exclusive license for an operating platform created byLiveOnTheNet.com, Inc. (LOTN), a privately held company. We had announced inFebruary 2004 that we had entered into an agreement to acquire all of theassets of LOTN. The asset acquisition plans were discarded in favor of alicense agreement resulting from our final stages of due diligence.

 

On April 12, 2004, our Board of Directorsdeclared a dividend from our retained earnings of $0.08 per share on theoutstanding shares of our common stock for the quarter ended February 29, 2004.Such dividend is payable on or about May 10, 2004 to holders of record of suchshares at the close of business on May 1, 2004.  We can give you no assurance that our Board will declare anydividends in future fiscal periods. Any further declarations will depend uponour performance, the level of our then current and retained earnings, capitaland other pertinent factors relating to our financial position. You should notrely on any prior approvals of our Board as an indicator of its intent toapprove the declaration of any dividends in the future.

 

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

 

The matters discussed in the followingManagement’s Discussion and Analysis of Financial Condition and Results ofOperations contains forward-looking statements and information relating to theCompany that are based on the current beliefs, expectations and estimations ofManagement, as well as assumptions made by and information currently availableto the Company. When used in this Management’s Discussion and Analysis, andelsewhere in this Form 10-Q, the words “anticipate”, “believe”, “estimate”,“continue”, and “expect” variations of such words and similar expressions, asthey relate to the Company, are intended to identify forward-lookingstatements. Such statements are not guarantees of future performance, butreflect the current views of the Company’s management with respect to futureevents and are subject to certain risks, uncertainties and assumptions, whichcould cause the actual results to differ materially from those reflected in theforward-looking statements. These forward-looking statements are made pursuantto the safe harbor provisions of the Private Securities Litigation Reform Actof 1995.

 

**Overview**

We are a leading on-line database marketingcompany that uses our on-line media network to generate leads, customers andsales for our proprietary products and services, and our corporate clients’products and services. We provide complete end-to-end marketing solutions forcompanies seeking to increase sales and customers through on-line marketingprograms, and database development and enhancement programs. The services weoffer include the development of a complete creative promotion to be used tomarket the client’s product to consumers, broadcasting a promotion on-line inorder to generate new customers for the client, delivery of data files from theresults of campaigns, creating and hosting the customized websites or web pagesnecessary to effect the consumer transaction that drives the client’s sales andgenerating comprehensive reporting in order for the client to analyze theeffectiveness of a promotion. We use our websites, on-line promotions,interactive games, email marketing and database of permission-based, profiled

 

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records(and the on-line media of third parties) to generate the customers, sales andleads for our clients, and for our own product and service offers. We are paidby our clients primarily on a success-based model, in that we receive a fee forevery lead, customer or sale generated for the client.

 

In addition to our third-party client-basedrevenue, we generate revenue directly from consumers from our own products andservices. In Fiscal 2003, we expanded our line of direct-to-consumer productsand services to include Internet based services, such as iMatchUp.com, ouron-line dating service, and TXNet/WorldWebAccess, our ISP, VOIP and emailproducts, which comprise our LEC Billed Products segment. These“direct-to-consumer” generated products and services accounted forapproximately $1.5 million, or 22% of our revenue during the three-month periodended February 29, 2004, compared to $0.5 million, or 6% for the three-monthperiod ended February 28, 2003.

 

We also generate revenues from the salesand rentals (for use both on-line and off-line) of our proprietary, profileddatabases.

 

**Background**

 

From our inception in 1993 (under the name“Quintel Entertainment, Inc.”) through 1999, we generated the bulk of ourrevenue from direct marketing using the traditional media of television, postalmail and telemarketing. In 2000, we repositioned our direct marketing businessto the on-line media of the Web. Applying the direct marketing disciplineshoned from our years of operating in the “off-line” media arena, we have beenable to provide enhanced response-based results in a cost-efficient andscaleable manner via on-line marketing. In addition, as a result of our directmarketing background, we have been able to design on-line marketing programs tocost-effectively generate traffic and leads for traditional direct marketingmedia channels, such as inbound and outbound telemarketing and direct mail.

 

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

 

We own and operate a number of on-lineproperties, such as our free on-line sweepstakes group of sites (sponsored byour sweepstakes management subsidiary, PrizeDistributors, Inc.) includingPrizeamerica.com and GroupLotto.com; our consumer credit site, AtlasCreditGroup.com;our automobile information and lead generation site, AtlasAutomotiveGroup.com;our DVD promotions site, Take 1 Entertainment.com; and our premier on-linedating service, iMatchup.com. We also operate a number of interactive games andpromotions such as Direct Deposit Promotions and Prizecade.com. We generatetraffic to our websites from cross marketing, marketing to our database andmarketing on the media of third parties. Our Web properties and our marketingactivities are designed to generate real-time response-based marketing resultsfor our corporate clients, as well as for our own product and service offers.When visiting 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) inbound telemarketingcalls, (c) outbound telemarketing leads,(d) demographically/psychographicallyprofiled lists of consumers, (e) highly-targeted customized response-basedleads, (f) completed applications for products, and (g) sales of products andservices.

 

*Websites.* Our PrizeDistributors, Inc. sponsored group of websitesoffers consumers the opportunity to win multiple game promotions of up to $1million daily in our free, on-line sweepstakes. The sweepstakes grand prizesare indemnified by an independent, third-party agency. In order to play, eachconsumer must provide complete and accurate registration information and agreeto receive (“opt-in”) marketing messages from us and our marketing partners(write-ins are accepted). The interactive media on this group of websitesinclude registration pages, banner advertisements and survey questions, thepurpose of which is to generate web traffic, leads and sales. Revenue is

 

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generatedat this group of websites from our own products and our corporate clients whopay for such traffic, leads and sales. We generate the bulk of our consumertraffic to this group of websites through proprietary and third partypermission-based email marketing programs, banner advertisements and otheronline media.

 

We own and operate several other websitessuch as AtlasCreditGroup.com, TheBargainSpot.com, AltasAutomotiveGroup.com,Take 1 Entertainment.com, prizecade.com and jewelclaimcenter.com. Such websitesare deployed to generate revenue for our clients in a similar manner as thePrizeDistributor, Inc. model described above. Each of these sites is designedto appeal to a specific consumer interest category that we match with productpromotions that appeal to such interest category.

 

*Email Marketing.* Each program that we market for ourclients can be implemented not only through the websites, interactive games and“pop-ups” discussed above, but also, and often, through email marketing. Wecurrently market to a vast database, which includes consumer data that is eitherowned by us or is managed by us under our revenue share arrangements.

 

One of the attractive features for clientsand, we believe, a significant competitive advantage, is our ability to createand test a variety of marketing campaigns for prospective and existingcorporate clients at no risk to the client. Since we own, and have access to,extensive databases, manage our own internal creative department, and candeliver email at a low cost, we are able to offer prospective and existingclients the opportunity to test market new products, services, price points andcreative concepts in order to determine if an on-line campaign works for theclient, and which campaigns work most effectively.

 

Even after campaigns are fully implemented,we further analyze the marketing results to gauge whether the campaigns arecontinuing to generate

 

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adequateresults for the client, whether the media is being utilized cost-efficiently,and to determine whether new and different copy is yielding better overallresults. These are traditional direct-marketing disciplines that we apply andthat, we believe (when coupled with our proprietary databases, the otherdatabases under our management and our delivery and reporting systems),distinguish us from many of our competitors in the on-line marketing industry.

 

*Syndication.* We expend a significant portion ofour email resources to generate sales for our own products and services and fortraffic to our websites. After we develop a campaign that works efficiently onour own media, we may “syndicate” the program to third-party media. Typically,we have expended time, media and other costs in developing certain campaigns.In exchange for this invested effort, we obtain the right to market thosecampaigns to other on-line media companies (Syndication). We enter intoagreements with these other on-line media companies to run the campaigns,generally on a fee-share arrangement. We believe such media companies obtain abenefit from receiving an immediately marketable, fully-packaged and testedmarketing program. As a result, we believe we maintain the ability to leveragecampaigns we have developed (including our own products and services) so thatin future fiscal periods we can generate additional revenue with reduced costsand risks associated with such business extension.

 

**TRAFFIX’S PRODUCTS ANDSERVICES**

 

During the fiscal year ended November 30,2002, we introduced the on-line marketing of our own products and servicesthrough the Thanksmuch.com website which sells gift items (such as DVD’s, CD’sand costume jewelry) directly to consumers. When a consumer selects a gift itemand tenders his

 

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creditcard, he is given the opportunity to purchase other, more valuable products andservices at special discounts.

 

We introduced several new business unitsduring the year ended November 30, 2003, including an on-line dating program(“iMatchup.com”) and Internet-based service products such as ISP and emailaccounts that are LEC Billed (“TxNET” and “WorldWideAccess”). These newbusiness units are designed as monthly recurring billing programs, such asmemberships to our iMatchUp.com dating sites.

 

During the three-month period endedFebruary 29, 2004 and February 28, 2003, the combination of all of these newlyintroduced services generated approximately $1.7 million and $0.8 million,respectively, or approximately 23% and 9%, respectively, of consolidated netrevenue.

 

Our expansion in, and dependence on, ouron-line direct marketing efforts, coupled with the potential for state and/orfederal legislation limiting our ability to contact consumers on-line (see“Business-Government Regulation”) should all be considered when referring to our current fiscalyear’s quarterly 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 are subject to a varietyof State and Federal laws and regulations designed to protect consumers thatgovern certain of our marketing practices. 

 

Federal legislation was signed into law, effective January 1, 2004,pre-empting, in large part, all existing and pending state e-mail marketinglegislation. The CAN-SPAM Act of 2003 requires that certain “opt-out” procedures, including, butnot limited to, a functioning return e-mail address (and a time limit of ten(10) days to comply with all opt-out requests sent by consumers), be includedin commercial e-mail marketing. The CAN-SPAM Act prohibits the sending ofe-mail containing false, deceptive or misleading subject lines, routinginformation, headers and / or return address information. The CAN-SPAM Act doesnot permit consumers to file suit against e-mail marketers for violation ofsuch Act. We believe that this may benefit us, as individuals will be morelimited in their ability to file frivolous suits against us, as they have inthe past. The Federal Trade Commission (“FTC”) is empowered by the CAN-SPAM Act to enact regulations,within the next four (4) to twenty-four (24) months, that would implementcertain provisions of the CAN-SPAM Act such as standardized subject linelabeling, a “bounty” system to compensateconsumers for being the first to report a spammerand a potential “do-not-spamregistry” If the regulations promulgated by the FTCspecifically limit our ability to market our offers, we could potentiallyrealize a material adverse impact in future fiscal period net revenue growth,and, therefore, profitability and cash flows could be adversely affected.

 

**TRANSACTIONS WITH MAJOR CUSTOMERS**

 

Transactions with major customers andrelated economic dependence information is set forth (1) following ourdiscussion of Liquidity and Capital Resources, (2) in our discussion ofCritical Accounting Policy and Accounting Estimate Discussion (immediatelyfollowing (1) previously mentioned) and (3) under the heading Transactions withMajor Customers in Note 1 to the Unaudited Consolidated Financial Statementsincluded herein.

 

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**SEGMENTINFORMATION**

 

During the three-month periods endedFebruary 29, 2004 and February 28, 2003, we generated revenue fromthe following segments: E-Commerce, Off-line Marketing (the subsidiaryresponsible for this activity was sold on March 7, 2003) and LEC BilledProducts. The E-Commerce segment currently represents the core of our businessoperations. Revenue in the E-commerce segment is generated primarily frommarketing of third-party products and services on our websites and throughemail. The Off-Line Marketing services segment had consisted of revenuegenerated by us through off-line direct marketing channels. The LEC BilledProducts segment consists of our proprietary LEC billed products, marketedunder the brands TXNet ISP and WorldWebAccess, Inc. These products wereintroduced during Fiscal 2003.

 

Segment information is set forth in Note 6 tothe Consolidated Financial Statements referred to in the Financial Statementsand Supplementary Data section hereof included herein.

 

**RESULTS OF OPERATIONS**

 

The following is a discussion of our financial condition and results of operations for the three-month periods ended February 29, 2004 and February 28, 2003. It should be read in conjunction with our Form 10-K as filed for the year ended November 30, 2003, the Notes thereto and other financial information included elsewhere in this report.

 

THREE MONTHS ENDED FEBRUARY 29, 2004 AND FEBRUARY 28, 2003

 

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 February 29, 2004 and February 28, 2003, are detailed in the following tables:

 

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**SEGMENT DATA - NET REVENUES, BY SEGMENT, BYCOMPONENT**

 
|                                             |   | **Three  Months Ended**     |       |                        |       |                 |       |
|--------------------------------------------------|--------|-----------------------------|------------|-----------------------------|------------|----------------------|------------|
|                                             |   | **February 29,  2004** |       | **February 28,  2003** |       | **Change  Inc(Dec)** |       | **Change  Inc(Dec)** |   |
|                                             |   |                        | ** ** |                        | ** ** | **$****$$**          | ** ** | **%%****%** | ** ** |
|                                             |   |                        |       |                        |       |                 |       |   |   |
| **E-Commerce  components**                       |   |                        |       |                        |       |                 |       |   |   |
| iMatchUp.com dating sites                        |   | $                           | 1,396,611  |                        | $          | 333,153              |       | $ | 1,063,458 |   | 319 | % |
| GroupLotto.com and other web sites               |   | 3,589,722                   |       | 2,733,886                   |       | 855,836              |       | 31 | % |
| Net branch commission fees                       |   | —                      |       | 331,760                     |       | (331,760             | )          | -100 | % |
| Email marketing programs                         |   | 1,401,321                   |       | 2,217,658                   |       | (816,337             | )          | -37 | % |
| Data sales and rentals                           |   | 359,411                     |       | 935,149                     |       | (575,738             | )          | -62 | % |
| Sales of jewelry and gifts                       |   | 100,855                     |       | 245,462                     |       | (144,607             | )          | -59 | % |
| Internet game development and other              |   | 198,781                     |       | 245,861                     |       | (47,080              | )          | -19 | % |
|                                             |   |                        |       |                        |       |                 |       |   |   |
| **Total E-commerce**                             |   | 7,046,701                   |       | 7,042,929                   |       | 3,772                |       | 0 | % |
|                                             |   |                        |       |                        |       |                 |       |   |   |
| **Off-line Marketing  Service components**       |   |                        |       |                        |       |                 |       |   |   |
| Net branch commission fees                       |   | —                      |       | 1,879,971                   |       | (1,879,971           | )          | -100 | % |
| Other off-line marketing                         |   |                        |       |                        |       |                 |       |   |   |
|                                             |   |                        |       |                        |       |                 |       |   |   |
| **Total Off-line  Marketing Service**            |   | —                      |       | 1,879,971                   |       | (1,879,971           | )          | -100 | % |
|                                             |   |                        |       |                        |       |                 |       |   |   |
| **LEC Billed Products  and Services components** |   |                        |       |                        |       |                 |       |   |   |
| TXNet and WWA LEC Products                       |   | 123,593                     |       | 194,329                     |       | (70,736              | )          | -36 | % |
|                                             |   |                        |       |                        |       |                 |       |   |   |
| **Total LEC Billed  Products and Services**      |   | 123,593                     |       | 194,329                     |       | (70,736              | )          | -36 | % |
|                                             |   |                        |       |                        |       |                 |       |   |   |
| **Total Consolidated  Net Revenue**              |   | $                           | 7,170,294  |                        | $          | 9,117,229            |       | $ | (1,946,935 | ) | -21 | % |

 

 

Net Revenue decreased approximately $1.9 million, or 21%, to $7.2 million for the three months ended February 29, 2004 from $9.1 million in the comparable prior year period. The primary factor contributing to the decline in net revenue was the sale of a majority-owned subsidiary (Montvale Management, LLC) during the quarter ended May 31, 2003. Such subsidiary accounted for approximately $2.2 million, or 24% of our revenue during the three months ended February 28, 2003. Our E-commerce segment’s net revenue increased approximately $0.3 million in the Fiscal 2004 first quarter, after consideration of the on-line revenue attributable to Montvale. This net increase was attributable to increases in revenue earned at our dating websites ($1.1 million) and other websites ($0.8 million), offset by a decrease of $1.6 million in our other e-commerce segment components. Net revenue in our LEC Billed Product segment declined $71,000, resulting from a

 

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decreased marketing emphasis during the three months ended February 29, 2004 when compared to February 28, 2003, coupled with increased chargeback rates.

 

Our cost of sales during the three months ended February 29, 2004 and February 28, 2003 were comprised of (1) direct and indirect marketing costs associated with the acquisition and retention of consumers for our databases, including direct response email marketing costs, data purchases, promotional 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 February 29, 2004 and February 28, 2003 are set forth below: 

 

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

 
|                                              |   | **Three  Months Ended**     |      |                        |   |                 |       |
|---------------------------------------------------|--------|-----------------------------|-----------|-----------------------------|--------|----------------------|------------|
|                                              |   | **February 29,  2004** |      | **February 28,  2003** |   | **Change  Inc(Dec)** |       | **Change  Inc(Dec)** |   |
|                                              |   |                        |      |                        |   | **$****$$**          | ** ** | **%%****%** |   |
|                                              |   |                        |      |                        |   |                 |       |   |   |
| **E-commerce**                                    |   |                        |      |                        |   |                 |       |   |   |
| **Advertising,  promotion and fulfillment costs** |   |                        |      |                        |   |                 |       |   |   |
| Email marketing and related delivery costs        |   | $                           | 874,691   |                        | $      | 1,399,933            |       | $ | (525,242 | ) | -38 | % |
| Data and profile purchases, and premium  costs    |   | 2,502,548                   |      | 323,956                     |   | 2,178,592            |       | 672 | % |
| Promotional, creative and other costs             |   | 56,232                      |      | 125,917                     |   | (69,685              | )          | -55 | % |
|                                              |   |                        |      |                        |   |                 |       |   |   |
|                                              |   |                        |      |                        |   |                 |       |   |   |
| **Total E-commerce Advertising**                  |   | $                           | 3,433,471 |                        | $      | 1,849,806            |       | $ | 1,583,665 |   | 86 | % |
|                                              |   |                        |      |                        |   |                 |       |   |   |
| **Service Bureau fees**                           |   |                        |      |                        |   |                 |       |   |   |
| Contingent based prize indemnification costs      |   | $                           | 62,513    |                        | $      | 69,595               |       | (7,082 | ) | -10 | % |
|                                              |   |                        |      |                        |   |                 |       |   |   |
| **Total E-commerce Cost of Sales**                |   | $                           | 3,495,984 |                        | $      | 1,919,401            |       | $ | 1,576,583 |   | 82 | % |
|                                              |   |                        |      |                        |   |                 |       |   |   |
| **Off-line Marketing  Services**                  |   |                        |      |                        |   |                 |       |   |   |
| **Advertising,  promotion and fulfillment costs** |   |                        |      |                        |   |                 |       |   |   |
| Telemarketing, direct mail and related  costs     |   | $                           | —    |                        | $      | 188,040              |       | $ | (188,040 | ) | -100 | % |
|                                              |   |                        |      |                        |   |                 |       |   |   |
|                                              |   |                        |      |                        |   |                 |       |   |   |
| **Total Off-line Marketing Cost of Sales**        |   | $                           | —    |                        | $      | 188,040              |       | $ | (188,040 | ) | -100 | % |
|                                              |   |                        |      |                        |   |                 |       |   |   |
| **LEC Billed Products  and Services**             |   |                        |      |                        |   |                 |       |   |   |
|                                              |   |                        |      |                        |   |                 |       |   |   |
| **Service Bureau fees**                           |   |                        |      |                        |   |                 |       |   |   |
| Service provision, billing and collection  fees   |   | $                           | 309,970   |                        | $      | 138,489              |       | 171,481 |   | 124 | % |
|                                              |   |                        |      |                        |   |                 |       |   |   |
| **Total LEC Billed Cost of Sales**                |   | $                           | 309,970   |                        | $      | 138,489              |       | $ | 171,481 |   | 124 | % |
|                                              |   |                        |      |                        |   |                 |       |   |   |
| **Consolidated Cost of Sales**                    |   | $                           | 3,805,954 |                        | $      | 2,245,930            |       | $ | 1,560,024 |   | 69 | % |

 

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Cost of sales on a consolidated basis increased $1.6 million, or 69%, to $3.8 million for the three months ended February 29, 2004 from $2.2 million in the comparable prior year period.

 

The significant factor contributing to theincrease in cost of sales was an approximate $2.2 million, or 672%, increase indata acquisition costs incurred for customer profiles related to our on-linedating sites, yielding a revenue increase of $1.1 million, or 319% from suchsites as recognized in the prior year’s comparable period; and increasedacquisitions of registrants for our other websites, yielding a revenue increaseof $0.9 million, or 31%, at such other sites. The three-month period endedFebruary 28, 2003 included a reversal of a fulfillment accrual from Fiscal2002 of approximately $0.5 million. The increase in data, profile and premiumcosts, after adjustment for Fiscal 2002’s fulfillment reversal, was approximately$1.7 million.

 

Other increases in cost of sales related toour LEC Billed Product segment, which amount to approximately $0.2 million, oran increase of 100% when compared to the prior year’s comparable period. Theincrease relates to higher levels of customer service on our existing customerbase and initial marketing expenditures incurred in the expansion of thesegment in the latter part of the quarter ended February 29, 2004.

 

The above referenced cost increases wereoffset by: (a) decreases in email marketing delivery costs of approximately$0.5 million, or 38%, related

 

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to decreased reliance on third-partymailing vendors and an overall decrease in the level of revenue-generatingemail promotions (with a decline in the corresponding email-marketing revenueof $0.8 million, or 37%); and (b) a decrease in marketing costs associated withour Off-line Marketing segment resulting from the sale of Montvale Management,LLC in March 2003.

 

Our gross profit in terms of dollars, on asegmental basis, and our gross profit percentage, on a segmental basis, foreach of the three-month periods ended February 29, 2004 andFebruary 28, 2003, are set forth below: 

 

**Consolidated Gross Profit, bySegment**

 
|                             |   | **Three  Months Ended**     |      |                        |   |                 |   |
|----------------------------------|--------|-----------------------------|-----------|-----------------------------|--------|----------------------|--------|
|                             |   | **February 29,  2004** |      | **February 28,  2003** |   | **Change  inc(dec)** |   | **Change  inc(dec)** |   |
|                             |   |                        |      |                        |   | **$$$**              |   | **%****%****%** |   |
| E-commerce                       |   | $                           | 3,550,717 |                        | $      | 5,123,528            |   | $ | (1,572,811 | ) | -31 | % |
|                             |   |                        |      |                        |   |                 |   |   |   |
| Off-line Marketing services      |   | —                      |      | 1,691,931                   |   | (1,691,931           | )      | 100 | % |
|                             |   |                        |      |                        |   |                 |   |   |   |
| LEC Billed products and services |   | (186,377                    | )         | 55,840                      |   | (242,217             | )      | -434 | % |
|                             |   |                        |      |                        |   |                 |   |   |   |
|                             |   |                        |      |                        |   |                 |   |   |   |
| **CONSOLIDATED TOTALS**          |   | $                           | 3,364,340 |                        | $      | 6,871,299            |   | $ | (3,506,959 | ) | -51 | % |

 

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

 
|                                      |   |                    |   | **Absolute**          |   | **Relative**   |   |
|-------------------------------------------|--------|-------------------------|--------|-----------------------|--------|----------------|--------|
|                                      |   | **Three  Months Ended** |   | **percentage**        |   | **percentage** |   |
|                                      |   | **February 29,**   |   | **February 28,** |   | **change**     |   | **change** |   |
|                                      |   | **2004**                |   | **2003**              |   | **inc(dec)**   |   | **inc(dec)** |   |
| E-commerce                                |   | 50.4                    | %      | 72.7                  | %      | -22.4          | %      | -30.7 | % |
|                                      |   |                    |   |                  |   |           |   |   |   |
| Off-line Marketing services               |   | 0.0                     | %      | 90.0                  | %      | -90.0          | %      | -100.0 | % |
|                                      |   |                    |   |                  |   |           |   |   |   |
| LEC Billed products and services          |   | -150.8                  | %      | 28.7                  | %      | -179.5         | %      | -624.8 | % |
|                                      |   |                    |   |                  |   |           |   |   |   |
|                                      |   |                    |   |                  |   |           |   |   |   |
| **CONSOLIDATED GROSS  PROFIT PERCENTAGE** |   | 46.9                    | %      | 75.4                  | %      | -28.4          | %      | -37.7 | % |

 

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Consolidated Gross Profit Percentage(“Gross Margin”) as a percentage of net revenue was 46.9% during the threemonths ended February 29, 2004, compared to 75.4% in the prior year’scomparable fiscal period, representing an absolute percentage point decrease of28.4%, or a 37.7% decrease on a relative basis.

 

The decline in gross profit is primarilyattributable to (a) increased data acquisition costs for our iMatchUp.comdating sites, (b)increased marketing and related data acquisition costs for ourother website properties, and (c) the reintroduction of the LEC Billed Productssegment activity, which has a gross profit that is lower than our historicalgross profit. The impact on gross profit from our iMatchUp.com dating sitesresults from the expensing of the costs of customer acquisition during theperiod we acquire and pay for the free iMatchUp.com membership account, whilethe recognition of the revenue is dependent upon whether or not the freeaccount converts to a paying membership. The period that a free account mayconvert to a billable account ranges from one week after acquisition, to aslong as fifteen months after acquisition, based on available historicalexperience. Therefore, predicated on stabilized acquisition costs in futurefiscal periods, we expect that the future conversions of free membershipacquisitions to billable members, coupled with the revenue deferred forthree-month, six-month and annual memberships at February 29, 2004, aswell as the anticipated renewal revenues from such acquired customers, should allowus to report improved gross profit margins in our E-commerce segment in futurefiscal quarters.

 

Our Selling Expenses for each of the threemonths ended February 29, 2004 and February 28, 2003 are presented,on a segmental basis, and with the components of the individual segments, inthe tables set forth below:

 

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###### **Segment Data -Consolidated Selling Expenses, by Segment, by Component**

 
|                                    |   |                    |    |                  |   |         |   |
|-----------------------------------------|--------|-------------------------|---------|-----------------------|--------|--------------|--------|
|                                    |   | **Three  Months Ended** |    |                  |   |         |   |
|                                    |   | **February 29,**   |    | **February 28,** |   | **Change -** |   | **Change -** |   |
|                                    |   | **2004**                |    | **2003**              |   | **inc(dec)** |   | **inc(dec)** |   |
|                                    |   |                    |    |                  |   | **$$$**      |   | **%%****%** |   |
|                                    |   |                    |    |                  |   |         |   |   |   |
| **E-commerce**                          |   |                    |    |                  |   |         |   |   |   |
| Fee share commissions                   |   | $                       | 213,097 |                  | $      | 1,053,616    |   | $ | (840,519 | ) | -80 | % |
| Selling salaries and related expenses   |   | 201,966                 |    | 393,524               |   | (191,558     | )      | -49 | % |
| Travel and entertainment                |   | 32,867                  |    | 59,384                |   | (26,517      | )      | -45 | % |
| **TOTAL Selling -  E-commerce segment** |   | $                       | 447,930 |                  | $      | 1,506,524    |   | $ | (1,058,594 | ) | -70 | % |
|                                    |   |                    |    |                  |   |         |   |   |   |
| **Off-line Marketing  Services**        |   |                    |    |                  |   |         |   |   |   |
| Selling salaries and related expenses   |   | $                       | —  |                  | $      | 762,407      |   | $ | (762,407 | ) | -100 | % |
| Occupancy and equipment costs           |   | —                  |    | 45,623                |   | (45,623      | )      | -100 | % |
| Travel and entertainment                |   | —                  |    | 5,005                 |   | (5,005       | )      | -100 | % |
| **TOTAL Selling -  Off-line segment**   |   | $                       | —  |                  | $      | 813,035      |   | $ | (813,035 | ) | -100 | % |
|                                    |   |                    |    |                  |   |         |   |   |   |
| **Consolidated Totals**                 |   | $                       | 447,930 |                  | $      | 2,319,559    |   | $ | (1,871,629 | ) | -81 | % |

 

Sellingexpenses, on a consolidated basis, decreased approximately $1.9 million, or81%, from $2.3 million during the three months ended February 28, 2003 to$0.4 million during the three months ended February 29, 2004. The decreasewas primarily related to an approximate $1.1 million reduction in   E-commerce segment selling expenses, ofwhich (a) approximately $0.8 million relates to a decrease in fee sharecommissions and correlates to our reduced use of third-party databases in thepromotion of our email services (note that this decrease relates to thealternative use of capital for data acquisition costs as discussed in the costof goods sold section above), and (b) approximately $0.2 million relatesto decreases in salaries and related costs resulting from cost-cuttingreductions to our sales force undertaken in the third and fourth quarters ofFiscal 2003.

 

Additionally, a portion of the decrease, or$0.8 million, resulted from the sale of our majority-owned subsidiary, MontvaleManagement, LLC, in March 2003. Such majority-owned subsidiary was activefor the entire three months ended February 29, 2003.

 

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Our general and administrative expenses (“G&A”) are principally comprised of (i) compensation costs and related expenses for executive, finance, information and operation systems, and general administration personnel, (ii) professional fees (which include legal; audit, accounting and tax; public relations; database management and consulting; and public company related printing 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 February 29, 2004 and February 28, 2003 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, by segment, by component***

 
|                                             |   |                    |      |                  |   |         |   |
|--------------------------------------------------|--------|-------------------------|-----------|-----------------------|--------|--------------|--------|
|                                             |   | **Three  Months Ended** |      |                  |   |         |   |
|                                             |   | **February 29,**   |      | **February 28,** |   | **Change -** |   | **Change -** |   |
|                                             |   | **2004**                |      | **2003**              |   | **inc(dec)** |   | **inc(dec)** |   |
|                                             |   |                    |      |                  |   | **$$$**      |   | **%%****%** |   |
|                                             |   |                    |      |                  |   |         |   |   |   |
| **E-commerce**                                   |   |                    |      |                  |   |         |   |   |   |
| Compensation costs and related expenses          |   | $                       | 893,099   |                  | $      | 1,128,644    |   | $ | (235,545 | ) | -21 | % |
| Professional fees                                |   | 220,613                 |      | 509,537               |   | (288,924     | )      | -57 | % |
| Insurance costs                                  |   | 141,759                 |      | 135,687               |   | 6,072        |   | 4 | % |
| Occupancy and equipment costs                    |   | 40,993                  |      | 88,805                |   | (47,812      | )      | -54 | % |
| Site development, maintenance and  Modifications |   | 352,782                 |      | 141,842               |   | 210,940      |   | 149 | % |
| All other G&A expenses                       |   | 213,487                 |      | 425,534               |   | (212,047     | )      | -50 | % |
| **TOTAL G&A -  E-commerce segment**          |   | $                       | 1,862,733 |                  | $      | 2,430,049    |   | $ | (567,316 | ) | -23 | % |
|                                             |   |                    |      |                  |   |         |   |   |   |
| **Off-line Marketing  Services**                 |   |                    |      |                  |   |         |   |   |   |
| Professional fees                                |   | $                       | —    |                  | $      | 21,229       |   | $ | (21,229 | ) | -100 | % |
| All other G&A expenses                       |   | —                  |      | 691,351               |   | (691,351     | )      | -100 | % |
| **TOTAL G&A -  Off-line segment**            |   | $                       | —    |                  | $      | 712,580      |   | $ | (712,580 | ) | -100 | % |
|                                             |   |                    |      |                  |   |         |   |   |   |
| **LEC Billed Products  and Services**            |   |                    |      |                  |   |         |   |   |   |
| Compensation costs and related expenses          |   | $                       | 56,563    |                  | $      | —       |   | $ | 56,563 |   | 100 | % |
| Insurance costs                                  |   | 17,888                  |      | —                |   | 17,888       |   | 100 | % |
| Occupancy and equipment costs                    |   | 13,934                  |      | —                |   | 13,934       |   | 100 | % |
| All other G&A expenses                       |   | 6,116                   |      | —                |   | 6,116        |   | 100 | % |
| **TOTAL G&A - LEC  segment**                 |   | $                       | 94,501    |                  | $      | —       |   | $ | 94,501 |   | 100 | % |
|                                             |   |                    |      |                  |   |         |   |   |   |
| **Corporate and other**                          |   |                    |      |                  |   |         |   |   |   |
| Compensation costs and related expenses          |   | $                       | 499,740   |                  | $      | 545,821      |   | $ | (46,081 | ) | -8 | % |
| Professional fees                                |   | 160,993                 |      | 228,222               |   | (67,229      | )      | -29 | % |
| Insurance costs                                  |   | 125,410                 |      | 130,333               |   | (4,923       | )      | -4 | % |
| All other G&A expenses                       |   | 116,200                 |      | 159,032               |   | (42,832      | )      | -27 | % |
| **TOTAL G&A -  Corporate and other**         |   | $                       | 902,343   |                  | $      | 1,063,408    |   | $ | (161,065 | ) | -15 | % |
|                                             |   |                    |      |                  |   |         |   |   |   |
| **Consolidated Totals**                          |   | $                       | 2,859,577 |                  | $      | 4,206,037    |   | $ | (1,346,460 | ) | -32 | % |

 

Generaland Administrative expenses (“G&A”) on a consolidated basis decreasedapproximately $1.3 million, or 32%, when comparing G&A of $4.2 million forthe three months ended February 28, 2003 to G&A of $2.9 millionincurred during the three months ended February 29, 2004. The net decreasewas attributable to decreases in our: (a) Off-line Marketing Service segment($712,000) pursuant to our disposition of our majority-owned subsidiary(Montvale Management, LLC) in March 2003; (b) E-commerce segment($567,000) and Corporate ($161,000), both relating to reductions in: (i)compensation costs pursuant to cost cutting reductions to our workforceundertaken in the third and fourth quarters of Fiscal 2003, (ii) professionalfees reflecting reduced requirements for litigation defense, and (iii) otherexpenses primarily reflecting the benefit of general cost reduction effortsundertaken in the third and fourth quarters of Fiscal 2003, all being partiallyoffset by an increase in website related costs of approximately $0.2 million.

 

Feder, Kaszovitz, Issacson, Weber, Skala,Bass and Rhine LLP (“FKIWSBR”) provides general legal services to us in theordinary course of business and litigation services in defense of actionsarising from such business activities. Murray L. Skala, a partner in such firm,has been a member of our

 

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Board of Directors since inception. Weincurred approximately $102,000 in legal fees (exclusive of disbursements) fromFKIWSBR during the three months ended February 29, 2004. We incurredapproximately $305,000 in legal fees (exclusive of disbursements) from FKIWSBRduring the three months ended February 28, 2003.

 

**Consolidated Bad DebtExpense, by segment**

 
|                             |   |                    |    |                  |   |         |     |
|----------------------------------|--------|-------------------------|---------|-----------------------|--------|--------------|----------|
|                             |   | **Three  Months Ended** |    |                  |   |         |     |
|                             |   | **February 29,**   |    | **February 28,** |   | **CHANGE -** |     | **CHANGE -** |   |
| **For the periods:**             |   | **2004**                |    | **2003**              |   | **INC(DEC)** |     | **INC(DEC)** |   |
|                             |   |                    |    |                  |   | **$$$**      |     | **%%****%** |   |
| E-commerce                       |   | (46,457                 | )       | 336,188               |   | $            | (382,645 | ) | -114 | % |
|                             |   |                    |    |                  |   |         |     |   |   |
| Off-line Marketing Services      |   | —                  |    |                  |   | —       |     | 0 | % |
|                             |   |                    |    |                  |   |         |     |   |   |
| LEC Billed Products and Services |   | —                  |    |                  |   | —       |     | 0 | % |
|                             |   |                    |    |                  |   |         |     |   |   |
|                             |   |                    |    |                  |   |         |     |   |   |
| **Consolidated Totals**          |   | $                       | (46,457 | )                     | $      | 336,188      |     | $ | (382,645 | ) | -114 | % |
|                                  |        |                         |         |                       |        |              |          |  |  |  |  |  |

 

Bad Debt expense decreased approximately$0.4, or 114%, to a recapture of bad debt expense of $46,457 in the threemonths ended February 29, 2004 from bad debt expense of approximately $0.3million in the three months ended February 28, 2003. Our bad debt expenserecapture resulted from our assessment of the risk of collection embedded inour customer base as a product of the processes described below. When comparingthe aging of our receivables, subsequent collections on such receivables andother factors, it was deemed that our allowance for doubtful accounts requireda reduction, with such reduction yielding the current quarter’s bad debtrecapture of approximately $46,000.

 

We continuously evaluate the potential ofthe collectibility of trade receivables by reviewing such factors asdeterioration in the operating results, financial condition or bankruptcyfilings of our customers. As a

 

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result of this review process, we recordadjustments to bad debt provisions 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, (b) historicalexperience and other factors obtained during collection efforts. Ifcircumstances related to specific customers change, our estimates for bad debtprovisions could be further increased or decreased.

 

**OTHER INCOME (EXPENSE)**

 

The components of our “Other income(expense)” for the three months ended February 29, 2004 and February 28,2003 are set forth below:

 
|                                             |   |                    |    |                  |   |         |   |
|--------------------------------------------------|--------|-------------------------|---------|-----------------------|--------|--------------|--------|
|                                             |   | **Three  Months Ended** |    |                  |   |         |   |
|                                             |   | **February 29,**   |    | **February 28,** |   | **Change**   |   | **Change** |   |
|                                             |   | **2004**                |    | **2003**              |   | **Inc(Dec)** |   | **Inc(Dec)** |   |
|                                             |   |                    |    |                  |   | **$$$**      |   | **%%****%** |   |
|                                             |   |                    |    |                  |   |         |   |   |   |
| Other income (expense):                          |   |                    |    |                  |   |         |   |   |   |
|                                             |   |                    |    |                  |   |         |   |   |   |
| Interest income and dividends                    |   | $                       | 108,732 |                  | $      | 154,601      |   | (45,869 | ) | -30 | % |
| Realized gains on sale of marketable  securities |   | 11,023                  |    | 738                   |   | 10,285       |   | 1394 | % |
| Realized gain on prior year sale of  subsidiary  |   | 195,000                 |    | —                |   | 195,000      |   | 100 | % |
| Other non-operating income (expense):            |   |                    |    |                  |   |         |   |   |   |
| Other miscellaneous income(expense)              |   | 16,335                  |    | (6,697                | )      | 23,032       |   | -344 | % |
| Foreign Currency Exchange Rate Fees              |   | (4,323                  | )       | (7,341                | )      | 3,018        |   | -41 | % |
| Reduction of prior year’s LEC reserve       |   | 34,181                  |    | —                |   | 34,181       |   | 100 | % |
| Minority interest (income) loss                  |   |                    |    | (120,328              | )      | 120,328      |   | -100 | % |
| **Total Consolidated  Other Income (Expense)**   |   | $                       | 360,948 |                  | $      | 20,973       |   | 339,975 |   | 1,621 | % |

 

Consolidated Other Income (Expense)increased approximately $0.3 million, from approximately $21,000 for the threemonths ended February 28, 2003, to approximately $0.4 million for thethree months ended February 29, 2004.

 

The primary factors contributing to the netincrease, in the order of the table set forth above, are as follows:

 

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(a) We recognized a decrease in interestand dividend income of approximately $46,000 resulting from decreases in theinterest rates available on short-term commercial paper during the three monthsended February 29, 2004 when compared with interest rates available onshort-term commercial paper during the three months ended February 28,2003;

 

(b) We recognized an increase in gainsrealized through the sale of marketable securities of approximately $10,000 inthe three months ended February 29, 2004;

 

(c) We recognized an increase in realizedgains of approximately $195,000 arising from the sale of Montvale Management,LLC, (see Note 7 to the attached financial statements) and a reduction toMinority interest in (income) from such subsidiary; and

 

(d) We recognized an increase ofapproximately $60,000 in other non-operating income (expense) during the threemonths ended February 29, 2004 relating to: (i) collections ofapproximately $16,000 for marketing program tests and residual receipts fromterminated promotions; (ii) a decrease in foreign currency exchange rate feesof $3,000 paid on at our Canadian subsidiary; and (iii) a receipt of a prioryear’s LEC segment chargeback reserve that exceeded our receivable for suchreserve by approximately $34,000.

 

**PROVISION FOR INCOME TAXES**

 

Quarterlyincome taxes are calculated in accordance with the Interim Financial Reportingrequirements as set forth in the Accounting Principal Board’s Opinion 28. SuchOpinion considers interim quarterly periods as an integral part of the annualperiod, with interim quarterly tax periods reflecting the estimated annualeffective tax rate. We believe that we have adequately provided for tax-relatedmatters. We are subject to examination by taxing authorities in variousjurisdictions. Matters raised upon audit may involve substantial amounts andcould be material. Management considers it

 

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unlikelythat resolution of any such matters would have a material adverse effect uponour consolidated financial statements.

 

Thethree months ended February 29, 2004 reflects a tax expense ofapproximately $111,000 on pre-tax income of $464,238. This effective tax rateof 24% differs from our historically recognized effective tax rate ofapproximately 39%. We recognized tax benefits from the use of approximately$0.2 million in previously devalued capital loss carryover deferred tax assets.Such prior year devalued capital loss deferred tax assets were utilized in thethree months ended February 29, 2004 to offset the tax expense on thecurrent period’s capital gain income of approximately $0.2 million.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

As of February 29, 2004, we hadaggregate working capital of $38.5 million compared to aggregate workingcapital of $38.2 million as of November 30, 2003. We had available cash,cash equivalents and readily available marketable debt securities of $36.8million as of February 29, 2004 compared to available cash, cashequivalents and readily available marketable debt securities of $36.7 millionas of November 30, 2003. The equity component of our marketable securitieswas $1.8 million at February 29, 2004 compared to $1.6 million atNovember 30, 2003.

 

Cash provided by operating activities wasapproximately $0.8 million for the three months ended February 29, 2004,compared to approximately $0.3 million in cash used in operating activities inthe three months ended February 28, 2003, representing an approximate $1.1million increase in cash provided by operating activities. The significantcomponents giving rise to the increase in cash provided by operating activitiesrelate to the changes in our other operating assets and liabilities, wherebysuch changes in the three months ended February 29, 2004 absorbedapproximately $1.1 million less in

 

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cash than the comparable prior year period.The comparable prior year period included significant vendor payments, coupledwith increases in account receivable when compared to the three months endedFebruary 29, 2004.

 

Cash provided by investing activities wasapproximately $0.2 million during the three months ended February 29,2004, compared to $14.5 million used in financing activities during the prioryear’s comparable quarter. The primary source of cash from investing activitiesrelated to the collection of approximately $0.2 million on installments fromthe prior year’s sale of one of our subsidiaries, offset by approximately$19,000 paid for capital expenditures. The prior year’s comparable quarter usedcash of approximately $14.5 million, approximately $14.3 million of which wasused for the acquisition of short-term marketable debt securities purchased forus by our professional money managers and approximately $0.2 million of whichwas paid for capital expenditures.

 

Cash used for financing activities wasapproximately $0.9 million for the three months ended February 29, 2004,compared to $26,267 provided by financing activities for the three months endedFebruary 28, 2003. During the three months ended February 29, 2004 wedeclared and paid a quarterly dividend, amounting to approximately $1.0 millionand offset such outflow with approximately $0.2 million in proceeds from stockoptions exercised.  For furtherdiscussion of our dividend policy, see "Note 10. - Subsequent Events"included in the accompanying unaudited financial statements.

 

Our days-sales-outstanding (“DSO”) inaccounts receivable at February 29, 2004 was 52 days, compared to 46 daysat November 30, 2003, 49 days at August 31, 2003, 54 days at May 31,2003, and 52 days at February 28, 2003. The increase in the currentquarter’s DSO compared to the third and fourth quarter of the prior fiscal yearrelates to the longer collection cycles attributable to our recently reinstatedLEC Billed Products and Services segment activities, offset by improvedcollection cycles on our client billed business. Our DSO may rise above 52 daysin future fiscal periods primarily in the event of growth in revenues from theCompany’s LEC Billed Products and Services segment.

 

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The majority of our customers are extended30-day credit terms. In limited instances, credit is extended to rangesapproximating 90 days. Currently, one such customer accounts for approximately$0.9 million, or 21.6%, of our accounts receivable at February 29, 2004,such extension of credit also contributes to our increased DSO referencedabove.  We continually monitor customeradherence to their credit terms and constantly strive to improve theeffectiveness of our collection efforts with the goal of achieving a DSO in the40-day range. Future fiscal periods might not reflect this goal of a 40-dayDSO, and might exceed the 52-day DSO recognized in the three-month period endedFebruary 29, 2004.

 

Historically, our primary cash requirementshave been used to fund the cost of advertising and promotion and test-marketingnew products, services and promotions, with additional funds having been usedin the purchasing of equipment and services in connection with the commencementof new business lines, further development of businesses being test marketedand for the development of the equipment infrastructure of subsidiariesorganized in Fiscal 2002.

 

In Fiscal 2000, we executed our on-linedirect marketing strategy. Our future plans and business strategy may continueto call for our Internet-based E-commerce segment to be our primary operatingfocus, with such segment generating the material portion of our revenues forthe three months ended February 29, 2004. We may, in future fiscalperiods, continue to invest considerable amounts capital into our E-commercesegment ($1.5 million in Fiscal 2003, $1.9 million in Fiscal 2002, less than$20,000 in the three months ended February 29, 2004). If the E-commercesegment’s activities fail to generate sufficient revenue, we could realize amaterial adverse impact on our capital and liquidity resources resulting fromexpenditures necessary to generate such revenue, including, but not limited to,expenditures for (a) marketing campaigns, (b) product development costs, (c)site development and maintenance and related technology based costs, (d)potential on-line, and/or

 

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off-line, business acquisitions, (e) costsassociated with developing alternative means of email promotion delivery, or(f) other unexpected and/or currently unidentifiable costs.

 

On April 1, 2004, we announced that wehad acquired an exclusive license for an operating platform created byLiveOnTheNet.com, Inc. (LOTN), a privately held company. We had announced inFebruary 2004 that we had entered into an agreement to acquire all of theassets of LOTN. The asset acquisition plans were discarded in favor of a licenseagreement resulting from our final stages of due diligence.

 

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 ofApril 7, 2004, nine installments were received and recorded as realizedgain on sale of subsidiary. Based on management’s assessment of Montvale’sfuture cash flows, after taking into consideration Montvale’s increasedobligations with respect to the note obligations due us, we have deemed itprudent to defer recognition of income on the unpaid portion of the note.Recognition will therefore take place in future periods under the cost recoverymethod.

 

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 April 7, 2004, we have collected therequisite nine payments, for a total of $360,000.

 

In the fiscal year ended November 30,1999, the adoption of our Internet

 

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business plan and strategy prompted us toterminate the marketing of our legacy products and services, which were activeat that time. Accordingly, this legacy activity has contributed in asignificantly decreasing degree, to our cash flows and results of operationsfor the three-year fiscal period, December 1, 1999 to November 30,2002, and did not contribute at all to the operations of Fiscal 2003. Thisshould be considered when using our historical results in evaluating futureoperations, cash flows and financial position. Nevertheless, we will continueto explore opportunities to offer other Off-line marketing services, and expectto expand our activities within our LEC Billed Products segment.

 

Under currently proposed operating plansand assumptions, management believes that projected cash flows from operationsand available cash resources and working capital, as described above, will besufficient to satisfy our anticipated cash requirements for at least the nexttwelve months. Our known identifiable short-term and long-term obligations aredescribed below in the “Obligations and Commitments” disclosure as required bythe Securities and Exchange Commission’s (the “Commission”) Release Nos.33-8056 and 34-45321 and FR-61, as issued on January 22, 2002.

 

 Additionally, as we seek to further extend our reach into theE-commerce and LEC Billed Product arenas, as well as identifying new and otherconsumer oriented products and services in the off-line arena, we may useexisting cash reserves, enter into long-term financing arrangements, or employother means to finance such diversification, none of which is specificallyidentifiable or measurable at this time.

 

###### **OBLIGATIONS ANDCOMMITMENTS**

###### ** **

We are not aware of any specific factors,outside of those described in the following table, and those “potentialfactors” described in the “Critical Accounting Policy and Accounting EstimateDiscussion” which is set forth

 

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below, that are reasonably likely to cause amaterial impact, either positive or negative, on our liquidity trends.  Additionally, we do not have off-balancesheet arrangements, other than those described in the following table, and donot engage in trading activities involving non-exchange traded contracts.

 

A summary table of future contractualcommitments, for future minimum lease payments under non-cancelable operatingleases and employment contracts are set forth below: 

 
|       |   | **Operating  Leases** |    | **Employment  agreements** |   | **Total  Contractual  Obligations** |   |
|------------|--------|-----------------------|---------|----------------------------|--------|-------------------------------------|--------|
|       |   | **Domestic**          |    | **Foreign**                |   | **Domestic**                        |   | **Foreign** |   | **Domestic** |   | **Foreign** |   |
|       |   |                  |    |                       |   |                                |   |   |   |   |   |   |   |
| 2004       |   | $                     | 331,600 |                       | $      | 72,220                              |   | $ | 1,484,500 |   | $ | 246,177 |   | $ | 1,816,100 |   | $ | 318,396 |   |
| 2005       |   | 322,500               |    | 30,091                     |   | 12,850                              |   | 268,556 |   | 335,350 |   | 298,648 |   |
| 2006       |   | 215,000               |    | —                     |   | —                              |   | 290,936 |   | 215,000 |   | 290,936 |   |
| 2007       |   |                  |    |                       |   |                                |   | 3,679 |   | — |   | 3,679 |   |
| Thereafter |   | —                |    |                       |   | —                              |   | — |   | — |   |   |   |
|       |   | $                     | 869,100 |                       | $      | 102,311                             |   | $ | 1,497,350 |   | $ | 809,348 |   | $ | 2,366,450 |   | $ | 911,659 |   |

 

###### **RELATED PARTIES**

###### ** **

Feder, Kaszovitz, Issacson, Weber, Skala,Bass and Rhine LLP (“FKIWSBR”) provides general legal services to us in theordinary course of business and litigation services in defense of actionsarising from such business activities. Murray L. Skala, a partner in such firm,has been a member of our Board of Directors since inception. FKIWSBR legalservices are billed on an arms length transaction basis. We incurredapproximately $102,000 in legal fees (exclusive of disbursements) from FKIWSBRduring the three months ended February 29, 2004. We incurred approximately$305,000 in legal fees (exclusive of disbursements) from FKIWSBR during thethree months ended February 28, 2003.

 

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**TRANSACTIONS WITHMAJOR CUSTOMERS**

 

During the three months ended February 29, 2004, we had one customer in our E-commerce segment accounting for approximately $1.0 million, or 13.5% of consolidated net revenue. Approximately $0.4 million, or 9.5% of consolidated net accounts receivable, was attributable to such major customer as of February 29, 2004. Regarding the balance of our customer base, no single customer had net revenues that equaled or exceeded 9% of consolidated net revenues for the three months ended February 29, 2004. During the three months ended February 28, 2003 no single customer had net revenues that equaled or exceeded 8% of consolidated net revenues for such period.

 

Currently, 21.2% of the Company’s revenue is derived for its proprietary products; 19.5% from iMatchUp.com, the Company’s online dating sites, and 1.7% from our LEC segment’s proprietary products.

 

**CRITICAL ACCOUNTING POLICY AND ACCOUNTING ESTIMATE DISCUSSION**

 

Wehave set forth below what we believe to be the most pervasive accountingpolicies and estimates that could have a material effect on our Company’sresults of operations and cash flows, if general business conditions orindividual customer financial circumstances change in an adverse way relativeto the policies and estimates used in the attached financial statements or inany “forward looking” statements contained herewith.

 

**FACTORS THAT COULD EFFECT FUTURE RESULTS**

 

**Continuation of trend relative to decreasing revenues andincreasing overhead**

 

The following chart and subsequentdiscussion provide the details of a known trend in revenue deterioration, andthe effect of the potential continuation of such trend. Our quarterly netrevenues for the prior nine quarterly periods are set forth in the table below:

 

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| **Quarterly  period ended** |   | **net  revenue** |       | **%****change  from previous  quarter** |   |
|-----------------------------|--------|------------------|------------|-----------------------------------------|--------|
|                        |   |             |       |                                    |   |
| February 28, 2002      |   | $                | 12,370,897 |                                    | -11.95 | %(1) |
| May 31, 2002                |   | 10,804,538       |       | -12.66                                  | %(1)   |
| August 31, 2002        |   | 10,664,246       |       | -1.30                                   | %(1)   |
| November 30, 2002      |   | 10,203,244       |       | -4.32                                   | %(1)   |
| February 28, 2003      |   | 9,117,229        |       | -10.64                                  | %(1)   |
| May 31, 2003                |   | 7,422,604        |       | -18.59                                  | %(1)   |
| August 31, 2003        |   | 8,503,267        |       | 14.56                                   | %      |
| November 30, 2003      |   | 7,345,752        |       | -13.61                                  | %      |
| February 29, 2004      |   | 7,170,294        |       | -2.39                                   | %      |
|                             |        |                  |            |                                         |        |  |

 

----

(1)                  Ourmajority owned subsidiary, Montvale management, LLC, was sold inMarch 2003. Such subsidiary contributed to quarterly revenue as follows:

 
| **Quarterly  period ended**                      |   |      |    |
|--------------------------------------------------|--------|-----------|---------|
|                                             |   |      |    |
| February 28, 2002                           |   | $         | 866,408 |   |
| May 31, 2002                                     |   | 1,387,903 |    |
| August 31, 2002                             |   | 1,876,069 |    |
| November 30, 2002                           |   | 1,941,270 |    |
| February 28, 2003                           |   | 2,211,731 |    |
| May 31, 2003 (activity sold in  March 2003) |   | 161,475   |    |
|                                                  |        |           |         |  |

 

We have been ableto replace a portion of Montvale’s revenue through: (a) the expansion of itsdirect-to-consumer based proprietary products and services; (b) the expansionof existing client relationships; and (c) the client contact strategies.

 

Our quarterly overhead, which is thecombination of selling expenses, general and administrative expenses, and baddebt expense, for the prior nine quarterly periods are set forth in the tablebelow:

 
| **Quarterly  period ended** |   | **Selling  expense** |      | **G&A  Expense** |   | **Bad Debt  expense** |   | **Total  Overhead** |    |
|-----------------------------|--------|----------------------|-----------|----------------------|--------|-----------------------|--------|---------------------|---------|
|                        |   |                 |      |                 |   |                  |   |                |    |
| February 28, 2002      |   | $                    | 3,168,568 |                 | $      | 3,578,591             |   | $                   | 329,334 |   | $ | 7,076,493 | (1) |
| May 31, 2002                |   | 2,370,775            |      | 3,949,851            |   | 109,172               |   | 6,429,798           | (1)     |
| August 31, 2002        |   | 3,133,682            |      | 3,665,681            |   | 48,941                |   | 6,848,304           | (1)     |
| November 30, 2002      |   | 2,799,663            |      | 4,057,299            |   | 160,428               |   | 7,017,390           | (1)     |
| February 28, 2003      |   | 2,319,559            |      | 4,206,037            |   | 336,188               |   | 6,861,784           | (1)     |
| May 31, 2003                |   | 1,777,890            |      | 3,978,704            |   | 153,860               |   | 5,910,454           | (1)     |
| August 31, 2003        |   | 1,480,191            |      | 2,946,741            |   | 117,382               |   | 4,544,314           |    |
| November 30, 2003      |   | 918,284              |      | 2,515,042            |   | (31,080               | )      | 3,402,246           |    |
| February 29, 2004      |   | 447,930              |      | 2,859,577            |   | (46,457               | )      | 3,261,050           |    |
|                             |        |                      |           |                      |        |                       |        |                     |         |  |  |  |  |

 

----

(1)Our majority owned subsidiary, Montvale management, LLC, was sold in

 

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March 2003.Such subsidiary contributed to quarterly Selling and G&A expenses asfollows:

 
| **Quarterly  period ended**                      |   |      |    |
|--------------------------------------------------|--------|-----------|---------|
|                                             |   |      |    |
| February 28, 2002                           |   | $         | 638,358 |   |
| May 31, 2002                                     |   | 890,686   |    |
| August 31, 2002                             |   | 1,130,917 |    |
| November 30, 2002                           |   | 1,233,823 |    |
| February 28, 2003                           |   | 1,525,615 |    |
| May 31, 2003 (activity sold in  March 2003) |   | 33,607    |    |
|                                                  |        |           |         |  |

 

Should the trend of quarterly decreases innet revenue, as recognized to February 29, 2004, continue in futurequarterly fiscal periods, and the corresponding overhead environment remainstable, or be subject to increases necessary to generate revenues, ourliquidity trends and our capital resources could be adversely affected.

 

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

 

We currently earn the most significantportion of our revenue from the E-commerce segment pursuant to marketingagreements with marketing partners and corporate customers. The provisions ofeach agreement determine the type and timing of revenue to be recorded. Weinvoice our customers in accordance with the terms of the underlying agreement.Revenue is recognized at the time the marketing activity is delivered, orservice is provided, net of estimated contractually specified dataqualification allowances, when applicable. Such data qualification allowancesmay include duplications, invalid addresses, and age restrictions, and arerecorded as contra-revenue. Our revenues are adjusted in later fiscal periodsif actual allowances vary from amounts previously estimated. Historically, thevariance between actual allowances and previously estimated allowances has beenimmaterial. If events were to occur that would cause actual allowances (which arerecorded as offsets against

 

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gross revenue, as contra-revenues, inarriving at reported net revenue) to vary significantly from those originallyestimated and 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 arerecorded at the time revenue is recognized. They include costs payable to otheron-line, as well as off-line, media companies for generating registered usersand consumer data for us, database fee sharing costs under third-party databaseuse agreements, email message delivery costs, contingent-based prizeindemnification coverage (i.e., sweepstakes payout indemnification), estimatedpremium fulfillment costs related to the respective promotion (if applicable)and all other variable costs directly associated with completing ourobligations relative to the revenue being recognized. Our actual premiumfulfillment estimates have varied from that which were accrued at the time ofrecording the related revenue. This is deemed a change in management’sestimate, and we take the additional cost, or benefit, on the accrualadjustment in the fiscal period that the variance is determinable. The threemonths ended February 28, 2003 included a benefit of approximately$507,000 on the adjustment of the premium fulfillment accruals fromNovember 30, 2002.

 

Should the Internet operating landscapechange resulting in (a) higher costs of acquiring consumer data and registeredusers for our websites; (b) higher costs of acquiring data for our marketingpartners, compromising such marketing partners’ ability to maintain adequatesized databases to allow for continued third-party database use agreements; (c)the InfiKnowledge asset acquisition failing to maintain a lower cost of ouremail delivery activities and web development and web hosting service costs ascompared to our competitors, or us being required to depend on third-partyemailing service

 

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bureaus, to a degree higher, and/or at acost in excess of our anticipated internally-generated costs, than thatcurrently utilized during the three months ended February 29, 2004, orother currently unknown third party influences on our ability to deliver emailmessages to the records in our databases, or the records in our marketingaffiliates’ databases; (d) our contingent-based prize indemnification premiumsfor indemnification coverage increasing due to an increase in the number ofprize winners at the sites, or as a result of the insurance industry ingeneral, or other currently unknown factors; (e) our accruals for fulfillmentobligations arising out of promotions proving to be less than the actualredemptions processed in subsequent fiscal periods; or (f) unpredictabletechnology changes or commercial technology applications; then, if any one, ora combination, of the above factors were to materialize we could suffermaterial deterioration in future fiscal period revenue growth and gross marginsand, therefore, our profitability, cash flows and capital resources could bematerially adversely affected.

 

Revenue recognition is also subject toprovisions based 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 operating results,financial condition, or bankruptcy filings, of our customers. As a result ofthis review process, we record bad debt provisions to adjust the relatedreceivables’ carrying amount to an estimated realizable value. Provisions forbad debts are also recorded due to the review of other factors, including thelength of time the receivables are past due, historical experience and otherfactors obtained during the conduct of collection efforts. If circumstanceschange regarding our specific customers on an individual basis, or if demandfor Internet direct marketing softens, or if the U.S. economy stumbles, ourestimates for bad debt provisions could be further increased, which couldadversely affect

 

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our operating margins, profitability, cashflows and capital resources.

 

**Major Customers and Disposition of Majority-owned Subsidiary**

 

During the three months ended February 29, 2004, one customer in our E-commerce segment accounted for approximately $1.0 million, or 13.5% of consolidated net revenue. Approximately $0.4 million, or 9.5% of consolidated net accounts receivable, was attributable to such major customer as of February 29, 2004. No other single customer had net revenues that equaled or exceeded 9% of consolidated net revenues for the three months ended February 29, 2004. During the three months ended February 28, 2003, no single customer had net revenues that equaled or exceeded 8% of consolidated net revenues for such period.

 

Currently, 21.2% of our revenue is derived from our proprietary products; 19.5% from iMatchUp.com, our online dating sites, and 1.7% from our LEC Billed Product segment.

 

In March 2003, we sold our interest inour majority-owned subsidiary, Montvale Management LLC, for $1.6 million, plusour investment. Pursuant to the terms of the sale, we received $1 million incash at closing on March 7, 2003. Additionally, we received a note fromthe Purchaser for $600,000, payable in 24 monthly installments of $25,000. Wehave also received approximately $299,000, representing our GAAP basis capitalaccount in such majority-owned subsidiary as at November 30, 2002.  We also entered into a  two-year Media Purchase Agreement whereby weagreed to provide certain media lead generation and related services to thecontinuing owners of Montvale for consideration of $40,000 per month over theterm of the agreement. We estimate that the cash flow from the Media PurchaseAgreement will equal or exceed the cash flows surrendered pursuant to the dispositionof the majority-owned subsidiary.

 

Our revenues and profitability fromoperations have historically varied.

 

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Our revenues, cost of providing revenues,profit margins and overhead expenses have varied historically among segments,as well as on a consolidated basis. The revenue allocation among our segmentsin future periods will most probably be different than our current revenueallocation due to several factors, including consumer tastes, business opportunities,regulatory issues that may exist in future periods, and other currently unknownfactors that could impact our revenue generating cycle or cost structure.Therefore, it is difficult to predict revenue and gross margin trends, andtheir corresponding impact on liquidity and capital resources. Actual trendsmay cause 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 that any such potential change would besuccessful in its implementation, and there can be no assurance that any suchimplementation would benefit our operating margins, profitability, cash flowsor capital resources.

 

**Impairment of Goodwill, Other Intangibles and investmentPortfolio Could Impact net Income**

 

We carry goodwill and other identifiableintangibles on our balance sheet arising from prior-year acquisitions. We arerequired to review, at least annually, such goodwill and other identifiableintangibles for any asset impairment. If the review of the goodwill and otheridentifiable intangibles related to the subsidiaries organized to acquire suchassets determines that

 

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such assets are impaired, then we will berequired to recognize an impairment charge on such goodwill and otheridentifiable intangibles necessary to reduce the carrying value of the assetsto their net realizable value. Should events occur that would give rise to suchimpairment charge, we would recognize decreased profitability to the extent ofsuch adjustment. Cash flows would not be directly affected by the impairmentcharge, but cash flows would, most likely, be adversely affected as a result ofthe facts and circumstances that created the impairment charge.

 

**Market Fluctuation and Debt Repayment Risk of MarketableSecurities Investment Portfolio**

 

We maintain an investment portfolio that ismanaged by 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 ofFebruary 29, 2004 amounted to approximately $1.8 million. Theseinvestments are subject to market price volatility, in addition to thepotential for business failure at the company level. Moreover, due to theeconomic downturn and difficulties that may be faced by some of the companiesin which we have investments, our investment portfolio could be furtherimpaired by the failure of such companies to fulfill their responsibility ofadhering to the repayment of principal upon maturity. Additionally, our cashflows and interest income could be negatively impacted by continued FederalReserve Bank interest rate reductions.

 

**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-14(c) and15d-14(c) as of the end of period covered by this Quarterly Report (the“Evaluation Date”) have

 

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concluded that as of the Evaluation Date,our disclosure controls and procedures were adequate and effective to ensurethat material information relating to us and our consolidated subsidiarieswould be made known to us and them by others within those entities,particularly during the period in which this Quarterly Report was beingprepared.

 

(b) Changes in internal controls.

 

There were no significant changes in ourinternal controls or in other factors that could significantly affect ourdisclosure controls and procedures subsequent to the Evaluation Date, nor anysignificant deficiencies or material weaknesses in such disclosure controls andprocedures requiring corrective actions. As a result, no corrective actionswere taken.

 

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**PARTII**

 

**OTHER INFORMATION**

 

**Item1. Legal Proceedings**

 

The Securities Exchange Act of 1934, asamended (the “Exchange Act”), requires us to describe briefly any materialpending legal proceedings to which we are a party or of which any of ourproperty is subject. The Exchange Act further provides that no information needbe given with respect to any proceeding that involves primarily a claim fordamages if the amount involved, exclusive of interest and costs, does notexceed 10% of our current assets. We believe that all of the claims madeagainst us to date are either without merit or will ultimately result in ajudgment against us (if at all) in an amount less than 10% of our currentassets. Nevertheless, as the plaintiff in the *Wingler*action is seeking damages in excess of 10% of our current assets, and ascertain of the remaining legal claims made against us fail to specify an amountof damages being sought by the plaintiff, and as there is a potential that theultimate damages awarded in a claim could exceed such 10% threshold, incompliance with the Exchange Act, we listed below the *Wingler* action, as well as all legalclaims made against us for which no amount of damages has been specified. The *Qwest* action seeks damages against us inan amount slightly less than 10% of our current assets.

 

*Mavies Wingler -*

 

On or about May 9, 2001, Mavies Winglercommenced an action against Group Lotto, Inc. (“GLI”), one of ourwholly-owned subsidiaries, in the Circuit Court of Logan County, West Virginia.Ms. Wingler claims to have picked the winning numbers entitling her to$10 million. On June 8, 2001, the action was removed to the UnitedStates District Court, Southern District of

 

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West Virginia, and is entitled *Wingler v. Grouplotto, Inc.*, DocketNumber 2:01–CV–518. At the end of 2002, Ms. Wingler’s attorney withdrew,and she is now representing herself. We and GLI have a contract ofindemnification with SCA Promotions, Inc. to be indemnified for prizespaid out to qualified winners. GLI winners are required to produce the GroupLotto Entry Notification form (“GLEN”) within a specified period of time aftermatching a drawing’s winning numbers in order to qualify for receipt of theappropriate prize winnings. We do not believe that there is any merit to Ms. Wingler’sclaim and intend to vigorously continue our defense thereof.

 

In March 2004, the Court granted ourmotion for summary judgment dismissing the complaint. Ms. Wingler has filed anappeal, which she must perfect by April 30, 2004. We intend to continue todefend against the claim.

 

*Plasmanet*

 

On November 21, 2002,Plasmanet, Inc., one of our competitors, commenced an action allegingpatent infringement and misappropriation of trade secrets entitled *Plasmanet, Inc. v. Apax Partners, Inc.,et al.,* Case No. 02 Civ 9290 (S.D.N.Y.). Plasmanetoperates a website, FreeLotto.com, which is similar to one operated by GLI.Plasmanet alleged that on September 24, 2002 it obtained a patent for a“Free Remote Lottery System” and that we infringed this patent. In addition,Plasmanet asserted that trade secrets were contained in a private placementmemorandum and that we misappropriated these trade secrets after we wereallegedly shown such private placement memorandum by an agent of Plasmanet’sinvestment banker. The complaint sought injunctive relief and unspecified moneydamages. We asserted counterclaims, inter alia, to declare Plasmanet’s patentinvalid. In December 2003, the complaint was dismissed with prejudice withrespect to Plasmanet’s patent infringement claim and our counterclaims, andwithout prejudice with respect to the misappropriation of

 

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trade secrets claim. Such misappropriationclaim has been reasserted by Plasmanet in New York court (Sup. Ct. N.Y. Co.,January 27, 2004, Index No. 60021-04). We believe there is no merit to thereasserted claim and have filed a motion to dismiss this claim, that motion iscurrently scheduled to be submitted on May [ - ], 2004. We intend to vigorouslydefend against this action.

 

*Qwest Communications*

 

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 ofSibley, Case No. C0-00-242. In that action, plaintiffs claim that fromSeptember 1998 to July 1999, they were misled when they weresolicited to change their long distance carrier to Qwest. They assert that theywere not told that they would have to stay at certain hotels and pay theirregular rates as part of a promotion, which offered them free airline tickets.We introduced the promotion (“Fly Free America”) to Qwest, and were retained byQwest to operate the telemarketing campaign. In or about May 2000, we andQwest entered into an agreement terminating our contract and settling theamount due us (the “May 2000 Agreement”). The May 2000 Agreementcontained language which Qwest claims obligates us to indemnify Qwest for anyloss it may sustain by reason of this class action. We maintain that we have noliability in the matter. Fraud claims in the class action have been dismissed,leaving breach of contract and false advertising claims. The court hascertified the class and Qwest is defending the action.

 

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In November 2002, we commenced anarbitration against Qwest to recover certain amounts due us pursuant to theMay 2000 Agreement. In December 2002, Qwest filed counterclaims inthe arbitration relating to the Fly Free America program. Qwest asserts that wemust indemnify Qwest for, among other things, fines and penalties amounting toapproximately $1.5 million which Qwest claims it paid in connection with anumber of consent decrees it entered into with various state attorneys general,an unspecified amount of attorneys’ fees, and any and all expenses, penaltiesor other amounts Qwest becomes liable for in connection with the class action.Qwest also seeks reimbursement of approximately $3.1 million it paid us pursuantto the May 2000 Agreement. A panel of arbitrators was appointed inDecember 2003 and a preliminary conference was held in January 2004.After the conference, a schedule was established for substantive motionsand for hearings in June 2004. The arbitrators also provided for exchangesof information in the arbitration subject to Qwest’s right to seek to preventsuch exchanges. Qwest moved to prevent exchanges of information and thisapplication was granted. Qwest moved for summary judgment with respect to itsindemnification counterclaim. We have opposed the motion and it is scheduled tobe heard on April 20, 2004. We believe that there is no merit to Qwest’scounterclaims and intend vigorously to defend against them, as well as topursue our claim.

 

*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. Columbia House advised usthat it believes that the email in question was not approved by Columbia

 

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House when it was sent, and asserted a claimfor indemnification against us pursuant to our contract. We and Columbia Houseagreed to defer resolution of the indemnification claim (and reserved each ofour respective rights). Columbia House is defending against the class action.Its motion to dismiss the complaint has been denied.

 

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 complaintsought injunctive relief and unspecified damages. Our motion to dismiss thecomplaint was granted in June 2003, and the plaintiff has filed an appeal.We believe that there is no merit to the claim, and, in the event the dismissalof the claim is reversed on appeal, we intend to vigorously defend against it.

 

*Missouri CivilInvestigative Demand*

 

On September 26, 2003, we were servedwith a Civil Investigative Demand by the Missouri Attorney General’s Officerequesting certain documents and inquiring into our Company’s merchandisingpractices in connection with games of chance available for entry atgrouplotto.com. We have responded to the document and information requests andawait a response from the Missouri Attorney General’s Office.

 

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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Item 5.             OtherInformation

 

On April 1, 2004, we announced that wehad acquired an exclusive license for an operating platform created byLiveOnTheNet.com, Inc. (LOTN), a privately held company. We had announced in February 2004that we had entered into an agreement to acquire all of the assets of LOTN. Theasset acquisition plans were discarded in favor of a license agreementresulting from our final stages of due diligence.

 

On April 12, 2004, our Board ofDirectors declared a dividend out of our retained earnings of $0.08 per shareon the outstanding shares of our common stock for the quarter endedFebruary 29, 2004. Such dividend is payable on or about May 10, 2004 toholders of record of such shares at the close of business on May 1, 2004.  We can give you no assurance that our Boardwill declare any dividends in future fiscal periods. Any further declarationswill depend upon our performance, the level of our then current and retainedearnings, capital and other pertinent factors relating to our financialposition. You should not rely on any prior approvals of our Board as anindicator of its intent to approve the declaration of any dividends in thefuture.

 

**Item 6.Exhibitsand Reports on Form 8-K**

 
| ***(a)*** |   | ***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 * |

 

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| 32.1   |   | Section 1350 Certification of Chief Executive Officer * |
|--------|--------|--------------------------------------------------------------|
|   |   |                                                         |
| 32.2   |   | Section 1350 Certification of Chief Financial Officer * |

 

----

*                                         Filedherewith.

 

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

 

(2)                                  Filed as an Exhibitto the Company’s Quarterly Report on Form 10-Q for the fiscal quarter endedAugust 31, 1998, and incorporated herein by reference.

 

(3)                                  Filed as an Exhibitto the Company’s Registration Statement on Form S-1 (the “S-1 RegistrationStatement”), dated September 6, 1995 (File No. 33-96632), and incorporatedherein by reference.

 

***(b)******                                 Reportson Form 8-K.***

 

On February 25, 2004, we filed a Current Report on Form 8-Kincorporating our Fiscal 2003 and Fiscal 2003 fourth quarter’s earningsrelease. Other than the foregoing, we did not file any reports on Form 8-Kduring the first quarter of the fiscal year ending November 30, 2004.

 

**FORWARD LOOKING INFORMATION**

 

This Quarterly Report on Form 10-Q includes “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933 and Section 21E of 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 identify forward-looking statements.  We believe that the assumptions and expectations reflected insuch forward-looking statements are reasonable, based on information availableto it on the date of this Quarterly Report, but no assurances can be given thatthese assumptions and expectations will prove to have been correct or that wewill take any action that we may presently be planning.  We are not undertaking to publicly update orrevise any forward-looking statement if we obtain new information or upon theoccurrence of future events or otherwise.

 

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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           |
| Date:  April 14, 2004 | Chairman and CEO              |
|                                 |                          |
|                                 |                          |
|                                 | By:                           | /s/ Daniel Harvey |   |
|                                 | Daniel Harvey                 |
|                                 | Chief Financial Officer       |
| Date:  April 14, 2004 | (Principal Financial Officer) |
|                                      |                               |  |  |  |  |

 

68

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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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*                                         Filedherewith.

 

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

 

(2)                                  Filed as an Exhibitto the Company’s Quarterly Report on Form 10-Q for the fiscal quarter endedAugust 31, 1998, and incorporated herein by reference.

 

(3)                                  Filed as an Exhibitto the Company’s Registration Statement on Form S-1 (the “S-1 RegistrationStatement”), dated September 6, 1995 (File No. 33-96632), and incorporatedherein by reference.

 

69

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