**UNITED
STATES SECURITIES AND EXCHANGE COMMISSION**
 **WASHINGTON,
D.C. 20549**
 
 **FORM
10-Q**
 
 (Mark
One)
  x Quarterly
Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934
  For the quarterly period ended March 31, 2005
  o Transition
Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act
  For the transition period from _____________ to _______________
 
 Commission File Number 0-24217
 
 
 **YP
CORP.**
 (Exact
Name of Registrant as Specified in Its Charter)
  **Nevada**
      (State
      or Other Jurisdiction ofIncorporation or Organization)
    
    **85-0206668**
      (IRS
      Employer Identification No.)**4840
      East Jasmine St. Suite 105**
      **Mesa,
      Arizona**
      (Address
      of Principal Executive Offices)
    
    **85205**
      (Zip
      Code)
 
 **(480)
654-9646**
 (Registrant’s
Telephone Number, Including Area Code)
  Indicate
by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.     Yes þ No o
  Indicate
by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act).      Yes o No þ
  **APPLICABLE
ONLY TO CORPORATE ISSUERS**
  The
number of shares of the issuer’s common equity outstanding as of May 1, 2005 was
50,869,294 shares of common stock, par value $.001.
  
 **INDEX
TO FORM 10-Q FILING**
 **FOR
THE QUARTER ENDED MARCH 31, 2005**
 
 **TABLE OF CONTENTS**
 
 **PART
I.**
 
 **FINANCIAL
      INFORMATION****Page****Item 1.    Financial
      Statements****Consolidated Balance Sheets as of March 31, 2005 and
      September 30, 2004**
    ******3****Unaudited Consolidated Statements of Operations for the
      Three- and Six-Month Periods Ended March 31, 2005 and****March 31, 2004**
    **4****Unaudited Consolidated Statement of Cash Flows for the
      Six-Month Periods Ended March 31, 2005 and March 31,
      2004**
    **5****Notes to the Unaudited Consolidated Financial
      Statements**
    **6******Item
      2.   Management’s Discussion and Analysis of Financial Condition
      & Results
      of**Operations**
    **13****Item 3.   Quantitative and Qualitative Disclosures
      About Market Risk**
    **37****Item 4.   Controls and
      Procedures**
    **37****PART
      II****OTHER
      INFORMATION****Item 1.   Legal
    Proceedings**
    **38****Item 6.   Exhibits and Reports on Form
      8-K**
    **38****SIGNATURES**
  2
 *Table of Contents*
 
 **PART
I - FINANCIAL INFORMATION**
 
 ITEM
1.  FINANCIAL
STATEMENTS
 **YP CORP. AND SUBSIDIARIES****CONSOLIDATED
      BALANCE SHEETS****March
      31,**
    
    **September
      30,****2005**
    
    **2004****(unaudited)****Assets**Cash
      and equivalents
    
    $
    8,201,559
    
    $
    3,576,529Accounts
      receivable, net of allowance for doubtful accounts of
      $1,273,045and
      $3,400,575
    
    
    6,271,276
    
    
    8,362,283Prepaid
      expenses and other current assets
    
    
    1,180,870
    
    
    822,919Income
      tax refund receivable
    
    
    -
    
    
    1,239,436Deferred
      tax asset
    
    
    -
    
    
    352,379Total
      current assets
    
    
    15,653,705
    
    
    14,353,546Accounts
      receivable, long term portion, net of allowancefor
      doubtful accounts of $85,523 and $269,662
    
    
    1,836,596
    
    
    2,075,334Customer
      acquisition costs, net of accumulated amortization of
      $3,977,694and
      $5,096,669
    
    
    2,980,972
    
    
    4,482,173Property
      and equipment, net
    
    
    579,468
    
    
    725,936Deposits
      and other assets
    
    
    60,919
    
    
    239,060Intangible
      assets, net of accumulated amortization of $2,849,428 and
      $2,446,403
    
    
    3,139,018
    
    
    3,326,274Advances
      to affiliates
    
    
    4,052,834
    
    
    3,894,862Total
      assets
    
    $
    28,303,512
    
    $
    29,097,185**Liabilities
      and Stockholders' Equity**Accounts
      payable
    
    $
    584,211
    
    $
    1,210,364Accrued
      liabilities
    
    
    413,416
    
    
    542,481Income
      taxes payable
    
    
    243,497
    
    
    -Deferred
      tax liability
    
    
    14,988
    
    
    -Notes
      payable- current portion
    
    
    115,868
    
    
    115,868Total
      current liabilities
    
    
    1,371,980
    
    
    1,868,713Deferred
      income taxes
    
    
    408,220
    
    
    1,116,314Total
      liabilities
    
    
    1,780,200
    
    
    2,985,027Commitments
      and contingencies
    
    
    -
    
    
    -Series
      E convertible preferred stock, $.001 par value, 200,000 shares
      authorized,127,840
      and 128,340 issued and outstanding, liquidation preference
      $38,202
    
    
    10,866
    
    
    10,909Common
      stock, $.001 par value, 100,000,000 shares authorized,50,254,294
      and 50,071,302 issued and outstanding
    
    
    50,254
    
    
    50,071Paid
      in capital
    
    
    10,131,250
    
    
    11,375,384Deferred
      stock compensation
    
    
    (3,965,108
    )
    
    (5,742,814
    )Retained
      earnings
    
    
    20,296,050
    
    
    20,418,608Total
      stockholders' equity
    
    
    26,523,312
    
    
    26,112,158Total
      liabilities and stockholders' equity
    
    $
    28,303,512
    
    $
    29,097,185See
      accompanying notes to consolidated financial
statements.
  3
 *Table of Contents*




**YP CORP. AND SUBSIDIARIES****UNAUDITED
      CONSOLIDATED STATEMENTS OF OPERATIONS****Three
      Months Ended March 31,**
    
    **Six
      Months Ended March 31,****2005**
    
    **2004**
    
    **2005**
    
    **2004**Net
      revenues
    
    $
    6,444,609
    
    $
    16,367,853
    
    $
    12,634,764
    
    $
    30,207,820Cost
      of services
    
    
    860,933
    
    
    6,600,782
    
    
    1,995,517
    
    
    11,482,984Gross
      profit
    
    
    5,583,676
    
    
    9,767,071
    
    
    10,639,247
    
    
    18,724,836Operating
      expenses:General
      and administrative expenses
    
    
    3,181,644
    
    
    3,107,522
    
    
    6,566,495
    
    
    5,871,265Sales
      and marketing expenses
    
    
    1,720,034
    
    
    1,445,965
    
    
    3,330,527
    
    
    2,736,345Depreciation
      and amortization
    
    
    298,192
    
    
    199,719
    
    
    593,879
    
    
    395,912Total
      operating expenses
    
    
    5,199,870
    
    
    4,753,206
    
    
    10,490,901
    
    
    9,003,522Operating
      income
    
    
    383,806
    
    
    5,013,865
    
    
    148,346
    
    
    9,721,314Other
      income (expense):Interest
      expense and other financing costs
    
    
    (4,447
    )
    
    (3,795
    )
    
    (8,610
    )
    
    (7,667
    )Interest
      income
    
    
    91,650
    
    
    82,340
    
    
    176,762
    
    
    157,365Other
      income
    
    
    21,088
    
    
    71,395
    
    
    107,453
    
    
    346,153Total
      other income (expense)
    
    
    108,291
    
    
    149,940
    
    
    275,605
    
    
    495,851Income
      before income taxes and cumulativeeffect
      of accounting change
    
    
    492,097
    
    
    5,163,805
    
    
    423,951
    
    
    10,217,165Income
      tax benefit (provision)
    
    
    (193,817
    )
    
    (1,815,206
    )
    
    (176,447
    )
    
    (3,583,881
    )Income
      before cumulative effect ofaccounting
      change
    
    
    298,280
    
    
    3,348,599
    
    
    247,504
    
    
    6,633,284Cumulative
      effect of accounting change (net ofincome
      taxes of $53,764 in 2004)
    
    
    -
    
    
    -
    
    
    99,848
    
    
    -Net
      income
    
    $
    298,280
    
    $
    3,348,599
    
    $
    347,352
    
    $
    6,633,284Net
      income per common share:Basic:Income
      applicable to common stock before cumulative effect of accounting
      change
    
    $
    0.01
    
    $
    0.07
    
    $
    0.01
    
    $
    0.14Cumulative
      effect of accounting change
    
    $
    -
    
    $
    -
    
    $
    0.00
    
    $
    -Net
      income applicable to common stock
    
    $
    0.01
    
    $
    0.07
    
    $
    0.01
    
    $
    0.14Diluted:Income
      applicable to common stock before cumulative effect of accounting
      change
    
    $
    0.01
    
    $
    0.07
    
    $
    0.01
    
    $
    0.14Cumulative
      effect of accounting change
    
    $
    -
    
    $
    -
    
    $
    0.00
    
    $
    -Net
      income applicable to common stock
    
    $
    0.01
    
    $
    0.07
    
    $
    0.01
    
    $
    0.14Weighted
      average common shares outstanding:Basic
    
    
    46,749,794
    
    
    46,946,458
    
    
    46,749,544
    
    
    46,904,402Diluted
    
    
    46,825,577
    
    
    48,145,140
    
    
    46,901,954
    
    
    47,640,118See
      accompanying notes to consolidated financial
statements.


4
 *Table of Contents*




**YP CORP. AND SUBSIDIARIES****UNAUDITED
      CONSOLIDATED STATEMENTS OF CASH FLOWS****Six
      Months Ended March 31,****2005**
    
    **2004**CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income
    
    $
    347,352
    
    $
    6,633,284Adjustments
      to reconcile net income to net cashprovided
      by operating activities:Depreciation
      and amortization
    
    
    593,878
    
    
    395,912Amortization
      of deferred stock compensation
    
    
    567,599
    
    
    503,071Issuance
      of common stock as compensation for services
    
    
    119,500
    
    
    -Cumulative
      effect of accounting change
    
    
    (99,848
    )
    
    -Deferred
      income taxes
    
    
    (394,491
    )
    
    37,962Loss
      on disposal of equipment
    
    
    -
    
    
    36,932Provision
      for uncollectible accounts
    
    
    (16,220
    )
    
    -Changes
      in assets and liabilities:Accounts
      receivable
    
    
    2,345,965
    
    
    (5,801,351
    )Customer
      acquisition costs
    
    
    1,501,201
    
    
    (502,547
    )Prepaid
      and other current assets
    
    
    (357,951
    )
    
    (152,539
    )Deposits
      and other assets
    
    
    178,141
    
    
    35,000Accounts
      payable
    
    
    (626,153
    )
    
    394,051Accrued
      liabilities
    
    
    (129,065
    )
    
    (72,743
    )Income
      taxes payable
    
    
    1,482,933
    
    
    1,466,113Advances
      to affiliates (accrued interest)
    
    
    (157,972
    )
    
    -Net
      cash provided by operating activities
    
    
    5,354,869
    
    
    2,973,145CASH
      FLOWS FROM INVESTING ACTIVITIES:Advances
      made to affiliates and related parties
    
    
    -
    
    
    (2,725,000
    )Expenditures
      for intangible assets
    
    
    (215,767
    )
    
    -Purchases
      of equipment
    
    
    (44,387
    )
    
    (384,991
    )Net
      cash used for investing activities
    
    
    (260,154
    )
    
    (3,109,991
    )CASH
      FLOWS FROM FINANCING ACTIVITIES:Series
      E preferred stock dividends
    
    
    (960
    )
    
    -Common
      stock dividends
    
    
    (468,950
    )
    
    -Proceeds
      from conversion of preferred stock
    
    
    225
    
    
    -Net
      cash used for financing activities
    
    
    (469,685
    )
    
    -INCREASE
      (DECREASE) IN CASH AND CASH EQUIVALENTS
    
    
    4,625,030
    
    
    (136,846
    )CASH
      AND CASH EQUIVALENTS, beginning of period
    
    
    3,576,529
    
    
    2,378,848CASH
      AND CASH EQUIVALENTS, end of period
    
    $
    8,201,559
    
    $
    2,242,002See
      accompanying notes to consolidated financial statements.


5
 *Table of Contents*


**YP CORP. AND SUBSIDIARIES**
 **NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**





1.
    ORGANIZATION
      AND BASIS OF PRESENTATION





The
accompanying consolidated financial statements include the accounts of YP Corp.,
a Nevada Corporation, and its wholly owned subsidiaries (collectively the
“Company”). The Company is an Internet-based provider of yellow page directories
and advertising space on or through www.YP.com, www.YP.net
and www.Yellow-Page.net .
No material or information contained on these websites is a part of the notes or
the quarterly report to which notes are attached. All material intercompany
accounts and transactions have been eliminated.




The
accompanying unaudited financial statements as of March 31, 2005 and for the
three and six months ended March 31, 2005 and 2004,  respectively,
have been prepared in accordance with generally accepted accounting principles
for interim financial information. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for audited financial statements. In the opinion of the Company’s management,
the interim information includes all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of the results for the
interim periods. The footnote disclosures related to the interim financial
information included herein are also unaudited. Such financial information
should be read in conjunction with the consolidated financial statements and
related notes thereto as of September 30, 2004 and for the year then ended
included in the Company’s annual report on Form 10-KSB for the year ended
September 30, 2004.




All
amounts, except share and per share amounts, are rounded to the nearest thousand
dollars.




The
preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amount of assets and liabilities at the date of the
financial statements and the reported amount of revenues and expenses during the
reporting period. Significant estimates and assumptions have been used by
management in conjunction with establishing
allowances for customer refunds, non-paying customers, dilution and fees,
analyzing the recoverability of the carrying amount of intangible assets,
estimating amortization periods for direct response advertising costs,
estimating forfeitures of restricted stock and evaluating the recoverability of
deferred tax assets. Actual results could differ from these estimates. Certain
prior period amounts have been revised to conform to the current period
presentation. These changes had no impact on previously reported net income or
stockholders’ equity.





2.
    ACCOUNTING
      CHANGES





Effective
October 1, 2004, the Company changed its method of accounting for forfeitures of
restricted stock granted to employees, executives and consultants. Prior to this
date, the Company recognized forfeitures as they occurred. Upon occurrence, the
Company reversed the previously recognized expense associated with such grant.
Effective October 1, 2004, the Company changed to an expense recognition method
that is based on an estimate of the number of shares for which the service is
expected to be rendered. The Company believes that this is a preferable method
as it provides less volatility in expense recognition.




6
 *Table of Contents*





Additionally,
while both methods of accounting for forfeitures are acceptable under current
guidance, the implementation of FAS 123R
(effective during the Company’s first
quarter of fiscal 2006) will no longer permit companies to recognize forfeitures
as they occur .
See Note 8. As this new guidance will require the Company to change its method
of accounting for restricted stock forfeitures, the Company has decided to adopt
such change as of the beginning of its fiscal year. The Company is not adopting
the provisions of FAS 123R prior to its effective date. Rather, the Company is
changing its accounting for forfeitures under the allowed options prescribed in
FAS 123.





The
impact of this change for periods prior to October 1, 2004 was an increase to
income of $100,000 (less than $0.01 per share), net of taxes of $54,000, and has
been reflected as a cumulative effect of a change in accounting principle in the
Company’s consolidated statement of operations for the six months ended March
31, 2005. Because stock grants are now recorded net of estimated forfeitures,
the cumulative effect of this change also reduced Additional Paid in Capital and
Deferred Compensation by $1,013,000 and $1,166,000, respectively, at October 1,
2004. The effect of the change during the three and six months ended March 31,
2005 was to increase net income by $22,000 and $53,000 (net of income taxes of
$13,000 and $31,000), respectively.





The
estimated pro forma effects of the accounting change on the Company’s results of
operations for the three and six months ended March 31, 2004 are as
follows:


**Three
      Months Ended March 31, 2004**
    
    **Six
      Months Ended March 31, 2004**As
      reported:Net
      income
    
    $
    3,349,000
    
    $
    6,633,000Basic
      net income per share
    
    $
    0.07
    
    $
    0.14Diluted
      net income per share
    
    $
    0.07
    
    $
    0.14Pro
      forma amounts reflecting the accounting change applied
      retroactively:Net
      income
    
    $
    3,393,000
    
    $
    6,715,000Basic
      net income per share
    
    $
    0.07
    
    $
    0.14Diluted
      net income per share
    
    $
    0.07
    
    $
    0.14


7
 *Table of Contents*




3.
    BALANCE
      SHEET INFORMATION
 
 Balance
sheet information is as follows:


**March
      31, 2005**Current
    
    Long-Term
    
    TotalGross
      accounts receivable
    
    $
    7,544,000
    
    $
    1,922,000
    
    $
    9,466,000Allowance
      for doubtful accounts
    
    
    (1,273,000
    )
    
    (85,000
    )
    
    (1,358,000
    )Net
    
    $
    6,271,000
    
    $
    1,837,000
    
    $
    8,108,000**September
      30, 2004**Current
    
    
    Long-Term
    
    
    TotalGross
      accounts receivable
    
    $
    11,763,000
    
    $
    2,345,000
    
    $
    14,108,000Allowance
      for doubtful accounts
    
    
    (3,401,000
    )
    
    (270,000
    )
    
    (3,671,000
    )Net
    
    $
    8,362,000
    
    $
    2,075,000
    
    $
    10,437,000Components
      of allowance for doubtful accounts are as follows:**March
      31, 2005**
    
    
    
    
    
    **September
      30, 2004**Allowance
      for dilution and fees on amounts due from billing
    aggregators
    
    $
    1,067,000
    
    
    
    
    $
    2,978,000Allowance
      for customer refunds
    
    
    291,000
    
    
    
    
    
    638,000Other
      allowances
    
    
    -
    
    
    
    
    
    55,000$
    1,358,000
    
    
    
    
    $
    3,671,000Property
      and equipment consists of the following:**March
      31, 2005**
    
    
    
    
    
    **September
      30, 2004**Leasehold
      improvements
    
    $
    439,000
    
    
    
    
    $
    439,000Furnishings
      and fixtures
    
    
    298,000
    
    
    
    
    
    298,000Office,
      computer equipment and other
    
    
    1,038,000
    
    
    
    
    
    993,000Total
    
    
    1,775,000
    
    
    
    
    
    1,730,000Less
      accumulated depreciation
    
    
    (1,195,000
    )
    
    
    
    
    (1,004,000
    )Property
      and equipment, net
    
    $
    580,000
    
    
    
    
    $
    726,000
 4.
    COMMITMENTS
      AND CONTINGENCIES
 
 At
March 31, 2005, future minimum annual lease payments under operating lease
agreements for fiscal years ended September 30 are as follows:
  Remainder
      of Fiscal 2005
    
    $
    220,000Fiscal
      2006
    
    
    326,000Fiscal
      2007
    
    
    19,000Thereafter
    
    
    -Total
    
    $
    565,000
   8
 *Table of
Contents*




Commitments
to Investment Banking Firm
  On
October 8, 2004, pursuant to the terms of a Letter Agreement with Jefferies
& Company, Inc., the Company issued a total of 925,000 shares of common
stock to Jefferies. These shares were issued in lieu of cash fees for Jefferies’
investment banking services. These shares were not issued under the Company’s
2003 Stock Plan. Of the total shares issued to Jefferies, 100,000 shares were
issued without restrictions on transfer other than those imposed by Rule 144
under the Securities Act of 1933, as amended. The remaining 825,000 shares were
granted pursuant to a Restricted Stock Agreement. Accordingly, these shares
remain subject to restrictions on transfer and sale, which lapse in accordance
with a vesting schedule depending on the achievement of certain performance
goals.
 
 In
accordance with the provisions of EITF Topic D-90, *Grantor
Balance Sheet Presentation of Unvested, Forfeitable Equity Instruments Granted
to a Nonemployee,* because
the Company has a right to receive future services in exchange for unvested,
forfeitable equity instruments, the 825,000 shares are treated as unissued for
accounting purposes until such time that the performance goals are achieved.
  Commitments
to Stockholders
  As
part of the December 2003 agreement between the Company and two of its largest
stockholders, Morris & Miller, Ltd. and Mathew & Markson, Ltd., the
Company terminated all prior obligations to make advances to these stockholders.
Accrued interest on outstanding balances are reflected in the Due from
Affiliates line item of the accompanying balance sheet.
 
 As
part of this agreement, the Company agreed to pay recurring quarterly dividends
of not less than $0.01 per share to all of its common stockholders, subject to
applicable law and certain restrictions with respect to the Company’s
liquidity *.* The
quarterly dividend associated with the second quarter
of fiscal 2005 was declared and paid in April 2005 and, therefore, was not accounted for
in the three months ended March 31, 2005.
 
 Termination
Agreements with Related Parties
  Prior
to fiscal 2004, the Company entered into Executive Consulting Agreements with four entities,
each of which was controlled by one of the Company’s four executive officers at
that time and through which each entities’ support staff provided executive
management services to the Company. During
the fiscal year ended September 30, 2004, the Company terminated the Executive
Consulting Agreements with the entities controlled by its former CEO, former
Executive Vice President of Marketing, and former CFO. In the case of the former
CEO, the Company will pay Sunbelt Financial Concepts, Inc. $960,000 over two
years in lieu of the amounts due under the original contract, which called for
approximately $2.6 million in payments over three years. In the case of the
former Executive Vice President of Marketing, the Company will pay Advertising
Management & Consulting Services, Inc. $697,000 over two years in lieu of
the amounts due under the original contract, which called for approximately $1.9
million in payments over three years. In the case of the former CFO, the Company
paid MAR & Associates, Inc. $120,000 over six months in lieu of the amounts
due under the original contract, which called for approximately $750,000 in
payments over three years. With respect to these agreements, approximately
$1,360,000 of the settlement payments described above has been allocated to
non-compete agreements, as paid, based on values determined by an independent
third party valuation firm. The non-compete agreements extend for six years. The
balance of the payments will be expensed as incurred as two of the agreements
call for ongoing services to be provided over a two-year period.  See
Note 6.
 
 9
 *Table of Contents*
 
 During
the three months ended December 31, 2004, the Company terminated the remaining
Executive Consulting Agreement with Advanced Internet Marketing, Inc., an entity
controlled by DeVal Johnson, a director and former Executive Vice President.
Under the terms of this termination agreement, the Company will pay $368,000
over an 18-month period of time. Approximately $281,000 of this amount has been
allocated to non-compete agreements, as paid. See Note 6.
  5.
    NET
      INCOMEPER SHARE
 
 Net
income per
share is calculated using the weighted average number of shares of common stock
outstanding during the year. Preferred stock dividends are subtracted from net
income  to
determine the amount available to common stockholders.
  10
 *Table of Contents*
  The
following table presents
the computation of basic and diluted income per share:
 **Three
      Months Ended March 31,**
    
    **Six
      Months Ended March 31,****2005**
    
    **2004**
    
    **2005**
    
    **2004**Income
      before cumulative effect of accounting change
    
    $
    298,000
    
    $
    3,349,000
    
    $
    248,000
    
    $
    6,633,000Less:
      preferred stock dividends
    
    
    -
    
    
    -
    
    
    (1,000
    )
    
    (1,000
    )Income
      applicable to common stock before cumulative effect of accounting
      change
    
    
    298,000
    
    
    3,349,000
    
    
    247,000
    
    
    6,632,000Cumulative
      effect of accounting change
    
    
    -
    
    
    -
    
    
    100,000
    
    
    -Net
      income applicable to common stock
    
    $
    298,000
    
    $
    3,349,000
    
    $
    347,000
    
    $
    6,632,000Basic
      weighted average common shares outstanding
    
    
    46,749,794
    
    
    46,946,458
    
    
    46,749,544
    
    
    46,904,402Add
      incremental shares for:Unvested
      restricted stock
    
    
    3,795
    
    
    990,886
    
    
    73,021
    
    
    608,739Series
      E convertible preferred stock
    
    
    71,988
    
    
    -
    
    
    79,389
    
    
    -Outstanding
      warrants
    
    
    -
    
    
    207,796
    
    
    -
    
    
    126,977Diluted
      weighted average common shares outstanding
    
    
    46,825,577
    
    
    48,145,140
    
    
    46,901,954
    
    
    47,640,118Net
      income per share:Basic:Income
      applicable to common stock before cumulative effect of accounting
      change
    
    $
    0.01
    
    $
    0.07
    
    $
    0.01
    
    $
    0.14Cumulative
      effect of accounting change
    
    $
    0.00
    
    $
    0.00
    
    $
    0.00
    
    $
    0.00Net
      income applicable to common stock
    
    $
    0.01
    
    $
    0.07
    
    $
    0.01
    
    $
    0.14Diluted:Income
      applicable to common stock before cumulative effect of accounting
      change
    
    $
    0.01
    
    $
    0.07
    
    $
    0.01
    
    $
    0.14Cumulative
      effect of accounting change
    
    $
    0.00
    
    $
    0.00
    
    $
    0.00
    
    $
    0.00Net
      income applicable to common stock
    
    $
    0.01
    
    $
    0.07
    
    $
    0.01
    
    $
    0.14


The
following potentially dilutive securities were excluded from the calculation of
net income per share because the effects are antidilutive:
 **Three
      Months Ended March 31,**
    
    **Six
      Months Ended March 31,****2005**
    
    **2004**
    
    **2005**
    
    **2004**Warrants
      to purchase shares of common stock
    
    
    500,000
    
    
    500,000
    
    
    500,000
    
    
    500,000Shares
      of non-vested restricted stock
    
    
    2,920,831
    
    
    -
    
    
    1,978,591
    
    
    5,0113,420,831
    
    
    500,000
    
    
    2,478,591
    
    
    505,011


6.
    RELATED
      PARTY TRANSACTIONS
   As
described in Note 4, the former CEO, CFO, Executive Vice President and Corporate Secretary provided their services and those of their respective staffs through separate entities
controlled by these individuals. All
of these contracts were terminated prior to March 31, 2005. The
following table includes the compensation paid to these entities during the three months ended March 31, 2005 and the amounts remaining to be
paid as of March 31, 2005, pursuant to the termination agreements between the
Company and the former officers’ respective entities.




11
 *Table of Contents*




****Payments
      Under Termination Agreements for the Quarter
      Ended**March 31, 2005**
    
    ****Remaining
      Termination Payments as of**March 31,
      2005**Sunbelt
      Financial Concepts
    
    $
    53,000
    
    $
    550,000Advertising
      Management & Consulting Services, Inc.
    
    
    32,000
    
    
    371,000Advanced
      Internet Marketing, Inc.
    
    
    95,000
    
    
    208,000MAR
      & Associates
    
    
    20,000
    
    
    -$
    200,000
    
    $
    1,129,000


7.
    CONCENTRATION
      OF CREDIT RISK
 
 The
Company maintains cash balances at major nationwide institutions in Arizona and
Nevada. Accounts are insured by the Federal Deposit Insurance Corporation up to
$100,000. At March 31, 2005, the Company had bank balances exceeding those
insured limits of approximately
$7,897,000.
  Financial
instruments that potentially subject the Company to concentrations of credit
risk are primarily trade accounts receivable. The trade accounts receivable are
due primarily from business customers over widespread geographical locations
within the LEC billing areas across the United States. The Company historically
has experienced significant dilution and customer credits due to billing
difficulties and uncollectible trade accounts receivable. The Company estimates
and provides an allowance for uncollectible accounts receivable. The handling
and processing of cash receipts pertaining to trade accounts receivable is
maintained primarily by two third-party billing companies. The net receivable
due from a single billing services provider at March 31, 2005 was $6,508,000,
net of  an
allowance for doubtful accounts of $698,000. The net receivable from that
billing services provider at March 31, 2005, represents approximately 80% of the
Company’s total net accounts receivable at March 31, 2005.
  8.
    RECENT
      ACCOUNTING PRONOUNCEMENTS
 
 In
December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No.
123R, “Share-Based Payment” (“SFAS 123R”). Under this new standard, companies
will no longer be able to account for share-based compensation transactions
using the intrinsic method in accordance with APB 25. Instead, companies will be
required to account for such transactions using a fair-value method and to
recognize the expense over the service period. This new standard also changes
the way in which companies account for forfeitures of share-based compensation
instruments. SFAS 123R will be effective for periods beginning after June 15,
2005 and allows for several alternative transition methods. In light of this
upcoming change, the Company decided
to change its method of accounting for forfeitures of restricted
stock , under current GAAP rules effective October 1, 2004. See Note 2. The Company expects to adopt the provisions of SFAS 123R in the fourth quarter of fiscal 2005 on a prospective basis and does not expect this to have a material effect on its
financial condition or results of operations.
 
 12
 *Table of Contents*
 
 9.
    SUBSEQUENT
      EVENTS
 
 On
April 1, 2005, the Company and Morris & Miller, Ltd. and Matthew and
Markson, Ltd., (together, the “Shareholders”) entered into a Transfer and
Repayment Agreement (the “Agreement”). Under the Agreement, the Shareholders
satisfied their outstanding debt obligations to the Company (reflected as
Advances to Affiliates in the accompanying Consolidated Balance Sheet) as
follows:
 
 ·
    The
      Shareholders agreed to surrender and deliver to the Company 1,889,566
      shares of its common stock previously owned by the Shareholders;
 
 ·
    The
      Shareholders forgave $115,865 of debt owed by the Company to the
      Shareholders;
 
 ·
    The
      Shareholders released any liens they previously had on any shares of the
      Company’s common stock;
 
 ·
    The
      Shareholders assigned certain intellectual property to the Company; and
 
 ·
    The
      Shareholders agreed to a non-compete and non-solicitation agreement
      whereby the Shareholders and their affiliates agree not to compete with
      the Company or solicit any customers for a period of five years.
 
 The
Company expects this transaction to result in a non-cash charge to its earnings
for the third fiscal quarter ended June 30, 2005 equal to the difference between
the $3,895,000 of debt forgiven and the value of the consideration received. As
the fair value of the intellectual property and non-compete and non-solicitation
agreement has not been determined, the exact amount of the charge is currently
unknown. However, the Company expects the charge to be between $1.7 million and
$2.2 million.
 
 
 ITEM
      2.
    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
      RESULTS OF OPERATIONS
 
 For
a description of our significant accounting policies and an understanding of the
significant factors that influenced our performance during the three and six
months ended March 31, 2005, this “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” should be read in conjunction
with the Consolidated Financial Statements, including the related notes,
appearing in Item 1 of this Quarterly Report ,
as well as the Company’s Annual Report on Form 10-KSB for the year ended
September 30, 2004.
  13
 *Table of Contents*
   **Forward-Looking
Statements**
  This
portion of this Quarterly Report on Form 10-Q, includes statements that
constitute “forward-looking statements.” These forward-looking statements are
often characterized by the terms “may,” “believes,” “projects,” “expects,” or
“anticipates,” and do not reflect historical facts. Specific forward-looking
statements contained in this portion of the Quarterly Report include, but are
not limited to our (i )
assertion that there is an expectation of tremendous growth in online
advertising; (ii )
expectation that our adoption of the provisions of SFAS 123R in the first
quarter of fiscal 2006 on a prospective basis will not have a material effect on
its financial condition or results of operations; (iii) expectation that our
revenues, paying customer count and profitability will continue to grow in the
second half of fiscal 2005 as we continue to migrate customers to alternative
billing channels, attract new customers through marketing initiatives and engage
in cost containment activities ;
and (iv) expectation that cost of services to continue to be directly correlated
to our usage of LEC billing channel
  Forward-looking
statements involve risks, uncertainties and other factors, which may cause our
actual results, performance or achievements to be materially different from
those expressed or implied by such forward-looking statements. Factors and risks
that could affect our results and achievements and cause them to materially
differ from those contained in the forward-looking statements include those
identified in the section titled “Risk Factors,” as well as other factors that
we are currently unable to identify or quantify, but that may exist in the
future.
  In
addition, the foregoing factors may affect generally our business, results of
operations and financial position. Forward-looking statements speak only as of
the date the statement was made. We do not undertake and specifically decline
any obligation to update any forward-looking statements.
  **Executive
Overview**
  This
section presents summary information regarding our industry and operating trends
only. For further information regarding the events summarized herein, you should
read “Management’s Discussion and Analysis of Financial Condition and Results of
Operations” in its entirety.
  *Industry
Overview*
  The
Kelsey Group has published the following market information regarding the growth
of the online and print Yellow Pages advertising revenue market. While print
advertising is expected to be largely flat in the next five years, the Kelsey
Group expects online advertising to experience tremendous growth, as evidenced
by an estimated 29% annual growth rate from 2003 to 2008.
  14
 *Table of Contents*
  **Advertising
      Revenue**
      **(in
      Billions)****2003**
    **Market
      Share**
    **2008**
    **%
      Growth Per Year**
    **Market
      Share****Print**
    $ 
      15.0
    97.0%
    $15.3
    0.4%
    90.0%**Online**
    $ 
      0.45
    3.0%
    $ 
      1.6
    29.0%
    10.0%**Total**
    $15.45
    100.0%
    $16.9
    1.2%
    100.0%
 *Source:
Kelsey Group, September 2004*
  *Business
and Company Overview*
  We
use a business model similar to print Yellow Pages publishers. We publish basic
directory listings on the Internet free of charge. Our basic listings contain
the business name, address, and telephone number for over 17 million U.S.
businesses. We strive to maintain a listing for almost every business in America
in this format.
  We
generate revenues from advertisers that desire increased exposure for their
businesses. As described below, advertisers pay us monthly fees in the same
manner that advertisers pay additional fees to traditional print Yellow Pages
providers for enhanced advertisement font, location or display. The users of our
website are prospective customers for our advertisers, as well as the other
businesses for which we publish basic listings.
  Our
primary product is our Internet Advertising PackageTM, or IAP. Under this
package, advertisers pay for additional exposure by purchasing a Mini-WebPageTM.
In order to provide search traffic to our advertiser’s Mini-WebPage, we elevate
the advertiser to a preferred listing status, at no additional charge. We also
provide our IAP advertisers with enhanced presentation and additional unique
products, such as larger font, bolded business name, map directions, ease of
communication between our advertisers and users of our website, a link to the
advertiser’s webpage, as well as other benefits.
  **Recent
Developments**
  *Changes
in Billing Practices*
  Until
late 2004, we billed most of our customers directly through their monthly phone
bill (referred to as LEC billing). As discussed in recent SEC filings, our
revenues have been negatively impacted by recent changes in LEC billing
practices, which require us to perform additional procedures to confirm new and
existing customers before we are allowed to bill via certain local telephone
companies. There has also been an increasing presence of Competitive Local Exchange Carriers, or CLECs ,
in the local telephone market. If an advertiser changes its telephone service
from a LEC to a CLEC, we are no longer able to utilize LEC billing channels to
bill for services. Therefore we must discontinue revenue recognition until an
acceptable alternate billing method can be implemented.
  15
 *Table of Contents*
 
 During
the fiscal quarter ended March 31, 2005, we continued to deal with the impacts
of the billing issues. As a result, we have made strides to reduce our
dependence on LEC billing and have identified effective alternative methods of
billing our customers. We have
migrated a substantial portion of our customers to automated
clearing house, or ACH, billing,
which is less expensive, has a faster collection time than LEC billing, and
presents minimal dilution. However, it is time-consuming and labor-intensive to
convert customers from one billing channel to another and can result in missed
billings or customer cancellations. In situations where we cannot bill a
customer via LEC or ACH billing, or in instances where the customer requests
that we bill them directly, we utilize direct invoices. Direct billing has a
higher percentage of uncollectible accounts than other billing methods and,
therefore, is our least attractive billing option.
 
 The
following represents the breakdown of net billings by channel during recent
fiscal quarters:
 
 **Q2
      2005**
    **Q1
      2005**
    **Q4
      2004**
    **Q3
      2004**
    **Q2
      2004**LEC
      billing
    26%
    49%
    67%
    92%
    98%ACH
      billing
    56%
    42%
    30%
    6%
    1%Direct
      billing
    18%
    9%
    3%
    2%
    1%
  **
 *Recent
Financial Results*
  The
following represents a summary of recent financial results:
  **Q2
      2005**
    **Q1
      2005**
    **Q4
      2004**
    **Q3
      2004**
    **Q2
      2004**Revenues
    $6,444,609
    $6,190,155
    $10,069,924
    $16,890,361
    $16,367,853Gross
      margin
    5,583,676
    5,055,571
    4,990,492
    8,695,098
    9,874,452Operating
      expenses
    (5,199,870)
    (5,291,031)
    (5,518,453)
    (5,213,413)
    (4,773,053)Operating
      income (loss)
    383,806
    (235,459)
    (527,961)
    3,481,685
    5,101,399Net
      income (loss)
    298,280
    49,072
    (311,721)
    2,639,420
    3,348,599
 
 Our
revenues have been adversely affected as we transition from LEC billing to other
billing methods. During this transitional period, we have experienced increased
customer cancellations and missed billings as we continue to gather the
information necessary to convert customers to more desirable billing methods
such as ACH billing.
  Despite
the effects of the transition from LEC billing, we have experienced the
following recent positive operating trends:
  ·
    Increased
      revenues by approximately 4% in the second quarter of fiscal 2005.
  ·
    Decreased
      operating expenses over the last two quarters despite incurring an
      estimated $550,000 of incremental expenses over the last six months
      associated with the transition from LEC billing to other billing methods.
      This is a result of proactive measures taken to reduce operating expenses,
      including personnel reductions, contract renegotiations, and other cost
      containment measures
  ·
    Increased
      operating income and net income by over $900,000 and $600,000,
      respectively, over the last two quarters despite a 40% reduction in
      revenues over the same period.
  16
 *Table of Contents*
 
 We expect
that our revenues and paying customer count will continue to grow in the second
half of fiscal 2005 as we continue to migrate customers to alternative billing
channels and to attract new customers through marketing initiatives. We also
expect to increase profitability in the second half of fiscal 2005 through
revenue growth and continued cost containment activities.
  *Other*
  On
April 1, 2005, we entered into a Transfer and Repayment Agreement (the
“Agreement”) with Morris & Miller, Ltd. and Matthew and Markson, Ltd.,
(together, the “Shareholders”). Under the Agreement, the Shareholders satisfied
their outstanding debt obligations to us (reflected as Advances to Affiliates in
the accompanying Consolidated Balance Sheet included elsewhere in this report).
See the more detailed discussion of this matter in note 9 in the Notes to
Unaudited Consolidated Financial Statements.
  **Results
of Operations**
  *Net
Revenues*
 **Net
      Revenues****2005**
    
    **2004**
    
    **Change**
    
    **Percent**Three
      Months Ended March 31,
    
    $
    6,444,609
    
    $
    16,367,853
    
    $
    (9,923,244
    )
    
    (61
    )%Six
      Months Ended March 31,
    
    $
    12,634,764
    
    $
    30,207,820
    
    $
    (17,600,056
    )
    
    (58
    )%
 
 The
decrease in revenues for the three and six months ended March 31, 2005, as
compared to the corresponding periods ending March 31, 2004 was largely due to
declines in our paying subscriber base resulting from our LEC billing issues.
The following table sets forth our quarter-end paying customer
counts:
 **Q2
      2005**
    
    **Q1
      2005**
    
    **Q4
      2004**
    
    **Q3
      2004**
    
    **Q2
      2004**
    
    **Q1
      2004**105,000
    
    
    95,000
    
    
    196,000
    
    
    224,000
    
    
    265,000
    
    
    253,000
 
 We
have experienced significant customer count declines from the second quarter of
2004 to the first quarter of 2005 as a result of our transition from LEC billing
to other billing channels as described in the “Recent Developments” section
above. Despite our continued transition away from LEC billing, we increased our
paying customer count during the second quarter of 2005 as compared to the first
quarter of 2005, resulting in increased revenues.
  The
price for our IAP product ranges from $17.95 to $29.95 per month.
  *Cost
of Services*
 **Cost
      of Services****2005**
    
    **2004**
    
    **Change**
    
    **Percent**Three
      Months Ended March 31,
    
    $
    860,933
    
    $
    6,600,782
    
    $
    (5,739,849
    )
    
    (87
    )%Six
      Months Ended March 31,
    
    $
    1,995,517
    
    $
    11,482,984
    
    $
    (9,487,467
    )
    
    (83
    )%
  17
 *Table of Contents*
 
 The
decrease in our cost of services is directly attributable to a reduction in our
dilution expense as a result of our transition from LEC billing to alternative
billing methods. Billings through LEC channels, which drives a substantial
majority of our dilution expense, decreased to 26% of total billings in the
second quarter of fiscal 2005 from over 97% of total billings in the second
quarter of fiscal 2004. A significant portion of these customers were converted
to ACH and direct billing methods, which have minimal dilution. We expect cost
of services to continue to be directly correlated to our usage of LEC billing
channels.
  *Gross
Profit*
 **Gross
      Profit****2005**
    
    **2004**
    
    **Change**
    
    **Percent**Three
      Months Ended March 31,
    
    $
    5,583,676
    
    $
    9,767,071
    
    $
    (4,183,395
    )
    
    (43
    )%Six
      Months Ended March 31,
    
    $
    10,639,247
    
    $
    18,724,836
    
    $
    (8,085,589
    )
    
    (43
    )%
 
 The
decrease in our gross profits was due to decreased revenues resulting from the
previously mentioned decrease in paying IAP advertisers, offset in part by the decreased dilution as discussed above.
Gross margins increased to 86.6% and 84.2% of net revenues in the second quarter
and first half of fiscal 2005, respectively, compared to 59.7% and 62.0% of net
revenues in the second quarter and first half of fiscal 2004, respectively, due
to decreased dilution in fiscal 2005.
  *General
and Administrative Expenses*
 **General
      and Administrative Expenses****2005**
    
    **2004**
    
    **Change**
    
    **Percent**Three
      Months Ended March 31,
    
    $
    3,181,644
    
    $
    3,107,522
    
    $
    74,122
    
    
    2
    %Six
      Months Ended March 31,
    
    $
    6,566,495
    
    $
    5,871,265
    
    $
    695,230
    
    
    12
    %
  General
and administrative expenses were largely consistent for the second quarter of
fiscal years 2005 and 2004; however, there were changes to certain components of
such expenses. During the second quarter of fiscal 2005, as compared to the
second quarter of fiscal 2004, we experienced increased costs of approximately
$230,000 associated with our efforts to reconfirm our existing subscriber base,
and increased mailing and customer-related expenses of approximately $335,000
for expenses related to ACH notices, paper invoices, and other customer mailings
associated with the conversion of many of our customers from LEC billing to
other billing methods. These increases were offset by decreased legal costs
associated with the conclusion of several outstanding legal matters in fiscal
2004, and general expense reductions associated with cost-containment
initiatives. General and administrative expenses for the first six months of
fiscal 2005 were higher than the first six months of fiscal 2004 due to costs
associated with reconfirming existing customers and increased mailing and
customer-related expense previously described.
  Our
general and administrative expenses consist largely of fixed expenses such as
compensation, rent, utilities, etc .
Therefore, we do not consider short-term trends of general and administrative
expenses as a percent of revenues to be meaningful indicators for evaluating
operational performance.
  18
 *Table of Contents*
 
 We
have been successful in reducing our general and administrative expenses,
despite incurring significant costs associated with the transition from LEC
billing to acceptable alternate billing methods. The following table sets forth
our recent operating performance for general and administrative
expenses:
  **Q2
      2005**
    **Q1
      2005**
    **Q4
      2004**
    **Q3
      2004**
    **Q2
      2004**Reconfirmation,
      mailing, billing and other customer-related costs
    $635,624
    $309,592
    $
      132,390
    $244,324
    $
      67,511Compensation
      for employees, consultants, officers and directors
    1,937,592
    2,265,863
    2,458,735
    2,029,536
    2,006,719Other
      G&A costs
    608,428
    809,396
    950,677
    1,029,252
    945,758
 
 *Sales
and Marketing Expenses*
 **Sales
      and Marketing Expenses****2005**
    
    **2004**
    
    **Change**
    
    **Percent**Three
      Months Ended March 31,
    
    $
    1,720,034
    
    $
    1,445,965
    
    $
    274,069
    
    
    19
    %Six
      Months Ended March 31,
    
    $
    3,330,527
    
    $
    2,736,345
    
    $
    594,182
    
    
    22
    %
  The
primary reason for the increase in sales and marketing expenses is increased
expenditures for brand awareness as we attempt to increase traffic to our
website. Branding expenses include radio and Internet advertising and fees paid
to redirect traffic from other websites.
  We
capitalize certain direct marketing expenses and amortize those costs over an
18-month period based on the estimated
IAP advertiser attrition rates. A substantial portion of the current period
expense relates to the amortization of costs previously incurred, thereby
creating a significant fixed component of this expense. Accordingly, revenue
declines resulted in our sales and marketing expenses increasing as a percentage
of revenues to 26.7% for the second quarter of fiscal 2005 compared to 8.8% for
the second quarter of fiscal 2004.
  *Depreciation
and Amortization*
  **Depreciation
      and Amortization****2005**
    
    **2004**
    
    **Change**
    
    **Percent**Three
      Months Ended March 31,
    
    $
    298,192
    
    $
    199,719
    
    $
    98,473
    
    
    49
    %Six
      Months Ended March 31,
    
    $
    593,879
    
    $
    395,912
    
    $
    197,967
    
    
    50
    %


The
increase in depreciation and amortization expense is attributable to (i) increased
depreciation due to additional purchases of equipment related to our upgrade in
infrastructure in the information technology department and hardware purchased
relating to our quality assurance and outbound marketing initiatives,
and (ii) increased amortization of intangible assets associated with website development
costs that were capitalized during 2004 and 2005. Amortization relating to the
capitalization of our direct mail marketing costs is included in marketing
expenses, as discussed previously.
  19
 *Table of Contents*
 **
 *Operating
Income*
 **Operating
      Income****2005**
    
    **2004**
    
    **Change**
    
    **Percent**Three
      Months Ended March 31,
    
    $
    383,806
    
    $
    5,013,865
    
    $
    (4,630,059
    )
    
    (92
    )%Six
      Months Ended March 31,
    
    $
    148,346
    
    $
    9,721,314
    
    $
    (9,572,968
    )
    
    (98
    )%
  Operating
income experienced substantial decline due primarily to revenue declines
previously described. However, we have returned to profitability in the second
quarter of fiscal 2005 and we expect to continue increasing our operating income
in the second half of fiscal 2005.
  *Other
Income*
  **Other
      Income****2005**
    
    **2004**
    
    **Change**
    
    **Percent**Three
      Months Ended March 31,
    
    $
    21,088
    
    $
    71,395
    
    $
    (50,307
    )
    
    (70
    )%Six
      Months Ended March 31,
    
    $
    107,453
    
    $
    346,153
    
    $
    (238,700
    )
    
    (69
    )%
  Other
income decreased due to the termination of a service agreement with Simple.Net,
an entity owned by a former director of the Company. Prior to the termination of
this agreement on March 2, 2004, we provided technical and customer service
support to Simple.Net.
  *Income
Tax Provision*
  **Income
      Tax Provision****2005**
    
    **2004**
    
    **Change**
    
    **Percent**Three
      Months Ended March 31,
    
    $
    (193,817
    )
    $
    (1,815,206
    )
    $
    1,621,389
    
    
    (89
    )%Six
      Months Ended March 31,
    
    $
    (176,447
    )
    $
    (3,583,881
    )
    $
    3,407,434
    
    
    (95
    )%
 The
decrease in our income tax provision for the second quarter and first half of
fiscal 2005 as compared to fiscal 2004 is due almost entirely to our decrease in
profitability.
  *Cumulative
Effect of Accounting Change*
  **Cumulative
      Effect of Accounting Change****2005**
    
    **2004**
    
    **Change**
    
    **Percent**Three
      Months Ended March 31,
    
    $
    -
    
    $
    -
    
    $
    -
    
    
    0
    %Six
      Months Ended March 31,
    
    $
    99,848
    
    $
    -
    
    $
    99,848
    
    
    100
    %
  During
the first fiscal quarter of 2005, we changed our method of accounting for
forfeitures of restricted stock awards to employees, officers, and directors.
Prior to October 1, 2004, we recognized forfeitures as they occurred .
Upon occurrence, we reversed the previously recognized expense associated with such
grant. Effective October 1,
2004 we changed to an expense recognition method that is based on an estimate of the
number of shares that are ultimately expected to vest. We believe that this is a
preferable method as it provides less volatility in expense recognition.
Additionally, while both methods of accounting for forfeitures are acceptable
under current guidance, the implementation of FAS 123R
(effective during the first
quarter of fiscal 2006) will no longer permit us to recognize forfeitures as
they occur .
This change resulted in an increase to net income of $99,848, net of income
taxes of $53,764 during the first quarter of fiscal 2005.
  20
 *Table of Contents*
 **
 *Net
Income*
  **Net
      Income****2005**
    
    **2004**
    
    **Change**
    
    **Percent**Three
      Months Ended March 31,
    
    $
    298,280
    
    $
    3,348,599
    
    $
    (3,050,319
    )
    
    (91
    )%Six
      Months Ended March 31,
    
    $
    347,352
    
    $
    6,633,284
    
    $
    (6,285,932
    )
    
    (95
    )%
 Net
income for the second quarter and first half of fiscal 2005, as compared to the
corresponding periods for fiscal 2004, decreased due primarily to decreased
revenues. As a percentage of revenues, net income was 4.6% and 2.8% for the
second quarter and first half of fiscal 2005, respectively, as compared to 20.4%
and 21.9% for the second quarter and first half of fiscal 2004, respectively. As
a significant portion of our expenses are fixed, our profitability margins are
negatively impacted by declines in revenue.
  **Liquidity
and Capital Resources**
  Net
cash provided by operating activities increased $2,381,724 or 80.1%, to
$5,354,869 for the six months ended March 31, 2005 compared to $2,973,145 for
the six months ended March 31, 2004. The increase in cash generated from
operations is primarily due to a conversion of many of our customers from LEC
billing to alternate billing channels that have a shorter collection time and
the fact we did not actively market for new customer acquisition during the
first half of 2005 as we worked to resolve the previously discussed billing
issues.
  Our
primary source of cash inflows is net remittances from our billing channels,
including LEC billings and ACH billings. For LEC billings, we receive
collections on accounts receivable through the billing service aggregators under
contracts to administer this billing and collection process. The billing service
aggregators generally do not remit funds until they are collected. Generally,
cash is collected and remitted to us (net of dilution and other fees and
expenses) over a 60- to 120-day period subsequent to the billing dates.
Additionally, for each monthly billing cycle, the billing aggregators and LECs
withhold certain amounts, or “holdback reserves,” to cover potential future
dilution and bad debt expense. These holdback reserves lengthen our cash
conversion cycle as they are remitted to us over a 12 to 18-month period of
time. We classify these holdback reserves as current or long-term receivables on
our balance sheet, depending on when they are scheduled to be remitted to us.
For ACH billings, we generally receive the net proceeds through our billing
service processors within 15 days of submission. Additionally, approximately 80%
of our accounts receivable are due from one of the Company’s
aggregators.
  21
 *Table of Contents*
 
 Our
most significant cash outflows include payments for marketing expenses and
general operating expenses. Cash outflows for direct response advertising, our
primary marketing strategy, typically occur in advance of expense recognition as
these costs are capitalized and amortized over 18 months, the average estimated
retention period for new customers. General operating cash outflows consist of
payroll costs, income taxes, and general and administrative expenses that
typically occur within close proximity of expense recognition.
  Net
cash used for investing activities totaled $260,154 for the first half of fiscal
2005 and consisted of minor purchases of equipment and expenditures for
intangible assets. During the first half of fiscal 2004, cash used for investing
activities was $3,109,991, of which the primary component was advances to
affiliates of $2,725,000.
  Net
cash flows from financing activities for the first half of fiscal 2005 consisted
primarily of payments of common stock dividends of $468,950. There were no
financing cash flows for the first half of fiscal 2004.
  We
had working capital of $14,281,725 as of March 31, 2005, compared to $12,484,833
as of September 30, 2004. Despite our near breakeven performance during the
first fiscal quarter of 2005, our operating expenses consist of a substantial
amount of non-cash expenses, such as amortization of customer acquisition costs
and deferred stock compensation, which allows us to continue to grow our cash
and working capital.
  We
maintain a $1,000,000 credit facility with Merrill Lynch Business Financial
Services, Inc. The applicable interest rate on borrowings, if any, will be a
variable rate of the one-month LIBOR rate (as published in the *Wall
Street Journal* ),
plus 3%. The facility requires an annual line fee of 1% of the committed amount.
Outstanding advances are secured by all of our existing and acquired tangible
and intangible assets located in the United States. There was no balance
outstanding at March 31, 2005. The line is in process of being renewed for an
additional one-year period. The Company has received verbal approval of the
renewal and is awaiting updated documentation.
  The
credit facility requires us to maintain a “Leverage Ratio” (total liabilities to
tangible net worth) that does not exceed 1.5-to-1 and a “Fixed Charge Ratio”
(earnings before interest, taxes, depreciation, amortization and other non-cash
charges minus any internally financed capital expenditures divided by the sum of
debt service, rent under capital leases, income taxes and dividends) that is not
less that 1.5-to-1 as determined quarterly on a 12-month trailing basis. The
credit facility includes additional covenants governing permitted indebtedness,
liens, and protection of collateral. As of March 31, 2005, we were in compliance
with the covenants and are able to fully draw on the credit
facility.
  We
are contractually obligated to pay a $0.01 per share dividend each quarter,
subject to compliance with applicable laws, to all common stockholders,
including those who hold unvested restricted stock. The quarterly dividend
associated with the second fiscal quarter of 2005 was declared and paid in April
2005 and, therefore, was not accounted for in the three months ended March 31,
2005.
 
 Although
our revenues have recently declined and we have only been slightly profitable
for the first half of fiscal 2005, we believe that our existing cash on hand
will provide us with sufficient liquidity to meet our operating needs for the
next twelve months.
 
 22
 *Table of Contents*
   **Risk
Factors**
  An
investment in our common stock involves a substantial degree of risk. Before
making an investment decision, you should give careful consideration to the
following risk factors in addition to the other information contained in this
report. The following risk factors, however, may not reflect all of the risks
associated with our business or an investment in our common stock. Accordingly,
you should only consider investing in our common stock if you can afford to lose
your entire investment.
  **Risks
Related to Our Business**
 
 **The
loss of our ability to use existing billing methods would adversely impact our
results of operations.**
 
 Our
business model historically has depended heavily upon our ability to bill
advertisers on their telephone bills through their respective Local Exchange
Carriers, or LECs. We have recently faced challenges and impediments to our
ability to bill certain advertisers in this manner, causing significant revenue
declines from the third quarter of fiscal 2004 to the first quarter of fiscal
2005. While we have transitioned most of our existing customers to alternative
billing methods, such as ACH billing, we continue to utilize LEC billing for
approximately 26% of our customers. We bill the majority of our customers
through ACH billing.
 
 The
existence of the LECs is the result of Federal legislation. In the same manner,
Congress could pass future legislation that obviates the existence of or the
need for the LECs. Additionally, regulatory agencies could limit or prevent our
ability to use the LECs to bill our advertisers. The introduction of and
advancement of new technologies, such as WiFi technology or other
wireless-related technologies, could render unnecessary the existence of fixed
telecommunication lines, which also could obviate the need for and access to the
LECs. Additionally, if the restrictions imposed on us by certain LECs become
more widespread, we could further lose the ability to utilize LEC billing. If
any of these events occur or, alternatively, if changes in regulations regarding
ACH billing limit our use of that billing method, our revenues and would have a
material adverse impact on our financial condition and results of
operations.
 
 **We
may experience increased dilution and our revenue may decline over time due to
the involvement of the CLECs.**  ****
 
 We
have experienced a decrease in revenue from the LECs from the effects of the
Competitive Local Exchange Carriers, or CLECs, that are providing local
telephone services to IAP advertisers. With the competition in the telephony
industry, many business customers are finding alternative telephony suppliers,
such as CLECs, that offer less expensive alternatives to the LECs. When the LECs
effectuate a price increase this causes a rush of LEC customers looking for an
alternative telephone company, which may be a CLEC. When our advertising
customers switch service providers from the LECs to a CLEC, we are precluded
from billing these customers on their monthly telephone bill and must instead
convert them to alternative billing methods such as ACH billing or direct
invoicing. This conversion process can be disruptive to our operations and
result in lost revenue. We cannot provide any assurances that our efforts to
transition such customers to alternative billing methods will be successful. We
may experience future increases in dilution of our customer base that we are
able to bill on their monthly telephone bills, which, in turn, may result in
decreases in our revenue.
 
 23
 *Table of Contents*
 ****
 **We
face a concentration of credit risk with respect to our billing service
providers.**
 
 Currently,
we utilize multiple vendors for both LEC and ACH billing; however, one service
provider handles a substantial majority of our LEC billing activity. If this
vendor discontinued providing services to us, we could face missed billings and
lost revenue which would adversely affect our ability to meet our existing
financial obligations. Moreover, over 80% of our existing outstanding
receivables are due from this service provider. If this vendor were to face
financial difficulty, our financial position would be materially impacted.
 
 **We
face intense competition, including from companies with greater resources, which
could adversely affect our growth and could lead to decreased revenues.**
 
 Several
companies, including Verizon, Yahoo and Microsoft, currently market Internet
Yellow Pages services that directly compete with our services and products. We
may not compete effectively with existing and potential competitors for several
reasons, including the following:
 
 ·
    some
      competitors have longer operating histories and greater financial and
      other resources than we have and are in better financial condition than we
      are;
  ·
    some
      competitors have better name recognition, as well as larger, more
      established, and more extensive marketing, IAP advertiser service, and IAP
      advertiser support capabilities than we
have;
  ·
    some
      competitors may supply a broader range of services, enabling them to serve
      more or all of their IAP advertisers’ needs. This could limit our sales
      and strengthen our competitors’ existing relationships with their IAP
      advertisers, including our current and potential IAP
      advertisers;
  ·
    some
      competitors may be able to better adapt to changing market conditions and
      IAP advertiser demand; and
  ·
    barriers
      to entry are not significant. As a result, other companies that are not
      currently involved in the Internet-based Yellow Pages advertising business
      may enter the market or develop technology that reduces the need for our
      services.
 
 Increased
competitive pressure could lead to reduced market share, as well as lower prices
and reduced margins for our services. If we experience reductions in our revenue
for any reason, our margins may continue to decline, which would adversely
affect our results of operations. We cannot assure you that we will be able to
compete successfully in the future.
 
 24
 *Table of Contents*
  
 **Our
success depends upon our ability to establish and maintain relationships with
our advertisers.**
 
 Our
ability to generate revenue depends upon our ability to maintain relationships
with our existing advertisers, to attract new advertisers to sign up for
revenue-generating services, and to generate traffic to our advertisers’
websites. We primarily use direct marketing efforts to attract new advertisers.
These direct marketing efforts may not produce satisfactory results in the
future. We attempt to maintain relationships with our advertisers through IAP
advertiser service and delivery of traffic to their businesses. An inability to
either attract additional advertisers to use our service or to maintain
relationships with our advertisers could have a material adverse effect on our
business, prospects, financial condition, and results of
operations.
 
 **If
we do not introduce new or enhanced offerings to our advertisers and users, we
may be unable to attract and retain those advertisers and users, which would
significantly impede our ability to generate revenue.**
 
 We
will need to introduce new or enhanced products and services in order to attract
and retain advertisers and users and to remain competitive. Our industry has
been characterized by rapid technological change, changes in advertiser and user
requirements and preferences, and frequent new product and service introductions
embodying new technologies. These changes could render our technology, systems,
and website obsolete. We may experience difficulties that could delay or prevent
us from introducing new products and services. If we do not periodically enhance
our existing products and services, develop new technologies that address our
advertisers’ and users’ needs and preferences, or respond to emerging
technological advances and industry standards and practices on a timely and
cost-effective basis, our products and services may not be attractive to
advertisers and users, which would significantly impede our revenue growth. In
addition, our reputation and our brand could be damaged if any new product or
service introduction is not favorably received.
 
 **Our
quarterly results of operations could fluctuate due to factors outside of our
control.**
 
 Our
net revenues may grow at a slower rate on a quarter-to-quarter basis than we
have experienced in recent periods. Factors that could cause our results of
operations to fluctuate in the future include the following:
 
 ·
    fluctuating
      demand for our services, which may depend on a number of factors
      including
  o
    changes
      in economic conditions and our IAP advertisers’
    profitability,
  o
    varying
      IAP advertiser response rates to our direct marketing
    efforts,
  o
    our
      ability to complete direct mailing solicitations on a timely basis each
      month,
  o
    changes
      in our direct marketing efforts,
  o
    IAP
      advertiser refunds or cancellations, and
  o
    our
      ability to continue to bill IAP advertisers on their monthly telephone
      bills, ACH or credit card rather than through direct
      invoicing;
  25
 *Table of Contents*
  ·
    timing
      of new service or product introductions and market acceptance of new or
      enhanced versions of our services or products;
  ·
    our
      ability to develop and implement new services and technologies in a timely
      fashion in order to meet market demand;
  ·
    price
      competition or pricing changes by us or our
competitors;
  ·
    new
      product offerings or other actions by our
competitors;
  ·
    month-to-month
      variations in the billing and receipt of amounts from LECs, such that
      billing and revenues may fall into the subsequent fiscal quarter;
  ·
    the
      ability of our check processing service providers to continue to process
      and provide billing information regarding our solicitation
      checks;
  ·
    the
      amount and timing of expenditures for expansion of our operations,
      including the hiring of new employees, capital expenditures, and related
      costs;
  ·
    technical
      difficulties or failures affecting our systems or the Internet in
      general;
  ·
    a
      decline in Internet traffic at our website;
  ·
    the
      cost of acquiring, and the availability of, information for our database
      of potential advertisers; and
  ·
    our
      expenses are only partially based on our expectations regarding future
      revenue and are largely fixed in nature, particularly in the short
      term.
  ****
 **Our
ability to efficiently process new advertiser sign-ups and to bill our
advertisers monthly depends upon our check processing service providers and
billing aggregators, respectively.**
 
 We
currently use check processing companies to provide us with advertiser
information at the point of sign-up for our Internet Advertising Package. Our
ability to gather information to bill our advertisers at the point of sign-up
could be adversely affected if one or more of these providers experiences a
disruption in its operations or ceases to do business with us.
 
 We
also depend upon our billing aggregators to efficiently bill and collect monies
from the LECs relating to the LECs’ billing and collection of our monthly
charges from advertisers, as well as collecting from those advertisers on ACH
billing. We currently have agreements with two billing aggregators and two ACH
service providers. Any disruption in our billing aggregators’ ability to perform
these functions could adversely affect our financial condition and results of
operations.
 
 **We
depend upon third parties to provide certain services and software, and our
business may suffer if the relationships upon which we depend fail to produce
the expected benefits or are terminated.**
 
 We
currently outsource to third parties certain of the services that we provide,
including the work of producing usable templates for and hosting of the
QuickSites, website templates known as Ezsites, and wholesale Internet access.
These relationships may not provide us with benefits that outweigh the costs of
the relationships. If any strategic supplier demands a greater portion of
revenue derived from the services it provides or increases its charges for its
services, we may decide to terminate or refuse to renew that relationship, even
if it previously had been profitable or otherwise beneficial. If we lose a
significant strategic supplier, we may be unable to replace that relationship
with other strategic relationships with comparable revenue potential. The loss
or termination of any strategic relationship with one of these third-party
suppliers could significantly impair our ability to provide services to our
advertisers and users.
 
 26
 *Table of Contents*
 
 We
depend upon third-party software to operate certain of our services. The failure
of this software to perform as expected would have a material adverse effect on
our business. Additionally, although we believe that several alternative sources
for this software are available, any failure to obtain and maintain the rights
to use such software would have a material adverse effect on our business,
prospects, financial condition, and results of operations. We also depend upon
third parties to provide services that allow us to connect to the Internet with
sufficient capacity and bandwidth so that our business can function properly and
our websites can handle current and anticipated traffic. Any restrictions or
interruption in our connection to the Internet would have a material adverse
effect on our business, prospects, financial condition, and results of
operations.
 
 **The
market for our services is uncertain and is still evolving.**
 
 Internet
Yellow Pages services are evolving rapidly and are characterized by an
increasing number of market entrants. Our future revenues and profits will
depend substantially upon the widespread acceptance and the use of the Internet
and other online services as an effective medium of commerce by merchants and
consumers. Rapid growth in the use of and interest in the Internet may not
continue on a lasting basis, which may negatively impact Internet-based
businesses such as ours. In addition, advertisers and users may not adopt or
continue to use Internet-base Yellow Pages services and other online services
that we may offer in the future. The demand and market acceptance for recently
introduced services generally is subject to a high level of uncertainty.
 
 Most
potential advertisers have only limited, if any, experience advertising on the
Internet and have not devoted a significant portion of their advertising
expenditures to Internet advertising. Advertisers may find Internet Yellow Pages
advertising to be less effective for meeting their business needs than
traditional methods of Yellow Pages or other advertising and marketing. Our
business, prospects, financial condition or results of operations will be
materially and adversely affected if potential advertisers do not adopt Internet
Yellow Pages as an important component of their advertising
expenditures.
 
 **We
may not be able to secure additional capital to expand our operations.**
 
 Although
we currently have no material long-term needs for capital expenditures, we will
likely be required to make increased capital expenditures to fund our
anticipated growth of operations, infrastructure, and personnel. We currently
anticipate that our cash on hand as of September 30, 2004, together with cash
flows from operations, will be sufficient to meet our anticipated liquidity
needs for working capital and capital expenditures over the next 12 months. In
the future, however, we may seek additional capital through the issuance of debt
or equity depending upon our results of operations, market conditions or
unforeseen needs or opportunities. Our future liquidity and capital requirements
will depend on numerous factors, including the following:
 
 27
 *Table of Contents*
  ·
    the
      pace of expansion of our operations;
  ·
    our
      need to respond to competitive pressures;
and
  ·
    future
      acquisitions of complementary products, technologies or
      businesses.
 
 Our
forecast of the period of time through which our financial resources will be
adequate to support our operations is a forward-looking statement that involves
risks and uncertainties and actual results could vary materially as a result of
the factors described above. As we require additional capital resources, we may
seek to sell additional equity or debt securities or draw on our existing bank
line of credit. Debt financing must be repaid at maturity, regardless of whether
or not we have sufficient cash resources available at that time to repay the
debt. The sale of additional equity or convertible debt securities could result
in additional dilution to existing stockholders. We cannot provide assurance
that any financing arrangements will be available in amounts or on terms
acceptable to us, if at all.
 
  **We
depend upon our executive officers and key personnel** .
 
 Our
performance depends substantially on the performance of our executive officers
and other key personnel. The success of our business in the future will depend
on our ability to attract, train, retain and motivate high quality personnel,
especially highly qualified technical and managerial personnel. The loss of
services of any executive officers or key personnel could have a material
adverse effect on our business, results of operations or financial condition. We
do not maintain key person life insurance on the lives of any of our executive
officers or key personnel.
 
 Competition
for talented personnel is intense, and there is no assurance that we will be
able to continue to attract, train, retain or motivate other highly qualified
technical and managerial personnel in the future. In addition, market conditions
may require us to pay higher compensation to qualified management and technical
personnel than we currently anticipate. Any inability to attract and retain
qualified management and technical personnel in the future could have a material
adverse effect on our business, prospects, financial condition, and results of
operations.
  ****
 **Our
business is subject to a strict regulatory environment** .
 
 28
 *Table of Contents*
 
 Existing
laws and regulations and any future regulation may have a material adverse
effect on our business. For example, we believe that our direct marketing
programs meet or exceed existing requirements of the United States Federal Trade
Commission. Any changes to FTC requirements or changes in our direct or other
marketing practices, however, could result in our marketing practices failing to
comply with FTC regulations. Our increasing dependence on ACH billing has
exposed us to greater scrutiny by the National Automated Clearing House
Association, or NACHA. As a result, we could be subject to substantial liability
in the future, including fines and criminal penalties, preclusion from offering
certain products or services, and the prevention or limitation of certain
marketing practices.
 
 **We
may face risks as we expand our business into international
markets.**
 
 We
currently are exploring opportunities to offer our services in other
English-speaking countries. We have limited experience in developing and
marketing our services internationally, and we may not be able to successfully
execute our business model in markets outside the United States. We will face a
number of risks inherent in doing business in international markets, including
the following:
 
 ·
    international
      markets typically experience lower levels of Internet usage and Internet
      advertising than the United States, which could result in
      lower-than-expected demand for our
services;
  ·
    unexpected
      changes in regulatory requirements;
  ·
    potentially
      adverse tax consequences;
  ·
    difficulties
      in staffing and managing foreign
operations;
  ·
    changing
      economic conditions;
  ·
    exposure
      to different legal standards, particularly with respect to intellectual
      property and distribution of information over the
  Internet;
  ·
    burdens
      of complying with a variety of foreign laws;
and
  ·
    fluctuations
      in currency exchange rates.
  To
the extent that international operations represent a significant portion of our
business in the future, our business could suffer if any of these risks
occur.
  **We
may be unable to promote and maintain our brands.**
 
 We
believe that establishing and maintaining the brand identities of our Internet
Yellow Pages services is a critical aspect of attracting and expanding a base of
advertisers and users. Promotion and enhancement of our brands will depend
largely on our success in continuing to provide high quality service. If
advertisers and users do not perceive our existing services to be of high
quality, or if we introduce new services or enter into new business ventures
that are not favorably received by advertisers and users, we will risk diluting
our brand identities and decreasing their attractiveness to existing and
potential IAP advertisers.
 
 **We
may not be able to adequately protect our intellectual property
rights.**
 
 Our
success depends both on our internally developed technology and our third party
technology. We rely on a variety of trademarks, service marks, and designs to
promote our brand names and identity. We also rely on a combination of
contractual provisions, confidentiality procedures, and trademark, copyright,
trade secrecy, unfair competition, and other intellectual property laws to
protect the proprietary aspects of our products and services. Legal standards
relating to the validity, enforceability, and scope of the protection of certain
intellectual property rights in Internet-related industries are uncertain and
still evolving. The steps we take to protect our intellectual property rights
may not be adequate to protect our intellectual property and may not prevent our
competitors from gaining access to our intellectual property and proprietary
information. In addition, we cannot provide assurance that courts will always
uphold our intellectual property rights or enforce the contractual arrangements
that we have entered into to protect our proprietary technology.
 
 29
 *Table of Contents*
 
 Third
parties may infringe or misappropriate our copyrights, trademarks, service
marks, trade dress, and other proprietary rights. Any such infringement or
misappropriation could have a material adverse effect on our business,
prospects, financial condition, and results of operations. In addition, the
relationship between regulations governing domain names and laws protecting
trademarks and similar proprietary rights is unclear. We may be unable to
prevent third parties from acquiring domain names that are similar to, infringe
upon or otherwise decrease the value of our trademarks and other proprietary
rights, which may result in the dilution of the brand identity of our services.
 
 We
may decide to initiate litigation in order to enforce our intellectual property
rights, to protect our trade secrets, or to determine the validity and scope of
our proprietary rights. Any such litigation could result in substantial expense,
may reduce our profits, and may not adequately protect our intellectual property
rights. In addition, we may be exposed to future litigation by third parties
based on claims that our products or services infringe their intellectual
property rights. Any such claim or litigation against us, whether or not
successful, could result in substantial costs and harm our reputation. In
addition, such claims or litigation could force us to do one or more of the
following:
 
 ·
    cease
      selling or using any of our products that incorporate the challenged
      intellectual property, which would adversely affect our
      revenue;
  ·
    obtain
      a license from the holder of the intellectual property right alleged to
      have been infringed, which license may not be available on reasonable
      terms, if at all; and
  ·
    redesign
      or, in the case of trademark claims, rename our products or services to
      avoid infringing the intellectual property rights of third parties, which
      may not be possible and in any event could be costly and
      time-consuming.
  Even
if we were to prevail, such claims or litigation could be time-consuming and
expensive to prosecute or defend, and could result in the diversion of our
management’s time and attention. These expenses and diversion of managerial
resources could have a material adverse effect on our business, prospects,
financial condition, and results of operations.
 
 **Current
capacity constraints may require us to expand our infrastructure and IAP
advertiser support capabilities.**
 
 Our
ability to provide high-quality Internet Yellow Pages services largely depends
upon the efficient and uninterrupted operation of our computer and
communications systems. We may be required to expand our technology,
infrastructure, and IAP advertiser support capabilities in order to accommodate
any significant increases in the numbers of advertisers and users of our
websites. We may not be able to project accurately the rate or timing of
increases, if any, in the use of our services or expand and upgrade our systems
and infrastructure to accommodate these increases in a timely manner. If we do
not expand and upgrade our infrastructure in a timely manner, we could
experience temporary capacity constraints that may cause unanticipated system
disruptions, slower response times, and lower levels of IAP advertiser service.
Our inability to upgrade and expand our infrastructure and IAP advertiser
support capabilities as required could impair the reputation of our brand and
our services, reduce the volume of users able to access our website, and
diminish the attractiveness of our service offerings to our advertisers.
 
 30
 *Table of Contents*
 
 Any
expansion of our infrastructure may require us to make significant upfront
expenditures for servers, routers, computer equipment, and additional Internet
and intranet equipment, as well as to increase bandwidth for Internet
connectivity. Any such expansion or enhancement will need to be completed and
integrated without system disruptions. An inability to expand our infrastructure
or IAP advertiser service capabilities either internally or through third
parties, if and when necessary, would materially and adversely affect our
business, prospects, financial condition, and results of
operations.
  **Failure
to achieve and maintain effective internal controls in accordance with Section
404 of the Sarbanes-Oxley Act could have a material adverse effect on our
business and stock price.**
  Pursuant
to Section 404 of the Sarbanes-Oxley Act of 2002, beginning with our Annual
Report on Form 10-K for the fiscal year ending September 30, 2006, we will be
required to furnish a report by our management on our internal control over
financial reporting. The internal control report must contain (i) a statement of
management’s responsibility for establishing and maintaining adequate internal
control over financial reporting, (ii) a statement identifying the framework
used by management to conduct the required evaluation of the effectiveness of
our internal control over financial reporting, (iii) management’s assessment of
the effectiveness of our internal control over financial reporting as of the end
of our most recent fiscal year, including a statement as to whether or not
internal control over financial reporting is effective, and (iv) a statement
that the Company’s independent auditors have issued an attestation report on
management’s assessment of internal control over financial reporting.
  In
order to achieve compliance with Section 404 of the Act within the prescribed
period, we will need to engage in a process to document and evaluate our
internal control over financial reporting, which will be both costly and
challenging. In this regard, management will need to dedicate internal
resources, engage outside consultants and adopt a detailed work plan to (i)
assess and document the adequacy of internal control over financial reporting,
(ii) take steps to improve control processes where appropriate, (iii) validate
through testing that controls are functioning as documented and (iv) implement a
continuous reporting and improvement process for internal control over financial
reporting. We can provide no assurance as to our, or our independent auditors’,
conclusions at September 30, 2006 with respect to the effectiveness of our
internal control over financial reporting under Section 404 of the Act. There is
a risk that neither we nor our independent auditors will be able to conclude at
September 30, 2006 that our internal controls over financial reporting are
effective as required by Section 404 of the Act.
  31
 *Table of Contents*
 
 During
the course of our testing we may identify deficiencies which we may not be able
to remediate in time to meet the deadline imposed by the Sarbanes-Oxley Act for
compliance with the requirements of Section 404. In addition, if we fail to
achieve and maintain the adequacy of our internal controls, as such standards
are modified, supplemented or amended from time to time, we may not be able to
ensure that we can conclude on an ongoing basis that we have effective internal
controls over financial reporting in accordance with Section 404 of the
Sarbanes-Oxley Act. Moreover, effective internal controls, particularly those
related to revenue recognition, are necessary for us to produce reliable
financial reports and are important to helping prevent financial fraud. If we
cannot provide reliable financial reports or prevent fraud, our business and
operating results could be harmed, investors could lose confidence in our
reported financial information, and the trading price of our stock could drop
significantly.
  **Risks
Related to the Internet**
 
 **We
may not be able to adapt as the Internet, Internet Yellow Pages services, and
IAP advertiser demands continue to evolve.**
 
 Our
failure to respond in a timely manner to changing market conditions or client
requirements could have a material adverse effect on our business, prospects,
financial condition, and results of operations. The Internet, e-commerce, and
the Internet Yellow Pages industry are characterized by:
 
 ·
    rapid
      technological change;
  ·
    changes
      in advertiser and user requirements and
preferences;
  ·
    frequent
      new product and service introductions embodying new technologies;
      and
  ·
    the
      emergence of new industry standards and practices that could render our
      existing service offerings, technology, and hardware and software
      infrastructure obsolete.
  In
order to compete successfully in the future, we must:
  ·
    enhance
      our existing services and develop new services and technology that address
      the increasingly sophisticated and varied needs of our prospective or
      current IAP advertisers;
  ·
    license,
      develop or acquire technologies useful in our business on a timely basis;
      and
  ·
    respond
      to technological advances and emerging industry standards and practices on
      a cost-effective and timely basis.
  **Our
future success may depend on continued growth in the use of the
Internet.**
 
 Because
Internet Yellow Pages is a new and rapidly evolving industry, the ultimate
demand and market acceptance for our services will be subject to a high level of
uncertainty. Significant issues concerning the commercial use of the Internet
and online service technologies, including security, reliability, cost, ease of
use, and quality of service, remain unresolved and may inhibit the growth of
Internet business solutions that use these technologies. In addition, the
Internet or other online services could lose their viability due to delays in
the development or adoption of new standards and protocols required to handle
increased levels of Internet activity, or due to increased governmental
regulation. Our business, prospects, financial condition, and results of
operations would be materially and adversely affected if the use of Internet
Yellow Pages and other online services does not continue to grow or grows more
slowly than we expect.
 
 32
 *Table of Contents*
 ****
 **We
may be required to keep pace with rapid technological change in the Internet
industry.**
 
 In
order to remain competitive, we will be required continually to enhance and
improve the functionality and features of our existing services, which could
require us to invest significant capital. If our competitors introduce new
products and services embodying new technologies, or if new industry standards
and practices emerge, our existing services, technologies, and systems may
become obsolete. We may not have the funds or technical know-how to upgrade our
services, technology, and systems. If we face material delays in introducing new
services, products, and enhancements, our advertisers and users, may forego the
use of our services and select those of our competitors, in which event our
business, prospects, financial condition and results of operations could be
materially and adversely affected.
 
 **Regulation
of the Internet may adversely affect our business.**
 
 Due
to the increasing popularity and use of the Internet and online services such as
online Yellow Pages, federal, state,  local,
and foreign governments may adopt laws and regulations, or amend existing laws
and regulations, with respect to the Internet and other online services. These
laws and regulations may affect issues such as user privacy, pricing, content,
taxation, copyrights, distribution, and quality of products and services. The
laws governing the Internet remain largely unsettled, even in areas where
legislation has been enacted. It may take years to determine whether and how
existing laws, such as those governing intellectual property, privacy, libel,
and taxation, apply to the Internet and Internet advertising and directory
services. In addition, the growth and development of the market for electronic
commerce may prompt calls for more stringent consumer protection laws, both in
the United States and abroad, that may impose additional burdens on companies
conducting business over the Internet. Any new legislation could hinder the
growth in use of the Internet generally or in our industry and could impose
additional burdens on companies conducting business online, which could, in
turn, decrease the demand for our services, increase our cost of doing business,
or otherwise have a material adverse effect on our business, prospects,
financial condition, and results of operations.
 
 **We
may not be able to obtain Internet domain names that we would like to
have.**
 
 We
believe that our existing Internet domain names are an extremely important part
of our business. We may desire, or it may be necessary in the future, to use
these or other domain names in the United States and abroad. Various Internet
regulatory bodies regulate the acquisition and maintenance of domain names in
the United States and other countries. These regulations are subject to change.
Governing bodies may establish additional top-level domains, appoint additional
domain name registrars or modify the requirements for holding domain names. As a
result, we may be unable to acquire or maintain relevant domain names in all
countries in which we plan to conduct business in the future.
 
 33
 *Table of Contents*
 
 The
extent to which laws protecting trademarks and similar proprietary rights will
be extended to protect domain names currently is not clear. We therefore may be
unable to prevent competitors from acquiring domain names that are similar to,
infringe upon or otherwise decrease the value of our domain names, trademarks,
trade names, and other proprietary rights. We cannot provide assurance that
potential users and advertisers will not confuse our domain names, trademarks,
and trade names with other similar names and marks. If that confusion occurs, we
may lose business to a competitor and some advertisers and users may have
negative experiences with other companies that those advertisers and users
erroneously associate with us. The inability to acquire and maintain domain
names that we desire to use in our business, and the use of confusingly similar
domain names by our competitors, could have a material adverse affect on our
business, prospects, financial conditions, and results of operations in the
future.
 
 **Our
business could be negatively impacted if the security of the Internet becomes
compromised.**
 
 To
the extent that our activities involve the storage and transmission of
proprietary information about our advertisers or users, security breaches could
damage our reputation and expose us to a risk of loss or litigation and possible
liability. We may be required to expend significant capital and other resources
to protect against security breaches or to minimize problems caused by security
breaches. Our security measures may not prevent security breaches. Our failure
to prevent these security breaches or a misappropriation of proprietary
information may have a material adverse effect on our business, prospects,
financial condition, and results of operations.
 
 **Our
technical systems could be vulnerable to online security risks, service
interruptions or damage to our systems.**
 
 Our
systems and operations may be vulnerable to damage or interruption from fire,
floods, power loss, telecommunications failures, break-ins, sabotage, computer
viruses, penetration of our network by unauthorized computer users and
“hackers,” natural disaster, and similar events. Preventing, alleviating, or
eliminating computer viruses and other service-related or security problems may
require interruptions, delays or cessation of service. We may need to expend
significant resources protecting against the threat of security breaches or
alleviating potential or actual service interruptions. The occurrence of such
unanticipated problems or security breaches could cause material interruptions
or delays in our business, loss of data, or misappropriation of proprietary or
IAP advertiser-related information or could render us unable to provide services
to our IAP advertisers for an indeterminate length of time. The occurrence of
any or all of these events could materially and adversely affect our business,
prospects, financial condition, and results of operations.
 
 34
 *Table of Contents*
  
 **If
we are sued for content distributed through, or linked to by, our website or
those of our advertisers, we may be required to spend substantial resources to
defend ourselves and could be required to pay monetary damages.**
 
 We
aggregate and distribute third-party data and other content over the Internet.
In addition, third-party websites are accessible through our website or those of
our advertisers. As a result, we could be subject to legal claims for
defamation, negligence, intellectual property infringement, and product or
service liability. Other claims may be based on errors or false or misleading
information provided on or through our website or websites of our directory
licensees. Other claims may be based on links to sexually explicit websites and
sexually explicit advertisements. We may need to expend substantial resources to
investigate and defend these claims, regardless of whether we successfully
defend against them. While we carry general business insurance, the amount of
coverage we maintain may not be adequate. In addition, implementing measures to
reduce our exposure to this liability may require us to spend substantial
resources and limit the attractiveness of our content to users.
 
 **Risks
Related to Our Securities**
 
 **Stock
prices of technology companies have declined precipitously at times in the past
and the trading price of our common stock is likely to be volatile, which could
result in substantial losses to investors.**
  The
trading price of our common stock has risen and fallen significantly over the
past twelve months and could continue to be volatile in response to factors
including the following, many of which are beyond our control:
  ·
    decreased
      demand in the Internet services sector;
  ·
    variations
      in our operating results;
  ·
    announcements
      of technological innovations or new services by us or our
      competitors;
  ·
    changes
      in expectations of our future financial performance, including financial
      estimates by securities analysts and
investors;
  ·
    our
      failure to meet analysts’ expectations;
  ·
    changes
      in operating and stock price performance of other technology companies
      similar to us;
  ·
    conditions
      or trends in the technology industry;
  ·
    additions
      or departures of key personnel; and
  ·
    future
      sales of our common stock.
  Domestic
and international stock markets often experience significant price and volume
fluctuations that are unrelated to the operating performance of companies with
securities trading in those markets. These fluctuations, as well as political
events, terrorist attacks, threatened or actual war, and general economic
conditions unrelated to our performance, may adversely affect the price of our
common stock. In the past, securities holders of other companies often have
initiated securities class action litigation against those companies following
periods of volatility in the market price of those companies’ securities. If the
market price of our stock fluctuates and our stockholders initiate this type of
litigation, we could incur substantial costs and experience a diversion of our
management’s attention and resources, regardless of the outcome. This could
materially and adversely affect our business, prospects, financial condition,
and results of operations.
 
 35
 *Table of Contents*
 ****
 **Certain
provisions of Nevada law and in our charter, as well as our Shareholder Rights
Plan, may prevent or delay a change of control of our
company** .
 
 We
are subject to the Nevada anti-takeover laws regulating corporate takeovers.
These anti-takeover laws prevent Nevada corporations from engaging in a merger,
consolidation, sales of its stock or assets, and certain other transactions with
any stockholder, including all affiliates and associates of the stockholder, who
owns 10% or more of the corporation’s outstanding voting stock, for three years
following the date that the stockholder acquired 10% or more of the
corporation’s voting stock except in certain situations. In addition, our
amended and restated articles of incorporation and bylaws include a number of
provisions that may deter or impede hostile takeovers or changes of control or
management. These provisions include the following:
 
 ·
    our
      board is classified into three classes of directors as nearly equal in
      size as possible, with staggered three
year-terms;
  ·
    the
      authority of our board to issue up to 5,000,000 shares of serial preferred
      stock and to determine the price, rights, preferences, and privileges of
      these shares, without stockholder approval;
  ·
    all
      stockholder actions must be effected at a duly called meeting of
      stockholders and not by written consent unless such action or proposal is
      first approved by our board of directors;
  ·
    special
      meetings of the stockholders may be called only by the Chairman of the
      Board, the Chief Executive Officer, or the President of our company;
      and
  ·
    cumulative
      voting is not allowed in the election of our
directors.
  We
also recently adopted a Shareholder Rights Plan, commonly referred to as a
poison pill. This Plan serves as a strong deterrent to any unsolicited or
hostile takeover attempts and, effectively, requires an interested acquirer to
negotiate with our board of directors.
  These
provisions of Nevada law and our articles and bylaws, as well as our poison
pill, could prohibit or delay mergers or other takeover or change of control of
our company and may discourage attempts by other companies to acquire us, even
if such a transaction would be beneficial to our stockholders.
  **Our
common stock may be subject to the “penny stock” rules as promulgated under the
Exchange Act.**
 
 36
 *Table of Contents*
 In
the event that no exclusion from the definition of “penny stock” under the
Exchange Act is available, then any broker engaging in a transaction in our
common stock will be required to provide its customers with a risk disclosure document,
disclosure of market quotations, if any, disclosure of the compensation of the
broker-dealer and its sales person in the transaction, and monthly account
statements showing the market values of our securities held in the customer’s
accounts. The bid and offer quotation and compensation information must be
provided prior to effecting the transaction and must be contained on the
customer’s confirmation of sale. Certain brokers are less willing to engage in
transactions involving “penny stocks” as a result of the additional disclosure
requirements described above, which may make it more difficult for holders of
our common stock to dispose of their shares.
 
 ITEM
      3.
    QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
  RISK
  As
of March 31, 2005, we did not participate in any market risk-sensitive commodity
instruments for which fair value disclosure would be required under Statement of
Financial Accounting Standards No. 107. We believe that we are not subject in
any material way to other forms of market risk, such as foreign currency
exchange risk or foreign customer purchases (of which there were none in the
first six months of fiscal 2005 or in any of 2004) or commodity price
risk.
  ITEM
      4.
    CONTROLS
      AND PROCEDURES
  Disclosure
controls and procedures are designed with an objective of ensuring that
information required to be disclosed in our periodic reports filed with the
Securities and Exchange Commission, such as this Quarterly Report on Form 10-Q,
is recorded, processed, summarized and reported within the time periods
specified by the Securities and Exchange Commission. Disclosure controls are
also designed with an objective of ensuring that such information is accumulated
and communicated to our management, including our chief executive officer and
chief financial officer, in order to allow timely consideration regarding
required disclosures.
  The
evaluation of our disclosure controls by our principal executive officer and
principal financial officer included a review of the controls’ objectives and
design, the operation of the controls, and the effect of the controls on the
information presented in this Quarterly Report. Our management, including our
chief executive officer and chief financial officer, does not expect that
disclosure controls can or will prevent or detect all errors and all fraud, if
any. A control system, no matter how well designed and operated, can provide
only reasonable, not absolute, assurance that the objectives of the control
system are met. Also, projections of any evaluation of the disclosure controls
and procedures to future periods are subject to the risk that the disclosure
controls and procedures may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may
deteriorate.
  Based
on their review and evaluation as of the end of the period covered by this Form
10-Q, and subject to the inherent limitations all as described above, our
principal executive officer and principal financial officer have concluded that
our disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934) are effective as of the end
of the period covered by this report. They are not aware of any significant
changes in our disclosure controls or in other factors that could significantly
affect these controls subsequent to the date of their evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses. During the period covered by this Form 10-Q, there have not been any
changes in our internal control over financial reporting that have materially
affected, or that are reasonably likely to materially affect, our internal
control over financial reporting.
  37
 *Table of Contents*
 ****
 **PART
II - OTHER INFORMATION**
  ITEM
1.  LEGAL PROCEEDINGS
  From time
to time, we are party to certain legal proceedings incidental to the conduct of
our business. We believe that the outcome of pending legal proceedings will not,
either individually or in the aggregate, have a material adverse effect on our
business, financial position, results of operations, cash flows or
liquidity .
  ITEM
6.  EXHIBITS
  The
following exhibits are either attached hereto or incorporated herein by
reference as indicated:
 
 Exhibit
      Number
    
    Description10
    
    Form
      of Restricted Stock Agreement under 2003 Stock Plan31
    
    Certifications
      pursuant to SEC Release No. 33-8238, as adopted pursuant to Section 302 of
      the Sarbanes-Oxley Act of 200232
    
    Certifications
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002
  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 the undersigned, thereunto
duly authorized.
 
 YP.CORP.Dated:
      May 16, 2005
    */s/
      W. Chris Broquist*W.
      Chris BroquistChief
      Financial Officer
  38
 *Table of Contents*
 
 EXHIBIT
INDEX
 Exhibit
      Number
    
    Description10
    
    Form
      of Restricted Stock Agreement under 2003 Stock Plan31
    
    Certifications
      pursuant to SEC Release No. 33-8238, as adopted pursuant to Section 302 of
      the Sarbanes-Oxley Act of 200232
    
    Certifications
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002