Inuvo, Inc. - Quarter Report: 2007 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended    September 30, 2007

OR

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______ to ________

For Quarter Ended

Check whether the registrant (1) filed all reports required to be filed by Section 13 of 15(d) of the Exchange Act during the past 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   x   No o

Check whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act:

Check whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):

Yes o   No x

As of November 1, 2007, 67,646,350 shares of common stock, $0.001 par value, were outstanding.

THINK PARTNERSHIP INC.

Table of Contents

PART I.   FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS

THINK PARTNERSHIP INC.

CONSOLIDATED BALANCE SHEETS

September 30, 2007 and December 31, 2006

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The accompanying notes to the condensed consolidated financial statements are an integral part of these statements.

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THINK PARTNERSHIP INC.

CONSOLIDATED STATEMENTS OF OPERATIONS (“Unaudited”)

Nine and Three Months Ended September 30, 2007 and 2006

The accompanying notes to the condensed consolidated financial statements are an integral part of these statements.

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THINK PARTNERSHIP INC.

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY(“Unaudited”)

Nine Months Ended September 30, 2007

The accompanying notes to the condensed consolidated financial statements are an integral part of these statements.

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THINK PARTNERSHIP INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (“Unaudited”)

Nine Months Ended September 30, 2007 and 2006

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NonCash Investing and Financing Activities

On January 20, 2006, the Company purchased the members’ interests of Morex Marketing Group, LLC. $12.31 million of the purchase price was paid in shares of the Company’s common stock along with options valued at $75,600. The Company received net intangible assets of $21,830,722 and net tangible assets of $314,019.

On April 5, 2006, the Company purchased stock of Litmus Media, Inc. $6.5 million of the purchase price was paid in shares of the Company’s common stock along with options valued at $79,297. The Company received net intangible assets of $14,131,895 and net tangible liabilities of $705,094.

On April 27, 2006, the Company purchased the stock of WebDiversity Ltd. $1.0 million of the purchase price was paid in shares of the Company’s common stock along with options valued at $55,800. The Company received net intangible assets of $2,166,065 and net tangible assets of $76,867.

On May 23, 2006, the Company purchased the stock of iLead Media, Inc. $9.2 million of the purchase price was paid in shares of the Company’s common stock along with options valued at $90,450. The Company received net intangible assets of $20,636,341 and net tangible liabilities of $1,443,219.

The accompanying notes to the condensed consolidated financial statements are an integral part of these statements.

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Think Partnership Inc.
Footnotes to Consolidated Financial Statements
September 30, 2007 and 2006

Note 1 - Accounting Policies

The significant accounting policies of Think Partnership Inc. (the “Company”) are described in Note 1 of the Notes to Consolidated Financial Statements included in its 2006 Annual Report on Form 10-K filed with the Securities and Exchange Commission. For interim reporting purposes, the Company follows the same accounting policies and considers each interim period as an integral part of an annual period. Certain prior period amounts have been reclassified to conform to the current presentation.

Effective January 1, 2007, the Company adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109” (“FIN 48”). This statement clarifies the criteria that an individual tax position must satisfy for some or all of the benefits of that position to be recognized in a company’s financial statements. FIN 48 prescribes a recognition threshold of more-likely–than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order to be recognized in the financial statements. FIN 48 is effective for fiscal years beginning after December 31, 2006 (See Note 6 for additional information).

Basis of Presentation

The consolidated financial statements include the accounts of the Company and its subsidiaries.  All inter-company accounts and transactions have been eliminated in consolidation.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. The unaudited condensed consolidated financial statements for the interim periods ended September 30, 2007 and 2006, include all adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods. This includes all normal and recurring adjustments, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. Operating results for the nine and three months ended September 30, 2007, are not necessarily indicative of the results that may be expected for the year ended December 31, 2007. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

Use of Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements and the reported amounts of net revenue and expenses in the reporting period. The Company regularly evaluates estimates and assumptions related to allowances for doubtful accounts, goodwill and purchased intangible asset valuations, derivatives and deferred income tax asset valuation allowances. The Company bases its estimates and assumptions on current facts, historical experience and on various other factors that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The actual results experienced by the Company may differ materially and adversely from management’s estimates. To the extent there are material differences between the estimates and the actual results, future results of operations will be affected.

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Redeemable Preferred Stock and Warrants

On April 5, 2006, the Company completed the sale of 26,500 shares of $1,000 stated value Series A Convertible Preferred Stock (liquidation preference $33.1 million) and warrants to purchase 5.3 million shares of the Company’s common stock for gross proceeds of $26.5 million ($24.7 million, net of direct financing costs). Pursuant to the Certificate of Designation, Series A Convertible Preferred Stock is convertible into shares of the Company’s common stock at a fixed conversion rate of $2.00 and, if not converted by March 20, 2008, is redeemable for cash of $2.00 per share. Series A Convertible Preferred Stock is also redeemable for cash upon a change in control or certain other events at an amount equal to 110% of the greater of (i) the stated value or (ii) the number of indexed shares at the closing market price on the date of the redemption triggering event.

The Series A Convertible Preferred Stock is non-voting and carried a 10% cumulative dividend feature, reduced to 6% upon the registration of the underlying shares, which was completed on August 1, 2006. Detachable warrants issued in connection with the Series A Convertible Preferred Stock financing arrangement have a strike price of $2.50 and a term of five-years. Common shares indexed to the Series A Convertible Preferred Stock and warrants are subject to the conditions of a freestanding registration rights agreement that provides for monthly liquidating damages of 1.0% (not to exceed an aggregate of 10.0%) for non-filing, non-effectiveness and loss of effectiveness.

The Company has evaluated all freestanding instruments and embedded features embodied in the Series A Convertible Preferred Stock financing arrangement in accordance with current accounting standards for complex financing transactions. The following points illustrate the key considerations in the Company’s evaluation:

·

 The terms and features of the Series A Convertible Preferred Stock resulted in the Company’s conclusion that the instrument was more akin to a debt security than an equity security. Therefore, embedded features that met the definition of derivative financial features were evaluated for their clear and close relationship with a debt instrument. Significant features included conversion features; contingent redemption (put) features and interest features. While conversion features, such as those included in the Series A Convertible Preferred Stock, are generally not clearly and closely related to debt instruments, the Company was afforded the “Conventional Convertible” exemption from derivative accounting. While put features and interest features are generally considered clearly and closely related to debt instruments, the Company determined that terms of the redemption put feature, in fact, resulted in its treatment as a derivative financial feature, subject to bifurcation from the hybrid instrument.

·

The terms and features of the freestanding warrants and registration rights were evaluated under the guidance for equity classification set forth in EITF Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexed to a Company’s Own Stock” and EITF Issue No. 05-04, “The Effect of a Liquidating Damages Clause on a Freestanding Financial Instrument Subject to EITF Issue No. 00-19”. For purposes of this evaluation, the Company elected to consider the warrants and registration rights on a combined basis (View A; EITF Issue No. 05-04). As a result, the Company concluded that the combined arrangement did not rise to an uneconomic settlement. In addition, all other indicators of equity provided in EITF Issue No. 00-19 were present. Therefore, the warrants were afforded equity classification.

The proceeds from the Series A Convertible Preferred Stock financing arrangement were allocated to the Series A Convertible Preferred Stock ($22.3 million) and warrants ($4.2 million) on a relative fair value basis. Following this allocation, approximately $1.2 million was allocated from the Series A Convertible Preferred Stock to the fair value of the put option referred to above. The Company used the following valuation techniques to value the instruments:

·

Series A Convertible Preferred Stock was valued as a forward contract, enhanced by a conversion option. The forward element of the aggregate value was determined using the present value of cash flows. The conversion option component was valued using the Flexible Monte Carlo technique, since that technique embodies all assumptions necessary for the fair value of bifurcated features that are associated with debt instruments (credit risk, interest risk and exercise behaviors).

·

Warrants were valued using the Black-Scholes-Merton valuation technique, since that technique embodies all assumptions necessary for the fair value of warrants (expected volatility, expected term, and risk-free interest).

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·

The put feature was valued using the present value of cash flows arising from multiple, probability-weighted outcomes. Management used its best estimate in developing probability scenarios. Fair value adjustments to the put feature will result in charges or credits to income in future periods. Such adjustments will arise from (i) changes in estimates underlying the probability-weighted model and (ii) the recognition of the time value (amortization component). The Company recorded a fair value adjustment of $30,718 as other income on the statement of operations during the quarter ended March 31, 2007.

As a result of the aforementioned allocations, the Series A Convertible Preferred Stock contained a beneficial conversion feature amounting to approximately $1.7 million. A beneficial conversion feature arises when the effective conversion price (remaining allocated proceeds divided by the number of indexed shares) is lower than the trading market price, using an intrinsic approach, on the effective date of the transaction. The beneficial conversion feature was classified as a component of equity.

Due to the contingent cash redemption features, the Series A Convertible Preferred Stock is required to be recorded outside of stockholders’ equity. The carrying value of Series A Convertible Preferred Stock was being accreted to its redemption value over the remaining redemption period through periodic charges to retained earnings using the effective method. Preferred accretion, which is reported as a reduction of net income for purposes of earnings per common share, amounted to approximately $0.1 million for the nine months ended September 30, 2007.

On August 31, 2006, 1,500 Shares of Series A Convertible Preferred Stock were converted to 750,000 shares of the Company’s common stock $.001 par value. The relative carrying value on the conversion date of the Series A Convertible Preferred Stock and Embedded Put was allocated to common stock and additional paid in capital.

On December 12, 2006, we entered into separate legal agreements with the holders of $25 million of our Series A Convertible Preferred Stock, pursuant to which each holder agreed to convert all of its shares of preferred stock into an aggregate of 12.5 million shares of our common stock. The $2.00 per share conversion rate was established at the time the preferred stock was purchased by such investors in April 2006. As an inducement to effect the conversions, we issued additional warrants (“Warrants”) to the converting holders, exercisable for five years, to purchase up to an aggregate of 2,000,005 shares of common stock at an exercise price of $3.05 per share and an aggregate of 1,000,002 shares of common stock at an exercise price of $4.00 per share. The exercise prices and the number of shares underlying the Warrants are subject to adjustment in certain instances.  The relative carrying value on the conversion date of the Series A Convertible Preferred Stock and Embedded Put was allocated to common stock and additional paid in capital.  

In December of 2006, 20,000 Shares of Series A Convertible Preferred Stock were converted to 10,000,000 shares of the Company’s common stock $.001 par value. The relative carrying value on the conversion date of the Series A Convertible Preferred Stock and Embedded Put was allocated to common stock and additional paid in capital.

On February 28, 2007, the remaining 5,000 Shares of Series A Convertible Preferred Stock were converted to 2,500,000 shares of the Company’s common stock $.001 par value. The relative carrying value on the conversion date of the Series A Convertible Preferred Stock and Embedded Put was allocated to common stock and additional paid in capital.

Stock-based compensation plans

Pursuant to the provisions of SFAS 123R, the Company applied the modified-prospective transition method. Under this method, the fair value provision of SFAS 123R is applied to new employee share-based payment awards granted or awards modified, repurchased or cancelled after December 31, 2005. Measurement and attribution of compensation cost for unvested awards at December 31, 2005, granted prior to the adoption of SFAS 123R, are recognized based upon the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), after adjustment for estimated forfeitures. Accordingly, SFAS 123R no longer permits pro-forma disclosure for income statement periods after December 31, 2005 and compensation expense will be recognized for all share-based payments based on grant-date fair value.

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Note 2 - Intangible Assets and Goodwill

Goodwill is recorded as the difference, if any, between the aggregate consideration paid for an acquisition and the fair value of the net tangible and intangible assets acquired. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS 142”), the Company tests goodwill for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis or more frequently if the Company believes indicators of impairment exist. The performance of the test involves a two-step process. The first step of the impairment test involves comparing the fair values of the applicable reporting units with their aggregate carrying value, including goodwill. The Company generally determines the fair value of its reporting units using the income approach methodology of valuation that includes the discounted cash flow method as well as other generally accepted valuation methodologies. If the carrying amount of a reporting unit exceeds the reporting unit’s fair value, the Company performs the second step of the goodwill impairment test to determine the amount of impairment loss. The second step of the goodwill impairment test involves comparing the implied fair value of the affected reporting unit’s goodwill with the carrying value of that goodwill.

During the third quarter of 2007, the goodwill associated with the acquisition of Webcapades, Inc. was tested for impairment.  On December 31, 2006, goodwill associated with the acquisitions of MarketSmart Advertising, Inc., KowaBunga! Marketing, Inc., Personals Plus, Inc., Ozona Online Networks, Inc, Vintacom Media Group, Inc. and Morex Marketing Group LLC. was tested for impairment.  On March 31, 2007, the goodwill associated with the acquisitions of Litmus Media, Inc., PrimaryAds, Inc. and Web Diversity Ltd. was tested for impairment.  On June 30, 2007, the goodwill associated with the acquisitions of iLead Media, Inc. and Real Estate School Online, Inc. was tested for impairment.  The Company determined that it did not have an impairment of goodwill associated with any of these acquisitions.

The Company amortizes its identifiable intangible assets, which result from acquisitions accounted for under the purchase method of accounting, using the straight-line method over their estimated useful lives.

Since 2004, the Company has entered into fourteen purchase agreements in which it allocated a total of $103.4 million of the purchase price to intangible assets.  During 2006 and 2007, the Company consolidated certain subsidiaries containing similar products, services and customer classes into three segments. All prior periods have been adjusted for the new presentation.  The following is a schedule of the Company’s intangible assets, by segment, as of September 30, 2007:

Network Segment

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Direct Segment

Advertising Segment

COMPANY TOTALS

****  Amortization of Names Database included in cost of revenue. 

The Company’s amortization expense over the next five years is as follows:

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Note 3 - Long Term Liabilities

The long term liabilities consisted of the following as of September 30, 2007:

Note 4 - Reclassification of Accretion Charges

The Company has reclassified additional paid in capital and accumulated deficit in shareholders’ equity to properly reflect the accounting for accretion charges relating to the convertible preferred for 2006. Accretion charges are allocated to retained earnings as long as the company has positive retained earnings. If the company does not have retained earnings, accretion charges are characterized as a reduction of paid in capital. In 2006, the Company did not have sufficient retained earnings to charge the accretion to retained earnings. However, entries had been made to increase the accumulated deficit. The Company has reduced additional paid in capital and accumulated deficit for 2006 in the amount of $2,849,012, to reflect this reclassification.

Note 5 - Stock-based compensation plans

Our stock option program is a long-term retention program that is intended to attract, retain and provide incentives for talented employees, officers and directors, and to align stockholder and employee interests. We consider our option programs critical to our operation and productivity. Currently, we grant options from our 2005 Long-Term Incentive Plan. Option vesting periods are generally zero to three years.

As of September 30, 2007, we had reserved 10.0 million shares of common stock for issuance under our 2005 Long-Term Incentive Plan. As of September 30, 2007, we had 8.21 million shares available for grant under our 2005 Long-Term Incentive Plan.

Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123 (R), “Share-Based Payment”, and began recognizing compensation expense in its Consolidated Statements of Operations as a selling, general, and administrative expense, for its stock option grants based on the fair value of the awards.  Prior to January 1, 2006, the Company accounted for stock option grants under the recognition and measurement provisions of APB Opinion 25, “Accounting for Stock Issued to Employees”, and related Interpretations, as permitted by SFAS No. 123, “Accounting for Stock-Based Compensation”.  No stock-based compensation expense was reflected in net income prior to adopting SFAS 123 (R) as all options were granted at an exercise price equal to or greater than the market value of the underlying common stock on the date of grant. SFAS 123 (R) was adopted using the modified prospective transition method.  Under this transition method, compensation cost recognized in the periods after adoption includes:  (i) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of SFAS 123, and (ii) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123 (R).  Results from prior periods have not been restated. 

The company adopted SFAS 123 (R) in the first quarter of 2006, and evaluated the two methods available for ordering tax deductions.   The company has adopted the tax law approach, which was first presented in the December 31, 2006 financial statements.  The impact of the application of this method to the company’s interim periods in 2006 would not have been significant.  The application of SFAS 123 (R) requires that the company’s cash flow statement include an operating cash outflow with a corresponding financing cash inflow for the excess tax benefits resulting from the exercise of stock options.

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The fair value of restricted stock units and the fair value of stock options are determined using the Black-Scholes valuation model, which is consistent with the valuation techniques previously utilized for options in the footnote disclosures required under SFAS No. 123, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure.” The Company recorded stock-based compensation expense for equity incentive plans of $934,582 and $493,140 for the nine months ended September 30, 2007 and 2006.  The Company recorded stock-based compensation expense for equity incentive plans of $319,356 and $192,100 for the three months ended September 30, 2007 and 2006.

At September 30, 2007, the aggregate intrinsic value of all outstanding options was $802,782 with a weighted average remaining contractual term of 7.17 years, of which 1,656,480 of the outstanding options are currently exercisable with an aggregate intrinsic value of $802,782, a weighted average exercise price of $1.59 and a weighted average remaining contractual term of 6.41 years.  The total intrinsic value of options exercised during the nine and three months ended September 30, 2007 was $2,260,344 and $0, respectively.  The total compensation cost at September 30, 2007 related to non-vested awards not yet recognized was $734,981 with an average expense recognition period of 1.79 years.  The total intrinsic value of options exercised during the nine and three months ended September 30, 2006 was $2,698,454 and $2,364,430, respectively.

The Company estimates the fair value of all stock option awards as of the grant date by applying the Black-Scholes-Merton option pricing model.  The use of this valuation model involves assumptions that are judgmental and highly sensitive in the determination of compensation expense and include the expected life of the option, stock price volatility, risk-free interest rate, dividend yield, exercise price, and forfeiture rate. Under SFAS 123 (R), forfeitures are estimated at the time of valuation and reduce expense ratably over the vesting period.  The forfeiture rate, which is estimated at a weighted average of 9.25 percent of unvested options outstanding, is adjusted periodically based on the extent to which actual forfeitures differ, or are expected to differ, from the previous estimate.  Under SFAS 123 and APB 25, the Company elected to account for forfeitures when awards were actually forfeited and reflect the forfeitures as a cumulative adjustment to the pro forma expense.

The following table summarizes information about stock options activity during the nine months ended September 30, 2007 and 2006 respectively.

The weighted average grant date fair value of options granted during the nine months ended September 30, 2007 and 2006 were $1.15 and $0.91, respectively.

Cash received from option and warrant exercises under all share-based payment arrangements for the nine months ended September 30, 2007 and 2006 was $256,136 and $443,632, respectively.

In accordance with SFAS 123 (R), the fair values of options granted prior to adoption and determined for purposes of disclosure under SFAS 123 have not been changed.  The fair value of options granted was estimated assuming the following weighted averages:

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Expected volatility is based on the historical volatility of the Company’s common stock over the period commensurate with or longer than the expected life of the options.

Warrants Outstanding

As of September 30, 2007, the Company has outstanding warrants for the potential issuance of 10,946,881. These warrants were primarily issued in connection with private placements and debt issuances. Exercise prices range from $1.00 to $4.12.  

Note 6 - Income Taxes

The Company is currently open to audit under the statute of limitations by the Internal Revenue Service for the years ending December 31, 2003 through 2006. The Company’s 2004 income tax return was reviewed by the Internal Revenue Service.  No material items were discovered and the review was finalized in 2006.  The Company and its subsidiaries state income tax returns are open to audit under the statute of limitations for the years ending December 31, 2003 through 2006.   

Note 7 - Net (Loss) Income Per Common Share

Net (Loss) Income per common share (basic) is calculated by dividing Net (Loss) Income applicable to common shareholders by the weighted average number of shares of common stock outstanding during the year. Net (Loss) Income per common share (fully diluted) is calculated by adjusting outstanding shares, assuming any dilutive effects of options and warrants using the treasury stock method.

Note 8 - Impact of New Accounting Standards Recent Accounting Pronouncements

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”) which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS 159 will become effective for the Company on January 1, 2008. The Company is currently evaluating the impact of adopting SFAS 159 on its financial position, cash flows, and results of operations.

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Note 9 - Accounting for Contingent Consideration

In connection with its prior acquisitions, the merger consideration may be increased as the former shareholders of each entity are entitled to earn payments in cash or stock contingent upon the satisfaction of certain future internal performance goals set forth in the applicable merger and amended merger agreements.  Future consideration which may be earned by the former shareholders of each entity will be treated as additional purchase price and allocated to goodwill.  The respective maximum amounts of such future consideration of known dollar amounts which may be earned by the former shareholders of the acquired entities are as follows:

During August 2006, the Company restructured the earnout provisions for five of its prior merger agreements.  All of the restructured agreements provide for the potential earnout payments to be made solely in the Company’s common stock.  The table below lists the maximum number of shares that the previous shareholders will be entitled to under the restructured agreements.

During 2006, the Company paid to the former shareholder of Ozona Online Network, Inc. $25,000 to satisfy the earnout provisions of the purchase agreement.  

Also, during 2006 the earnout provision related to the acquisition of Personals Plus, Inc. was terminated.

As of September 30, 2007, there are no liabilities under any other earnout agreements.

In addition, the former shareholders of the above acquisitions were granted a total of 955,000 options which were allocated to the purchase price.

(1)   The number of shares is dependent on future prices of the Company’s common stock.

(2)   Value of shares is dependent on future prices of the Company’s common stock.

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Note 10 - Pro Forma Financial Information (Unaudited)

The pro forma results are not indicative of the results of operations had the acquisition taken place at the beginning of the year (or future results of the combined companies).

These pro forma statements of operations include the activities of all acquisitions as if they had occurred on January 1, 2006. 

Note 11 - Segment Analysis

The Company’s operations are divided into operating segments using individual products or services or groups of related products and services. During the second quarter of 2007, the Company consolidated its Direct and Consumer Services segments under one Executive Officer. All prior periods have been adjusted for the new presentation. The Chief Executive Officer of each of the Company’s subsidiaries reports to the Chief Operating Officer of the Company, who makes decisions about performance assessment and resource allocation for all segments.  The Company had three operating segments as of September 30, 2007: network, direct and advertising.  The Company evaluates the performance of each segment using pre-tax income or loss from operations.

Listed below is a presentation of revenue, gross profit and operating profit for all reportable segments.  The Company currently only tracks certain assets at the segment level and therefore assets by segment are not presented below.  The “corporate” category in the “(Loss) Income before Income Taxes by Industry Segment” table consists of corporate expenses not allocated to any segment. 

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

Certain statements in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this quarterly report on Form 10-Q constitute “forward-looking statements” within the meaning of the Federal Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that are not historical, including statements regarding management’s intentions, beliefs, expectations, representations, plans or predictions of the future and are typically identified by words such as “believe,” “expect,” “anticipate,” “intend,” “estimate,” “may,” “will,” “should” and “could.”  These forward-looking statements involve numerous risks and uncertainties that could cause our actual results to be materially different from those set forth in the forward-looking statements including, without limitation, our lack of profitable operating history, changes in our business, potential need for additional capital and the other additional risks and uncertainties that are set forth in the “Risk Factors” section, the “Legal Proceedings” section, the “Management’s Discussion and Analysis of Results of Operations and Financial Condition” section and other sections of this Quarterly Report on Form 10-Q, as well as in our 2006 Form 10-K filed with the Securities and Exchange Commission on March 29, 2007. The “Risk Factors’ described in our Form 10-K are not the only risks we face.  Additional risks and uncertainties not currently known to us or that we deem immaterial also may materially adversely effect our business, financial condition and/or operating results.   The Company assumes no obligation to update any forward-looking statements as a result of new information or future events or developments, except as required by law. The following discussion should also be read in conjunction with the Financial Statements and Notes thereto appearing elsewhere in this quarterly report on Form 10-Q.  

Overview

We are a Nevada corporation headquartered in Clearwater, Florida. Through our wholly-owned direct and indirect subsidiaries we provide world class marketing and technology solutions to businesses and individuals. Our business is organized into three segments:  Network, Direct and Advertising.

We were incorporated in the State of Nevada in October 1987. As of October 17, 2007 we employed, through our operating subsidiaries, 222 persons. Our principal executive offices are located at 15550 Lightwave Drive, Suite 300, Clearwater, Florida 33760. Our telephone number is (727) 324-0046. The address of our website is www.thinkpartnership.com.

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Critical Accounting Policies and Estimates

Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make significant estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. We evaluate estimates, including those related to bad debts, inventories, goodwill and amortizable intangibles and income taxes, on an ongoing basis. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies, among others, involve more significant judgments and estimates used in the preparation of our financial statements:

We recognize revenues in accordance with the following principles with respect to our different business services:

We recognize revenue in accordance with Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition in Financial Statements.”  Under SAB, we recognize revenue when the following criteria have been met: persuasive evidence of an arrangement exists, the fees are fixed and determinable, no significant obligations remain and collection of the related receivable is reasonably assured.

Network Segment

Affiliate Network - consistent with the provisions of EITF Issue No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent,” (“EITF 99-19”) we recognize revenue as an agent in affiliate marketing transactions. Accordingly, service fee revenue is recognized on a net basis because any affiliate expenses are the responsibility of our advertising customer. Revenue is recognized when the related services are performed.

Search Network - In accordance with EITF 99-19, the Company records as revenue the gross amount received from advertisers and the amount paid to the publishers placing the advertisements as cost of revenue. Revenue from Company owned networks are based on a “per click” basis and is recognized once the action is taken.

Affiliate Software - We recognize revenue the month in which the software is utilized. Customers are invoiced on the first of the month for the monthly services. All overages for the month are billed at the end of the month and are included in our accounts receivable.

Hosting Arrangements – We recognize revenue through a monthly hosting fee and additional usage fees as provided.

Direct Segment

Online Membership Income - We recognize revenue from online membership revenue when payment is received and the service date of providing membership benefits has taken place.

Lead Sales - For lead sales, our revenue recognition varies depending on the arrangement with the purchaser. Where the arrangement provides for delivery only, revenue is recognized when the lead information is provided to the purchaser. Where the arrangement provides for compensation based on sales generated by the purchaser from the lead, we recognize revenue in the period that the purchasing company makes a sale that was derived from the lead.

Product Sales - For product sales, we recognize revenue when payment is received and the goods are shipped.

List Management Services - Substantially all of our revenue is recorded at the net amount of its gross billings less pass-through expenses charged to a customer. In most cases, the amount that is billed to customers exceeds the amount of revenue that is earned and reflected in our financial statements, because of various pass-through expenses. In compliance with EITF 99-19, we assess whether we or a third-party supplier is the primary obligor. We have evaluated the terms of our customer agreements and considered other key indicators such as latitude in establishing price, discretion in supplier selection and credit risk to the vendor as part of this assessment. Accordingly, we generally record revenue net of pass-through charges.

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Subscription Income - We recognize revenue on monthly and multi-monthly subscription contracts on a straight-line basis over the term of the contract.

Advertising Segment

Search Engine Enhancement Services - We recognize revenue in accordance with EITF Issue No. 00-21 “Revenue Arrangements with Multiple Deliverables.”  As such, each deliverable is treated as a separate product or deliverable. We therefore recognize revenue for each deliverable either on a straight line basis over the term of the contract, or when value is provided to the customer, as appropriate.

Pay Per Click Management Fees - We recognize revenue on pay per click management services in the month the services are performed.

Advertising Services - We recognize revenue in the period in which services are performed.

Other Critical Accounting Policies

All assets are depreciated over their estimated useful life using the straight line method. Intangible assets are amortized over their estimated lives using the straight line method. Goodwill is tested for impairment annually per SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”).

We reserve for federal and state income taxes on items included in the Consolidated Statements of Operations regardless of the period when the taxes are payable. Deferred taxes are recognized for temporary differences between financial statement and income tax basis.

Additional consideration payable in connection with certain acquisitions, if earned, is accounted for using the following principles:

·

In accordance with SFAS No. 141, “Business Combinations” (“SFAS 141”) contingent consideration is recorded when a contingency is satisfied and additional consideration is issued or becomes issuable. We record the additional consideration issued or issuable in connection with the relevant acquisition when the contingency is satisfied.

·

In accordance with EITF Issue No. 95-8, “Accounting for Contingent Consideration Paid to the Shareholders of an Acquired Enterprise in a Purchase Business Combination” (“EITF 95-8”) and FIN 44, the portion of additional consideration issuable to holders of unrestricted (i.e. not subject to risk of forfeiture) common stock and fully vested options as of the acquisition date is recorded as additional purchase price because the consideration is unrelated to continuing employment with us and is allocated to goodwill.

·

In accordance with EITF 95-8, the intrinsic value associated with additional consideration related to stock or options that vest between the acquisition date and the date at which the contingency is satisfied is recorded as an immediate charge to stock-based compensation expense at the time of vesting because the consideration is related to continuing employment with us or the acquired subsidiary.

Prior to January 1, 2006, we accounted for employee stock-based awards under the intrinsic value method, which followed the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and related Interpretations. Effective January 1, 2006, the Company adopted SFAS No. 123R, “Share-Based Payment” (“SFAS 123R”). SFAS 123R requires measurement of compensation cost for employee stock-based awards based upon fair value over the requisite service period for awards expected to vest. Furthermore, under SFAS 123R, liability based awards are recorded at fair value through to their settlement date.

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Pursuant to the provisions of SFAS 123R, we applied the modified-prospective transition method. Under this method, the fair value provision of SFAS 123R is applied to new employee share-based payment awards granted or awards modified, repurchased or cancelled after December 31, 2005. Measurement and attribution of compensation cost for unvested awards at December 31, 2005, granted prior to the adoption of SFAS 123R, are recognized based upon the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”, after adjustment for estimated forfeitures. Accordingly, SFAS 123R no longer permits pro-forma disclosure for income statement periods after December 31, 2005 and compensation expense will be recognized for all share-based payments based on grant-date fair value.

We have evaluated all freestanding instruments and embedded features embodied in the Series A Convertible Preferred Stock financing arrangement in accordance with current accounting standards for complex financing transactions. The following points illustrate the key considerations in our evaluation:

The terms and features of the Series A Convertible Preferred Stock resulted in the conclusion that the instrument was more akin to a debt security than an equity security. Therefore, embedded features that met the definition of derivative financial features were evaluated for their clear and close relationship with a debt instrument. Significant features included conversion features; contingent redemption (put) features and interest features. While conversion features, such as those included in the Series A Convertible Preferred Stock, are generally not clearly and closely related to debt instruments, we were afforded the “Conventional Convertible” exemption from derivative accounting. While put features and interest features are generally considered clearly and closely related to debt instruments, we determined that terms of the redemption put feature, in fact, resulted in its treatment as a derivative financial feature, subject to bifurcation from the hybrid instrument.

The terms and features of the freestanding warrants and registration rights were evaluated under the guidance for equity classification set forth in EITF Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexed to a Company’s Own Stock” and EITF Issue No. 05-04, “The Effect of a Liquidating Damages Clause on a Freestanding Financial Instrument Subject to EITF 00-19.” For purposes of this evaluation, we elected to consider the warrants and registration rights on a combined basis (View A; EITF Issue No. 05-04). As a result, we concluded that the combined arrangement did not rise to an uneconomic settlement. In addition, all other indicators of equity provided in EITF Issue No. 00-19 were present. Therefore, the warrants were afforded equity classification.

Liquidity and Capital Resources

This section describes our balance sheet and liquidity and capital commitments.  Our most liquid asset is cash and cash equivalents, which consists of cash and short-term investments.  Cash and cash equivalents at September 30, 2007 and December 31, 2006 were approximately $1.9 million and $3.0 million, respectively.  Cash and cash equivalents consist of cash and short-term investments with original maturities of 90 days or less.  Our cash deposits exceeded FDIC-insured limits by approximately $1.6 million at various financial institutions.  We have not experienced any losses in such accounts and believe we are not exposed to any significant credit risk on cash.

We expect that we will continue to invest significant resources in order to enhance our existing products and services and to introduce new high-quality products and services.  Further, we may need to expend additional capital resources on member acquisition costs and integrating new technologies to improve the speed, performance, features, ease of use and reliability of our consumer services in order to adapt to rapidly changing industry standards.  If usage of our websites substantially increases, we may need to purchase additional servers and networking equipment to maintain adequate data transmission speeds, the availability of which may be limited or the cost of which may be significant.

As part of the agreements to acquire certain of our subsidiaries, we agreed to pay the stockholders of these entities additional consideration, or contingent payments, if the financial performance of these respective subsidiaries satisfies certain financial hurdles.  As of September 30, 2007, the cash portion of these potential contingent payments totaled approximately $14.4 million which, if and to the extent earned, will likely become payable starting the first quarter of 2008 through the first quarter of 2009. We expect to fund these earnout payments through cash generated from operations. To the extent we do not have sufficient cash flow from operations to fund these payments, we would need to incur indebtedness or issue equity to satisfy these contingent payments.  

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In January 2006, we entered into a loan agreement with Wachovia Bank, National Association (Wachovia). Pursuant to the loan agreement, on January 20, 2006, we borrowed $15 million from Wachovia, evidenced by a revolving credit promissory note which bears interest at the LIBOR Market Index Rate plus 2.10% as such rate may change from day to day, and $2.5 million, evidenced by a term promissory note which bears interest at the LIBOR Market Index Rate plus 2.15% as such rate may change from day to day. Amounts due under the revolving credit note are payable in consecutive monthly payments of accrued interest only until January 19, 2009, the revolving credit note’s maturity, at which time all principal and any accrued but unpaid interest is due and payable. As of September 30, 2007 we had $11.8 million due under the revolving credit note. Amounts due under the term note are payable in 12 consecutive monthly payments of equal principal in the amount of $208,333 plus accrued interest with the final payment due on January 19, 2007, the term note’s maturity. This obligation was paid in full during the quarter ended March 31, 2007. Our obligations under the Loan Agreement and the Notes are secured by a first priority lien, in favor of Wachovia, on all of our assets, including the stock of each of our operating subsidiaries and are subject to certain financial covenants. Further, each of our operating subsidiaries has guaranteed the performance of our obligations under the Loan Agreement and the Notes and the guaranty is secured by a first priority lien on each subsidiary’s assets. We used a portion of the proceeds from our preferred stock offering to repay approximately $14.7 million due to Wachovia on the revolving credit note during 2006. We also used $10.5 million from the line of credit to fund the cash portions of certain acquisitions during the 2006.

On April 5, 2006, we completed the sale of 26,500 shares of $1,000 stated value Series A Convertible Preferred Stock (liquidation preference $33.1 million) and warrants to purchase 5.3 million shares of our common stock for gross proceeds of $26.5 million ($24.7 million, net of direct financing costs). Pursuant to the Certificate of Designations, Series A Convertible Preferred Stock was convertible into shares of our common stock at a fixed conversion rate of $2.00 and, if not converted by March 20, 2008, was redeemable for cash of $2.00 per share. Series A Convertible Preferred Stock was also redeemable for cash upon a change in control and certain other events at an amount equal to 110% of the greater of (i) the stated value or (ii) the number of indexed shares at the closing market price on the date of the redemption triggering event. The Series A Convertible Preferred Stock was non- voting and carried a 10% cumulative dividend feature, reduced to 6% upon the registration of the underlying shares, which occurred on August 1, 2006.

Detachable warrants issued in connection with the Series A Convertible Preferred Stock financing arrangement have a strike price of $2.50 and a term of five years. Common shares indexed to the Series A Convertible Preferred Stock and warrants are subject to the conditions of a freestanding registration rights agreement that provides for monthly liquidating damages of 1.0% (not to exceed an aggregate of 10.0%) for non-filing, non-effectiveness and loss of effectiveness.

On August 31, 2006, 1,500 Shares of Series A Convertible Preferred Stock were converted to 750,000 shares of the Company’s common stock $.001 par value. The relative carrying value on the conversion date of the Series A Convertible Preferred Stock and Embedded Put was allocated to common stock and additional paid in capital.

During December 2006, 20,000 Shares of Series A Convertible Preferred Stock were converted to 10,000,000 shares of the Company’s common stock $.001 par value. The relative carrying value on the conversion date of the Series A Convertible Preferred Stock and Embedded Put was allocated to common stock and additional paid in capital.  The remaining 5,000 Shares of Series A Convertible Preferred Stock were converted on February 28, 2007.  As an inducement to convert the last 25,000 Shares we issued 2.0 million warrants to purchase our Common Stock at a price of $3.05 per share and 1.0 million warrants to purchase our Common Stock at a price of $4.00 per share.

Cash provided by operating activities primarily consists of net (loss) income adjusted for certain non-cash items such as depreciation and amortization, deferred income taxes, stock based compensation and changes in working capital. Cash provided by operating activities for the nine months ended September 30, 2007 of approximately $1.9 million consisted primarily of net loss of approximately $0.8 million adjusted for non-cash items of $6.7 million, including depreciation, amortization of intangible assets, allowance for doubtful accounts, stock-based compensation, deferred income taxes and approximately $3.9 million used by working capital and other activities. Cash provided by operating activities for the nine months ended September 30, 2006 of approximately $2.9 million consisted primarily of a net income of approximately $0.3 million adjusted for non-cash items of approximately $4.5 million, including depreciation and amortization of intangible assets, allowance for doubtful accounts, stock-based compensation and deferred income taxes, and approximately $1.9 million used by working capital and other activities.

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We used approximately $3.5 million and $29.0 million in investing activities during the nine months ended September 30, 2007 and 2006, respectively. During the nine months ended September 30, 2007 and 2006 we used approximately $1.1 million and $0.9 million respectively to acquire equipment and software. We used approximately $2.3 million and $1.8 million during the nine months ended September 30, 2007 and 2006 to acquire data for our direct division.   We also used approximately $26.5 million to fund acquisitions in the first nine months of 2006.

We generated approximately $0.5 million in financing activities during the nine months ended September 30, 2007 as opposed to generating approximately $28.7 million in cash from financing activities during the nine months ended September 30, 2006.  During the nine months ended September 30, 2007 we used approximately $0.2 million to pay down debt and approximately $0.3 million for the payment of dividends due.  We generated approximately $0.2 million from the exercise of stock options during the nine months ended September 30, 2007 and approximately $0.1 million from draws on our line of credit.  Cash generated from financing activities in 2006 included net proceeds, totaling approximately $24.7 from the sale of convertible preferred stock, $3.3 million from draws on our line of credit with Wachovia and proceeds from an installment note with Wachovia totaling $2.5 million. These proceeds were offset by cash used to repay principal on outstanding debt of approximately $2.1 million and dividends of approximately $0.6 million.  

Results of Operations

This section describes and compares our results of operations for the nine and three months ended September 30, 2007 and 2006.

Nine Months Ended September 30, 2007 and 2006

Operating Revenues

Operating revenues by business segment are presented below.

Revenue for the nine months ended September 30, 2007 increased approximately $0.5 million to approximately $53.5 million from the same period in the prior fiscal year.

Revenue from our Network segment decreased by approximately $0.2 million to approximately $12.6 million for the nine months ended September 30, 2007.  Our search network contributed approximately $0.2 million less in revenue during the current year or approximately $5.5 million.  Revenue from our affiliate network increased by approximately $0.1 million to approximately $6.2 million.  Revenue from hosting remained constant from year to year at approximately $0.9 million.

Revenue from our Direct segment contributed approximately $27.7 million during the nine months ended September 30, 2007 an increase of approximately $5.9 million from the previous year.  We completed an acquisition in May of 2006 which further expanded our revenue base to include online memberships.  Revenue from online memberships contributed approximately an additional $9.3 million during the first nine months of 2007 as compared to the prior year. Online memberships contributed approximately $14.8 million during the current year.  Revenue from our Baby to Bee property contributed approximately $6.5 million during the nine months ended September 30, 2007, an increase of approximately $0.4 million over last year.  Revenue from our dating properties decreased approximately $3.5 million to approximately $5.5 million while revenue from our online education properties decreased approximately $0.3 million to approximately $0.9 million.

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Revenue from our Advertising segment was approximately $14.0 million for the nine months ended September 30, 2007, a decrease of approximately $5.0 million compared to the same period last year.  Search engine enhancement revenue decreased by approximately $6.1 million to approximately $1.5 million during the current year as compared to last year.  Revenue from traditional offline advertising services has also declined by approximately $0.6 million to approximately $7.0 million during the current year.  This was offset by increased paid search revenue of approximately $1.6 million derived from our foreign operations.  Revenue from paid search totaled approximately $5.5 million during the nine months ended September 30, 2007.

Gross Profit

Gross profits by business segment are presented below.

The gross profits for the nine months ended September 30, 2007 were approximately $27.9 million, 52% of revenue.  In contrast the gross profits for the equivalent period in 2006 were approximately $33.9 million, 64% of revenue.

Gross profit from our Network segment for the nine months ended September 30, 2007 was approximately $8.2 million, 65% of revenue compared to approximately $8.6 million or 67% of revenue for the nine months ended September 30, 2006.  Gross profit from our affiliate network contributed approximately $5.5 million during the nine months ended September 30, 2007, a decrease of $0.4 million from last year.  Gross profit from our search network contributed approximately $2.0 million during the nine months ended September 30, 2007, an increase of $0.1 million from the prior year. Our gross profit percentage from our affiliate network was approximately 89% for the nine months ended September 30, 2007 while gross profit percentage from our search network was approximately 37% for the same period.  As the revenue mix between our networks changes so will our gross profit percentage for this segment.

Gross profit from our Direct segment for the nine months ended September 30, 2007 was approximately $16.0 million, 58% of revenue compared to approximately $17.0 million or 78% of revenue for the nine months ended September 30, 2006.  The decrease in gross profit percentage during the nine months was mainly attributable to three factors.  First, revenue from our email marketing campaigns which has traditionally higher margins decreased significantly during the first nine months of 2007 as compared to last year.  Second, we completed an acquisition in May of 2006 which expanded our revenue base to include online memberships.  Gross profit margins from this revenue source are much lower.  Third, revenue from our online dating has decreased during the first nine months of 2007 as compared to 2006.  Revenue from this source has higher gross margins.

Gross profit from our Advertising segment for the nine months ended September 30, 2007 was approximately $3.9 million, 28% of revenue compared to approximately $8.7 million or 46% of revenue for the nine months ended September 30, 2006.  Gross profit from our search engine enhancement services decreased by approximately $4.7 million for the nine months ended September 30, 2007 as compared to the same period last year.  These types of services had produced gross margins of approximately 66%.  As our revenue from this segment shifts to more traditional offline and paid search, the gross profit will decline.  Our traditional offline marketing services produce gross margins of approximately 35% while our paid search margins are approximately 15%.

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Selling, General and Administrative Expenses

Selling, general and administrative expenses were approximately $25.4 million, 47% of revenue for the nine months ended September 30, 2007.  For the same period last year, these expenses totaled approximately $30.4 million, 57% of revenue.

Selling, general and administrative expenses in our Network segment for the nine months ended September 30, 2007 were approximately $5.0 million, 40% of revenue as compared to approximately $4.5 million, 35% of revenue for the same period last year.  This change was due to the varying revenue mix within this segment.  In our Direct segment, selling general and administrative expenses were approximately $10.9 million, 40% of revenue as compared to approximately $12.6 million, 58% of revenue for the same period last year. The revenue mix from this segment has shifted over the last year to higher margin sources.  Revenue from our online memberships has increased while revenue from online education and online dating has decreased.  Due to the change in revenue mix, the selling, general and administrative expenses as a percentage of revenue has also decreased.   Selling, general and administrative expenses in our Advertising segment were approximately $4.8 million, 34% of revenue as compared to approximately $8.8 million, or 46% of revenue for the prior year.  The decline in these expenses is a result of the large reduction in revenue derived from search engine enhancement services.  Corporate overhead expenses increased to approximately $4.8 million from approximately $4.7 million for the nine months ended September 30, 2007 and 2006 respectively.

Amortization of purchased intangibles was approximately $3.2 million and $2.4 for the nine months ended September 30, 2007 and 2006 respectively.  Amortization has increased as compared to last year due to three acquisitions completed in the second quarter of 2006.

Interest expense for the nine months ended September 30, 2007 and 2006 was approximately $0.6 million and $0.7 million respectively.  We will continue to incur the same levels of interest expense until we pay down our current and long term debt assuming interest rates remain consistent.

Net Loss Applicable to Common Stockholders

Net loss applicable to common stockholders was approximately $1.0 million, $0.01 per share, and $2.7 million, $0.06 per share, for the nine months ended September 30, 2007 and 2006, respectively.  During the nine months ended September 30, 2007 we incurred a charge of approximately $0.1 million for dividends and accretion of redeemable preferred stock as compared to $3.0 million in 2006.  

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Three Months Ended September 30, 2007 and 2006

Operating Revenues

Operating revenues by business segment are presented below.

Revenue for the three months ended September 30, 2007 decreased approximately $2.7 million to approximately $18.9 million from the same period in the prior fiscal year.  Revenue from our Network segment decreased approximately $0.1 million to approximately $5.1 million.  Revenue from our search network contributed approximately $2.4 million, a $0.2 million increase during the current quarter as compared to last year.  Revenue from our affiliate network contributed approximately $2.3 million, a decline of approximately $0.3 million when compared to last year.  Revenue from our Direct segment contributed approximately $9.2 million during the three months ended September 30, 2007 a decrease of approximately $0.4 million from the previous year.  We completed an acquisition in May of 2006 which expanded our revenue base to include online memberships.  Revenue from online memberships contributed approximately an additional $0.7 million during the quarter ended September 30, 2007 as compared to the prior year. This was offset by a decrease in revenue from our dating and online education properties of approximately $1.3 million.  Revenue from our Advertising segment decreased by approximately $2.1 million during the three months ended September 30, 2007, compared to the same period last year.  Search engine enhancement revenue decreased by approximately $1.7 million during the current year as compared to last year.  Revenue from traditional offline advertising services has increased by approximately $0.2 million during the current year.  This was offset by decreased paid search revenue of approximately $0.6 million from our foreign operations.  

Gross Profit

Gross profits by business segment are presented below.

The gross profits for the three months ended September 30, 2007 were approximately $9.5 million, 51% of revenue.  In contrast the gross profits for the equivalent period in 2006 were approximately $13.9 million, 64% of revenue. 

Gross profit from our Network segment for the three months ended September 30, 2007 was approximately $2.9 million, 57% of revenue compared to approximately $3.7 million or 70% of revenue for the three months ended September 30, 2006.  The decrease in gross profit percentage is due to increased revenue contribution from our search network in the third quarter of 2007 as compared to 2006.  The gross profit derived from this revenue source was approximately 34% of revenue for the three months ended September 30, 2007.  Our gross profit percentage from our affiliate network was approximately 78% of revenue for the quarter ended September 30, 2007.  As the revenue mix between our networks changes so will our gross profit percentage for this segment.

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Gross profit from our Direct segment for the three months ended September 30, 2007 was approximately $5.5 million, 60% of revenue compared to approximately $7.3 million or 76% of revenue for the three months ended September 30, 2006.  The decrease in gross profit percentage during the three months was mainly attributable to two factors.  First, revenue from our email marketing campaigns which has traditionally higher margins decreased  during the quarter ended September 30, 2007 as compared to last year.  Second, revenue from our online dating has decreased during the three months ended September 30, 2007 as compared to 2006.  Revenue from this source has higher gross margins.

Gross profit from our Advertising segment for the three months ended September 30, 2007 was approximately $1.3 million, 26% of revenue compared to approximately $2.9 million or 42% of revenue for the three months ended September 30, 2006.  Gross profit from our search engine enhancement services decreased by approximately $1.4 million for the three months ended September 30, 2007 as compared to the same period last year.  These types of services had produced gross margins of approximately 66%.  As our revenue from this segment shifts to more traditional offline and paid search, the gross profit will decline.  Our traditional offline marketing services produce gross margins of approximately 35% while our paid search margins are approximately 15%.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were approximately $8.0 million, 42% of revenue for the three months ended September 30, 2007.  For the same period last year, these expenses totaled approximately $11.2 million, 52% of revenue.

Selling, general and administrative expenses in our Network segment for the three months ended September 30, 2007 were approximately $2.0 million, 38% of revenue as compared to approximately $1.6 million, 31% of revenue for the same period last year.  This change was due to the varying revenue mix within this segment.  In our Direct segment, selling, general and administrative expenses were approximately $3.2 million for the three months ended September 30, 2007, 35% of revenue as compared to approximately $4.9 million, 51% of revenue for the three months ended September 30, 2006.  The revenue mix from this segment has shifted over the last year to higher margin sources.  Revenue from our online memberships has increased while revenue from online education and online dating has decreased.  Due to the change in revenue mix, the selling, general and administrative expenses as a percentage of revenue have also decreased.   Selling, general and administrative expenses in our Advertising segment were approximately $1.5 million, 30% of revenue as compared to approximately $3.0 million, or 42% of revenue for the prior year.  The decline in these expenses is a result of the large reduction in revenue derived from search engine enhancement services.  Corporate overhead expenses decreased to approximately $1.5 million from approximately $1.7 million for the three months ended September 30, 2007 and 2006 respectively.

Amortization of purchased intangibles was approximately $1.2 million and $1.0 for the three months ended September 30, 2007 and 2006 respectively.

Interest expense for the three months ended September 30, 2007 and 2006 was approximately $0.2 million.  We will continue to incur the same levels of interest expense until we pay down our current and long term debt assuming interest rates remain consistent.

Net Loss Applicable to Common Stockholders

Net profit applicable to common stockholders was approximately $0.0 million, $0.00 per share, as opposed to a net loss of $0.5 million, $0.01 per share, for the three months ended September 30, 2007 and 2006, respectively.  During the three months ended September 30, 2006 we incurred a charge of approximately $1.4 million for dividends and accretion of redeemable preferred stock.  

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Segment Analysis

Our operations are divided into operating segments using individual products or services or groups of related products and services. During the second quarter of 2007, we consolidated our Direct and Consumer Services segments under one Executive Officer. All prior periods have been adjusted for the new presentation. The Chief Executive Officer of each of our subsidiaries reports to our Chief Operating Officer, who makes decisions about performance assessment and resource allocation for all segments.  We had three operating segments as of September 30, 2007: network, direct and advertising.  We evaluate the performance of each segment using pre-tax income or loss from continuing operations.

Listed below is a presentation of revenue, gross profit and operating profit for all reportable segments.  We currently only track certain assets at the segment level and therefore assets by segment are not presented below.  The “corporate” category in the “(Loss) Income before Income Taxes by Industry Segment” table consists of corporate expenses not allocated to any segments. 

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ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to market risk for changes in interest rates relates to the fact that some of our debt consists of variable interest rate loans.  We seek to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs by monitoring our variable rate debt and converting such debt to fixed rates when we deem such conversion advantageous.

Our interest rate risk is monitored by periodically evaluating fixed interest rate quotes on all variable rate debt and the costs associated with converting the debt to fixed rate debt.  Also, existing fixed and variable rate loans which are scheduled to mature in the next two years are evaluated for possible early refinancing and or extension due to consideration given to current interest rates.  The table below presents the principal amount of the debt maturing each year, including monthly annual amortization of principal, through December 31, 2009 based on debt outstanding at September 30, 2007 and weighted average interest rates for the debt maturing in each specified period.

The table above does not reflect indebtedness incurred after September 30, 2007.  Our ultimate exposure to interest rate fluctuations depends on the amount of indebtedness that bears interest at variable rates, the time at which the interest rate is adjusted, the amount of the adjustment, our ability to prepay or refinance variable rate indebtedness and hedging strategies used to reduce the impact of any increases in rates.

Foreign Exchange Risk

While our reporting currency is the U.S. Dollar, approximately 3% of our consolidated costs and expenses are denominated in Canadian Dollars and approximately 10% of our consolidated revenue and costs are denominated in British Pounds.  As a result, we are exposed to foreign exchange risk as our results of operations may be affected by fluctuations in the exchange rate between U.S. Dollars, Canadian Dollars and British Pounds. If the Canadian Dollar or British Pound depreciates against the U.S. Dollar, the amount of our foreign income and expenses expressed in our U.S. Dollar financial statements will be affected. We have not entered into any hedging transactions in an effort to reduce our exposure to foreign exchange risk.  We currently incur approximately $2.0 million of annual expenses payable in Canadian dollars.  If the exchange rate were to change by $0.01, our net earnings would change by $20,000.  We currently generate approximately $7.5 million of income and incur approximately $7.5 million of expenses in British Pounds.  Since our British Pounds income and expenses are approximately equal the effect of an exchange rate change is expected to have minimal effect on our consolidated profit.

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ITEM 4.

CONTROLS AND PROCEDURES

As required by Rule 13a-15(b) under the Exchange Act, we conducted an evaluation, under the supervision and with the participation of our management, including our chief executive officer and the chief financial officer, of the effectiveness and the design and operation of our disclosure controls and procedures as of September 30, 2007, the end of the period covered by this report.  Based upon that evaluation, our chief executive officer and our chief financial officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and includes controls and procedures designed to ensure that information required to be disclosed in these reports is accumulated and communicated to our management, including our chief executive officer and our chief financial officer, as appropriate to allow timely decisions regarding the required disclosure.

There was no change in our internal control over financial reporting that occurred during the fiscal quarter ended September 30, 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

None.

ITEM 1A.

RISK FACTORS

There have been no material changes from the risk factors disclosed in the “Risk Factors” section of the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 filed on March 29, 2007.

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following sets forth securities sold by us in the quarterly period ended September 30, 2007 without registration under the Securities Act.  Unless otherwise noted, in each case we sold shares of our common stock in private transactions to persons who we believed were existing security holders or “accredited investors” and/or “sophisticated investors” not affiliated with us unless otherwise noted, and purchasing the shares with an investment intent.  Each of the transactions involved the offering of such securities to a substantially limited number of persons.  Each person took the securities as an investment for his/her/its own account, and not with a view to distribution. We relied upon exemptions contained in Sections 3(9) and 4(2) of the Securities Act or Regulation D promulgated thereunder in each of these instances.  In each case we did not engage in general solicitation and advertising and the shares were purchased by investors with whom we, through our officers and directors, had preexisting relationships.  Each person had access to information equivalent to that which would be included on a registration statement on the applicable form under the Securities Act.  We did not use underwriters for any of the transactions described below; therefore, these transactions did not involve underwriter discounts or commissions.

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

ITEM 5.

OTHER INFORMATION

None.  

ITEM 6.

EXHIBITS

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