MARCHEX INC - Quarter Report: 2010 September (Form 10-Q)

Large accelerated filer

Accelerated filer

Non-accelerated filer

¨ (Do not check if a smaller reporting company)

Smaller reporting company

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, 2010

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

For

the transition period from to .

Commission File Number 000-50658

Marchex, Inc.

(Exact name of Registrant as specified in its charter)

Delaware

35-2194038

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

520 Pike Street, Suite 2000

Seattle, Washington 98101

(Address of principal executive offices)

Registrant’s telephone number, including area code: (206) 331-3300

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 and 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 x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its Corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.


Class		Outstanding at November 4, 2010
Class A common stock, par value $.01 per share		10,503,591
Class B common stock, par value $.01 per share		24,554,150

Marchex, Inc.

Form 10-Q

Table of Contents


		Page
	Part I—Financial Information		3
Item 1.	Condensed Consolidated Financial Statements (unaudited)		3
	Condensed Consolidated Balance Sheets		3
	Condensed Consolidated Statements of Operations		4
	Condensed Consolidated Statements of Cash Flows		5
	Notes to Condensed Consolidated Financial Statements		6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		16
Item 3.	Quantitative and Qualitative Disclosures about Market Risk		32
Item 4.	Controls and Procedures		32
	Part II—Other Information
Item 1.	Legal Proceedings		33
Item 1A.	Risk Factors		33
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		48
Item 6.	Exhibits		49
SIGNATURE			50

Part I—Financial Information

Item 1.

Condensed Consolidated Financial Statements (unaudited)

MARCHEX, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(unaudited)


	December 31, 2009			September 30, 2010
Assets
Current assets:
Cash and cash equivalents	$	33,638,002		$	32,003,763
Trade accounts receivable, net		14,783,429			20,736,743
Prepaid expenses and other current assets		3,463,430			3,840,893
Refundable taxes		5,380,029			6,061,571
Deferred tax assets		950,477			1,042,317

Total current assets		58,215,367			63,685,287
Property and equipment, net		5,051,717			4,818,774
Deferred tax assets		52,690,910			50,538,512
Intangible and other assets, net		3,667,398			2,398,934
Goodwill		35,438,289			35,346,712
Intangible assets from acquisitions, net		4,309,478			2,189,999

Total assets	$	159,373,159		$	158,978,218

Liabilities and Stockholders’ Equity

Current liabilities:
Accounts payable	$	8,763,090		$	11,835,851
Accrued expenses and other current liabilities		6,158,966			5,842,153
Deferred revenue		2,020,728			1,599,980

Total current liabilities		16,942,784			19,277,984
Other non-current liabilities		1,005,444			1,671,206

Total liabilities		17,948,228			20,949,190

Stockholders’ equity:
Class A common stock		111,317			107,661
Class B common stock		251,939			247,685
Treasury stock		(3,204,884	)		(530,849	)
Additional paid-in capital		281,952,605			279,578,838
Accumulated deficit		(137,686,046	)		(141,374,307	)

Total stockholders’ equity		141,424,931			138,029,028

Total liabilities and stockholders’ equity	$	159,373,159		$	158,978,218

See accompanying notes to condensed consolidated financial statements.

MARCHEX, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

(unaudited)


	Nine Months Ended September 30,						Three Months Ended September 30,
	2009			2010			2009			2010
Revenue	$	69,823,816		$	69,590,175		$	22,171,794		$	24,194,841

Expenses:
Service costs (1)		34,934,455			40,909,245			12,048,245			14,604,200
Sales and marketing (1)		14,485,213			10,605,457			3,213,946			3,183,374
Product development (1)		10,969,807			12,482,042			3,369,290			4,193,428
General and administrative (1)		12,055,096			12,809,459			3,997,361			4,683,639
Amortization of intangible assets from acquisitions (2)		4,680,879			2,119,479			1,211,328			704,106

Total operating expenses		77,125,450			78,925,682			23,840,170			27,368,747
Gain on sales and disposals of intangible assets, net		2,832,968			4,650,182			1,048,113			2,632,634

Loss from operations		(4,468,666	)		(4,685,325	)		(620,263	)		(541,272	)
Other income (expense):
Interest income		41,686			55,556			13,016			17,891
Interest and line of credit expense		(72,202	)		(79,894	)		(26,709	)		(27,256	)
Other		13,091			158,226			50			111,968

Total other income (expense)		(17,425	)		133,888			(13,643	)		102,603

Loss before provision for income taxes		(4,486,091	)		(4,551,437	)		(633,906	)		(438,669	)
Income tax expense (benefit)		(2,387,821	)		(863,176	)		(1,376,830	)		54,202

Net income (loss)		(2,098,270	)		(3,688,261	)		742,924			(492,871	)
Dividends paid to participating securities		(137,035	)		(146,229	)		(46,576	)		(54,540	)

Net income (loss) applicable to common stockholders	$	(2,235,305	)	$	(3,834,490	)	$	696,348		$	(547,411	)

Basic and diluted net income (loss) per share applicable to Class A and Class B common stockholders	$	(0.07	)	$	(0.12	)	$	0.02		$	(0.02	)
Dividends paid per share	$	0.06		$	0.06		$	0.02		$	0.02
Shares used to calculate basic net income (loss) per share applicable to common stockholders
Class A		10,889,326			10,725,333			10,869,216			10,556,988
Class B		22,971,777			22,037,273			22,724,209			21,948,520
Shares used to calculate diluted net income (loss) per share applicable to common stockholders
Class A		10,889,326			10,725,333			10,869,216			10,556,988
Class B		33,861,103			32,762,606			33,930,390			32,505,508
(1) Excludes amortization of intangible assets from acquisitions
(2) Components of amortization of intangible assets from acquisitions:
Service costs	$	4,636,435		$	2,119,479		$	1,211,328		$	704,106
General and administrative		44,444			-			-			-

Total	$	4,680,879		$	2,119,479		$	1,211,328		$	704,106

See accompanying notes to condensed consolidated financial statements.

MARCHEX, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(unaudited)


	Nine Months Ended September 30,
	2009			2010
Cash flows from operating activities:
Net loss	$	(2,098,270	)	$	(3,688,261	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Amortization and depreciation		9,404,409			5,991,304
Leasehold improvement incentive		-			779,100
Gain on sales of fixed assets, net		(615	)		(198	)
Gain on sales and disposals of intangible assets, net		(2,832,968	)		(4,650,182	)
Allowance for doubtful accounts and merchant advertiser credits		563,729			988,936
Stock-based compensation		7,316,570			7,906,255
Deferred income taxes		3,579,470			2,060,558
Excess tax benefit related to stock options		(68,827	)		-
Change in certain assets and liabilities, net of acquisition:
Trade accounts receivable, net		8,061,003			(6,942,250	)
Refundable taxes		(4,145,758	)		(1,208,053	)
Prepaid expenses, other current assets and restricted cash		399,030			(1,425,984	)
Accounts payable		(4,811,731	)		3,052,390
Accrued expenses and other current liabilities		(1,601,431	)		358,987
Deferred revenue		(178,838	)		(420,750	)
Other non current liabilities		(13,164	)		665,762

Net cash provided by operating activities		13,572,609			3,467,614
Cash flows from investing activities:
Purchases of property and equipment		(1,391,536	)		(2,727,614	)
Proceeds from sales of property and equipment		615			198
Proceeds from sales of intangible assets		2,925,677			4,652,208
Purchases of intangibles and changes in other non-current assets		18,577			(65,599	)

Net cash provided by investing activities		1,553,333			1,859,193
Cash flows from financing activities:
Capital lease obligation principal payments		(30,730	)		(6,161	)
Excess tax benefit related to stock options		68,827			-
Common stock dividend payments		(2,180,971	)		(2,114,763	)
Repurchase of Class B common stock		(7,501,226	)		(4,882,930	)
Proceeds from exercises of stock options		89,906			30,458
Proceeds from employee stock purchase plan		32,384			12,350

Net cash used in financing activities		(9,521,810	)		(6,961,046	)

Net increase (decrease) in cash and cash equivalents		5,604,132			(1,634,239	)
Cash and cash equivalents at beginning of period		27,418,396			33,638,002

Cash and cash equivalents at end of period	$	33,022,528		$	32,003,763

Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes, net of refunds	$	77,914		$	(1,651,963	)

See accompanying notes to condensed consolidated financial statements.

Marchex, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

(1) Description of Business and Basis of Presentation

Marchex, Inc. (the “Company”) was incorporated in the state of Delaware on January 17, 2003. The Company is a call advertising and small business marketing company. The Company delivers call and click-based advertising products to tens of thousands of advertisers. The accompanying unaudited condensed consolidated financial statements of Marchex, Inc. and its wholly-owned subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for annual financial statements. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010, or for any other period. The balance sheet at December 31, 2009 has been derived from the audited consolidated financial statements at that date but does not include all of the information and notes required by accounting principles generally accepted in the United States of America for complete financial statements. These condensed consolidated financial statements and notes should be read in conjunction with the Company’s audited consolidated financial statements and accompanying notes included in the Annual Report on Form 10-K for the year ended December 31, 2009 filed with the SEC.

The condensed consolidated financial statements include the accounts of Marchex and its wholly-owned subsidiaries. Acquisitions are included in the Company’s consolidated financial statements as of and from the date of acquisition. The Company’s purchase accounting resulted in all assets and liabilities of acquired businesses being recorded at their estimated fair values on the acquisition dates. All inter-company transactions and balances have been eliminated in consolidation. Certain reclassifications have been made to the condensed consolidated financial statements in the prior year to conform to the current year presentation.

The Company’s condensed consolidated financial statements presented include the condensed consolidated balance sheets as of December 31, 2009 and September 30, 2010, the condensed consolidated statements of operations for the three and nine months ended September 30, 2009 and 2010 and the condensed consolidated statements of cash flows for the nine months ended September 30, 2009 and 2010.

(2) Significant Accounting Policies

The preparation of financial statements in conformity with generally accepted accounting principles (“GAAP”) in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. These judgments are difficult as matters that are inherently uncertain directly impact their valuation and accounting. Actual results may vary from management’s estimates and assumptions.

There have been no changes to the Company’s significant accounting policies as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 filed with the SEC.

Recently Issued Accounting Pronouncements

In October 2009, the FASB issued Accounting Standards Update (ASU) 2009–No. 13 Multiple-Deliverable Revenue Arrangements, which amends FASB ASC 605 Revenue Recognition. This provides amendments to the criteria for separating deliverables, measuring and allocating arrangement consideration to one or more units of accounting. This update establishes a selling price hierarchy for determining the selling price of a deliverable. ASU 2009–No. 13 is effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. The Company is required to and plans to adopt the provisions of this update beginning in the first quarter of 2011. The Company is currently assessing the impact of the adoption of ASU 2009–No. 13.

Revenues

The following table presents the Company’s revenues, by revenue source, for the periods presented:


	Nine months ended September 30,				Three months ended September 30,
	2009		2010		2009		2010
Partner and Other Revenue Sources	$	45,270,588	$	49,894,781	$	15,899,331	$	17,999,797
Proprietary Traffic Sources		24,553,228		19,695,394		6,272,463		6,195,044

Total Revenue	$	69,823,816	$	69,590,175	$	22,171,794	$	24,194,841

The Company’s partner network revenues are primarily generated using third-party distribution networks to deliver the advertisers’ listings. The distribution network includes search engines, shopping engines, directories, destination sites, third-party Internet domains or Web sites, other targeted Web-based content, mobile and offline sources. The Company generates revenue upon delivery of qualified and reported phone calls or click-throughs to the Company’s advertisers or to advertising services providers’ listings. The Company pays a revenue share to the distribution partners to access their online, mobile, offline, or other user traffic. Other revenues include the Company’s call provisioning and call tracking services, campaign management services, natural search optimization services and outsourced search marketing platforms.

The Company’s proprietary traffic revenues are generated from the Company’s portfolio of owned Web sites which are monetized with pay-per-click listings that are relevant to the Web sites, as well as other forms of advertising, including call-based advertising units, banner advertising and sponsorships. When an online user navigates to one of the Company’s Web sites and clicks on a particular listing or completes the specified action, the Company receives a fee.

(3) Stock-based Compensation Plans

The Company accounts for stock-based compensation for employees and non-employees under the fair value method.

Stock-based compensation expense was included in the following operating expense categories as follows:


	Nine months ended September 30,				Three months ended September 30,
	2009		2010		2009		2010
Service costs	$	317,561	$	608,304	$	120,505	$	223,672
Sales and marketing		1,222,037		602,995		239,528		221,901
Product development		478,925		740,553		180,493		280,377
General and administrative		5,298,047		5,954,403		1,785,936		2,199,285

Total stock-based compensation	$	7,316,570	$	7,906,255	$	2,326,462	$	2,925,235

The per share fair value of stock options granted during the three and nine months ended September 30, 2009 and 2010 was determined on the date of grant using the Black-Scholes option-pricing model unless the stock options are subject to certain service and market conditions, in which case the Company uses other fair value models. The following weighted average assumptions were used in determining the fair value of option grants for the periods presented:


	Nine months ended September 30,						Three months ended September 30,
	2009			2010			2009			2010
Expected life (in years)		3.6			4.5			3.5			4.0
Risk-free interest rate		1.58	%		1.71	%		1.88	%		1.00	%
Expected volatility		64	%		66	%		66	%		68	%
Expected dividend yield		1.1	%		1.1	%		1.1	%		1.1	%

In May 2010, the Company’s Board of Directors approved an amendment to the Company’s 2003 Amended and Restated Stock Incentive Plan (the “Plan”) which provides for the grant of restricted stock units to eligible participants under the Plan.

In May 2010, the Company’s Compensation Committee of the Board of Directors (the “Compensation Committee”) approved stock option grants of 157,500 and restricted stock grants of 315,000 to certain executive officers. The stock options vest 25% on the first annual anniversary of the grant date and 1/12^th of the remainder will vest quarterly thereafter for the following three years. The

restricted shares will vest 25% on each of the first, second, third and fourth annual anniversaries of the grant date. The fair value of these awards is $2.0 million and is being recognized over their respective vesting periods.

In May 2010, the Compensation Committee also approved performance based equity awards to certain executive officers which included 405,000 stock option grants and grants of 135,000 restricted stock units. Each restricted stock unit represents the right to receive one share of the Company’s Class B common stock upon satisfaction of certain vesting considerations. These performance based awards have vesting based on certain service and market conditions. These performance based awards were issued in three separate tranches and each successive tranche will vest on the later of (a) the 12, 21, or 30 month anniversary of the grant date, respectively, and (b) the Company’s Class B common stock upon reaching certain average stock price targets for each tranche. The fair value of these performance based equity awards is being recognized over their explicit service periods.

Stock option activity during the nine months ended September 30, 2010 is summarized as follows:


	Shares			Weighted average exercise price		Weighted average remaining contractual term (in years)		Aggregate intrinsic value
Balance at December 31, 2009		4,701,151		$	9.59		5.61	$	1,669,404
Options granted (1)		1,294,750			5.05
Options exercised		(5,437	)		3.29
Options expired		(221,038	)		12.97
Options forfeited		(178,483	)		7.46

Balance at September 30, 2010 (1)		5,590,943		$	8.52		6.95	$	2,529,193

(1)	Includes 405,000 options that have vesting based on certain service and market conditions.

Restricted stock awards and restricted stock units activity during the nine months ended September 30, 2010 is summarized as follows:


	Shares			Weighted average grant date fair value
Awarded and unvested balance at December 31, 2009		2,541,802		$	8.99
Granted (1)		908,500			5.05
Vested		(553,802	)		8.64
Forfeited		(40,500	)		3.91

Awarded and unvested balance at September 30, 2010 (1)		2,856,000		$	7.87

(1)	Includes 135,000 restricted stock units which entitle the holder to receive one share of the Company’s Class B common stock upon satisfaction of certain service and market conditions.

The following table summarizes stock-based compensation expense related to all stock-based awards under the fair value method during the three and nine months ended September 30, 2009 and 2010:


	Nine months ended September 30,				Three months ended September 30,
	2009		2010		2009		2010
Total stock-based compensation included in net income (loss)	$	7,317,000	$	7,906,000	$	2,326,000	$	2,925,000
Income tax benefit related to stock-based compensation included in net income (loss)	$	2,163,000	$	2,186,000	$	670,000	$	822,000

(4) Net Income (Loss) Per Share

We compute net income (loss) per share of Class A and Class B common stock using the two class method. Under the provisions of the two class method, basic net income (loss) per share is computed by dividing net income (loss) applicable to common stockholders by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is computed by dividing net income (loss) applicable to common stockholders by the weighted average number of common and dilutive common equivalent shares outstanding during the period. The computation of the diluted net income (loss) per share of Class B common stock assumes the conversion of Class A common stock to Class B common stock, while the diluted net income (loss) per share of Class A common stock does not assume the conversion of those shares.

In accordance with the two class method, the undistributed earnings for each period are allocated based on the contractual participation rights of the Class A and Class B common shares and the restricted shares as if the earnings for the year had been distributed. Considering the terms of the Company’s charter which provides that, if and when dividends are declared on our common stock in accordance with Delaware General Corporation Law, equivalent dividends shall be paid with respect to the shares of Class A common stock and Class B common stock and that both classes of common stock have identical dividend rights and would share equally in our net assets in the event of liquidation, we have allocated undistributed losses on a proportionate basis. Additionally, the Company has paid dividends equally to both classes of common stock and the unvested restricted shares since it initiated a quarterly cash dividend in November 2006.

The provisions of FASB ASC 260 (previously FSP EITF 03-6-1) became effective for the Company on January 1, 2009, under this method instruments granted in unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents, whether paid or unpaid, are participating securities prior to vesting. As such, the Company’s restricted stock awards are considered participating securities for purposes of calculating earnings per share. Under the two class method, dividends paid on unvested restricted stock are allocated to these participating securities and therefore impacts the calculation of amounts allocated to common stock.

The following table includes net income (loss) applicable to common stockholders used to compute basic net loss per share for the periods ended:


	Nine months ended September 30, 2009						Nine months ended September 30, 2010
	Class A			Class B			Class A			Class B
Numerator:
Net loss	$	(718,847	)	$	(1,379,423	)	$	(1,255,278	)	$	(2,432,983	)
Dividends paid to participating securities		-			(137,035	)		-			(146,229	)

Net loss applicable to common stockholders	$	(718,847	)	$	(1,516,458	)	$	(1,255,278	)	$	(2,579,212	)

Denominator:
Weighted average number of shares outstanding used to calculate basic net loss per share		10,889,326			22,971,777			10,725,333			22,037,273

Basic net loss per share applicable to common stockholders	$	(0.07	)	$	(0.07	)	$	(0.12	)	$	(0.12	)

	Three months ended September 30, 2009						Three months ended September 30, 2010
	Class A			Class B			Class A			Class B
Numerator:
Net income (loss)	$	225,305		$	517,619		$	(177,786	)	$	(315,085	)
Dividends paid to participating securities					(46,576	)		-			(54,540	)

Net income (loss) applicable to common stockholders	$	225,305		$	471,043		$	(177,786	)	$	(369,625	)

Denominator:
Weighted average number of shares outstanding used to calculate basic net income (loss) per share		10,869,216			22,724,209			10,556,988			21,948,520

Basic net income (loss) per share applicable to common stockholders	$	0.02		$	0.02		$	(0.02	)	$	(0.02	)


	Nine months ended September 30, 2009						Nine months ended September 30, 2010
	Class A			Class B			Class A			Class B
Numerator:
Net loss	$	(718,847	)	$	(1,379,423	)	$	(1,255,278	)	$	(2,432,983	)
Dividends paid to participating securities		-			(137,035	)		-			(146,229	)
Reallocation of net loss for Class A shares as a result of conversion of Class A to Class B shares					(718,847	)					(1,255,278	)

Net loss applicable to common stockholders	$	(718,847	)	$	(2,235,305	)	$	(1,255,278	)	$	(3,834,490	)

Denominator:
Weighted average number of shares outstanding used to calculate basic net loss per share		10,889,326			22,971,777			10,725,333			22,037,273
Conversion of Class A to Class B common shares outstanding					10,889,326						10,725,333
Weighted average number of shares outstanding used to calculate diluted net loss per share		10,889,326			33,861,103			10,725,333			32,762,606

Diluted net loss per share applicable to common stockholders	$	(0.07	)	$	(0.07	)	$	(0.12	)	$	(0.12	)


	Three months ended September 30, 2009						Three months ended September 30, 2010
	Class A			Class B			Class A			Class B
Numerator:
Net income (loss)	$	225,305		$	517,619		$	(177,786	)	$	(315,085	)
Dividends paid to participating securities		-			(46,576	)		-			(54,540	)
Reallocation of net loss for Class A shares as a result of conversion of Class A to Class B shares		-			225,305			-			(177,786	)

Net income (loss) applicable to common stockholders	$	225,305		$	696,348		$	(177,786	)	$	(547,411	)

Denominator:
Weighted average number of shares outstanding used to calculate basic net loss per share		10,869,216			22,724,209			10,556,988			21,948,520
Conversion of Class A to Class B common shares outstanding		-			10,869,216			-			10,556,988
Weighted average stock options and warrants and common shares subject to repurchase or cancellation		-			336,965			-

Weighted average number of shares outstanding used to calculate diluted net income (loss) per share		10,869,216			33,930,390			10,556,988			32,505,508

Diluted net income (loss) per share applicable to common stockholders	$	0.02		$	0.02		$	(0.02	)	$	(0.02	)

The weighted average number of shares used to calculate the diluted net income (loss) per share includes the weighted average number of shares from the assumed conversion of Class A common stock to Class B common stock.

The computation of diluted net loss per share excludes the following because their effect would be anti-dilutive:

•

For the three and nine months ended September 30, 2009, outstanding options to acquire 4,007,959 and 4,645,528 shares of Class B common stock with a weighted average exercise price of $11.18 and $9.92 per share, respectively. For the

three and nine months ended September 30, 2010, outstanding options to acquire 4,810,941 and 4,483,907 shares of Class B common stock with a weighted average exercise price of $9.37 and $9.89 per share, respectively.

•

For the three and nine months ended September 30, 2009, 2,344,504 shares of unvested Class B restricted common shares at September 30, 2009 issued to employees and in connection with acquisitions. For the three and nine months ended September 30, 2010, 2,721,000 shares of unvested Class B restricted common shares at September 30, 2010 issued to employees and in connection with acquisitions. Unvested shares were excluded from the denominator of the computation of basic net loss per share.

•

For the three and nine months ended September 30, 2010, 405,000 stock options and 135,000 restricted stock units of performance based awards until certain service and market conditions are met. These performance based awards were excluded from the denominator of the computation of basic net loss per share.

(5) Concentrations

The Company maintains substantially all of their cash and cash equivalents with one financial institution.

A significant portion of the Company’s revenue earned from advertisers is generated through arrangements with distribution partners. The Company may not be successful in renewing any of these agreements, or if they are renewed, they may not be on terms as favorable as current agreements. The Company may not be successful in entering into agreements with new distribution partners or advertisers on commercially acceptable terms. In addition, several of these distribution partners or advertisers may be considered potential competitors.

There were no distribution partners representing more than 10% of consolidated revenue for the three and nine months ended September 30, 2009 and 2010.

The advertisers representing more than 10% of consolidated revenue are as follows:


	Nine months ended September 30,						Three months ended September 30,
	2009			2010			2009			2010
Advertiser A		11	%		*			12	%		*
Advertiser B		22	%		23	%		23	%		20	%
Advertiser D		11	%		*			12	%		*

*	Less than 10% of revenue.

Advertiser A and B are also distribution partners.

The outstanding receivable balance for each advertiser representing more than 10% of accounts receivable is as follows:


	At December 31, 2009			At September 30, 2010
Advertiser A		11	%		*
Advertiser B		43	%		44	%

(6) Segment Reporting and Geographic Information

Operating segments are revenue-producing components of the enterprise for which separate financial information is produced internally for the Company’s management. For all periods presented the Company operated as a single segment, principally in domestic markets providing Internet advertiser transaction services to enterprises.

Revenues from advertisers by geographical areas are tracked on the basis of the location of the advertiser. The vast majority of the Company’s revenue and accounts receivable are derived from domestic sales to advertisers engaged in various activities involving the Internet.

Revenues by geographic region are as follows (in percentages):


	Nine months ended September 30,						Three months ended September 30,
	2009			2010			2009			2010
United States		99	%		96	%		99	%		95	%
Canada		*			4	%		*			4	%
Other countries		*			*			*			*

		100	%		100	%		100	%		100	%

*	Less than 1% of revenue.

(7) Property and Equipment

Property and equipment consisted of the following:


	At December 31, 2009			At September 30, 2010
Computer and other related equipment	$	9,169,886		$	10,231,047
Purchased and internally developed software		6,436,820			6,194,913
Furniture and fixtures		936,170			1,118,695
Leasehold improvements		1,210,415			1,634,260

	$	17,753,291		$	19,178,915
Less: accumulated depreciation and amortization		(12,701,574	)		(14,360,141	)

Property and equipment, net	$	5,051,717		$	4,818,774

The Company has capitalized certain costs of internally developed software for internal use. The estimated useful life of costs capitalized is evaluated for each specific project. Amortization begins in the period in which the software is ready for its intended use.

Depreciation and amortization expense, related to property and equipment was approximately $868,000 and $738,000 for the three months ended September 30, 2009 and 2010, respectively, and was $2.9 million and $2.3 million for the nine months ended September 30, 2009 and 2010, respectively.

(8) Commitments

The Company has commitments for future payments related to office facilities leases and other contractual obligations. The Company leases its office facilities under operating lease agreements expiring through 2018. The Company has other contractual obligations expiring over varying time periods through 2013. Other contractual obligations primarily relate to minimum contractual payments due to distribution partners and other service providers. Future minimum payments are approximately as follows:


	Facilities operating leases		Other contractual obligations		Total
2010	$	318,239	$	647,435	$	965,674
2011		1,409,230		2,196,399		3,605,629
2012		1,593,537		1,238,804		2,832,341
2013		1,769,788		175,350		1,945,138
2014		1,840,062		-		1,840,062
2015 and after		6,397,143		-		6,397,143

Total minimum payments	$	13,327,999	$	4,257,988	$	17,585,987

In June 2009, the Company entered into a lease agreement for office facilities in Seattle, Washington which commenced in the fourth quarter of 2009 and expires on March 31, 2018. In the third quarter of 2010, the lessor paid $779,000 towards certain leasehold improvements which the Company accounted for as a lease incentive and is amortizing as a reduction of rent expense over the lease term.

In May 2010, the Company entered into a lease agreement for office facilities in New York, New York which commenced in the second quarter of 2010 and expires in March 2018. Future minimum payments related to these new facilities are approximately as follows: $2,000 for the remainder of 2010, $209,000 in 2011, $243,000 in 2012, $249,000 in 2013, $273,000 in 2014, and $978,000 in aggregate thereafter.

Rent expense incurred by the Company was approximately $410,000 and $414,000 for the three months ended September 30, 2009 and 2010, respectively, and was $1.2 million and $1.3 million for the nine months ended September 30, 2009 and 2010, respectively.

(9) Credit Agreement

In April 2008, the Company entered into a credit agreement providing for a senior secured $30 million revolving credit facility (“Credit Agreement”). The Credit Agreement matures and all outstanding borrowings are due in April 2011. Interest on outstanding balances under the Credit Agreement will accrue at LIBOR plus an applicable margin rate, as determined under the agreement and there is an unused commitment fee. The Credit Agreement contains certain customary representations and warranties, financial covenants, events of default and is secured by substantially all of the assets of the Company. As of September 30, 2010, the Company had no borrowings under the Credit Agreement.

(10) Contingencies and Taxes

(a) Contingencies

The Company is involved in legal and administrative proceedings and claims of various types from time to time. While any litigation contains an element of uncertainty, the Company is not aware of any legal proceedings or claims which are pending that the Company believes, based on current knowledge, will have, individually or taken together, a material adverse effect on the Company’s financial condition or results of operations or liquidity.

In some agreements to which we are a party, we have agreed to indemnification provisions of varying scope and terms with advertisers, vendors and other parties with respect to certain matters, including, but not limited to, losses arising out of the Company’s breach of agreements or representations and warranties made by the Company, services to be provided by the Company and intellectual property infringement claims made by third parties. As a result of these provisions, we may from time to time provide certain levels of financial support to our contract parties to seek to minimize the impact of any associated litigation in which they may be involved. To date, there have been no known events or circumstances that have resulted in any material costs related to these indemnification provisions and no liabilities therefore have been recorded in the accompanying unaudited condensed consolidated financial statements. However, the maximum potential amount of the future payments we could be required to make under these indemnification provisions could be material.

(b) Taxes

From time to time, various state, federal and other jurisdictional tax authorities undertake reviews of the Company and its tax filings. In evaluating the exposure associated with various tax filing positions, the Company on occasion accrues for uncertain tax positions. The Company adjusts these contingencies in light of changing facts and circumstances, such as the outcome of tax audits.

The Company does not have a material amount of unrecognized tax benefits. There were no changes to the amount of unrecognized tax benefits during the three and nine months ended September 30, 2010. The Company believes any adjustments that may ultimately be required as a result of any of these reviews will not be material to the financial statements. The Company will continue to evaluate its unresolved uncertain tax positions as of each balance sheet date to ensure appropriate accounting treatment.

The Company files U.S. federal, certain U.S. states, and certain foreign tax returns. Generally, U.S. federal, U.S. state, and foreign tax returns filed for years after 2005 are within the statue of limitations and are under examination or may be subject to examination.

(11) Intangible Assets from Acquisitions

Intangible assets from acquisitions consisted of the following:


	As of December 31, 2009
	Gross Carrying Amount		Accumulated Amortization			Net
Advertiser relationship	$	11,340,000	$	(11,340,000	)	$	—
Distribution partner relationship		3,100,000		(3,100,000	)		—
Non-compete agreements		10,360,000		(10,360,000	)		—
Trademarks/domains		42,436,650		(38,414,950	)		4,021,700
Acquired technology		16,900,000		(16,612,222	)		287,778

	$	84,136,650	$	(79,827,172	)	$	4,309,478


	As of September 30, 2010
	Gross Carrying Amount		Accumulated Amortization			Net
Advertiser relationship	$	11,340,000	$	(11,340,000	)	$	—
Distribution partner relationship		3,100,000		(3,100,000	)		—
Non-compete agreements		10,360,000		(10,360,000	)		—
Trademarks/domains		42,253,179		(40,063,180	)		2,189,999
Acquired technology		16,900,000		(16,900,000	)		—

	$	83,953,179	$	(81,763,180	)	$	2,189,999

Amortizable intangible assets are amortized on a straight-line basis over their useful lives. Amortization expense incurred by the Company was approximately $1.2 million and $704,000 for the three months ended September 30, 2009 and 2010, respectively, and was $4.7 million and $2.1 million for the nine months ended September 30, 2009 and 2010, respectively. Based upon the current amount of intangible assets subject to amortization, the estimated amortization expense for the next five years is as follows: $468,000 for the remainder of 2010, $1.2 million in 2011, and $476,000 in 2012, and $0 in 2013 and thereafter.

(12) Goodwill

Changes in the carrying amount of goodwill for the three months ended September 30, 2010 are as follows:


Balance as of December 31, 2009	$	35,438,289
Other		(91,577	)

Balance as of September 30, 2010	$	35,346,712

Goodwill is tested annually for impairment and is tested for impairment more frequently if events and circumstances indicate that the asset is more likely than not impaired. Events and circumstances considered in determining whether the carrying value of goodwill may be impaired include, but are not limited to: significant changes in performance relative to expected operating results; significant changes in the use of the assets; significant negative industry or economic trends; or a significant decline in the Company’s stock price and/or market capitalization for a sustained period of time.

No indicators of impairment of the Company’s intangible assets have been identified to date in 2010. The current business environment is subject to evolving market conditions and requires significant management judgment to interpret the potential impact to our assumptions. To the extent that changes in the current business environment impact the Company’s ability to achieve levels of forecasted operating results and cash flows, or should other events occur indicating the remaining carrying value of its assets might be impaired, the Company would test its goodwill and intangible assets for impairment and may recognize an additional impairment loss to the extent that the carrying amount exceeds such asset’s fair value.

(13) Intangible and other assets, net

Intangible and other assets, net consisted of the following:


	December 31, 2009			September 30, 2010
Internet domain names	$	15,686,370		$	15,669,873
Less accumulated amortization		(12,417,328	)		(13,553,744	)

Internet domain names, net		3,269,042			2,116,129
Other assets:
Registration fees, net		146,412			46,436
Other		251,944			236,369

Total intangibles and other assets, net	$	3,667,398		$	2,398,934

The Company capitalizes costs incurred to acquire domain names or URLs, which include the initial registration fees, to other intangible assets which excludes intangible assets acquired through business combinations. The capitalized costs are amortized over the expected useful life of the domain names on a straight-line basis.

The Company also capitalizes costs incurred to renew or extend the term of the domain names or URLs to prepaid expenses and other current assets or registration fees, net. The capitalized costs are amortized over the renewal or extended period on a straight-line basis. The total amount of costs incurred for the three and nine months ended September 30, 2010 to renew or extend the term for domain names was $625,000 and $1.7 million, respectively. The weighted average renewal period for registration fees as of September 30, 2010 was approximately one year.

Amortization expense for internet domain names was approximately $508,000 and $378,000 for the three months ended September 30, 2009 and 2010, respectively, and was $1.6 million and $1.2 million for the nine months ended September 30, 2009 and 2010, respectively. Based upon the current amount of domains subject to amortization, the estimated expense for the next five years is as follows: $373,000 for the remainder of 2010, $1.1 million in 2011, $422,000 in 2012, $175,000 in 2013 and $40,000 in 2014.

(14) Common Stock

In July 2010, the Company’s board of directors declared a regular quarterly dividend in the amount of $0.02 per share on the Company’s Class A and Class B common stock. The Company paid these dividends on August 16, 2010 to the holders of record as of the close of business on August 6, 2010. The Company paid approximately $705,000.

In November 2006, the Company’s board of directors authorized a share repurchase program for the Company to repurchase up to 3 million shares of the Company’s Class B common stock as well as the initiation of a quarterly cash dividend for the holders of the Class A and Class B common stock. The Company’s board of directors have authorized increases to the share repurchase program for the Company to repurchase up to 11 million shares in the aggregate (less shares previously repurchased under the share repurchase program) of the Company’s Class B common stock. Under the share repurchase program, repurchases may take place in the open market and in privately negotiated transactions and at times and in such amounts as the Company deems appropriate. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements, capital availability, and other market conditions. This stock repurchase program does not have an expiration date and may be expanded, limited or terminated at any time without prior notice.

During the nine months ended September 30, 2010, the Company repurchased 982,000 shares of Class B common stock for approximately $4.9 million at an average stock price of $4.95 per share. The 982,000 shares have been recorded as treasury stock in the condensed consolidated balance sheet as of September 30, 2010.

During the nine months ended September 30, 2010, the Company’s board of directors approved the retirement of approximately 1.6 million shares of treasury stock. The excess of purchase price over par value of $7.5 million was recorded as a deduction to additional paid in capital on the condensed consolidated balance sheet.

(15) Related Party Transactions

During the three and nine months ended September 30, 2010, a member of the Company’s board of directors entered into a consulting agreement with an advertiser of the Company. The majority of the Company’s revenue from the advertiser was derived from our feed management services which were discontinued as of December 31, 2009. The amounts related to this advertiser follow:


	Nine months ended September 30,				Three months ended September 30,
	2009		2010		2009		2010
Revenue	$	256,735	$	25,869	$	73,202	$	3,310

					At December 31, 2009		At September 30, 2010
Accounts Receivable					$	18,387	$	250

(16) Subsequent Events

In October 2010, the Company’s board of directors declared a regular quarterly dividend in the amount of $0.02 per share on the Company’s Class A and Class B common stock. The Company will pay these dividends on November 15, 2010 to the holders of record as of the close of business on November 5, 2010. The Company expects to pay approximately $702,000 for these quarterly dividends.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We use words such as “believes”, “intends”, “expects”, “anticipates”, “plans”, “may”, “will” and similar expressions to identify forward-looking statements. All forward-looking statements, including, but not limited to, statements regarding our future operating results, financial position, and business strategy, expectations regarding our growth and the growth of the industry in which we operate, and plans and objectives of management for future operations, are inherently uncertain as they are based on our expectations and assumptions concerning future events. Any or all of our forward-looking statements in this report may turn out to be inaccurate. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. They may be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties, including but not limited to the risks, uncertainties and assumptions described in this report, in Part II, Item 1A. under the caption “Risk Factors” and elsewhere in this report and in our Annual Report on Form 10-K for the year ended December 31, 2009 and those described from time to time in our future reports filed with the SEC. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this report may not occur as contemplated, and actual results could differ materially from those anticipated or implied by the forward-looking statements. All forward-looking statements in this report are made as of the date hereof, based on information available to us as of the date hereof, and we assume no obligation to update any forward-looking statement.

The following discussion and analysis provides information that we believe is relevant to an assessment and understanding of our results of operation and financial condition. You should read this analysis in conjunction with the attached condensed consolidated financial statements and related notes thereto, and with our audited consolidated financial statements and the notes thereto, included in our Annual Report on Form 10-K for the year ended December 31, 2009.

Overview

We are a call advertising and small business marketing company. We deliver call and click-based advertising products to tens of thousands of advertisers, ranging from small and medium-sized businesses to the Fortune 500. We have a suite of technology-based products and services that facilitate the efficient and cost-effective marketing and selling of goods and services for local and national advertisers who want to sell their products online and offline; and a proprietary, locally-focused Web site network where we help consumers find local information, as well as fulfill our advertiser marketing campaigns:

•

Small and Medium-Sized Businesses Marketing Products. Our small and medium-sized businesses marketing products enable reseller partners of local advertisers, such as Yellow Pages providers and vertical marketing service providers, to sell search marketing and/or call advertising packages through their existing sales channels, which are then fulfilled by us across our distribution network, including leading search engines and our own proprietary traffic sources. By creating a solution for companies who have relationships with small and medium-sized businesses, it makes it easy for these small and medium-sized businesses to participate in online, mobile, offline and call advertising. The lead services we offer to local advertisers through our small and medium-sized businesses marketing products include products typically available only to national advertisers, including ad creation, keyword selection, geo-targeting, call tracking, pay-for-call, advertising campaign management, reporting, and analytics. The small and medium-sized businesses marketing products have the capacity to support hundreds of thousands of advertiser accounts. Reseller partners and publishers generally pay us account fees and also agency fees for our products in the form of a percentage of the cost of every click or call delivered to their advertisers. Through our contract with Yellowpages.com LLC d/b/a AT&T Interactive which is a subsidiary of AT&T (collectively, “AT&T”), AT&T is our largest advertiser reseller partner and was responsible for 20% and 23% of our total revenues for the three and nine months ended September 30, 2010 of which the majority is derived from our small and medium-sized businesses marketing products.

•

Call Advertising Services. We deliver a variety of call advertising services to national advertisers, advertising agencies and small and medium-sized advertiser reseller partners. These services include pay-for-call, phone number and call tracking, call analytics, click-to-call, Web site proxying, and other call-based services which enable our customers to utilize mobile, offline and online advertising to drive calls as well as clicks into their businesses and to use call tracking to measure the effectiveness of both their online, mobile and offline advertising campaigns. Advertisers pay us a fee for each call they receive from call-based ads we distribute on our distribution network or for each phone number tracked and a pre-negotiated rate.

•

Pay-Per-Click Advertising. We deliver pay-per-click advertisements to online users in response to their keyword search queries or on pages they visit throughout our distribution network of search engines, shopping engines, certain third party vertical and local Web sites, mobile distribution and our own Publishing Network. In addition to distributing their ads, we offer account management services to help our advertisers optimize their pay-per-click campaigns, including editorial and keyword selection recommendations and report analysis. The pay-per-click advertisements are generally ordered based on the amount our advertisers choose to pay for a placement and the relevancy of their ads to the keyword search. Advertisers pay us when a user clicks on their advertisements in our distribution network and we pay publishers or distribution partners a percentage of the revenue generated by the click-throughs on their site(s). In addition, we generate revenue from cost-per-action events that take place on our distribution network. Cost-per-action revenue occurs when the user is redirected from one of our Web sites or a third-party Web site in our distribution network to an advertiser’s Web site and completes a specified action. We also offer a private-label platform for publishers, separate and distinct from our small

and medium-sized businesses marketing products which enable them to monetize their Web sites with contextual advertising from their own customers or from our advertising relationships. We sell pay-per-click contextual advertising placements on specialized vertical and branded publisher Web sites on a pay-per-click basis. Advertisers can target the placements by category, site- or page-specific basis. We believe our site- and page-specific approach provides publishers with an opportunity to generate revenue from their traffic while protecting their brand. Our approach gives advertisers greater transparency into the source of the traffic and relevancy for their ads and enables them to optimize the return on investment from their advertising campaign. The contextual advertisement placements are generally ordered based on the amount our advertisers choose to pay for a placement and the relevance of the advertisement, based on historic click-through rates. Advertisers pay us when a user clicks on their advertisements in our network and we pay publishers a percentage of the revenue generated by the click-throughs on their site.

•

Publishing Network. We believe that our Publishing Network is a significant source of local information online. It includes more than 200,000 of our owned and operated Web sites focused on helping users find and make informed decisions about where to get local products and services. It features listings from more than 10 million local businesses in the U.S. and millions of expert and user-generated reviews on local businesses. The more than 200,000 Web sites in our network include more than 75,000 U.S. ZIP code sites, such as 98102.com and 90210.com, covering ZIP code areas nationwide, as well as tens of thousands of other locally-focused sites such as Yellow.com, OpenList.com and geo-targeted sites such as chicagodoctors.com, seattleautorepairs.com, bostonmortgage.com and others. Traffic to our Publisher Network is primarily monetized with pay-per-click listings that are relevant to the Web sites, as well as other forms of advertising, including call-based ad units, banner advertising and sponsorships.

•

Feed Management and Related Services. Through the end of 2009, we used our proprietary technology to crawl and extract relevant product content from advertisers’ databases and Web sites to create automated and highly-targeted product and service listings feed, which we delivered primarily into Yahoo!’s search submit product. Advertisers generally paid us a fixed price for each click they received on an advertisement or listing included in the feed. In addition and as a supplement to feed management services, we offered campaign management services to enable our advertisers to consolidate the purchasing, management, optimization and reporting from their search and vertical advertising campaigns across a large number of search engines, local Web sites and pay-per-click networks into one centralized location. Under these services advertisers paid us a pre-negotiated rate for each click they receive on their advertisement placed or managed as part of our campaign management services. Yahoo! discontinued its feed management service relationship with us effective December 31, 2009 as a result of its recently announced partnership with Microsoft. Accordingly, we discontinued our feed management and related service offerings as of that date. We generated $7.5 million in revenues from feed management and related services for the year ended December 31, 2009. The impact on our financial statements attributable to our ending this service is lessened by the relatively low operating margin attributable to this service given our revenue share arrangement with Yahoo! with respect thereto.

We were incorporated in Delaware on January 17, 2003. Acquisition initiatives have played an important part in our corporate history to date. We have completed the following acquisitions since our inception:

•

On February 28, 2003, we acquired eFamily together with its direct wholly-owned subsidiary, formerly known as Enhance Interactive.

•

On October 24, 2003, we acquired TrafficLeader.

•

On July 27, 2004, we acquired goClick.

•

On February 14, 2005, we acquired certain assets of Name Development.

•

On April 26, 2005, we acquired certain assets of Pike Street Industries.

•

On July 27, 2005, we acquired IndustryBrains.

•

On May 1, 2006, we acquired certain assets of AreaConnect.

•

On May 26, 2006, we acquired certain assets of Open List.

•

On September 19, 2007, we acquired VoiceStar.

We currently have offices in Seattle, Washington; Las Vegas, Nevada; New York, New York and Philadelphia, Pennsylvania.

Consolidated Statements of Operations

The assets, liabilities and operations of our acquisitions are included in our consolidated financial statements as of and from the date of the respective acquisitions.

All inter-company transactions and balances within Marchex have been eliminated in consolidation. Our purchase accounting resulted in all assets and liabilities from our acquisitions being recorded at their estimated fair values on the respective acquisition dates. All goodwill, intangible assets and liabilities resulting from the acquisitions have been recorded in our financial statements.

Presentation of Financial Reporting Periods

The comparative periods presented are for the three and nine months ended September 30, 2009 and 2010.

Revenue

We currently generate revenue through our suite of services, including our small and medium-sized businesses marketing products, call advertising services, pay-per-click advertising, publishing network, and historically our feed management and related services. Our primary sources of revenue are the performance-based advertising services, which include pay-for-call services, pay-per-click services, cost-per-action services and historically our feed management and related services. These primary sources amounted to greater than 75% of our revenues in all periods presented. Our secondary sources of revenue are our campaign management services, natural search optimization services and outsourced search marketing platforms. These secondary sources amounted to less than 25% of our revenues in all periods presented. We have no barter transactions.

We recognize revenue upon the completion of our performance obligation, provided that: (1) evidence of an arrangement exists; (2) the arrangement fee is fixed and determinable; and (3) collection is reasonably assured.

In certain cases, we record revenue based on available and reported preliminary information from third parties. Collection on the related receivables may vary from reported information based upon third party refinement of the estimated and reported amounts owing that occurs subsequent to period ends.

Performance-Based Advertising Services

In providing call advertising and pay-per-click services, we generate revenue upon our delivery of qualified and reported phone calls or click-throughs to our advertisers or advertising service providers’ listings. These advertisers and advertising service providers pay us a designated transaction fee for each phone call or click-through, which occurs when an online user makes a phone call or clicks on based on any of their advertisement listings after it has been placed by us or by our distribution partners. Each qualified phone call or click-through on an advertisement listing represents a completed transaction. The advertisement listings are displayed within our distribution network, which includes search engines, directories, destination sites, third-party Internet domains or Web sites, our portfolio of owned Web sites, other targeted Web-based content and mobile and offline sources. We also generate revenue from cost-per-action services, which occurs when the online user is redirected from one of our Web sites or a third-party Web site in our distribution network to an advertiser Web site and completes the specified action, such as when a call is placed.

In providing pay-per-click contextual targeting services, advertisers purchase keywords or keyword strings, based on an amount they choose for a targeted placement on vertically-focused Web sites or specific pages of a Web site that are specific to their products or services and their marketing objectives. The contextual results distributed by our services are prioritized for users by the amount the advertiser is willing to pay each time a user clicks on the merchant’s advertisement and the relevance of the merchant’s advertisement, which is dictated by historical click-through rates. Advertisers pay us when a click-through occurs on their advertisement.

In providing feed management services, advertisers pay for their Web pages and product databases to be crawled, or searched, and included in search engine, directory and product shopping engine results within our distribution network. Generally, the feed management listings are presented in a different section of the Web page than the pay-per-click listings. For this service, revenue is generated when an online user clicks on a feed management listing from search engine, directory or product shopping engine results. Each click-through on an advertisement listing represents a completed transaction for which the advertiser pays for on a per-click basis. The placement of a feed management result is largely determined by its relevancy, as determined by the distribution partner. Yahoo! discontinued its feed management service relationship with us effective December 31, 2009 as a result of its recently announced partnership with Microsoft. Accordingly, we discontinued our feed management and related service offerings as of that date.

Search Marketing Services

Advertisers pay us additional fees for services such as campaign management and natural search engine optimization. Advertisers generally pay us on a click-through basis, although in certain cases we receive a fixed fee for delivery of these services. In some cases we also deliver banner campaigns for select advertisers. We may also charge initial set-up, account, service or inclusion fees as part of our services.

Banner advertising revenue may be based on a fixed fee per click and is generated and recognized on click-through activity. In other cases, banner payment terms are volume-based with revenue generated and recognized when impressions are delivered.

Non-refundable account set-up fees are paid by advertisers and are recognized ratably over the longer of the term of the contract or the average expected advertiser relationship period, which generally ranges from twelve months to more than two years. Other account and service fees are recognized in the month or period the account fee or services relate to.

Other inclusion fees are generally associated with monthly or annual subscription-based services where an advertiser pays a fixed amount to be included in our index of listings or our distribution partners’ index of listings. Revenues from these subscription arrangements are recognized ratably over the service period.

Outsourced Search Marketing Platforms

We generate revenue from reseller partners and publishers utilizing our web-based technologies. We are paid a management or agency fee based on the total amount of the purchase made by the advertiser. The partners or publishers engage the advertisers and are the primary obligor, and we, in certain instances, are only financially liable to the publishers in our capacity as a collection agency for the amount collected from the advertisers. We recognize revenue for these fees under the net revenue recognition method. In limited arrangements resellers pay us a fee for fulfilling an advertiser’s campaign in our distribution network and we act as the primary obligor. We recognize revenue for these fees under the gross revenue recognition method.

Industry and Market Factors

We enter into agreements with various distribution partners to provide distribution for the URL strings and advertisement listings of our advertisers. We generally pay distribution partners based on a percentage of revenue or a fixed amount for each phone call or per click-through on these listings. The level of phone calls and click-throughs contributed by our distribution partners has varied, and we expect it will continue to vary, from quarter to quarter and year to year, sometimes significantly. If we do not add new distribution partners, renew our current distribution partner agreements or replace traffic lost from terminated distribution agreements with other sources or if our distribution partners’ search businesses do not grow or are adversely affected, our revenue and results of operations may be materially and adversely affected. Our ability to grow will be impacted by our ability to increase our distribution, which impacts the number of Internet users who have access to our advertisers’ listings and the rate at which our advertisers are able to convert calls and clicks from these Internet users into completed transactions, such as a purchase or sign up. Our ability to grow also depends on our ability to continue to increase the number of advertisers who use our services and the amount these advertisers spend on our services.

We anticipate that these variables will fluctuate in the future, affecting our ability to grow and our financial results. In particular, it is difficult to project the number of phone calls or click-throughs we will deliver to our advertisers and how much advertisers will spend with us, and it is even more difficult to anticipate the average revenue per phone call or click-through. It is also difficult to anticipate the impact of worldwide economic conditions on advertising budgets, including due to the economic uncertainty resulting from recent disruptions in global financial markets.

In addition, we believe we will experience seasonality. Our quarterly results have fluctuated in the past and may fluctuate in the future due to seasonal fluctuations in levels of Internet usage and seasonal purchasing cycles of many advertisers. It is generally understood that during the spring and summer months, Internet usage is lower than during other times of the year, especially in comparison to the fourth quarter of the calendar year. The extent to which usage may decrease during these off-peak periods is difficult to predict. Prolonged or severe decreases in usage during these periods may adversely affect our growth rate and results. Additionally, the current business environment has generally resulted in advertisers and reseller partners reducing advertising and marketing services budgets, which we expect will impact our quarterly results of operations in addition to the typical seasonality seen in our industry.

Service Costs

Our service costs represent the cost of providing our performance-based advertising services and our search marketing services. The service costs that we have incurred in the periods presented primarily include:

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user acquisition costs;

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amortization of intangible assets;

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license and content fees;

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credit card processing fees;

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network operations;

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serving our search results;

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telecommunication costs, including the use of phone numbers relating to our call products and services;

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maintaining our Web sites;

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domain name registration renewal fees;

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network fees;

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fees paid to outside service providers;

•

delivering customer service;

•

depreciation of our Web sites, network equipment and internally developed software;

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colocation service charges of our Web site equipment;

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bandwidth and software license fees;

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payroll and related expenses of related personnel; and

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stock-based compensation of related personnel.

User Acquisition Costs

For the periods presented the largest component of our service costs consist of user acquisition costs that relate primarily to payments made to distribution partners for access to their online, mobile, offline, or other user traffic. We enter into agreements of varying durations with distribution partners that integrate our services into their Web sites and indexes. The primary economic structure of the distribution partner agreements is a variable payment based on a specified percentage of revenue. These variable payments are often subject to minimum payment amounts per phone call or click-through. Other payment structures that to a lesser degree exist include:

•

fixed payments, based on a guaranteed minimum amount of usage delivered;

•

variable payments based on a specified metric, such as number of paid phone calls or click-throughs; and

•

a combination arrangement with both fixed and variable amounts that may be paid in advance.

We expense user acquisition costs based on whether the agreement provides for fixed or variable payments. Agreements with fixed payments with minimum guaranteed amounts of usage are expensed as the greater of the pro-rata amount over the term of arrangement or the actual usage delivered to date based on the contractual revenue share. Agreements with variable payments based on a percentage of revenue, number of paid phone calls, click-throughs, or other metrics are expensed as incurred based on the volume of the underlying activity or revenue multiplied by the agreed-upon price or rate.

Sales and Marketing

Sales and marketing expenses consist primarily of:

•

payroll and related expenses for personnel engaged in marketing and sales functions;

•

advertising and promotional expenditures including online and outside marketing activities;

•

cost of systems used to sell to and serve advertisers; and

•

stock-based compensation of related personnel.

Product Development

Product development costs consist primarily of expenses incurred in the research and development, creation and enhancement of our Web sites and services.

Our research and development expenses include:

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payroll and related expenses for personnel;

•

costs of computer hardware and software;

•

costs incurred in developing features and functionality of the services we offer; and

•

stock-based compensation of related personnel.

For the periods presented, substantially all of our product development expenses are research and development.

Product development costs are expensed as incurred or capitalized into property and equipment in accordance with FASB ASC 350 (previously the American Institute of Certified Public Accountants’ Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use). This statement requires that costs incurred in the preliminary project and post-implementation stages of an internal use software project be expensed as incurred and that certain costs incurred in the application development stage of a project be capitalized.

General and Administrative

General and administrative expenses consist primarily of:

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payroll and related expenses for executive and administrative personnel;

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professional services, including accounting, legal and insurance;

•

bad debt provisions;

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facilities costs;

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other general corporate expenses; and

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stock-based compensation of related personnel.

Stock-Based Compensation

We account for stock-based compensation under the fair value method. As a result, stock-based compensation consists of the following:

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all share-based compensation arrangements granted after January 1, 2006 (adoption date of FASB ASC 718) and for any such arrangements that are modified, cancelled, or repurchased after that date, and

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the portion of previous share-based awards for which the requisite service has not been rendered as of January 1, 2006.

Stock-based compensation expense has been included in the same lines as compensation paid to the same employees in the consolidated statement of operations.

Amortization of Intangibles from Acquisitions

Amortization of intangible assets excluding goodwill relates to intangible assets identified in connection with our acquisitions.

The intangible assets have been identified as:

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non-competition agreements;

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trade and Internet domain names;

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distributor relationships;

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advertising relationships;

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patents; and

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acquired technology.

These assets are amortized over useful lives ranging from 12 to 84 months.

Provision for Income Taxes

We utilize the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax law is recognized in results of operations in the period that includes the enactment date.

Each reporting period we must assess the likelihood that our deferred tax assets will be recovered from existing deferred tax liabilities, available carrybacks or future taxable income, and to the extent that realization is not more likely than not, a valuation allowance must be established. The establishment of a valuation allowance and increases to such an allowance may result in either increases to income tax expense or reduction of income tax benefit in the statement of operations. Although realization is not assured, we believe it is more likely than not, based on operating performance, existing deferred tax liabilities, available carrybacks and projections of future taxable income, that our net deferred tax assets, excluding certain state and foreign net operating loss carryforwards, will be realized. In determining that it was more likely than not that we would realize the deferred tax assets, factors considered included: historical taxable income, historical trends related to advertiser usage rates, projected revenues and expenses, macroeconomic conditions and issues facing our industry, existing contracts, our ability to project future results and any appreciation of our other assets. The majority of our deferred tax assets are from goodwill and intangible assets recorded in connection with various acquisitions that are tax-deductible over 15 year periods. Based on available carrybacks and projections of future taxable income, the Company expects to be able to recover these assets. The amount of the net deferred tax assets considered realizable, however, could be reduced in the near term if our projections of future taxable income are reduced or if we do not perform at the levels we are projecting. This could result in increases to the valuation allowance for deferred tax assets and a corresponding increase to income tax expense of up to the entire net amount of deferred tax assets.

From time to time, various state, federal, and other jurisdictional tax authorities undertake reviews of us and our filings. We believe any adjustments that may ultimately be required as a result of any of these reviews will not be material to the financial statements.

certain deferred tax assets primarily relating to net operating loss carryforwards in certain state and foreign jurisdictions will be realizable and accordingly, have recorded a 100% valuation allowance of $3.8 million against these deferred tax assets. We do not have a history of taxable income in the relevant jurisdictions and the state and foreign net operating loss carryforwards will more likely than not expire unutilized. Should we determine in the future that we will be able to realize these deferred tax assets, or not be able to realize all or part of our remaining net deferred tax assets recorded as of September 30, 2010, an adjustment to the net deferred tax assets would impact net income or stockholders’ equity in the period such determination was made.

As of September 30, 2010, we had federal net operating loss, or NOL, carryforwards of $1.7 million which will begin to expire in 2019. The Tax Reform Act of 1986 limits the use of NOL and tax credit carryforwards in certain situations where changes occur in the stock ownership of a company. We believe that such a change has occurred, and that approximately $1.7 million of NOL carryforwards is limited such that substantially all of these federal NOL carryforwards will never be available. Accordingly, we have not recorded a deferred tax asset for these NOL’s.

Results of Operations

The following table presents certain financial data, derived from our unaudited consolidated statements of operations, as a percentage of total revenue for the periods indicated. The operating results for the three and nine months ended September 30, 2009 and 2010 and are not necessarily indicative of the results that may be expected for the full year or any future period.


	Nine Months Ended September 30,						Three Months Ended September 30,
	2009			2010			2009			2010
Revenue		100	%		100	%		100	%		100	%

Expenses:
Service costs		50	%		59	%		54	%		60	%
Sales and marketing		21	%		15	%		15	%		13	%
Product development		16	%		18	%		15	%		17	%
General and administrative		17	%		18	%		18	%		19	%
Amortization of intangible assets from acquisitions		7	%		3	%		6	%		3	%

Total operating expenses		110	%		113	%		108	%		113	%
Gain on sales and disposals of intangible assets, net		4	%		7	%		5	%		11	%

Loss from operations		-6	%		-7	%		-3	%		-2	%
Other income (expense):
Interest income		0	%		0	%		0	%		0	%
Interest expense		0	%		0	%		0	%		0	%
Other		0	%		0	%		0	%		1	%

Total other income		0	%		0	%		0	%		1	%

Loss before provision for income taxes		-6	%		-6	%		-3	%		-2	%
Income tax expense (benefit)		-3	%		-1	%		-6	%		0	%

Net income (loss)		-3	%		-5	%		3	%		-2	%
Dividends paid to participating securities		0	%		0	%		0	%		0	%

Net income (loss) applicable to common stockholders		-3	%		-5	%		3	%		-2	%

Comparison of the Three months ended September 30, 2009 to the Three months ended September 30, 2010 and of the Nine months ended September 30, 2009 to the Nine months ended September 30, 2010

Revenue

The following table presents our revenues, by revenue source, for the periods presented:


	Nine months ended September 30,				Three months ended September 30,
	2009		2010		2009		2010
Partner and Other Revenue Sources	$	45,270,588	$	49,894,781	$	15,899,331	$	17,999,797
Proprietary Traffic Sources		24,553,228		19,695,394		6,272,463		6,195,044

Total Revenue	$	69,823,816	$	69,590,175	$	22,171,794	$	24,194,841

Our partner network revenues are primarily generated using third-party distribution networks to deliver the advertisers’ listings. The distribution network includes search engines, shopping engines, directories, destination sites, third-party Internet domains or Web sites, other targeted Web-based content, mobile and offline sources. We generate revenue upon delivery of qualified and reported phone calls or click-throughs to our advertisers or to advertising services providers’ listings. We pay a revenue share to the distribution partners to access their online, mobile, offline or other user traffic. Other revenues include our call provisioning and call tracking services, campaign management services, natural search optimization services and outsourced search marketing platforms. Our publishing network revenues are generated from our portfolio of owned Web sites which are monetized with pay-per-click listings that are relevant to the Web sites, as well as other forms of advertising, including call-based advertising units, banner advertising and sponsorships. When an online user navigates to one of our Web sites and clicks on a particular listing or completes the specified action, we receive a fee.

Revenue increased 9% from $22.2 million for the three months ended September 30, 2009 to $24.2 million in the same period in 2010. The partner and other revenues increased $2.1 million and were affected primarily by increased revenues of $5.3 million from our call advertising services which in part was driven by adding more than 10,000 national and small and medium-sized business accounts to our platform across our small and medium-sized business marketing and call advertising services. This increase was offset by a decrease in revenue from AT&T from pricing reductions and incentives as part of an extension of our arrangement with AT&T, along with a $1.3 million decrease in revenue from our pay-per-click services, and a $1.5 million decrease in revenue generated from our feed management services. Effective December 31, 2009 Yahoo! discontinued its feed management service relationship with us as a result of its recently announced partnership with Microsoft. Accordingly, we discontinued our feed management service offering as of that date.

Under our primary arrangement with AT&T, we generate revenues from our small and medium-sized businesses marketing products to sell search marketing packages and/or call advertising packages through their existing sales channels, which are then fulfilled by us across our distribution network. We are paid account fees and also agency fees for our products in the form of a percentage of the cost of every call or click delivered to their advertisers. In the second quarter of 2010, we signed an extension of our arrangement with AT&T through June 30, 2015 that includes certain exclusivity provisions for new advertiser accounts and contemplates the migration of several thousand existing advertiser accounts over the following six to nine months. As part of the arrangement, we provided pricing reductions including significant near term pricing incentives. These incentives in comparison to the prior arrangement pricing could generate an estimated $8 million in savings for AT&T during 2010 and accordingly, we experienced a decrease in revenues but to a lesser extent in the third quarter relative to the second. We expect revenues from our arrangement with AT&T to scale back upwards further in the fourth quarter of 2010.

Our publishing network revenue was relatively consistent with higher revenues for cost-per-actions from resellers related to our local search and directory Web sites offset primarily by a $589,000 decrease in revenues from our arrangement with Yahoo! whereby we receive payment upon click-throughs on pay-per-click listings presented on our Web sites. This decrease was principally due to fewer click-throughs on pay-per-click listings from Yahoo!. Our paid listings arrangement with Yahoo! related to our Web sites expired on September 30, 2010, although we expect to continue various other contractual arrangements with Yahoo!. We have entered into a paid listings arrangement with another advertiser service provider and we do not anticipate any significant near term impact to our publishing network revenues.

AT&T and Yahoo! in the third quarter of 2009 accounted for 23% and 12%, respectively, of our total revenues compared to 20% and less than 10%, respectively, in the third quarter of 2010.

Except for our arrangement with AT&T where we generate revenues from our small and medium-sized businesses marketing products, in the near term we expect advertisers and resellers to have relatively stable advertising and marketing service budgets compared to the third quarter of 2010 and anticipate modest increases in our call advertising revenues.

Revenue was $69.8 million for the nine months ended September 30, 2009 compared to $69.6 million in the same period in 2010. The partner and other revenues increased $4.6 million and were affected primarily by increased revenues of $11.0 million in our call advertising services which in part was driven by adding more than 15,000 national and small and medium-sized business accounts to our platform across our small and medium-sized business marketing and call advertising services. This increase was offset by a decrease in revenue from AT&T from pricing reductions and incentives as part of an extension of our arrangement with AT&T in the second quarter of 2010 along with a decrease in revenue of $5.5 million generated from our feed management and related services. Effective December 31, 2009 Yahoo! discontinued its feed management service relationship with us as a result of its recently announced partnership with Microsoft. Accordingly, we discontinued our feed management service offering as of that date.

Our publishing network revenue decreased primarily due to $2.8 million lower revenues for cost-per-actions from resellers such as Dex One Corporation, WhitePages, Inc. and Intelius, Inc., particularly related to our local search and directory Web sites. The remainder of such decrease was largely due to lower revenues from our arrangement with Yahoo! whereby we receive payment upon click-throughs on pay-per-click listings presented on our Web sites. This decrease was principally due to fewer click-throughs on pay-per-click listings from Yahoo!.

Our ability to maintain and grow our revenues will depend in part on maintaining and increasing the number of phone calls and click-throughs performed by users of our service through our distribution partners and proprietary traffic sources and maintaining and increasing the number and volume of transactions and favorable variable payment terms with advertisers and advertising services providers, which we believe is dependent in part on marketing our Web sites and delivering high quality traffic that ultimately results in purchases or conversions for our advertisers and advertising services providers. We may increase our direct monetization of our proprietary traffic sources which may not be at the same rate levels as other advertising providers and could adversely affect our revenues and results of operations. If we do not add new distribution partners, renew our current distribution partner agreements or replace traffic lost from terminated distribution agreements with other sources or if our distribution partners’ businesses do not grow or are adversely affected, our revenue and results of operations may be materially and adversely affected. If revenue grows and the volume of transactions and traffic increases, we will need to expand our network infrastructure. Inefficiencies in our network infrastructure to scale and adapt to higher traffic volumes could materially and adversely affect our revenue and results of operations.

We anticipate that these variables will fluctuate in the future, affecting our growth rate and our financial results. In particular, it is difficult to project the number of phone calls and click-throughs we will deliver to our advertisers and how much advertisers will spend with us, and it is even more difficult to anticipate the average revenue per phone call or click-through. It is also difficult to anticipate the impact of worldwide economic conditions on advertising budgets due to the evolving market conditions. In addition, we believe we will experience seasonality. Our quarterly results have fluctuated in the past and may fluctuate in the future due to seasonal fluctuations in levels of Internet usage and seasonal purchasing cycles of many advertisers. It is generally understood that during the spring and summer months, Internet usage is lower than during other times of the year, especially in comparison to the fourth quarter of the calendar year. The extent to which usage may decrease during these off-peak periods is difficult to predict. Prolonged or severe decreases in usage during these periods may adversely affect our growth rate and results.

Expenses

Expenses were as follows:


	Nine months ended September 30,										Three months ended September 30,
	2009		% of revenue			2010		% of revenue			2009		% of revenue			2010		% of revenue
Service costs	$	34,934,455		50	%	$	40,909,245		59	%	$	12,048,245		54	%	$	14,604,200		60	%
Sales and marketing		14,485,213		21	%		10,605,457		15	%		3,213,946		15	%		3,183,374		13	%
Product development		10,969,807		16	%		12,482,042		18	%		3,369,290		15	%		4,193,428		17	%
General and administrative		12,055,096		17	%		12,809,459		18	%		3,997,361		18	%		4,683,639		19	%
Amortization of intangible assets from acquisitions		4,680,879		7	%		2,119,479		3	%		1,211,328		5	%		704,106		3	%

	$	77,125,450		110	%	$	78,925,682		113	%	$	23,840,170		108	%	$	27,368,747		113	%

Stock-based compensation expense was included in the following operating expense categories as follows:


	Nine months ended September 30,				Three months ended September 30,
	2009		2010		2009		2010
Service costs	$	317,561	$	608,304	$	120,505	$	223,672
Sales and marketing		1,222,037		602,995		239,528		221,901
Product development		478,925		740,553		180,493		280,377
General and administrative		5,298,047		5,954,403		1,785,936		2,199,285

Total stock-based compensation	$	7,316,570	$	7,906,255	$	2,326,462	$	2,925,235

See Note 3—“Stock-based Compensation Plans” of the condensed consolidated financial statements as well as our Critical Accounting Policies for additional information about stock-based compensation.

Service Costs. Service costs increased 21%, from $12.0 million in the three months ended September 30, 2009 to $14.6 million in the same period in 2010. The increase was primarily attributable to an increase in distribution partner payments, fees paid to outside service providers, personnel costs, stock compensation, facility costs, communication and network costs of $2.7 million, partially offset by a decrease in Internet domain amortization, depreciation and credit card processing fees of $165,000.

Service costs represented 54% of revenue in the three months ended September 30, 2009 as compared to 60% in 2010. The 2010 increase as a percentage of revenue in service costs as compared to 2009 was primarily a result of an increase in the proportion of revenue attributable to our pay-for-call or cost-per-action services for which there are related distribution partner payments and to a lesser extent communication and network costs, and the effect of the pricing incentives to AT&T.

Service costs represented 50% of revenue in the nine months ended September 30, 2009 as compared to 59% in 2010. The 2010 increase as a percentage of revenue in service costs as compared to 2009 was primarily a result of an increase in the proportion of revenue attributable to our pay-for-call, pay-per-click or cost-per-action services for which there are related distribution partner payments and to a lesser extent communication and network costs and the effect of the pricing incentives to AT&T. Payments to pay-for-call, pay-per-click or cost-per-action distribution partners account for higher user acquisition costs as a percentage of revenue relative to our overall service cost percentage.

We expect that user acquisition costs and revenue shares to distribution partners are likely to increase prospectively given the competitive landscape for distribution partners. To the extent that payments to pay-for-call, pay-per-click or cost-per-action distribution partners make up a larger percentage of future operations, or the addition or renewal of existing distribution partner agreements are on terms less favorable to us, we expect that service costs will increase as a percentage of revenue. To the extent of revenue declines in these areas, we expect revenue shares to distribution partners to decrease in absolute dollars. Our publishing network sources have a lower service cost as a percentage of revenue relative to our overall service cost percentage. Our publishing network sources have no corresponding distribution partner payments. To the extent our publishing network sources make up a larger percentage of our future operations, we expect that service costs will decrease as a percentage of revenue. As a result of significant pricing incentives we have provided for under our arrangement with AT&T, our recent service costs as a percentage of revenue have been higher. We expect with the addition of more accounts in the near term, service costs will decrease as a percentage of revenue. We also expect that in the longer term service costs will increase in absolute dollars as a result of costs associated with the expansion of our operations and network infrastructure as we scale and adapt to increases in the volume of transactions and traffic and invest in our platforms.

Sales and Marketing. Sales and marketing expenses were $3.2 million for both the three months ended September 30, 2009 and 2010. As a percentage of revenue, sales and marketing expenses were 15% and 13% for the three months ended September 30, 2009 and 2010, respectively. Sales and marketing expenses in total dollars were relatively unchanged year over year as a result of a decrease in online and outside marketing activities being offset by an increase in personnel costs, travel, fees paid to outside service providers and depreciation. We expect some volatility in sales and marketing expenses in the near term based on the timing of marketing initiatives but expect sales and marketing expenses in the near term to be relatively stable to modestly higher in absolute dollars. We expect that sales and marketing expenses will increase in connection with any revenue increase to the extent that we also increase our marketing activities and correspondingly could increase as a percentage of revenue. We also expect fluctuations in marketing expenditures as we redirect our online marketing efforts towards more of our updated Web sites and direct monetization of our proprietary traffic sources but expect expenditures related to these efforts to increase in absolute dollars in the long term.

Sales and marketing expenses decreased 27% from $14.5 million for the nine months ended September 30, 2009 to $10.6 million in the same period in 2010. As a percentage of revenue, sales and marketing expenses were 21% and 15% for the nine months ended September 30, 2009 and 2010, respectively. The net decrease in dollars and percentage of revenue was related primarily to a decrease in online and outside marketing activities and stock compensation.

Product Development. Product development expenses increased 24%, from $3.4 million for the three months ended September 30, 2009 to $4.2 million in the same period in 2010. The increase in dollars was primarily due to an increase in personnel costs and stock based compensation of $908,000. As a percentage of revenue, product development expenses were 15% and 17% for the three months ended September 30, 2009 and 2010, respectively. The 2010 increase as a percentage of revenue in product development expense as compared to 2009 was primarily a result of an increase in the proportion of personnel costs relative to revenue. In the near term, we do not expect significant changes to our product development expenditures. In the longer term, we expect that product development expenses will increase in absolute dollars as we increase the number of personnel and consultants to enhance our service offerings and as a result of additional stock-based compensation expense.

Product development expenses increased 14%, from $11.0 million for the nine months ended September 30, 2009 to $12.5 million in the same period in 2010. The increase in dollars was primarily due to an increase in personnel costs and stock based compensation of $1.8 million. As a percentage of revenue, product development expenses were 16% and 18% for the nine months ended September 30, 2009 and 2010, respectively. The 2010 increase as a percentage of revenue in product development expense as compared to 2009 was primarily a result of an increase in the proportion of personnel costs relative to revenue.

General and Administrative. General and administrative expenses increased 17%, from $4.0 million in the three months ended September 30, 2009 to $4.7 million in the same period in 2010. The increase in dollars was primarily due to an increase in stock based compensation, personnel costs, fees paid to outside service providers, bad debt, and other operating costs of $770,000. As a percentage of revenue, general and administrative expenses were 18% and 19% for the three months ended September 30, 2009 and 2010, respectively. We do not expect significant changes to our general and administrative expenses in the near term. We expect that our

general and administrative expenses will increase in the longer term to the extent that we expand our operations and incur additional costs in connection with being a public company, including expenses related to professional fees and insurance, and as a result of stock-based compensation expense. We also expect fluctuations in our general and administrative expenses to the extent the recognition timing of stock compensation is impacted by market conditions relating to our stock price.

General and administrative expenses increased 6%, from $12.1 million in the nine months ended September 30, 2009 to $12.8 million in the same period in 2010. The increases were primarily attributable to stock-based compensation, personnel costs, fees paid to outside service providers, and bad debt of $1.1 million which were offset by decreases in facility related costs and other operating costs. As a percentage of revenue, general and administrative expenses were 17% and 18% for the nine months ended September 30, 2009 and 2010, respectively.

Amortization of Intangible Assets from Acquisitions. Intangible amortization expense decreased 42%, from $1.2 million in the three months ended September 30, 2009 to $704,000 in the same period in 2010. The decrease was associated with certain intangible assets from acquisitions being fully amortized. During the three months ended September 30, 2010, the amortization of intangibles related to service costs.

Intangible amortization expense decreased 55%, from $4.7 million in the nine months ended September 30, 2009 to $2.1 million in the same period in 2010. The decrease was associated with certain intangible assets from acquisitions being fully amortized. During the nine months ended September 30, 2010, the amortization of intangibles related to service costs.

Our purchase accounting resulted in all assets and liabilities from our acquisitions being recorded at their estimated fair values on their respective acquisition dates. All goodwill, identifiable intangible assets and liabilities resulting from our acquisitions have been recorded in our financial statements. The identified intangibles amounted to $84.0 million and are being amortized over a range of useful lives of 12 to 84 months. We may acquire identifiable intangible assets as part of future acquisitions, and if so, we expect that our intangible amortization will increase in absolute dollars. Events and circumstances considered in determining whether the carrying value of amortizable intangible assets and goodwill may not be recoverable include, but are not limited to: significant changes in performance relative to expected operating results; significant changes in the use of the assets; significant negative industry or economic trends; or a significant decline in the Company’s stock price and/or market capitalization for a sustained period of time.

No indicators of impairment of the Company’s intangible assets have been identified to date in 2010. The current business environment is subject to evolving market conditions and requires significant management judgment to interpret the potential impact to our assumptions. To the extent that changes in the current business environment impact the Company’s ability to achieve levels of forecasted operating results and cash flows, or should other events occur indicating the remaining carrying value of our assets might be impaired, the Company would test its goodwill and intangible assets for impairment and may recognize an additional impairment loss to the extent that the carrying amount exceeds such asset’s fair value.

Gain on sales and disposals of intangible assets, net. Gains on sales and disposals of intangible assets, net were $1.0 million and $2.8 million for the three and nine months ended September 30, 2009, respectively, as compared to $2.6 million and $4.7 million in the same periods in 2010, and were primarily attributable to the sales and disposals of Internet domain names and other intangible assets.

Other Income (expense), net. Other income (expense), net were ($14,000) and ($17,000) in the three and nine months ended September 30, 2009, respectively, compared to $103,000 and $134,000 in the same periods in 2010.

Income Taxes. The income tax benefits were $1.4 million and $2.4 million for the three and nine months ended September 30, 2009 as compared to income tax expense of $54,000 and income tax benefit of $863,000 in the same periods in 2010, respectively.

In the three and nine months ended September 30, 2010, the effective tax rate of (12%) and 19%, respectively, differed from the expected effective tax rate of 35% due to state income taxes, non-deductible stock-based compensation related to restricted stock and incentive stock options recorded under the fair-value method and other non-deductible amounts.

During the three months ended September 30, 2009, we completed an analysis and recorded an adjustment totaling $1.3 million to reflect updated filings for research and experimentation tax credits for the periods 2005 through September 30, 2009. Our effective tax rate for the three and nine months ended September 30, 2009 was a benefit of 217% and 53%, respectively. In addition, our effective tax rate for these periods differed from the expected effective tax rate of 35% due to state income taxes, non-deductible stock-based compensation related to restricted stock and incentive stock options recorded under the fair-value method and other non-deductible amounts.

Net Income (Loss). Net income decreased from $743,000 for the three months ended September 30, 2009 to a net loss of $493,000 in the same period in 2010. The decrease was primarily attributable to the income tax benefit of $1.4 million for the three months ended September 30, 2009 compared to a $54,000 tax expense in the same period in 2010. The decrease was also a result of operating cost increases in distribution partner payments, communication and network costs, personnel costs and stock based compensation and less revenue due to pricing reductions and incentives to AT&T. This was offset by lower online and outside marketing costs and higher revenue and gain on sales and disposals of intangible assets.

Net loss increased from $2.1 million for the nine months ended September 30, 2009 to a net loss of $3.7 million in the same period in 2010. The increase was primarily attributable to an income tax benefit of $2.4 million for the nine months ended September 30, 2009 compared to an $863,000 tax benefit in the same period in 2010. The increase was also a result of operating cost increases in distribution partner payments, communication and network costs, personnel costs and stock based compensation, and less revenue due to pricing reductions and incentives to AT&T. This was offset by lower online and outside marketing costs and higher gain on sales and disposals of intangible assets.

Liquidity and Capital Resources

As of September 30, 2010, we had cash and cash equivalents of $32.0 million and we had current and long term contractual obligations of $17.6 million, of which $13.3 million is for rent under our facility leases.

Cash provided by operating activities primarily consists of net loss adjusted for certain non-cash items such as depreciation and amortization, deferred income taxes, stock-based compensation, excess tax benefit related to stock options, and changes in working capital. Cash provided by operating activities for the nine months ended September 30, 2010 of approximately $3.5 million consisted primarily of net loss of $3.7 million adjusted for non-cash items of $16.9 million, including depreciation, amortization of intangible assets, allowance for doubtful accounts and advertiser credits, stock-based compensation, and deferred income taxes, and approximately $9.8 million used for working capital and other activities which is net of cash received of $779,000 related to a lease incentive. Cash provided by operating activities for the nine months ended September 30, 2009 of approximately $13.6 million consisted primarily of net loss of $2.1 million adjusted for non-cash items of $20.8 million, including depreciation, amortization of intangible assets, allowance for doubtful accounts and advertiser credits, stock-based compensation, deferred income taxes, and excess tax benefit related to stock options and approximately $5.1 million used for working capital and other activities.

With respect to a significant portion of our call advertising and pay-per-click services, we have no corresponding payments to distribution partners related to our proprietary revenues or we receive payment from advertisers prior to our delivery of related phone calls or click-throughs with the corresponding payments to the distribution partners who provide placement for the listings generally made only after our delivery of a phone call or click-through. In most cases, the amount payable to the distribution partner will be calculated at the end of a calendar month, with a payment period following the delivery of the phone calls or click-throughs. This payment structure results in a lag period between the earlier receipt of the cash from the advertisers and the later payment to the distribution partners. These services constituted the majority of revenue in the nine months ended September 30, 2009 and 2010. In certain cases, payments to distribution partners are paid in advance or are fixed in advance based on a guaranteed minimum amount of usage delivered.

Nearly all of the advertising services provider arrangements are billed on a monthly basis following the month of our click-through delivery. This payment structure results in our advancement of monies to the distribution partners who have provided the corresponding placements of the listings. For these services, advertiser’s payments are generally received one to three weeks following payment to the distribution partners. We expect that in the future periods, if the amounts from our advertising services provider arrangements account for a greater percentage of our operating activity, working capital requirements will increase as a result.

We have payment arrangements with reseller partners particularly related to our proprietary traffic sources or our small and medium-sized businesses marketing products, such as AT&T, SuperMedia Inc., Yellowbook USA Inc., The Cobalt Group, WhitePages, Inc., and Vantage Media LLC, whereby we receive payment between 30 and 60 days following the delivery of services. For the nine months ended and as of September 30, 2010 amounts from these partners along with Yahoo! totaled 48% of revenue and $13.5 million in accounts receivable, respectively. Based on the timing of payments, we generally have this level of amounts in outstanding accounts receivable at any given time from these partners. There can be no assurances that these partners or other advertisers will not experience further financial difficulty, curtail operations, reduce or eliminate spend budgets, delay payments or otherwise forfeit balances owed. Net accounts receivable balances outstanding at September 30, 2010 from Yahoo! and AT&T totaled $1.3 million and $9.1 million, respectively.

Cash provided by investing activities for the nine months ended September 30, 2010 of approximately $1.9 million was primarily attributable to net purchases for property and equipment of $2.7 million which were more than offset by proceeds from the sales of intangible assets of approximately $4.7 million. Cash provided by investing activities for the nine months ended September 30, 2009 of approximately $1.6 million was primarily attributable to net purchases for property and equipment of $1.4 million which were more than offset by proceeds from the sales of intangible assets of approximately $2.9 million. We expect property and equipment purchases will increase as we continue to invest in equipment and software. To the extent our operations increase, we expect to increase expenditures for our systems and personnel. Additionally, we have expended amounts for product development initiatives as well as amounts recorded as part of property and equipment for internally developed software. We expect our expenditures for product development initiatives and internally developed software will increase in the longer term in absolute dollars as our development activities accelerate and we increase the number of personnel and consultants to enhance our service offerings.

Cash used in financing activities for the nine months ended September 30, 2010 of approximately $7.0 million was primarily attributable to the repurchase of 982,000 shares of Class B common stock for treasury stock totaling approximately $4.9 million and

common stock dividend payments of $2.1 million. Cash used in financing activities for the nine months ended September 30, 2009 of approximately $9.5 million was primarily attributable to the repurchase of 2.1 million shares of Class B common stock for treasury stock totaling approximately $7.5 million, and common stock dividend payments of $2.2 million, partially offset by net proceeds of approximately $122,000 from the sale of stock through employee stock options and employee stock plan purchases and $69,000 of excess tax benefits related to stock options.

The following table summarizes our contractual obligations as of September 30, 2010, and the effect these obligations are expected to have on our liquidity and cash flows in future periods.


	Total		Less than 1 year		1-3 years		4-5 years		thereafter
Contractual Obligations:
Operating leases	$	13,327,999	$	318,239	$	3,002,767	$	3,609,850	$	6,397,143
Other contractual obligations		4,257,988	$	647,435		3,435,203		175,350		-

Total contractual obligations (1), (2)	$	17,585,987	$	965,674	$	6,437,970	$	3,785,200	$	6,397,143

(1)

In February 2005 we entered into a license agreement with an advertising partner which provides for a contingent royalty based on a discounted rate of 3% (3.75% under certain circumstances) of certain of our gross revenues payable on a quarterly basis through December 2016. The royalty payment is recognized as incurred in service costs and is not included in the above schedule.

(2)	Our tax contingencies are not included due to their uncertainty.

(3)

In May 2010, we entered into a lease agreement for office facilities in New York, New York which commenced in the second quarter of 2010 and expires in March 2018. Future minimum payments related to these new facilities are approximately as follows: $2,000 for the remainder of 2010, $209,000 in 2011, $243,000 in 2012, $249,000 in 2013, $273,000 in 2014, and $978,000 in aggregate thereafter.

We anticipate that we will need to invest working capital towards the development and expansion of our overall operations. We may also make a significant number of acquisitions, which could result in the reduction of our cash balances or the incurrence of debt. Furthermore, we expect that capital expenditures may increase in future periods, particularly if our operating activity increases. On April 1, 2008, we entered into a three year credit agreement which provides us with a $30 million senior secured revolving credit line, which may be used for various corporate purposes including financing permitted acquisitions, subject to compliance with applicable covenants. As of September 30, 2010, we had $30 million of availability under the credit agreement.

In November 2006, our Board of Directors authorized a share repurchase program to repurchase up to 3 million shares of our Class B common stock as well as the initiation of a quarterly cash dividend for the holders of the Class A common stock and Class B common stock. The Board of Directors have authorized increases in the share repurchase program to provide for the repurchase of up to 11 million shares in the aggregate (less shares previously repurchased under the share repurchase program) of our Class B common stock. Under the revised share repurchase program, repurchases may take place in the open market and in privately negotiated transactions and at times and in such amounts as we deem appropriate. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements, capital availability, and other market conditions. This stock repurchase program does not have an expiration date and may be expanded, limited or terminated at any time without prior notice. During the nine months ended September 30, 2010, approximately 982,000 shares of Class B common stock were repurchased. The quarterly cash dividend was initiated at $0.02 per share of Class A common stock and Class B common stock. For 2009, quarterly dividends were paid on February 17, May 15, August 17 and November 16, to Class A and Class B common stockholders of record as of the close of business of February 6, May 4, August 7 and November 6, respectively. For 2010, quarterly dividends were paid on February 15, May 17, and August 16 to Class A and Class B common stockholders of record as of the close of business of February 4, May 5, and August 6, respectively. The aggregate quarterly dividend paid in February 2010, May 2010, and August 2010 was approximately $2.1 million. Under Delaware law, dividends to stockholders may be made only from the surplus of a company, or, in certain situations, from the net profits for the current fiscal year before the dividend is declared by the board of directors. In October 2010, our Board of Directors declared a regular quarterly dividend of $0.02 per share on our Class A common stock and Class B common stock. Marchex will pay these dividends on November 15, 2010 to the holders of record as of the close of business on November 5, 2010. Although we expect that the annual cash dividend, subject to capital availability, will be $0.08 per common share or approximately $2.8 million for the foreseeable future, there can be no assurance that we will continue to pay dividends at such a rate or at all.

Based on our operating plans we believe that our existing credit availability, resources and cash flow provided by ongoing operations, will be sufficient to fund our operations for at least twelve months. Additional equity and debt financing may be needed to support our acquisition strategy, our long-term obligations and our Company’s needs. If additional financing is necessary, it may not be available; and if it is available, it may not be possible for us to obtain financing on satisfactory terms. Failure to generate sufficient revenue or raise additional capital could have a material adverse effect on our ability to continue as a going concern and to achieve our intended business objectives.

Critical Accounting Policies

The policies below are critical to our business operations and the understanding of our results of operations. In the ordinary course of business, we make a number of estimates and assumptions relating to the reporting of our results.

Our consolidated financial statements have been prepared using accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and the related disclosures of contingent assets and liabilities. We base our estimates on historical experience and on various assumptions that we believe 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. Actual results may differ from these estimates under different assumptions or conditions.

Our critical accounting policies relate to the following matters and are described below:

•

Revenue;

•

Goodwill and intangible assets;

•

Stock-based compensation;

•

Allowance for doubtful accounts, advertiser and incentive program credits; and

•

Provision for income taxes.

Revenue

We currently generate revenue through our operating businesses by delivering call and click-based advertising products that enable advertisers of all sizes to reach local consumers across online, mobile and offline sources. The primary revenue driver has been performance-based advertising, which includes call advertising service, pay-per-click advertising, cost-per-action services and feed management and related services. For pay-for-call, pay-per-click advertising and feed management and related services, revenue is recognized upon our delivery of qualified and reported phone calls or click-throughs to our advertisers or advertising service providers’ listing which occurs when an online, mobile, or offline user makes a phone call or clicks based on any of their advertisements after it has been placed by us or by our distribution partners. Each phone call or click-through on an advertisement listing represents a completed transaction. For cost-per-action services, revenue is recognized when the online user is redirected from one of our Web sites or a third-party Web site in our distribution network to an advertiser Web site and completes the specified action, such as when a call is placed. In certain cases, we record revenue based on available and reported preliminary information from third parties. Collection on the related receivables may vary from reported information based upon third party refinement of the estimated and reported amounts owing that occurs subsequent to period ends.

We have entered into agreements with various distribution partners in order to expand our distribution network, which includes search engines, directories, product shopping engines, third-party vertical and branded Web sites, mobile and offline sources, and our portfolio of owned Web sites, on which we include our advertisers’ listings. We generally pay distribution partners based on a specified percentage of revenue or a fixed amount per phone call or click-through on these listings. We act as the primary obligor in these transactions, and we are responsible for providing customer and administrative services to the advertiser. In accordance with FASB ASC 605 (previously Emerging Issues Task Force Issue (EITF) No. 99-19, Reporting Revenue Gross as a Principal Versus Net as an Agent), the revenue derived from advertisers who receive paid introductions through us as supplied by distribution partners is reported gross based upon the amounts received from the advertiser. We also recognize revenue for certain agency contracts with advertisers under the net revenue recognition method. Under these specific agreements, we purchase listings on behalf of advertisers from search engines and directories. We are paid account fees and also agency fees based on the total amount of the purchase made on behalf of these advertisers. Under these agreements, our advertisers are primarily responsible for choosing the publisher and determining pricing, and the Company, in certain instances, is only financially liable to the publisher for the amount collected from our advertisers. This creates a sequential liability for media purchases made on behalf of advertisers. In certain instances, the web publishers engage the advertisers directly and we are paid an agency fee based on the total amount of the purchase made by the advertiser. In limited arrangements resellers pay us a fee for fulfilling an advertiser’s campaign in our distribution network and we act as the primary obligor. We recognize revenue for these fees under the gross revenue recognition method.

We apply FASB ASC 605 (previously EITF Issue No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables), to account for revenue arrangements with multiple deliverables. FASB ASC 605 addresses certain aspects of accounting by a vendor for arrangements under which the vendor will perform multiple revenue-generating activities. When an arrangement involves multiple elements, the entire fee from the arrangement is allocated to each respective element based on its relative fair value and recognized when revenue recognition criteria for each element are met. Fair value for each element is established based on the sales price charged when the same element is sold separately.

Goodwill and Intangible Assets

Goodwill represents the excess of the purchase price over the fair value of identifiable assets acquired and liabilities assumed in business combinations accounted for under the purchase method.

We apply the provisions of FASB ASC 350 (previously SFAS No. 142, Goodwill and Other Intangible Assets). Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead tested for impairment at least annually in accordance with the provisions of FASB ASC 350. FASB ASC 350 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with FASB ASC 360 (previously SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Asset SFAS 144).

Goodwill is tested annually for impairment and is tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. Events and circumstances considered in determining whether the carrying value of goodwill may not be recoverable include, but are not limited to: significant changes in performance relative to expected operating results; significant changes in the use of the assets; significant negative industry or economic trends; and a significant decline in the Company’s stock price and/or market capitalization for a sustained period of time. If our stock price were to trade below book value per share for a extended period of time and/or we continue to experience adverse effects of a continued downward trend in the overall economic environment, changes in the business itself, including changes in projected earnings and cash flows, we may have to recognize an impairment of all or some portion of our goodwill. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. If the fair value is lower than the carrying value, a material impairment charge may be reported in our financial results. We exercise judgment in the assessment of the related useful lives of intangible assets, the fair values and the recoverability. In certain instances, the fair value is determined in part based on cash flow forecasts and discount rate estimates. We review our long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. To the extent such evaluation indicates that the useful lives of intangible assets are different than originally estimated, the amortization period is reduced or extended and, accordingly, amortization expense is increased or decreased. Recoverability of assets held and used is measured by a comparison of the carrying amount of an asset group to estimated undiscounted future cash flows expected to be generated by the asset group. If such asset group is considered to be impaired, the impairment is to be recognized by the amount by which the carrying amount of the assets exceeds fair value. Assets to be disposed of are separately presented on the balance sheet and reported at the lower of their carrying amount or fair value less costs to sell, and are no longer depreciated. We cannot accurately predict the amount and timing of any impairment of goodwill or other intangible assets. Should the value of goodwill or other intangible assets become impaired, we would record the appropriate charge, which could have an adverse effect on our financial condition and results of operations.

In the fourth quarter of 2008 we performed our annual goodwill impairment testing in accordance with FASB ASC 350 and in light of the then adverse macroeconomic environment and significant decrease in market capitalization. We also performed a review on certain of our intangible assets under FASB ASC 360. As a result of this testing, we recorded $176.7 million pre-tax impairment charge on goodwill and intangible assets in the fourth quarter of 2008. The impairment charge resulted in part from adverse equity and credit market conditions that caused a sustained decrease in market multiples and the company’s stock price, a decrease in valuations of U.S. public companies and corresponding increased costs of capital created by the weakness in the U.S. financial markets and decreases in cash flow forecasts for us and the markets in which we operate. Certain technology and domain assets were written-down due to the decreased cash flow forecasts and planned utilization of the assets. The impairment charges will not result in any current or future cash expenditures.

No indicators of impairment of our intangible assets have been identified to date in 2010. The current business environment is subject to evolving market conditions and requires significant management judgment to interpret the potential impact to our assumptions. To the extent that changes in the current business environment impact our ability to achieve levels of forecasted operating results and cash flows, or should other events occur indicating the remaining carrying value of our assets might be impaired, we would test our intangible assets for impairment and may recognize an additional impairment loss to the extent that the carrying amount exceeds such asset’s fair value.

Any future additional impairment charges or changes to the estimated amortization periods could have a material adverse effect on our financial results.

Stock-Based Compensation

FASB ASC 718 requires the measurement and recognition of compensation for all stock-based awards made to employees, non-employees and directors including stock options, restricted stock issuances, and restricted stock units based on estimated fair values. In the second quarter of 2010, we issued performance based awards of stock options and restricted stock units that have vesting based on certain service and market conditions. Under the fair value recognition provisions, we recognize stock-based compensation net of an estimated forfeiture rate, and therefore only recognize compensation cost for those shares expected to vest over the service period of the award. For performance based awards, we factor an estimated probability of achieving certain service and market conditions and recognize compensation cost over the service period of the award.

We generally use the Black-Scholes option pricing model as our method of valuation for stock-based awards with time-based vesting and use other fair value models for performance based awards that have vesting based on certain service and market conditions. Our determination of the fair value of stock-based awards on the date of grant using an option pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to the expected life of the award, our expected stock price, volatility over the term of the award and actual and projected exercise behaviors. Although the fair value of stock-based awards is determined in accordance with FASB ASC 718, the assumptions used in calculating fair value of stock-based awards and the Black-Scholes option pricing model and other fair value models are highly subjective, and other reasonable assumptions could provide differing results. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future. For stock-based awards with time-based vesting, we are required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. We estimate the forfeiture rate based on historical experience of our stock-based awards that are granted, exercised and cancelled. If our actual forfeiture rate is materially different from our estimate, the stock-based compensation expense could be significantly different from what we have recorded in the current period. See Note 3 —“Stock-based Compensation Plans” in the condensed consolidated financial statements for additional information.

Allowance for Doubtful Accounts and Advertiser and Incentive Program Credits

Accounts receivable balances are presented net of allowance for doubtful accounts and advertiser credits. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our accounts receivable. We determine our allowance based on analysis of historical bad debts, advertiser concentrations, advertiser creditworthiness and current economic trends. We review the allowance for collectability on a quarterly basis. Account balances are written off against the allowance after all reasonable means of collection have been exhausted and the potential recovery is considered remote. If the financial condition of our advertisers were to deteriorate, resulting in an impairment of their ability to make payments, or if we underestimated the allowances required, additional allowances may be required which would result in increased general and administrative expenses in the period such determination was made.

We determine our allowance for advertiser credits and adjustments based upon our analysis of historical credits. Under the advertiser incentive program, we grant advertisers credits depending upon the individual amounts of prepayments made. The incentive program allowance is determined based on the historical rate of incentives earned and used by advertisers compared to the related revenues recognized by us. Material differences may result in the amount and timing of our revenue for any period if our management made different judgments and estimates.

Provision for Income Taxes

Each reporting period we must assess the likelihood that our deferred tax assets will be recovered from existing deferred tax liabilities, available carrybacks or future taxable income, and to the extent that realization is not more likely than not, a valuation allowance must be established. The establishment of a valuation allowance and increases to such an allowance may result in either increases to income tax expense or reduction of income tax benefit in the statement of operations. Although realization is not assured, we believe it is more likely than not, based on operating performance, existing deferred tax liabilities, available carrybacks and projections of future taxable income, that our net deferred tax assets, excluding certain state and foreign net operating loss carryforwards, will be realized. In determining that it was more likely than not that we would realize the deferred tax assets, factors considered included: historical taxable income, historical trends related to advertiser usage rates, projected revenues and expenses, macroeconomic conditions, issues facing our industry, existing contracts, our ability to project future results and any appreciation of our other assets. The majority of our deferred tax assets have arisen due to deductions taken in our financial statements related to the impairment of goodwill and amortization of intangible assets recorded in connection with various acquisitions that are tax-deductible over 15 year periods. Based on available carrybacks and projections of future taxable income the Company expects to be able to recover these assets. The amount of the net deferred tax assets considered realizable, however, could be reduced in the near term if our projections of future taxable income are reduced or if we do not perform at the levels we are projecting. This could result in increases to the valuation allowance for deferred tax assets and a corresponding increase to income tax expense of up to the entire net amount of deferred tax assets.

FASB ASC 740 (previously FIN No. 48, Accounting for Uncertainty in Income Taxes), clarifies the accounting for uncertainty in income taxes recognized in the financial statements. This pronouncement prescribes a recognition threshold and measurement

process for recording in the financial statements uncertain tax positions taken or expected to be taken in the our tax return. FASB ASC 740 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure requirements for uncertain tax positions.

As of September 30, 2010, we have net deferred tax assets of $51.6 million, relating to the impairment of goodwill, amortization of intangibles assets and certain other temporary differences. Although realization is not assured, we believe it is more likely than not that our net deferred tax assets, excluding certain state and foreign net operating loss carryforwards, will be realized. As of September 30, 2010, based upon both positive and negative evidence available, we have determined it is not more likely than not that certain deferred tax assets primarily relating to net operating loss carryforwards in certain state and foreign jurisdictions will be realizable and accordingly, have recorded a valuation allowance of $3.8 million against these deferred tax assets. We do not have a history of taxable income in the relevant jurisdictions and the state and foreign net operating loss carryforwards will more likely than not expire unutilized. Should we determine in the future that we will be able to realize these deferred tax assets, or not be able to realize all or part of our remaining net deferred tax assets recorded as of September 30, 2010, an adjustment to the net deferred tax assets would impact net income or stockholders’ equity in the period such determination was made.

Recently Issued Accounting Pronouncements

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

Our exposure to market risk is limited to interest income sensitivity, which is affected by changes in the general level of U.S. interest rates, particularly because the majority of our investments are in short-term, money market funds. Due to the nature of our short-term investments, we believe that we are not subject to any material market risk exposure. We do not have any material foreign currency or other derivative financial instruments.

Our existing credit facility bears interest at a rate which will be, at our option, either: (i) the applicable margin rate (depending on our leverage) plus the one-month LIBOR rate reset daily, or (ii) the applicable margin rate plus the 1, 2, 3, or 6-month LIBOR rate. This facility is exposed to market rate fluctuations and may impact the interest paid on any borrowings under the credit facility. Currently, we have no borrowings under this facility; however, an increase in interest rates would impact interest expense on future borrowings.

Item 4.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our chief executive officer and our chief financial officer, of the effectiveness of our “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934). Based on this evaluation, our chief executive officer and our chief financial officer have concluded that, as of the date of the evaluation, our disclosure controls and procedures were effective.

Changes in Internal Control over Financial Reporting

During the quarter ended September 30, 2010, no change was made to our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Limitations on the Effectiveness of Controls

In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can not provide absolute assurance of achieving the desired control objectives.

In addition, because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Part II—Other Information

Item 1.

Legal Proceedings

We are not a party to any material legal proceedings. From time to time, however, we may be subject to legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of intellectual property rights, and a variety of claims arising in connection with our services.

Item 1A.

Risk Factors

We have updated the risk factors previously disclosed in Part I, Item 1A. under the caption “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2009, which was filed with the SEC on March 10, 2010. We do not believe any of the changes constitute material changes to the risk factors. An investment in our Class B common stock involves various risks, including those mentioned below and those that are discussed from time to time in our other periodic filings with the SEC. Investors should carefully consider these risks, along with the other information contained in this report, before making an investment decision regarding our stock. There may be additional risks of which we are currently unaware, or which we currently consider immaterial. All of these risks could have a material adverse effect on our financial condition, our results of operations, and the value of our stock.

Risks Relating to Our Company

Our limited operating history makes evaluation of our business difficult.

We were formally incorporated in January of 2003. We acquired Enhance Interactive in February of 2003, TrafficLeader in October of 2003, and goClick in July of 2004. In February and April of 2005, we completed the acquisitions of certain assets of Name Development and Pike Street Industries, respectively. In July of 2005 we completed the acquisition of IndustryBrains. In May of 2006 we completed the acquisition of certain assets of AreaConnect and Open List. In September of 2007, we completed the acquisition of VoiceStar.

We have limited historical financial data upon which to base planned operating expenses or forecast accurately our future operating results. Further, our limited operating history will make it difficult for investors and securities analysts to evaluate our business and prospects. Our failure to address these risks and difficulties successfully could seriously harm us.

We have largely incurred net losses since our inception, and we may incur net losses in the foreseeable future.

We had an accumulated deficit of $141.4 million as of September 30, 2010. Our net expenses may increase based on the initiatives we undertake which for instance, may include increasing our sales and marketing activities, hiring additional personnel, incurring additional costs as a result of being a public company, acquiring additional businesses and making additional equity grants to our employees.

We may increase our direct monetization of our proprietary traffic sources, which could adversely affect our revenues.

Our strategic plan has been to increase our direct monetization of our proprietary traffic sources by using more of the advertising listings on our Publishing Network to display the advertisements of advertisers who are on our direct technology platform and those with whom we have direct relationships, as opposed to advertisers from third parties. This monetization may not be of the same rate levels as other advertising providers and as a result could adversely affect our revenues.

We are dependent on certain distribution partners, for distribution of our services, and we derive a significant portion of our total revenue through these distribution partners. A loss of distribution partners or a decrease in revenue from certain distribution partners could adversely affect our business.

A relatively small number of distribution partners currently deliver a significant percentage of traffic and calls to our advertisers, although no one distribution partner accounts for in excess of 10% of our revenues.

Our existing agreements with many of our other larger distribution partners permit either company to terminate without penalty on short notice and are primarily structured on a variable-payment basis, under which we make payments based on a specified percentage of revenue or based on the number of paid click-throughs. Yahoo! discontinued its feed management service relationship with us effective December 31, 2009 as a result of its recently announced partnership with Microsoft. Accordingly, we ended our feed management and related service offerings to advertisers on that date. We generated $7.5 million in revenues from feed management and related services for the year ended December 31, 2009. The impact on our financial statements attributable to our ending this service is lessened by the relatively low operating margin attributable to this service given our revenue share arrangement with Yahoo! with respect thereto. We intend to continue devoting resources in support of our larger distribution partners, but there are no guarantees that these relationships will remain in place over the short- or long-term. In addition, we cannot be assured that any of these distribution partners will continue to generate current levels of revenue for us or that we will be able to maintain the applicable variable payment terms at their current levels. A loss of any of these distribution partners or a decrease in revenue due to lower traffic or less favorable variable payment terms from any one of these distribution relationships could have a material adverse effect on our business, financial condition and results of operations.

Companies distributing advertising on the Internet have experienced, and will likely continue to experience, consolidation. This consolidation has reduced the number of partners that control the online advertising outlets with the most user traffic. According to the comScore Media Metrix Core Search Report for December 2009, Yahoo! accounted for 17% of the online searches in the United States and Google accounted for 66%. As a result, the larger distribution partners have greater control over determining the market terms of distribution, including placement of advertisements and cost of placement. In addition, many participants in the performance-based advertising and search marketing industries control significant portions of the traffic that they deliver to advertisers. We do not believe, for example, that Yahoo! and Google are as reliant as we are on a third-party distribution network to deliver their services. This gives these companies a significant advantage over us in delivering their services, and with a lesser degree of risk.

We rely on certain advertiser reseller partners and agencies, including AT&T (through our contract with AT&T’s subsidiary Yellowpages.com LLC d/b/a AT&T Interactive), Yellowbook USA Inc., The Cobalt Group, Super Media, Inc., Vantage Media, LLC, and Yellow Pages Group Canada for the purchase of various advertising and marketing services, as well as to provide us with a large number of advertisers. A loss of certain advertiser reseller partners and agencies or a decrease in revenue from these reseller partners could adversely affect our business. Such advertisers are subject to varying terms and conditions which may result in claims or credit risks to us.

We benefit from the established relationships and national sales teams that certain of our reseller partners, who are leading reseller partners of advertisers and advertising agencies, have in place throughout the country and in local markets. These advertiser reseller partners and agencies refer or bring advertisers to us for the purchase of various advertising products and services. We derive a sizeable portion of our total revenue through these advertiser reseller partners and agencies. A loss of certain advertiser reseller partners and agencies or a decrease in revenue from these clients could adversely affect our business. AT&T is our largest advertiser reseller partner and was responsible for 23% of our total revenues for the nine months ended September 30, 2010. We recently entered into an amendment to our agreement with AT&T which extends its term through June 30, 2015.

These advertisers may in certain cases be subject to negotiated terms and conditions separate from those applied to online clients accepted and processed through our automated advertiser management platform. In some cases, the applicable contract terms may be the result of legacy or industry association documentation or simply customized advertising solutions for large reseller partners and agencies. In any case, as a consequence of such varying terms and conditions, we may be subject to claims or credit risks that we may otherwise mitigate more efficiently across our automated advertiser management platform.

These claims and risks may vary depending on the nature of the aggregated client base. Among other claims, we may be subject to disputes based on third party tracking information or analysis. We may also be subject to differing credit profiles and risks based on the agency relationship associated with these advertisers. For such advertisers, payment may be made on an invoice basis, unlike our retail platform which in many instances is paid in advance of the service. In some limited circumstances we may also have accepted individual advertiser payment liability in place of liability of the advertising agency or media advisor.

We received approximately 52% and 47% of our revenue from our five largest customers for the year ended December 31, 2009, and for the nine months ended September 30, 2010, respectively, and the loss of one or more of these customers could adversely impact our results of operations and financial condition.

Our five largest customers accounted for approximately 52% of our total revenues for the year ended December 31, 2009 and 47% for the nine months ended September 30, 2010, respectively. AT&T is our largest customer and was responsible for 23% of our total revenues for the nine months ended September 30, 2010 and 44% of accounts receivable at September 30, 2010. We recently entered into an amendment to our agreement with AT&T which extends its term through June 30, 2015. Certain of these customers are not subject to long term contracts with us and are generally able to reduce advertising spending at any time and for any reason. A significant reduction in advertising spending by our largest customers, or the loss of one or more of these customers, if not replaced by new customers or an increase in business from existing customers, would adversely affect revenues. This could have a material adverse effect on our results of operations and financial condition.

Our large customers have substantial negotiating leverage, which may require that we agree to terms and conditions that may have an adverse effect on our business.

Our large customers (including AT&T and Yahoo!) have substantial purchasing power and leverage in negotiating contractual arrangements with us. These customers may seek for us to develop additional features, may require penalties for failure to deliver such features, may seek discounted product or service pricing and may seek more favorable contractual terms. As we sell more products and services to this class of customer, we may be required to agree to such terms and conditions. Such large customers also have substantial leverage in negotiating resolution of any disagreements or disputes than may arise. Any of the foregoing factors could result in a material adverse effect on our business, financial condition and results of operations.

If some of our customers experience financial distress, their weakened financial position could negatively affect our own financial position and results.

We have a diverse customer base and, at any given time, one or more customers may experience financial distress, file for bankruptcy protection or go out of business. If a customer with whom we do a substantial amount of business experiences financial difficulty, it could delay or jeopardize the collection of accounts receivable, result in significant reductions in services provided by us and may have a material adverse effect on our results of operations and liquidity.

We may incur liabilities for the activities of our advertisers, distribution partners and other users of our services, which could adversely affect our business.

Many of our advertisement generation and distribution processes are automated. In most cases, advertisers use our online tools and account management systems to create and submit advertiser listings. These advertiser listings are submitted in a bulk data feed to our distribution partners. Although we monitor our distribution partners on an ongoing basis primarily for traffic quality, these partners control the distribution of the advertiser listings provided in the data feed.

We have a large number of distribution partners who display our advertiser listings on their networks. Our advertiser listings are predominantly delivered to our distribution partners in an automated fashion through an XML data feed or data dump. Our distribution partners are contractually required to use the listings created by our advertiser customers in accordance with applicable laws and regulations and in conformity with the publication restrictions in our agreements, which are intended to promote the quality and validity of the traffic provided to our advertisers. Nonetheless, we do not operationally control or manage these distribution partners and any breach of these agreements on the part of any distribution partner or its affiliates could result in liability for our business. These agreements include indemnification obligations on the part of our distribution partners, but there is no guarantee that we would be able to collect against offending distribution partners or their affiliates in the event of a claim under these indemnification provisions.

We do not conduct a manual editorial review of a substantial number of the advertiser listings directly submitted by advertisers online, nor do we manually review the display of the vast majority of the advertiser listings by our distribution partners submitted to us by XML data feeds or data dumps. Likewise, in cases where we provide editorial or value-added services for our large reseller partners or agencies, such as ad creation and optimization for local advertisers or landing pages and micro-sites for pay-for-call customers, we rely on the content and information provided to us by these agents on behalf of their individual advertisers. We do not investigate the individual business activities of these advertisers other than the information provided to us or in some cases review of advertiser Web sites. We may not successfully avoid liability for unlawful activities carried out by our advertisers and other users of our services or unpermitted uses of our advertiser listings by distribution partners and their affiliates.

Our potential liability for unlawful activities of our advertisers and other users of our services or unpermitted uses of our advertiser listings and advertising services and platform by distribution partners and advertiser reseller partners and agencies could require us to implement measures to reduce our exposure to such liability, which may require us, among other things, to spend substantial resources, to discontinue certain service offerings or to terminate certain distribution partner relationships. For example, as a result of the actions of advertisers in our network, we may be subject to private or governmental actions relating to a wide variety of issues, such as privacy, gambling, promotions, and intellectual property ownership and infringement. Under agreements with certain of our larger distribution partners, we may be required to indemnify these distribution partners against liabilities or losses resulting from the content of our advertiser listings or resulting from third- party intellectual property infringement claims. Although our advertisers agree to indemnify us with respect to claims arising from these listings, we may not be able to recover all or any of the liabilities or losses incurred by us as a result of the activities of our advertisers.

Our insurance policies may not provide coverage for liability arising out of activities of users of our services. In addition, our reliance on some content and information provided to us by our large advertiser reseller partners and agencies may expose us to liability not covered by our insurance policies. Furthermore, we may not be able to obtain or maintain adequate insurance coverage to reduce or limit the liabilities associated with our businesses. Any costs incurred as a result of such liability or asserted liability could have a material adverse effect on our business, operating results and financial condition.

If we do not maintain and grow a critical mass of advertisers and distribution partners, the value of our services could be adversely affected.

Our success depends, in large part, on the maintenance and growth of a critical mass of advertisers and distribution partners and a continued interest in our pay-for-call, performance-based advertising, telemarketing analytics and search marketing services. Advertisers will generally seek the most competitive return on investment from advertising and marketing services. Distribution partners will also seek the most favorable payment terms available in the market. Advertisers and distribution partners may change providers or the volume of business with a provider, unless the product and terms are competitive. In this environment, we must compete to acquire and maintain our network of advertisers and distribution partners.

If our business is unable to maintain and grow our base of advertisers, our current distribution partners may be discouraged from continuing to work with us, and this may create obstacles for us to enter into agreements with new distribution partners. Our business also in part depends on certain of our large advertiser reseller partners and agencies to grow their base of advertisers as these advertisers become increasingly important to our business and our ability to attract additional distribution partners and opportunities. Similarly, if our distribution network does not grow and does not continue to improve over time, current and prospective advertisers and reseller partners and agencies may reduce or terminate this portion of their business with us. Any decline in the number of advertisers and distribution partners could adversely affect the value of our services.

We are dependent upon the quality of traffic in our network to provide value to our advertisers and the advertisers of our partners, and any failure in our quality control could have a material adverse effect on the value of our services to our advertisers and adversely affect our revenues.

We utilize certain monitoring processes with respect to the quality of the Internet and voice traffic that we deliver to our advertisers. Among the factors we seek to monitor are sources and causes of low quality clicks such as non-human processes, including robots, spiders or other software, the mechanical automation of clicking, and other types of invalid clicks, click fraud, or click spam, the purpose of which is something other than to view the underlying content. Additionally, we also seek to identify other indicators which may suggest that a user may not be targeted by or desirable to our advertisers. Even with such monitoring in place, there is a risk that a certain amount of low-quality traffic or traffic that is deemed to be less valuable by our advertisers will be delivered to such advertisers, which may be detrimental to those relationships. We have regularly refunded fees that our advertisers had paid to us which were attributed to low quality traffic. If we are unable to stop or reduce low quality traffic, these refunds may increase. Low-quality traffic may further prevent us from growing our base of advertisers and cause us to lose relationships with existing advertisers, or become the target of litigation, both of which would adversely affect our revenues.

We may be subject to intellectual property claims, which could adversely affect our financial condition and ability to use certain critical technologies, divert our resources and management attention from our business operations and create uncertainty about ownership of technology essential to our business.

Our success depends, in part, on our ability to protect our intellectual property and to operate without infringing on the intellectual property rights of others in the process. There can be no guarantee that any of our intellectual property will be adequately safeguarded, or that it will not be challenged by third parties. We may be subject to patent infringement claims or other intellectual property infringement claims, including claims of trademark infringement in connection with our acquisition of previously-owned Internet domain names and claims of copyright infringement with respect to certain of our proprietary Web sites that would be costly to defend and could limit our ability to use certain critical technologies.

Any patent or other intellectual property litigation could negatively impact our business by diverting resources and management attention from other aspects of the business and adding uncertainty as to the ownership of technology, services and property that we view as proprietary and essential to our business. In addition, a successful claim of patent infringement against us and our failure or inability to license the infringed or similar technology on reasonable terms, or at all, could prevent us from using critical technologies which could have a material adverse effect on our business.

We may need additional funding to meet our obligations and to pursue our business strategy. Additional funding may not be available to us and our financial condition could therefore be adversely affected.

We may require additional funding to meet our ongoing obligations and to pursue our business strategy, which may include the selective acquisition of businesses and technologies. In addition, we have incurred and we may incur certain obligations in the future. There can be no assurance that if we were to need additional funds to meet these obligations that additional financing arrangements would be available in amounts or on terms acceptable to us, if at all. Furthermore, if adequate additional funds are not available, we will be required to delay, reduce the scope of, or eliminate material parts of the implementation of our business strategy, including potential additional acquisitions or internally-developed businesses.

Our acquisitions could divert management’s attention, cause ownership dilution to our stockholders, cause our earnings to decrease and be difficult to integrate.

Our business strategy includes identifying, structuring, completing and integrating acquisitions. Acquisitions in the technology and Internet sectors involve a high degree of risk. We may also be unable to find a sufficient number of attractive opportunities to meet our objectives which include revenue growth, profitability and competitive market share. Our acquired companies may have histories of net losses and may expect net losses for the foreseeable future. Acquisitions are accompanied by a number of risks that could harm our business, operating results and financial condition:

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We could experience a substantial strain on our resources, including time and money, and we may not be successful;

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Our management’s attention could be diverted from our ongoing business concerns;

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While integrating new companies, we may lose key executives or other employees of these companies;

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We may issue shares of our Class B common stock as consideration for acquisitions which may result in ownership dilution to our stockholders;

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We could fail to successfully integrate our financial and management controls, technology, reporting systems and procedures, or adequately expand, train and manage our workforce;

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We could experience customer dissatisfaction or performance problems with an acquired company or technology;

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We could become subject to unknown or underestimated liabilities of an acquired entity or incur unexpected expenses or losses from such acquisitions;

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We could incur possible impairment charges related to goodwill or other intangible assets or other unanticipated events or circumstances, any of which could harm our business; and

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We may be exposed to investigations and/or audits by federal, state or other taxing authorities.

Consequently, we might not be successful in integrating any acquired businesses, products or technologies, and might not achieve anticipated revenue and cost benefits.

The loss of our senior management, including our founding executive officers, could harm our current and future operations and prospects.

We are heavily dependent upon the continued services of Russell C. Horowitz, our chairman and chief executive officer, and the other members of our senior management team. Each member of our senior management team is an at-will employee and may voluntarily terminate his employment with us at any time with minimal notice. Russell C. Horowitz, Ethan A. Caldwell, Peter Christothoulou and John Keister, our founding executive officers, each own shares of fully vested Class A common stock. Following any termination of employment, each of these employees would only be subject to a twelve-month non-competition and non-solicitation obligation with respect to our customers and employees under our standard confidentiality agreement.

Further, as of September 30, 2010, Russell C. Horowitz, Ethan A. Caldwell, Peter Christothoulou and John Keister together controlled 92% of the combined voting power of our outstanding capital stock. Their collective voting control is not tied to their continued employment with Marchex. The loss of the services of any member of our senior management, including our founding executive officers, for any reason, or any conflict among our founding executive officers, could harm our current and future operations and prospects.

We may have difficulty retaining current personnel as well as attracting and retaining additional qualified, experienced, highly skilled personnel, which could adversely affect the implementation of our business plan.

Our performance is largely dependent upon the talents and efforts of highly skilled individuals. In order to fully implement our business plan, we will need to retain our current qualified personnel, as well as attract and retain additional qualified personnel. Thus, our success will in significant part depend upon our retention of current personnel as well as the efforts of personnel not yet identified and upon our ability to attract and retain highly skilled managerial, engineering, sales and marketing personnel. We are also dependent on managerial and technical personnel to the extent they may have knowledge or information about our businesses and technical systems that may not be known by our other personnel. There can be no assurance that we will be able to attract and retain necessary personnel. The failure to hire and retain such personnel could adversely affect the implementation of our business plan.

If we are unable to obtain and maintain adequate insurance, our financial condition could be adversely affected in the event of uninsured or inadequately insured loss or damage. Our ability to effectively recruit and retain qualified officers and directors may also be adversely affected if we experience difficulty in maintaining adequate directors’ and officers’ liability insurance.

We may not be able to obtain and maintain insurance policies on terms affordable to us that would adequately insure our business and property against damage, loss or claims by third parties. To the extent our business or property suffers any damages, losses or claims by third parties that are not covered or adequately covered by insurance, our financial condition may be materially adversely affected.

We currently have directors’ and officers’ liability insurance. If we are unable to maintain sufficient insurance as a public company to cover liability claims made against our officers and directors, we may not be able to retain or recruit qualified officers and directors to manage our company, which could have a material adverse effect on our operations.

It may be difficult for us to retain or attract qualified officers and directors, which could adversely affect our business and our ability to maintain the listing of our Class B common stock on the Nasdaq Global Market.

We may be unable to attract and retain qualified officers, directors and members of board committees required to provide for our effective management as a result of changes in the rules and regulations which govern publicly-held companies, including, but not limited to, certifications from executive officers and requirements for financial experts on boards of directors. The perceived increased personal risk associated with these recent changes may deter qualified individuals from accepting these roles. Further, applicable rules

and regulations of the Securities and Exchange Commission and the Nasdaq Stock Market heighten the requirements for board or committee membership, particularly with respect to an individual’s independence from the corporation and level of experience in finance and accounting matters. We may have difficulty attracting and retaining directors with the requisite qualifications. If we are unable to attract and retain qualified officers and directors, our business and our ability to maintain the listing of our shares of Class B common stock on the Nasdaq Global Market could be adversely affected.

If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud, which could harm our brand and operating results.

Effective internal controls are necessary for us to provide reliable and accurate financial reports and effectively prevent fraud. We have devoted significant resources and time to comply with the internal control over financial reporting requirements of the Sarbanes-Oxley Act of 2002. In addition, Section 404 under the Sarbanes-Oxley Act of 2002 requires that we assess and our auditors attest to the effectiveness of our controls over financial reporting. Our current and future compliance with the annual internal control report requirement will depend on the effectiveness of our financial reporting and data systems and controls across our operating subsidiaries. We expect these systems and controls to become increasingly complex to the extent that we integrate acquisitions and our business grows. To effectively manage this growth, we will need to continue to improve our operational, financial and management controls and our reporting systems and procedures. We cannot be certain that these measures will ensure that we design, implement and maintain adequate controls over our financial processes and reporting in the future. Any failure to implement required new or improved controls, or difficulties encountered in their implementation or operation, could harm our operating results or cause us to fail to meet our financial reporting obligations. Inadequate internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our stock and our access to capital.

Accounting for employee stock options using the fair value method has significantly reduced and will likely continue to significantly reduce our net income.

We adopted the provisions of FASB ASC 718 on January 1, 2006. Thus, our consolidated financial statements reflect the fair value of stock options granted to employees as a compensation expense, which has had, and will in the future likely continue to have a significant adverse impact on our results of operations and net income per share. We rely heavily on stock options to compensate existing employees and to attract new employees. If we reduce or alter our use of stock-based compensation to minimize the recognition of these expenses, our ability to recruit, motivate and retain employees may be impaired, which could put us at a competitive disadvantage in the employee marketplace. In order to prevent any net decrease in their overall compensation packages, we may choose to make corresponding increases in the cash compensation or other incentives we pay to existing and new employees. Any increases in employee wages and salaries would diminish our cash available for marketing, product development and other uses and might cause our GAAP profits to decline. Any of these effects might cause the market price of our Class B common stock to decline.

Impairment of goodwill and other intangible assets would result in a decrease in earnings.

Current accounting rules require that goodwill and other intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually. These rules also require that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Events and circumstances considered in determining whether the carrying value of amortizable intangible assets and goodwill may not be recoverable include, but are not limited to: significant changes in performance relative to expected operating results; significant changes in the use of the assets; significant negative industry or economic trends; or a significant decline in our stock price and/or market capitalization for a sustained period of time. To the extent such evaluation indicates that the useful lives of intangible assets are different than originally estimated, the amortization period is reduced or extended and, accordingly, the quarterly amortization expense is increased or decreased. To the extent such evaluation indicates that the useful lives of intangible assets are different than originally estimated, the amortization period is reduced or extended and, accordingly, amortization expense is increased or decreased.

We recorded a substantial non-cash impairment charge for goodwill and intangible assets during the fourth quarter of 2008 as a result of the impact of the recent adverse economic environment including the deterioration in the equity and credit markets. We may be required to record future charge to earnings in our financial statements during the period in which any additional impairment of our goodwill or amortizable intangible assets is determined. Any impairment charges or changes to the estimated amortization periods could have a material adverse effect on our financial results.

We may not be able to realize the intended and anticipated benefits from our acquisitions of Internet domain names, which could affect the value of these acquisitions to our business and our ability to meet our financial obligations and targets.

We may not be able to realize the intended and anticipated benefits that we currently expect from our acquisitions of Internet domain names. These intended and anticipated benefits include increasing our cash flow from operations, broadening our distribution offerings and delivering services that strengthen our advertiser relationships.

Factors that could affect our ability to achieve these benefits include:

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Our revenue will also depend on the levels of traffic, calls and click-throughs that occur on our network of Web sites is able to achieve in any period. Traffic levels, calls and click-throughs will increase and decrease based upon a number of factors not entirely within our control, including the extent of indexing of our Web sites within search engines and directories, placement within search results and success of marketing efforts. Traffic levels, the number of calls and click-throughs may also be affected by service interruptions or other technical outages. Our ability to meet the traffic demands, calls and click-throughs of our network of Web sites is also dependent on a number of third party vendors and our technical teams to manage the operations effectively. Any downtime of our servers or other outages will negatively impact the revenue from our Publishing Network.

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We will need to continue to acquire commercially valuable Internet domain names to grow our presence in local online advertising. We will need to continuously improve our technologies to acquire valuable Internet domain names as competition in the marketplace for appropriate Internet domain names intensifies. Our domain name acquisition efforts are subject to rules and guidelines in the United States and in foreign countries established by registries which maintain Internet domain name registrations and the registrars which process and facilitate Internet domain name registrations. The registries and registrars may change the rules and guidelines for acquiring Internet domains or establish additional requirements for previously-owned Internet domain names or modify the requirements for holding Internet domain names. As a result, we might not acquire or maintain names that contribute to our financial results.

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Some of our existing distribution partners may perceive our Publishing Network as a competitive threat and therefore may decide to terminate their agreements with us.

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We intend to apply our technology and expertise to geography-specific Web sites that we believe are under-commercialized and not yet mature from a monetization perspective. However, if the current disparities in traffic and monetization of such search terms do not narrow in a favorable way, we may expend significant company resources on business efforts that do not realize the results we anticipate.

If the acquired assets are not integrated into our business as we anticipate, we may not be able to achieve these benefits or realize the value paid for our acquisitions of Internet domain names, which could materially harm our business, financial condition and results of operations.

We do not control the means by which users access our Web sites, and material changes to current navigation practices or technologies or marketing practices or significant increases in our marketing costs could result in a material adverse effect on our business.

The success of our Publishing Network depends in large part upon consumer access to our Web sites. Consumers access our Web sites primarily through the following methods: directly accessing our Web sites by typing descriptive keywords or keyword strings into the uniform resource locator (URL) address box of an Internet browser; accessing our Web sites by clicking on bookmarked Web sites; and accessing our Web sites through search engines and directories.

Each of these methods requires the use of a third party product or service, such as an Internet browser or search engine or directory. Internet browsers may provide alternatives to the URL address box to locate Web sites, and search engines may from time to time change and establish rules regarding the indexing and optimization of Web sites. We also market certain Web sites through search engines. Historically, we have limited our search engine marketing to less than five leading search engines.

Product developments and market practices for these means of access to our Web sites are not within our control. We may experience a decline in traffic to our Web sites if third party browser technologies or search engine methodologies and rules are changed to our disadvantage. We have experienced abrupt search engine algorithm and policy changes in the past. We expect the search engines we utilize to market and drive users to our Web sites to continue to periodically change their algorithms, policies and technologies. These changes may result in an interruption in users ability to access our Web sites or impair our ability to maintain and grow the number of users who visit our Web sites. We may also be forced to significantly increase marketing expenditures in the event that market prices for online advertising and paid-listings escalate. Any of these changes could have a material adverse effect on our business.

We may experience unforeseen liabilities in connection with our acquisitions of Internet domain names or arising out of third party domain names included in our distribution network, which could negatively impact our financial results.

The Name Development, Pike Street and AreaConnect asset acquisitions involved the acquisition of a large number of previously-owned Internet domain names. Furthermore, we have separately acquired and intend to continue to acquire in the future additional previously-owned Internet domain names. In some cases, these acquired names may have trademark significance that is not readily apparent to us or is not identified by us in the bulk purchasing process. As a result we may face demands by third party trademark owners asserting infringement or dilution of their rights and seeking transfer of acquired Internet domain names under the Uniform Domain Name Dispute Resolution Policy administered by ICANN or actions under the U.S. Anti-Cybersquatting Consumer

Protection Act. Additionally, we display paid listings on third party domain names and third party Web sites that are part of our distribution network, which also could subject us to a wide variety of civil claims including intellectual property ownership and infringement.

We intend to review each claim or demand which may arise from time to time on its merits on a case-by-case basis with the assistance of counsel and we intend to transfer any rights acquired by us to any party that has demonstrated a valid prior right or claim. We cannot, however, guarantee that we will be able to resolve these disputes without litigation. The potential violation of third party intellectual property rights and potential causes of action under consumer protection laws may subject us to unforeseen liabilities including injunctions and judgments for money damages.

Risks Relating to Our Business and Our Industry

If we are unable to compete in the highly competitive performance-based advertising and search marketing industries, we may experience reduced demand for our products and services.

We operate in a highly competitive and changing environment. We principally compete with other companies which offer services in the following areas:

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sales to advertisers of pay-per-click services;

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sales to advertisers of pay-for-call services;

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aggregation or optimization of online advertising for distribution through search engines, product shopping engines, directories, Web sites or other outlets;

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provision of local and vertical Web sites containing information and user feedback designed to attract users and help consumers make better, more informed local decisions, while providing targeted advertising inventory for advertisers;

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delivery of online advertising to end users or customers of advertisers through destination Web sites or other distribution outlets;

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delivery of pay-for-call advertising to end users or customers of advertisers through destination Web sites or other distribution outlets;

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local search sales training;

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services and outsourcing of technologies that allow advertisers to manage their advertising campaigns across multiple networks and track the success of these campaigns;

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third party domain monetization; and

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sales to advertisers of call tracking and call analytics services.

Although we currently pursue a strategy that allows us to potentially partner with all relevant companies in the industry, there are certain companies in the industry that may not wish to partner with us. Despite the fact that we currently work with several of our potential competitors, there are no guarantees that these companies will continue to work with us in the future.

We currently or potentially compete with a variety of companies, including Google, IAC/InterActiveCorp, Microsoft, Yahoo!, WebVisible and ReachLocal. Many of these actual or perceived competitors also currently or may in the future have business relationships with us, particularly in distribution. However, such companies may terminate their relationships with us. Furthermore, our competitors may be able to secure agreements with us on more favorable terms, which could reduce the usage of our services, increase the amount payable to our distribution partners, reduce total revenue and thereby have a material adverse effect on our business, operating results and financial condition.

We expect competition to intensify in the future because current and new competitors can enter our market with little difficulty. The barriers to entering our market are relatively low. In fact, many current Internet and media companies presently have the technical capabilities and advertiser bases to enter the search marketing services industry. Further, if the consolidation trend continues among the larger media and search engine companies with greater brand recognition, the share of the market remaining for smaller search marketing services providers could decrease, even though the number of smaller providers could continue to increase. These factors could adversely affect our competitive position in the search marketing services industry.

Some of our competitors, as well as potential entrants into our market, may be better positioned to succeed in this market. They may have:

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longer operating histories;

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more management experience;

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an employee base with more extensive experience;

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better geographic coverage;

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larger customer bases;

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greater brand recognition; and

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significantly greater financial, marketing and other resources.

Currently, and in the future, as the use of the Internet and other online services increases, there will likely be larger, more well-established and well-financed entities that acquire companies and/or invest in or form joint ventures in categories or countries of interest to us, all of which could adversely impact our business. Any of these trends could increase competition and reduce the demand for any of our services.

We face competition from traditional media companies, and we may not be included in the advertising budgets of large advertisers, which could harm our operating results.

In addition to Internet companies, we face competition from companies that offer traditional media advertising opportunities. Most large advertisers have set advertising budgets, a very small portion of which is allocated to Internet advertising. We expect that large advertisers will continue to focus most of their advertising efforts on traditional media. If we fail to convince these companies to spend a portion of their advertising budgets with us, or if our existing advertisers reduce the amount they spend on our programs, our operating results would be harmed.

If we are not able to respond to the rapid technological change characteristic of our industry, our products and services may cease to be competitive.

The market for our products and services is characterized by rapid change in business models and technological infrastructure, and we will need to constantly adapt to changing markets and technologies to provide new and competitive products and services. If we are unable to ensure that our users, advertisers, and distribution partners have a high-quality experience with our products and services, then they may become dissatisfied and move to competitors’ products and services. Accordingly, our future success will depend, in part, upon our ability to develop and offer competitive products and services for both our target market and for applications in new markets. We may not, however, be able to successfully do so, and our competitors may develop innovations that render our products and services obsolete or uncompetitive.

Our technical systems are vulnerable to interruption and damage that may be costly and time-consuming to resolve and may harm our business and reputation.

A disaster could interrupt our services for an indeterminate length of time and severely damage our business, prospects, financial condition and results of operations. Our systems and operations are vulnerable to damage or interruption from:

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fire;

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floods;

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network failure;

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hardware failure;

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software failure;

•

power loss;

•

telecommunications failures;

•

break-ins;

•

terrorism, war or sabotage;

•

computer viruses;

•

denial of service attacks;

•

penetration of our network by unauthorized computer users and “hackers” and other similar events;

•

natural disaster; and

•


Period	Total number of shares purchased		Average price paid per share		Total number of shares purchased as part of publicly announced plans or programs		Maximum number of shares (or approximate dollar value) that may yet be purchased under the plans or programs (1)
July 1, 2010 – July 31, 2010		168,068	$	4.16		168,068		1,385,356
August 1, 2010 – August 31, 2010		28,234	$	4.82		28,234		1,357,122
September 1, 2010 – September 30, 2010 (2)		116,142	$	3.40		86,142		1,270,980

Total Class B Common Shares		312,444	$	3.94		282,444		1,270,980


†31(i)		Certification of CEO pursuant to Rule 13a-14(a)/15d-14(a).

†31(ii)		Certification of CFO pursuant to Rule 13a-14(a)/15d-14(a).

††32.1		Certification of CEO pursuant to Section 1350.

††32.2		Certification of CFO pursuant to Section 1350.


MARCHEX, INC.

By:		/S/ MICHAEL A. ARENDS
Name:		Michael A. Arends
Title:		Chief Financial Officer (Principal Accounting Officer)