Inphonic 10Q 2006 Q3 Quarterly report

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 AND EXCHANGE ACT OF 1934

For the quarter ended September 30, 2006

¨	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 000-51023

INPHONIC, INC.

(Exact name of Registrant as specified in its Charter)


Delaware		52-2199384
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer identification no.)

1010 Wisconsin Avenue, Suite 600, Washington, DC		20007
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (202) 333-0001

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x. No ¨.

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


Large accelerated filer ¨		Accelerated filer x		Non-accelerated filer ¨

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

The registrant had 36,633,309 shares of common stock outstanding as of November 1, 2006.

INPHONIC, INC.

INDEX

FORM 10-Q


		Page
PART I.—FINANCIAL INFORMATION

Item 1.	Financial Statements	3

	Unaudited Condensed Consolidated Balance Sheets at December 31, 2005 and September 30, 2006	3

	Unaudited Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2005 and September 30, 2006	4

	Unaudited Condensed Consolidated Statements of Stockholders’ Equity for the Nine Months Ended September 30, 2006	5

	Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2005 and September 30, 2006	6

	Notes to Unaudited Condensed Consolidated Financial Statements	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	33

Item 4.	Controls and Procedures	33

PART II.—OTHER INFORMATION

Item 1.	Legal Proceedings	34

Item 1A.	Risk Factors	35

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	46

Item 3.	Defaults Upon Senior Securities	46

Item 4.	Submission of Matters to a Vote of Security Holders	46

Item 5.	Other Information	46

Item 6.	Exhibits	46

SIGNATURES		47

PART I

ITEM 1. FINANCIAL STATEMENTS

INPHONIC, INC.

Condensed Consolidated Balance Sheets

(in thousands, except per share and share amounts)


	December 31, 2005			September 30, 2006
				(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	70,783		$	57,537
Accounts receivable, net of allowance for doubtful accounts of $2,042 and $2,520, respectively		34,606			56,545
Inventory, net		19,680			18,160
Prepaid expenses		2,405			6,650
Deferred costs and other current assets		6,823			2,220
Current assets of discontinued operations		2,430			392

Total current assets		136,727			141,504
Restricted cash and cash equivalents		400			—
Property and equipment, net		12,121			19,439
Goodwill		31,140			36,634
Intangible assets, net		12,651			9,660
Deposits and other assets		3,058			8,721

Total assets	$	196,097		$	215,958

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	31,543		$	58,071
Accrued expenses and other liabilities		31,588			19,438
Current portion of deferred revenue		13,851			10,169
Current liabilities of discontinued operations		3,130			1,178
Current maturities of capital leases		377			350

Total current liabilities		80,489			89,206
Long term debt and capital lease obligations, net of current maturities		15,474			20,258
Deferred revenue, net of current portion		284			553

Total liabilities		96,247			110,017

Stockholders’ equity:
Common stock, $0.01 par value
Authorized 200,000,000 shares at December 31, 2005 and September 30, 2006; issued and outstanding 35,232,869 and 36,564,298 shares at December 31, 2005 and September 30, 2006, respectively		353			366
Additional paid-in capital		264,155			284,244
Accumulated deficit		(164,658	)		(178,669	)

Total stockholders’ equity		99,850			105,941

Total liabilities and stockholders’ equity	$	196,097		$	215,958

See accompanying notes to unaudited condensed consolidated financial statements

INPHONIC, INC.

Unaudited Condensed Consolidated Statements of Operations

(in thousands, except per share and share amounts)


	Three Months Ended September 30,						Nine Months Ended September 30,
	2005			2006			2005			2006

Revenue:
Activations and services	$	65,405		$	85,171		$	170,608		$	230,196
Equipment		26,555			17,013			64,729			55,161

Total revenue		91,960			102,184			235,337			285,357
Cost of revenue, exclusive of depreciation and amortization:
Activations and services		(564	)		551			895			1,876
Equipment		54,317			52,770			134,985			150,574

Total cost of revenue		53,753			53,321			135,880			152,450
Operating expenses:
Sales and marketing, exclusive of depreciation and amortization		24,274			29,480			61,599			83,610
General and administrative, exclusive of depreciation and amortization		15,750			19,685			44,326			49,824
Depreciation and amortization		2,460			4,543			6,379			11,986
Restructuring costs		453			209			848			2,115
Investment write-off		—			—			228			—

Total operating expenses		42,937			53,917			113,380			147,535

Operating loss		(4,730	)		(5,054	)		(13,923	)		(14,628	)

Other income (expense):
Interest income		549			442			1,576			1,616
Interest expense		(185	)		(276	)		(599	)		(900	)

Total other income		364			166			977			716

Loss from continuing operations		(4,366	)		(4,888	)		(12,946	)		(13,912	)
Discontinued operations:
Income (loss) from discontinued operations		(587	)		72			(653	)		(99	)

Net loss	$	(4,953	)	$	(4,816	)	$	(13,599	)	$	(14,011	)

Basic and diluted net loss per share:
Net loss from continuing operations	$	(0.12	)	$	(0.13	)	$	(0.38	)	$	(0.39	)
Net income (loss) from discontinued operations		(0.02	)		0.00			(0.02	)		(0.00	)

Basic and diluted net loss per share	$	(0.14	)	$	(0.13	)	$	(0.40	)	$	(0.39	)

Basic and diluted weighted average shares outstanding		35,515,210			36,304,160			34,099,325			35,836,331

See accompanying notes to unaudited condensed consolidated financial statements

INPHONIC, INC.

Unaudited Condensed Consolidated Statements of Stockholders’ Equity

(in thousands, except share amounts)


	Common Stock					Additional Paid-in Capital			Accumulated Deficit			Total
	Shares		Amount			Additional Paid-in Capital			Accumulated Deficit			Total
Balance, December 31, 2005	35,232,869		$	353		$	264,155		$	(164,658	)	$	99,850
Stock-based compensation expense	—			—			10,944			—			10,944
Issuance of common stock in connection with the acquisition earnouts of:
A1 Wireless, Inc.	15,408			—			235			—			235
VMC Satellite, Inc.	697,045			7			4,939			—			4,946
Issuance of common stock warrant	—			—			3,228			—			3,228
Repurchase and retirement of common stock	(62,761	)		(1	)		(502	)		—			(503	)
Exercise of common stock options, restricted stock awards and other	681,737			7			1,245			—			1,252
Net loss	—			—			—			(14,011	)		(14,011	)

Balance, September 30, 2006	36,564,298		$	366		$	284,244		$	(178,669	)	$	105,941

See accompanying notes to unaudited condensed consolidated financial statements

INPHONIC, INC.

Unaudited Condensed Consolidated Statements of Cash Flows

(in thousands)


	Nine Months Ended September 30,
	2005			2006
Cash flows from operating activities:
Net loss	$	(13,599	)	$	(14,011	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization		6,379			11,986
Non-cash sales and marketing expense related to common stock warrant		—			296
Non-cash interest expense, net		486			—
Stock-based compensation		13,721			10,088
Non-cash write-off of investment		228			—
Changes in operating assets and liabilities, net of assets and liabilities received from business acquisitions:
Accounts receivable		(23,621	)		(21,594	)
Inventory		(23,201	)		3,843
Prepaid expenses		(1,267	)		(5,723	)
Deferred costs and other assets		(1,060	)		4,607
Deposits and other assets		(1,357	)		(2,153	)
Accounts payable		17,144			25,598
Accrued expenses and other liabilities		5,538			(9,856	)
Deferred revenue		5,028			(3,413	)

Net cash used in operating activities		(15,581	)		(332	)
Cash flows from investing activities:
Capitalized expenditures, including internal capitalized labor		(8,745	)		(15,525	)
Cash paid for acquisitions		(8,670	)		(3,989	)
Cash paid for intangible assets		(2,532	)		(193	)
Purchase of short-term investments		(5,005	)		(5,000	)
Proceeds from the maturity of short-term investments		—			5,000
Proceeds from the sale of assets of discontinued operations		—			1,111
Reduction in restricted cash and cash equivalents		—			400

Net cash used in investing activities		(24,952	)		(18,196	)
Cash flows from financing activities:
Principal repayments on debt		(215	)		(1,751	)
Borrowings on line of credit		15,000			—
Trade borrowings on line of credit		—			6,355
Cash paid for repurchase of common stock		(3,090	)		(503	)
Proceeds from exercise of warrants and options		9,669			1,181
Net costs of initial public offering		(291	)		—

Net cash provided by financing activities		21,073			5,282

Net decrease in cash and cash equivalents		(19,460	)		(13,246	)
Cash and cash equivalents, beginning of the period		100,986			70,783

Cash and cash equivalents, end of the period	$	81,526		$	57,537

Supplemental disclosure of cash flows information:
Cash paid during the period for:
Interest	$	107		$	774
Supplemental disclosure of non-cash activities:
Release of funds in escrow related to acquisitions		10,700			—
Issuance of common stock in business acquisitions		8,209			5,181
Issuance of warrant to purchase common stock to vendor		—			3,228
Purchase consideration in accrued liabilities		3,000			224
Inventory issued for advertising credits		—			2,323
Issuance of common stock in intangible asset purchase		1,549			—
Stock-based compensation capitalized as internal labor		—			443
Equipment purchased on capital lease		366			152

See accompanying notes to unaudited condensed consolidated financial statements

INPHONIC, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share and share amounts)

(1) The Company and Basis of Presentation

(a) Preparation of Interim Financial Statements

We have prepared the accompanying condensed consolidated financial statements pursuant to the rules and regulations of the U.S Securities and Exchange Commission (the “SEC”) for interim financial reporting. The financial information included herein, other than the consolidated balance sheet as of December 31, 2005, has been prepared without audit. The consolidated balance sheet at December 31, 2005 has been derived from, but does not include all the disclosures contained in the audited financial statements for the year ended December 31, 2005. The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of certain assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reported period. In the opinion of management, these unaudited statements include all the adjustments and accruals necessary for a fair presentation of the results of the periods presented herein. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2005. The results of operations for the interim periods presented are not necessarily indicative of the results that may be expected for a full year. Certain prior year amounts have been reclassified to conform to the current period presentation.

The accompanying financial statements for the three month period ended September 30, 2005 include adjustments to reduce depreciation and amortization expense by $733. These adjustments to depreciation were made to correct a computational error in the fixed asset subledger that caused depreciation expense to be overstated in each prior period between fiscal years 2001 and 2004 and for the six months ended June 30, 2005. We do not believe the impact of the adjustments to be material to the three month or nine month periods ended September 30, 2005 or any other prior period.

(b) Business

We are a leading online seller of wireless services and devices based on the number of activations of wireless services sold online in the United States. We sell wireless service plans and devices, including satellite television services through our own branded websites; including Wirefly.com, A1 Wireless.com, and VMCsatellite.com and through websites that we create and manage for third parties. We offer marketers the ability to sell wireless voice and data services and devices under mobile virtual network enabler (“MVNE”) agreements. This service utilizes the same e-commerce platform, operational infrastructure and marketing relationships that we use in our operations. We provide customers the ability to organize personal communication by providing real time wireless access to e-mail, voicemail, faxes, contacts, scheduling, calendar and conference calling functionality through a website or telephone.

(c) Risks and Uncertainties

Our operations are subject to certain risks and uncertainties including, among others, actual and potential competition by entities with greater financial resources, rapid technological changes, the need to retain key personnel and protect intellectual property and the availability of additional capital financing on terms acceptable to us.

Since inception we have incurred net losses attributable to common stockholders of approximately $178,669. To date, management has relied on debt and equity financings to fund our operating deficit. While we currently have $57,537 of cash and cash equivalents on hand as of September 30, 2006, we may require additional financing to fund future operations.

INPHONIC, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share and share amounts)

(d) Acquisitions and Discontinued Operations

We acquired certain assets and assumed certain liabilities of A1 Wireless USA, Inc. (“A1 Wireless”); VMC Satellite, Inc. (“VMC”); and FONcentral.com, Inc. (“FC”). We accounted for these transactions using the purchase method of accounting in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141,Business Combinations. Accordingly our results of operations include the operating results of A1 Wireless effective January 1, 2005, VMC as of April 26, 2005 and FC as of May 26, 2005, their respective acquisition dates.

On December 31, 2005, we completed the sale of substantially all of the operating assets of our mobile virtual network operator (“MVNO”) Liberty Wireless (“Liberty”) to Teleplus Wireless Corp, a subsidiary of Teleplus Enterprises, Inc. The sale of Liberty has enabled us to streamline and focus our resources on our other operations including the growth of our MVNE business. The sale of Liberty was recorded as a discontinued operation in the financial statements pursuant to SFAS No. 144,Accounting for Impairment or Disposal of Long Lived Assets.Cash flows pertaining to discontinued operations are not disclosed separately in the Unaudited Condensed Consolidated Statements of Cash Flows.

(2) Summary of Significant Accounting Policies

(a) Revenue Recognition

Activations and Services Revenue

We recognize revenue from the sale of wireless services and the provisioning of MVNE and data services.

Wireless Services:We generate revenue from wireless carriers, including a satellite television carrier, who pay commissions and volume and performance-based bonuses, for activating wireless services and features on their networks. We recognize commissions from wireless carriers upon shipment of activated devices to the customer. In addition to activation commissions, certain carriers pay us a monthly residual fee either for as long as a customer who we activate for that carrier continues to be its subscriber, or for a fixed period of time depending on the carrier. We purchase satellite activation certificates evidencing activation rights in advance of their resale to customers. Revenue from satellite television customers includes sales of these satellite activation certificates, net of the certificate cost, as we are acting as an agent in the transaction. Our wireless revenue is reduced for estimated deactivations of customers prior to the expiration of a time period that ranges 90 to 180 days from the date of activation, depending on the wireless carrier. We estimate deactivations based on historical experience, which we developed based on our experience with carriers, customer behavior and sources of customers, among other factors, allowing us to accrue estimates with what we believe is a high degree of certainty. If we determine that we cannot accurately predict future deactivation experience, we may be required to defer 100% of our carrier commissions revenue until the expiration of the appropriate chargeback period. Our reserves for deactivations are included in accounts receivable and deferred revenue on the accompanying balance sheets.

INPHONIC, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share and share amounts)

recognize these monthly bonuses as earned in accordance with the provisions of Staff Accounting Bulletin (“SAB”) No. 104,Revenue Recognition in Financial Statements. Revenue is recognized only when all of the following criteria are met: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred or services have been rendered, (3) the seller’s price to the buyer is fixed or determinable, and (4) collectibility is reasonably assured. Amounts collected in cash prior to meeting the above criteria are recorded as deferred revenue. Through 2005, commission revenue earned from the activation of carrier features had been deferred until the contractual chargeback period had lapsed. Beginning in 2006, we began to estimate commission revenue earned from feature activations based on historical experience which we have developed based on our experience with carriers and customer behavior over a period of time in excess of 24 months.

MVNE Services:We offer marketers the ability to sell wireless services to their customers under their own brands using our e-commerce platform and operational infrastructure through MVNE contracts. We receive fees for the development of the network platform, for custom functional enhancements to the network platform, and for operational support services. We defer the fees attributable to the production of the network platform and recognize these fees and costs over the expected life of the agreement (typically 12 to 48 months). Fees received for custom functional enhancements to the network platform and for operational services are deferred until all revenue criteria have been satisfied. Deferred revenue from MVNE contracts as of December 31, 2005 and September 30, 2006 was $1,852 and $1,590, respectively.

Data Services:We sell data services, including a service that allows customers to access email, voicemail, facsimiles, contacts and personal calendar information through a website or a telephone; wireless email; and mobile marketing services. We bill customers and recognize revenue monthly, as the services are performed.

Equipment Revenue

Revenue from the sale of wireless devices and accessories in a multiple-element arrangement with services are recognized at the time of sale in accordance withEmerging Issues Task ForceEITF No. 00-21,Revenue Arrangements with Multiple Deliverables, when fair value of the services element exists. Customers have the right to return devices within a specific period of time or usage, whichever occurs first. We provide an allowance for estimated returns of devices based on historical experience. In accordance with the provisions of SAB No. 104, we determined we have sufficient operating history to estimate equipment returns. In connection with wireless activations, we sell customers wireless devices at a significant discount, which is generally in the form of a rebate. Rebates are recorded as a reduction of revenue. We recognize equipment revenue, less a reserve for customer rebates, which is based on historical experience of rebates claimed. Future experience could vary based upon rates of consumers redeeming rebates.

(b) Concentrations of Credit Risk

Financial instruments that potentially subject us to a concentration of credit risk consist principally of accounts receivable. We extend credit to wireless network carriers (“Carriers”) on an unsecured basis in the normal course of business. Three Carriers accounted for 67% and 70% of accounts receivable, net of the deactivation reserve, as of December 31, 2005 and September 30, 2006, respectively.

INPHONIC, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share and share amounts)

For the three and nine months ended September 30, 2005 and 2006, revenue from three Carriers exceeded 10% of our total revenue. Revenue as a percentage of total revenue for these Carriers was as follows:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2005		2006		2005		2006
Carrier A	32	%	37	%	29	%	36	%
Carrier B	13	%	18	%	16	%	17	%
Carrier C	17	%	15	%	21	%	15	%

Total	62	%	70	%	66	%	68	%

(c) Accrued Expenses and Other Liabilities

Accrued expenses and other liabilities at December 31, 2005 and September 30, 2006 consisted of:


	As of
	December 31, 2005		September 30, 2006
Accrued consumer liabilities	$	18,289	$	10,153
Accrued payroll and related expenses		1,452		1,479
Accrued acquisition costs and severance costs		5,063		591
Accrued taxes payable		593		386
Other		6,191		6,829

	$	31,588	$	19,438

(d) Restructuring Costs

We implemented a restructuring plan following the acquisition of A1 Wireless, to take advantage of synergies gained through the acquisition and to restructure our operations for efficiency purposes. For the three months ended September 30, 2005, we recognized $453 in restructuring costs, all of which related to workforce reduction. During the nine months ended September 30, 2005, we recognized $848 in restructuring costs, of which $812 related to workforce reduction and the remaining $36 to excess facilities. All costs related to this plan were paid out in 2005.

During 2006, we implemented a restructuring plan related to changes in our management and operational structure. For the nine months ended September 30, 2006, we recognized $2,115 related to the termination of our former president and chief operating officer and thirteen other senior executives and employees. Of this amount, $594 related to severance benefits that will be paid out in cash to the recipients on a monthly or semi-monthly basis over the terms of their respective severance agreements, $1,312 related to severance expenses incurred as a result of the modification of stock-based compensation awards under which vesting of 50% of unvested restricted share and option awards was accelerated for three of the former employees, and $209 related to other costs primarily due to relocation expenses for certain key employees. At September 30, 2006, we had an accrued liability recorded of $367 of which approximately $222 will be paid out in cash by December 31, 2006.

INPHONIC, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share and share amounts)

(e) Loss on investment

During the nine months ended September 30, 2005, we sold all data service software acquired from Avesair Inc. in May 2003, to a third party vendor and wrote off related capitalized labor, intangible assets, goodwill and other costs related to this asset. As a result of this transaction, we recognized a loss of $228 during the period.

(f) Stock-Based Compensation

We adopted Statement of Financial Accounting Standards “SFAS” No. 123 (revised 2004),Share Based Payment (SFAS No. 123(R)) on January 1, 2006 using the modified prospective application method (“MPA”). SFAS No. 123(R) established standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. SFAS No. 123(R) requires us to measure the cost of employee services received in exchange for an award of equity instruments (usually stock options or unvested (restricted) stock awards based on the grant-date fair value of the award. That cost is recognized over the period during which an employee is required to provide service in exchange for the award—the requisite service period (usually the vesting period). In March 2005, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 107 (“SAB 107”) relating to the interaction of the adoption of SFAS No. 123(R) and the SEC rules and regulations. We have applied the provisions of SAB 107 in our adoption of SFAS 123(R).

Prior to our adoption of SFAS No. 123(R), we applied the intrinsic value method of accounting for employee stock-based compensation as prescribed by Accounting Principles Board (“APB”) Opinion No. 25,Accounting for Stock Issued to Employees, and related interpretations including FASB Interpretation (“FIN”) No. 44,Accounting for Certain Transactions involving Stock Compensation an Interpretation of APB Opinion No. 25, to account for our stock option grants to employees. Under this method, compensation expense was recorded on the date of the grant only if the current market price of the underlying stock exceeded the exercise price. SFAS No. 123,Accounting for Stock-Based Compensation(“SFAS No. 123”), established accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans. As permitted by SFAS No. 123, we had elected to continue to apply the intrinsic value-based method of accounting described above, and had adopted the disclosure requirements of SFAS No. 123. All shares of restricted stock awarded to employees were accounted for at fair value in accordance with SFAS No. 123.

Under the MPA method, compensation cost for all share-based payments granted prior to, but not vested as of December 31, 2005, is based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS No. 123, and compensation cost for all share based payments granted subsequent to December 31, 2005, will be based on the grant date fair value estimated in accordance with the provisions of SFAS No.123(R). Results for prior periods have not been restated. We use the ratable method of attributing the value of stock-based compensation to expense. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. In our pro forma information required under SFAS No. 123 for the periods prior to January 1, 2006, we accounted for forfeitures as they occurred. The fair value of each option granted is estimated on the grant date using the Black-Scholes option pricing model which takes into account as of the grant date the exercise price and expected life of the option, the current price of the underlying stock and its expected volatility, expected dividends on the stock and the risk-free interest rate for the term of the option.

Stock Options—We have two stock plans under which we have issued or may issue options to purchase shares of our common stock. The 1999 Stock Incentive Plan (the “1999 Plan”), provided for grants of stock-based awards from time to time to employees, officers, directors and consultants of the Company at exercise prices determined by the board of directors. Options granted under the 1999 Plan generally vest over a four-year

INPHONIC, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share and share amounts)

period and expire ten years from the grant date. As of November 19, 2004, no additional options were available for grant under the 1999 Plan due to the adoption of the 2004 Equity Incentive Plan (the “2004 Plan”).

The 2004 Plan allows for grants of stock-based awards from time to time to employees, officers, directors and consultants at exercise prices determined by the board of directors. For incentive stock options, the exercise price must be at least equal to fair market value at the date of grant. For nonqualified stock options, the option may be granted with an exercise price less than fair market value. Options granted under the 2004 Plan vest over a period to be determined by the administrator, generally four years, and expire ten years from the grant date.

For the three and nine months ended September 30, 2006 as a result of our adoption of SFAS No. 123(R), we recognized stock-based compensation expense related to employee options granted prior to January 1, 2006 of $1,394 and $4,770, of which $24 and $260, respectively, was capitalized in accordance with our compensation policies and SFAS No. 123(R).

In addition on March 22 and June 13, 2006, we granted options to certain of our employees to purchase 679,900 and 207,000 shares of our common stock, respectively. The options granted on March 22 and June 13, 2006 were granted at an exercise price of $6.46 and $6.51 per share, respectively. The grant date fair value of employee share options was estimated using the Black-Scholes option-pricing model with the following assumptions: an expected life averaging 5.77 years; an average volatility of 72%; no dividend yield; and a risk-free interest rate averaging 4.75%. The weighted average fair value per share of options granted was $4.29. Compensation cost of the grant was reduced by an estimated forfeiture amount based on an annual experience rate of 9.93%. As of the date of grants, total compensation cost related to the grants including estimated forfeitures was approximately $2,324 and $715 for the March 22, and June 13, 2006 grants, respectively. Stock-based compensation expense for these grants for the three and nine months ended September 30, 2006 was $101 and $227 respectively.

The impact of adopting SFAS No. 123(R) increased stock-based compensation expense included in our operating expenses and increased net loss from continuing operations by approximately $718 and $1,715 for the three and nine months ended September 30, 2006 respectively or $0.02 and $0.05 per basic and diluted share. There was no impact from the adoption on cash flow from operations or cash flows from financing activities.

The following table summarizes the activity for stock options granted to employees and non-employees for the nine months ended September 30, 2006.


	Number of options		Weighted average exercise price		Weighted average contractual term (years)	Aggregate intrinsic value
Balance January 1, 2006	5,115,969		$	9.47
Granted	886,900			6.47
Exercised	(257,599	)		4.95
Forfeited	(813,324	)		11.88

Balance September 30, 2006	4,931,946		$	8.77	7.66	$	7,230

Ending vested & expected to vest	4,681,171		$	8.74	7.60	$	6,924

Exercisable at September 30, 2006	2,849,165		$	8.40	6.97	$	4,428

INPHONIC, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share and share amounts)

The weighted-average grant date fair value of options granted during the nine months ended September 30, 2006 was $4.29. The total intrinsic value of options exercised during the nine months ended September 30, 2006 was $663.

Restricted Common Stock—During the nine months ended September 30, 2006, we granted 1,205,127 shares of restricted common stock to certain of our key employees. The restrictions on this common stock lapse and the stock vests over periods ranging up to four years from the grant date. The following table summarizes the activity for restricted stock for the nine months ended September 30, 2006.


	Number of Restricted Stock Awards		Weighted-average grant date fair value
Non-vested at January 1, 2006	1,137,878		$	15.58
Granted	1,205,127			6.61
Vested	(443,432	)		14.65
Surrendered for taxes	(37,768	)		15.83
Forfeited	(170,979	)		15.10

Non-vested at September 30, 2006	1,690,826		$	9.47

As of September 30, 2006, there was approximately $12,566 of total unrecognized compensation cost related to restricted share-based compensation arrangements. That cost is expected to be recognized over a weighted-average period of 1.54 years. The total fair value of shares vested during the nine months ended September 30, 2006 was approximately $6,495.

Stock Purchase Warrants—In April 2006, we issued a warrant to purchase 566,324 shares of our common stock at an exercise price of $7.35 per share. The estimated fair value of the warrant granted was determined using the Black-Scholes Model. The weighted average grant date fair value per share of this warrant was $5.70. The following table summarizes warrant activity for the nine months ended September 30, 2006:


	Number of warrants		Weighted average exercise price		Range of exercise
Balance January 1, 2006	787,863		$	8.44	$0.03 - 24.00
Granted	566,324			7.35	7.35
Exercised	(17,270	)		0.28	0.03 - 2.49
Surrendered for cashless exercise	(627	)		2.25	0.03 - 2.49
Forfeited	(3,334	)		24.00	24.00

Balance at September 30, 2006	1,332,956		$	8.04	$0.03 - 15.60

In April 2006, we issued an additional warrant to purchase 188,775 shares of our common stock to a vendor that is exercisable upon certain performance conditions. The exercise price of the warrant will be based on the trading price of our common stock at the time the performance conditions are met by the vendor. Once it is probable that the vendor will achieve the performance conditions set forth under the terms of the warrant, the fair value of the warrant will be amortized to sales and marketing expense over the remaining contractual term of the vendor commitment.

Warrants outstanding at September 30, 2006 were exercisable for 1,332,956 shares of our common stock, excluding this contingent warrant.

INPHONIC, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share and share amounts)

Our pro forma net loss per common share, basic and diluted, for the three and nine months ended September 30, 2005 was as follows:


	Three Months Ended September 30, 2005			Nine Months Ended September 30, 2005
Net loss as reported	$	(4,953	)	$	(13,599	)
Add: Stock-based employee compensation expense included in net loss as reported, net of related tax effects		3,874			13,046
Less: Total stock-based employee compensation determined under fair value based methods for all stock award, net of related tax effects		(4,615	)		(9,786	)

Pro forma net loss	$	(5,694	)	$	(10,339	)

Net loss per common share, basic and diluted, as reported	$	(0.14	)	$	(0.40	)
Net loss per common share, basic and diluted, pro forma	$	(0.16	)	$	(0.30	)
Basic and diluted weighted average common shares outstanding		35,515,210			34,099,325

Stock-based compensation which includes compensation recognized on stock option grants and restricted stock awards has been included in the following line items in the accompanying condensed consolidated financial statements. There was no tax benefit recognized in the statements of operations for stock-based awards in either period:


	As of
Balance Sheet:	December 31, 2005		September 30, 2006

Property and equipment, net	$	—	$	404


	Three Months Ended September 30,				Nine Months Ended September 30,
Statement of operations:	2005		2006		2005		2006
Sales and marketing	$	709	$	674	$	1,761	$	2,212
General and administrative		3,148		2,304		11,703		6,564
Restructuring costs		—		—		—		1,312
Net income (loss) from discontinued operations		69		—		258		—

	$	3,926	$	2,978	$	13,722	$	10,088

During the nine months ended September 30, 2006, we modified the stock-based awards of 5 employees which accelerated the vesting of 81,035 shares of restricted stock and options underlying 122,258 shares of our common stock. As a result of the expedited vesting, we accelerated expense recognition of the compensation cost associated with the newly vested shares. Accordingly, stock-based compensation expense includes $1,312 from these actions. Incremental compensation cost arising from the modifications to the vesting terms of the awards was not significant.

(g) Net Loss per Share

We calculate net loss per share in accordance with SFAS No. 128,Earnings Per Share. Basic net loss per common share excludes any dilutive effects of options, warrants, restricted stock and convertible securities and is calculated by dividing net loss attributable to common stockholders by the weighted average number of common

INPHONIC, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share and share amounts)

shares issuable and outstanding for the period. Diluted net loss per common share equals basic net loss per common share, as the effects of options, warrants, restricted stock and convertible securities are anti-dilutive.

The following table reconciles net loss and basic and diluted weighted average common shares outstanding to the historical or pro forma net loss and the pro forma basic and diluted weighted average common shares outstanding for the three and nine months ended September 30, 2005 and 2006.


	Three Months Ended September 30,						Nine Months Ended September 30,
	2005			2006			2005			2006
Net loss from continuing operations	$	(4,366	)	$	(4,888	)	$	(12,946	)	$	(13,912	)
Net income (loss) from discontinued operations		(587	)		72			(653	)		(99	)

Net loss	$	(4,953	)	$	(4,816	)	$	(13,599	)	$	(14,011	)

Weighted average shares outstanding
Basic and diluted earnings per share:		35,515,210			36,304,160			34,099,325			35,836,331
Net loss from continuing operations	$	(0.12	)	$	(0.13	)	$	(0.38	)	$	(0.39	)
Net income (loss) from discontinued operations		(0.02	)		0.00			(0.02	)		(0.00	)

Basic and diluted earnings per share	$	(0.14	)	$	(0.13	)	$	(0.40	)	$	(0.39	)

During the three and nine months ended September 30, 2006 and 2005, we incurred a net loss. If our outstanding common stock equivalents were exercised or converted into common stock, the result would have been anti-dilutive and, accordingly, basic and diluted net loss attributable to common stockholders per share are identical for all periods presented in the accompanying condensed consolidated statements of operations. The following summarizes our potential outstanding common stock equivalents as of the end of each period:


	September 30,
	2005	2006
Options to purchase common stock	5,502,930	4,931,946
Restricted stock awards	1,021,266	1,690,826
Warrants to purchase common stock	897,647	1,521,731
Shares awarded in connection with the VMC acquisition	210,379	—

Total common stock equivalents convertible into common stock	7,632,222	8,144,503

(3) Discontinued Operations

On December 31, 2005, we completed the sale of substantially all of the operating assets of our Liberty Wireless business. During the nine months ended September 30, 2006 we collected $1,111 of notes receivable recorded at December 31, 2005 related to the divestiture. Summary operating results for discontinued operations was as follows:


	Three Months Ended September 30,					Nine Months Ended September 30,
	2005			2006		2005			2006
Revenue	$	4,777		$	—	$	19,625		$	—
Costs and expenses		(5,364	)		72		(20,278	)		(99	)

Income (loss) from discontinued operations	$	(587	)	$	72	$	(653	)	$	(99	)

INPHONIC, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share and share amounts)

Balance sheet data included:


	As of
	December 31, 2005		September 30, 2006
Accounts and notes receivable, net	$	1,848	$	392
Other current assets		582		—

Assets of discontinued operations	$	2,430	$	392

Accounts payable	$	931	$	—
Other accrued expenses		2,199		1,178

Liabilities of discontinued operations	$	3,130	$	1,178

(4) Goodwill

The following table reflects the changes to goodwill for the nine months ended September 30, 2006:


Balance as of December 31, 2005	$	31,140
Goodwill arising from VMC Satellite, Inc. earn-outs⁽¹⁾		5,494

Balance as of September 30, 2006	$	36,634

(1)

We achieved the earn-out performance target stipulated in the VMC Asset Purchase Agreement on February 28, 2006 and accordingly recorded additional goodwill of $2,984. The earn-out consideration consisted of amounts that were paid in cash of $2,362 and 119,389 shares of our common stock with a fair value of $622. Such consideration was paid in April 2006. An additional $2,510 of goodwill was earned in connection with achieved earn-out performance targets on August 24, 2006 and consisted of $1,186 of cash, of which $224 was still payable as of September 30, 2006, and 214,899 shares of our common stock with a fair value of $1,324. We may also be obligated to pay shareholders of VMC an additional $1,568 in cash based on future performance targets.

(5) Debt

We maintain a revolving operating line of credit which allows for aggregate borrowings of up to $25,000 subject to certain limits based on accounts receivable and inventory levels. On September 28, 2006, we entered into a Seventh Amendment (the “Amendment”) to Third Amended and Restated loan and Security Agreement (the “Agreement”) with Comerica Bank (the “Bank”). The Amendment amended the maturity date from January 1, 2007 to July 1, 2007, reduced the applicable interest to the Bank’s LIBOR plus a margin of 1.75% from the Bank’s LIBOR plus a margin of 2.00%, and modified the terms of the limits on our aggregate borrowing base. At September 30, 2006 and December 31, 2005, there were $19,924 and $15,000 outstanding under this line of credit, respectively. As of September 30, 2006, we had no additional borrowing availability under the facility based on the limits described above. The line of credit expires effective July 1, 2007 and accordingly the outstanding balance has been classified as a current liability as of September 30, 2006. We terminated our line of credit on November 7, 2006.

On November 7, 2006, we executed a $100 million aggregate principal amount senior secured term loan bearing a fixed rate of interest of nine percent per annum and secured by substantially all our assets. The term loan matures in November 2011. Beginning in November 2009, we have the ability to repay principal on the loan without

INPHONIC, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share and share amounts)

penalty and conversely, the lenders have the right to call the remaining outstanding principal of the debt without penalty. As additional consideration, we also granted the lenders warrants to purchase 1,250,000 shares of our common stock at an exercise price of $0.01 per share. We received $75.0 million of the term loan proceeds on November 7, 2006, and have the option to withdraw the remaining amount at a later date. Proceeds from the term loan will be used to repay all indebtedness under the existing credit facility, fund share repurchases of our common stock, and for general corporate and working capital needs. In conjunction with the loan transaction above, we terminated our credit facility with Comerica Bank and used proceeds from the term loan to repay the outstanding principal obligation of $19,924 plus accrued interest.

(6) Repurchase of Common Stock

On August 17, 2005, our Board of Directors authorized the repurchase of up to $30,000 of our common. We funded our share repurchases with cash on hand and cash generated from operations. During the nine months ended September 30, 2006, we repurchased 62,761 shares of our common stock at an average price of $8.01 per share for approximately $503. All shares repurchased were returned to the status of authorized but unissued shares of common stock as of September 30, 2006. For the duration of the program, we repurchased 1,144,248 shares for an aggregate consideration of $13,591. The program ended August 17, 2006.

(7) Commitments and Contingencies

Legal Matters

On August 5, 2004, Avesair, Inc., one of the companies the assets of which we acquired, filed suit against us demanding, among other matters, that we issue to Avesair shares of our common stock valued at approximately $4,000 as of June 30, 2004. The stock demanded by Avesair represents the maximum value of shares that they could have earned for achieving certain performance-based targets under the asset purchase agreement. We believe the performance-based targets were not achieved and intend to vigorously contest this matter. However, any adverse resolution of this matter could have a material adverse impact on our financial results if we are required to issue additional shares and would result in dilution to our stockholders.

On July 25, 2005, the Federal Communications Commission (FCC) issued a Notice of Apparent Liability, asserting that we registered with the FCC and reported and contributed to the Universal Service Fund (USF) and the Telecommunications Relay Service Fund later than required by FCC rules. The FCC has preliminarily proposed to fine us approximately $820 for late payment of such fees. In a letter dated August 24, 2005 we responded to the FCC’s preliminary finding and asserted that no fine is appropriate under the circumstances. However, any adverse resolution of this matter could have a material adverse impact on our financial results.

Thirteen related putative federal court class actions, have been filed against us arising out of InPhonic-sponsored rebate offers for online purchases of wireless telephones. Eight of these lawsuits also name a third-party rebate processor as a defendant. This rebate processor began to process claims for InPhonic-sponsored rebate offers in or about July 2005, and InPhonic’s agreement with the rebate processor expired in or about July 2006. One of these lawsuits also names our current third-party rebate processor as a defendant.

Of the thirteen federal court actions, five are pending in the District of Columbia, another five are pending in the District of Arizona, and one each is pending in the federal courts Newark, New Jersey, Chicago, and Los Angeles.

INPHONIC, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(in thousands, except per share and share amounts)

On October 25, 2006 we received a decision by the Judicial Panel on Multidistrict Litigation (“JPML”) granting our motion to consolidate the federal court actions in the United States District Court for the District of Columbia before the Honorable Ellen Segal Huvelle.

The putative class action complaints allege, among other things, violations of the consumer protection laws of various States and (in certain lawsuits) the federal RICO (anti-racketeering) statute in connection with our disclosure and implementation of the terms and conditions of rebate offers. The class action plaintiffs seek statutory penalties, treble damages, attorneys’ fees, and punitive damages under the consumer protection statutes, and treble damages and attorneys’ fees under the RICO statute, as well as injunctions concerning the content of our websites.

The federal lawsuits are in an early stage. We intend to vigorously defend these actions but cannot predict their outcome.

On June 8, 2006, the Attorney General of the District of Columbia brought a lawsuit in the Superior Court of the District of Columbia (the “DCAG Action”), alleging violations of the D.C. consumer protection statute based on factual allegations that are substantively the same as those in the private putative nationwide class actions. The DCAG Action sought injunctive relief, restitution for consumers, statutory penalties, and attorneys’ fees. We reached settlement in principle with the Attorney General of the District of Columbia on November 3, 2006 and are currently negotiating the terms of a definitive agreement.

From time to time we are party to other disputes or legal proceedings. We do not believe that any of the pending proceedings are likely to have a material adverse effect on our business.

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

The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes and the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2005.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains statements that are forward-looking within the meaning of the Securities Act of 1933, and the Securities Exchange Act of 1934 that involve risks and uncertainties. In some cases, forward-looking statements are identified by words such as “believe”, “anticipate”, “expect”, “intend”, “plan”, “will”, “may” and similar expressions. All of these forward-looking statements are based on information available to us at this time and we assume no obligation to update any of these statements. These statements are not guarantees of future performance and are subject to certain risks and uncertainties that are difficult to predict, including, among other things: our limited operating history; the ability to maintain strong relationships with wireless carriers; ongoing consolidation among wireless carriers; a decrease in the new subscriber growth rate; increased competition with additional retail and on-line distributors of wireless services and devices; increase in the rate of deactivations of active accounts; ability to attract new customers; ability to successfully integrate acquisitions; ability to accurately estimate reserve for future deactivations; interruptions or delays in service from third parties; our ability to effectively manage business growth; ability to attract and retain key personnel; and government regulation.

Existing and prospective investors are cautioned not to place undue reliance on these forward-looking statements, due to the risks listed below and other risks described in this filing under Item 1A, “Risk Factors.”

Overview

We are a leading online seller of wireless services and devices based on the number of activations of wireless services sold online in the United States. We sell wireless service plans and devices, including satellite television services through our own branded websites; including Wirefly.com, A1 Wireless.com, and VMCsatellite.com and through websites that we create and manage for third parties. We offer marketers the ability to sell wireless voice and data services and devices, under mobile virtual network enabler (“MVNE”) agreements. This service utilizes the same e-commerce platform, operational infrastructure and marketing relationships that we use in our operations. We provide customers the ability to organize personal communications by providing real time wireless access to e-mail, voicemail, faxes, contacts, scheduling, calendar and conference calling functionality through a website or telephone.

We measure our performance based on our financial results and various non-financial measures. Key financial factors that we focus on in evaluating our performance include revenue growth within a period, contribution margin (defined as revenue less cost of revenue and marketing expenses), and operating income (defined as contribution margin less other operating expenses including sales, general and administrative and depreciation and amortization expenses). Our financial results can, and do, vary significantly from quarter-to-quarter as a result of a number of factors which include economic conditions specific to online commerce and wireless communications industries, the timing of introduction of popular devices by mobile phone manufacturer, our ability to attract visitors to our websites, changes in wireless carrier commission and bonus structures, the timing of recognition of bonuses paid to us by wireless carriers and our competitors’ pricing and marketing strategies.

Key non-financial measures of our success are customer feedback and customer satisfaction ratings compiled by third parties. We believe that maintaining high overall customer satisfaction is critical to our ongoing efforts to promote the use of the private-labeled websites that we create and manage for our marketers,

as well as our own branded websites, and to improve our operating results. We actively solicit customer feedback on our website functionality as well as the entire purchase experience. To maintain a high level of performance by our customer service representatives, we also undertake an ongoing customer feedback process. If we are unable to meet customer expectations with respect to price or do not successfully expand our product lines or otherwise fail to maintain high overall customer satisfaction, our business and results of operations would be harmed.

Revenues include commissions, bonuses and other payments we receive from wireless carriers, including a satellite television provider, in connection with the activation of customers and features on their networks, as well as payments from customers for wireless services and devices. Our revenue continues to increase as a result of internal growth and acquisitions. As further described below, total revenue and net loss from continuing operations for the three months ended September 30, 2006 were $102.2 million and $4.9 million, respectively, compared to total revenue and net loss from continuing operations of $92.0 million and $4.4 million, respectively, for the three months ended September 30, 2005. Revenue from our top three wireless carriers represented 70% and 62% of our total consolidated revenue for the three months ended September 30, 2006 and 2005, respectively. For the nine months ended September 30, 2006 total revenue and net loss from continuing operations were $285.4 million and $13.9 million, respectively, compared to total revenue and net loss from continuing operations of $235.3 million and $12.9 million, respectively, for the same period of 2005. Revenue from our top three wireless carriers represented 68% and 66% of our total consolidated revenue for the nine months ended September 30, 2006 and 2005, respectively.

Since we began operations in 1999, we have incurred significant losses and have had negative cash flow from operations. For the nine months ended September 30, 2006, $0.3 million of cash was used in operations. As of September 30, 2006, our accumulated deficit was $178.7 million and our total stockholders’ equity was $105.9 million. In order to achieve profitability in the future, we are depending upon our ability to produce revenue at levels that exceed the costs of that revenue plus operating expenses.

In 2006, we have continued to concentrate our resources on the growth of our wireless activations and the MVNE services we provide. Three of our key goals include (i) improving the customer experience platform that we utilize for order processing, customer service and rebate handling to automate additional processes and make more efficient use of our system and internal work force and the outsourced call center resources; (ii) further balancing spending on marketing initiatives with customer activation and revenue generation characteristics; and (iii) reducing certain general and administrative operating expenses as a percentage of revenue.

In 2005, we acquired certain assets and assumed certain liabilities of A1 Wireless USA, Inc. (“A1 Wireless”); VMC Satellite, Inc. (“VMC”); and FONcentral.com, Inc. (“FC”). We accounted for these transactions using the purchase method of accounting in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141,Business Combinations. Accordingly our results of operations include the operating results of A1 Wireless effective January 1, 2005, VMC as of April 26, 2005 and FC as of May 26, 2005, their respective acquisition dates.

As a result of the sale of our MVNO operations on December 31, 2005, we no longer believe that segment information, in accordance with SFAS No. 131,Disclosures About Segments of an Enterprise and Related Information, is applicable as our Wireless Activation and Services segment (“WAS”) represents greater than 95% of our total revenue and cost of revenue. Accordingly we no longer report segment data separately in the notes to our financial statements. Our Management’s Discussion and Analysis of Results of Operations will continue to provide a comparison of our revenue and cost of revenue of our wireless activation and services and other components of revenue and cost of revenue to the extent MVNE and data services fluctuations appear significant in explaining and describing such results of operations.

Comparison of the Results of Operations for the Three Months Ended September 30, 2006 and 2005


	Three Months Ended September 30,									Change Between 2005 and 2006
	2005					2006				Change Between 2005 and 2006
	Amount			% of Revenue		Amount		% of Revenue		Amount			%
	(amounts in thousands)
Revenue:
Activation and services	$	65,405		71	%	$	85,171	83	%	$	19,766		30	%
Equipment		26,555		29	%		17,013	17	%		(9,542	)	-36	%

Total revenue	$	91,960		100	%	$	102,184	100	%	$	10,224		11	%

Cost of revenue
Activation and services	$	(564	)	-1	%	$	551	1	%	$	1,115		-198	%
Equipment		54,317		59	%		52,770	52	%		(1,547	)	-3	%

Total cost of revenue	$	53,753		58	%	$	53,321	53	%	$	(432	)	-1	%

Selected operating expenses:
Sales and marketing	$	24,274		26	%	$	29,480	29	%	$	5,206		21	%
General and administrative		15,750		17	%		19,685	19	%		3,935		25	%
Depreciation and amortization		2,460		3	%		4,543	4	%		2,083		85	%
Restructuring		453		0	%		209	0	%		(244	)	-54	%

REVENUE

Revenue

Revenue consists of activations and services revenue, and equipment revenue. Activations and services revenue consists of (i) revenue from commissions, bonuses and other payments for the activation of services of wireless carriers and a satellite television carrier through private-labeled websites that we create and manage for marketers as well as through our own branded websites; (ii) revenue from the provisioning of MVNE services which provide marketers the ability to sell MVNO services to their customers under their own brands using our e-commerce platform and operational infrastructure; and, (iii) revenue from data services under which we provide subscribers with real-time wireless access to work and personal information, including email, calendar, corporate directories, personal contacts and documents in addition to wireless entertainment and content. Activations and services revenue also includes amounts due from carriers resulting from ongoing disputes relating to commissions revenue. Such disputes arise in the normal course of reconciliation with carrier commission reports and we continue to update and improve our processes and procedures surrounding the collection of such disputed items. Equipment revenue consists mainly of revenue from the sale of wireless devices to our customers that subscribe to wireless services through our private-labeled websites or those websites that we manage for other marketers. The following further details the components of our revenue and a comparative discussion of performance:


	Three Months Ended September 30,								Change Between 2005 and 2006
	2005				2006				Change Between 2005 and 2006
	Amount		% of Revenue		Amount		% of Revenue		Amount			%
	(amounts in thousands)
Activations and services:
Wireless activation	$	63,799	69	%	$	82,126	80	%	$	18,327		29	%
MVNE and data services		1,606	2	%		3,045	3	%		1,439		90	%

	$	65,405	71	%	$	85,171	83	%	$	19,766		30	%
Equipment:
Wireless activation	$	26,555	29	%	$	17,013	17	%	$	(9,542	)	-36	%
Total Revenue:
Wireless activation	$	90,354	98	%	$	99,139	97	%	$	8,785		10	%
MVNE and data services		1,606	2	%		3,045	3	%		1,439		90	%

	$	91,960	100	%	$	102,184	100	%	$	10,224		11	%

Activations and Services

Activations and services revenue increased 30% to $85.2 million for the three months ended September 30, 2006 from $65.4 million for the three months ended September 30, 2005. The increase in activations and services revenue of $19.8 million was attributable to an increase in the number of wireless activations that we generated through marketing partners and increased advertising efforts compared to the prior period. Gross carrier commissions for activations subject to chargeback increased 17% to $87.7 million for the three months ended September 30, 2006 from $75.2 million for the three months ended September 30, 2005. Activations and services revenue of MVNE and data services increased $1.4 million to $3.0 million for the three months ended September 30, 2006, primarily as a result of increased MVNE revenue resulting from additional recurring revenue transactions for back-office support. Recurring revenue transactions increased due to a strategic business partnership beginning in April 2006.

Equipment

Revenue from sales of equipment for the three months ended September 30, 2006 decreased 36% to $17.0 million from $26.6 million for the three months ended September 30, 2005. The decrease in equipment revenue of $9.5 million was attributable to lower average sales prices due to an increase in point-of-sale discounts and other incentives provided to customers as compared to the three months ended September 30, 2005.

Total revenue

Total revenue increased 11% to $102.2 million for the three months ended September 30, 2006 from $92.0 million for the three months ended September 30, 2005. Revenue generated from the sale and activation of wireless devices and services accounted for approximately 97% of consolidated revenue for the three months ended September 30, 2006 compared to 98% for the three months ended September 30, 2005. Revenue from our top three wireless carriers represented 70% of consolidated revenue for the three months ended September 30, 2006 compared to 62% for the comparable period of 2005. Wireless activations and services revenue and equipment sales revenue may vary from period to period based on our promotional efforts, which include subsidizing the costs of devices purchased by our customers. We expect that revenue from the sale and activation of wireless devices and services will continue to increase during 2006 compared to 2005 performance.

COST OF REVENUE

Cost of revenue consists mainly of the cost of wireless devices (equipment) sold to our wireless activations and services customers. Our cost of revenue related to wireless equipment sales increased to $52.8 million for the three months ended September 30, 2006 as a result of a higher volume of devices sold during the period at a lower average cost compared to sales of such devices in the three months ended September 30, 2005. Total cost of revenue decreased 1% to $53.3 million for the three months ended September 30, 2006 compared to $53.8 million for the three months ended September 30, 2005. Cost of revenue from the sale of wireless devices accounted for approximately 99% of consolidated cost of revenue for the three months ended September 30, 2006 and 100% for the three months ended September 30, 2005. As a percentage of total revenue, cost of equipment revenue decreased to 52% of total revenue for the three months ended September 30, 2006 compared to 59% for the three months ended September 30, 2005.

OPERATING EXPENSES

Sales and Marketing

Sales and marketing expenses increased 21% to $29.5 million for the three months ended September 30, 2006 from $24.3 million for the corresponding period of 2005. The increase of $5.2 million mainly comprised

a $5.1 million increase from the growth of existing marketing relationships and the addition of new marketing partner relationships since the three months ended September 30, 2005. Our marketing expenses largely comprise payments to on-line advertisers, search engines and third-party marketing partners based on orders or activations. We incurred approximately $25.9 million of third-party marketing expenses in the three months ended September 30, 2006. Such expenses were higher in the three months ended September 30, 2006 than corresponding periods of 2005 due to increased wireless activation competition, and increased rates and volume of advertising, which caused our customer acquisition costs to increase. In addition, advertising placement and search costs also increased. We expect that marketing expenses will continue to represent a significant percentage of our revenue in future periods.

General and Administrative

General and administrative expenses increased 25% to $19.7 million for the three months ended September 30, 2006 from $15.8 million for the corresponding period of 2005. General and administrative expenses increased $3.9 million for the three months ended September 30, 2006 mainly as a result of costs incurred to evaluate, research and settle rebate matters associated with the District of Columbia attorney general’s action and increases in costs incurred for other professional services partially offset by decreases in bank related processing fees and severance expenses.

Depreciation and Amortization

Depreciation and amortization expenses, which are amortized over periods ranging from 18 months to 7 years, increased 85% to $4.5 million for the three months ended September 30, 2006 from $2.5 million for the three months ended September 30, 2005. The increase was primarily due to the costs associated with developing new functionality related to our websites, product offerings, and normal fixed asset depreciation on an increased amount of capital expenditures as compared to the corresponding period of 2005. In addition, 2005 expenses were reduced by a $0.7 million adjustment to correct a computational error in the fixed asset subledger that caused depreciation expense to be overstated.

Restructuring

We implemented a restructuring plan following the acquisition of A1 Wireless, to take advantage of synergies gained through the acquisition and to restructure our operations for efficiency purposes. For the three months ended September 30, 2005, we recognized $0.5 million in restructuring costs which related to workforce reduction excess facilities. All costs related to this plan were paid out in 2005. For the three months ended September 30, 2006, we incurred $0.2 million of restructuring costs primarily due to additional severance costs and relocation expenses for certain employees related to a plan which commenced in July 2006.

Loss from continuing operations

Loss from continuing operations increased to $4.9 million for the three months ended September 30, 2006 from $4.4 million for the three months ended September 30, 2005 as a result of increased costs for the rebate settlement and related expenses offset by decreasing cost of revenue and general operating expenses as a percentage of revenue.

Net Loss

Net loss decreased to $4.8 million for the three months ended September 30, 2006 from $5.0 million for the three months ended September 30, 2005.

Comparison of the Results of Operations for the Nine Months Ended September 30, 2006 and 2005


	Nine Months Ended September 30,								Change Between 2005 and 2006
	2005				2006				Change Between 2005 and 2006
	Amount		% of Revenue		Amount		% of Revenue		Amount			%
	(amounts in thousands)
Revenue:
Activation and services	$	170,608	72	%	$	230,196	81	%	$	59,588		35	%
Equipment		64,729	28	%		55,161	19	%		(9,568	)	-15	%

Total revenue	$	235,337	100	%	$	285,357	100	%	$	50,020		21	%

Cost of revenue:
Activation and services	$	895	1	%	$	1,876	1	%	$	981		110	%
Equipment		134,895	57	%		150,574	52	%		15,679		12	%

Total cost of revenue	$	135,790	58	%	$	152,450	53	%	$	16,660		12	%

Selected operating expenses:
Sales and marketing	$	61,599	26	%	$	83,610	29	%	$	22,011		36	%
General and administrative		44,327	19	%		49,824	17	%		5,497		12	%
Depreciation and amortization		6,379	3	%		11,986	4	%		5,607		88	%
Restructuring		848	0	%		2,115	1	%		1,267		149	%

REVENUE


	Nine Months Ended June 30,								Change Between 2005 and 2006
	2005				2006				Change Between 2005 and 2006
	Amount		% of Revenue		Amount		% of Revenue		Amount			%
	(amounts in thousands)
Activations and services:
Wireless activation	$	164,552	70	%	$	219,573	77	%	$	55,021		33	%
MVNE and data services		6,056	3	%		10,623	4	%		4,567		75	%

		170,608	73	%		230,196	81	%		59,588		35	%
Equipment:
Wireless activation	$	64,729	28	%	$	55,161	19	%	$	(9,568	)	-15	%
Total Revenue:
Wireless activation	$	229,281	97	%	$	274,734	96	%	$	45,453		20	%
MVNE and data services		6,056	3	%		10,623	4	%		4,567		75	%

	$	235,337	100	%	$	285,357	100	%	$	50,020		21	%

Activations and Services

Activations and services revenue increased 35% to $230.2 million for the nine months ended September 30, 2006 from $170.6 million for the nine months ended September 30, 2005. The increase in activations and services revenue of $59.6 million was attributable to an increase in the number of wireless activations that we generated through marketing partners and increased advertising efforts compared to prior year periods. Activations and services revenue also consisted of approximately $2.8 million associated with a change in our estimate of the amount of disputed carrier commissions that are deemed to be collectible. We believe these disputed commissions to be collectible based on our recent improvements in dispute commissions collections. Gross carrier commissions for activations subject to chargeback increased 23% to $240.0 for the nine months ended September 30, 2006 from $195.3 million for the nine months ended September 30, 2005. Activations and services revenue of MVNE and data services increased $4.6 million to $10.6 million for the nine months ended September 30, 2006. The increase in revenue was primarily the result of project development work completed and accepted by a customer in early June 2006.

Equipment

Revenue from sales of equipment for the nine months ended September 30, 2006 was $55.2 million compared to $64.7 million for the nine months ended September 30, 2005. The decrease in equipment revenue of $9.6 million was attributable to lower average sales prices due to an increase in point-of-sale discounts and other incentives provided to customers as compared to the nine months ended September 30, 2005.

Total revenue

Total revenue increased 21% to $285.4 million for the nine months ended September 30, 2006 respectively from $235.3 million for the nine months ended September 30, 2005. Revenue generated from the sale and activation of wireless devices and services accounted for approximately 96% of consolidated revenue for the nine months ended September 30, 2006 compared to 97% for the nine months ended September 30, 2005. Revenue from our top three wireless carriers represented 68% of consolidated revenue for the nine months ended September 30, 2006 compared to 66% for the comparable period of 2005. Wireless activations and services revenue and equipment sales revenue may vary from period to period based on our promotional efforts, which include subsidizing the costs of devices purchased by our customers. We expect that revenue from the sale and activation of wireless devices and services will continue to increase during 2006 compared to 2005 performance.

COST OF REVENUE

Cost of revenue consists mainly of the cost of wireless devices (equipment) sold to our wireless activations and services customers. Our cost of revenue related to wireless equipment sales increased to $150.6 million for the nine months ended September 30, 2006 as a result of a higher volume of devices sold during the period compared to sales of such devices for the nine months ended September 30, 2005. Total cost of revenue increased 12% to $152.5 million for the nine months ended September 30, 2006 as compared to $135.8 million for the nine months ended September 30, 2005. Cost of revenue from the sale of wireless devices accounted for approximately 99% of consolidated cost of revenue for the nine months ended September 30, 2006 and for the nine months ended September 2005. As a percentage of total revenue, cost of equipment revenue decreased to 52% of revenue for the nine months ended September 30, 2006 compared to 57% for the nine months ended September 30, 2005.

OPERATING EXPENSES

Sales and Marketing

Sales and marketing expenses increased 36% to $83.6 million for the nine months ended September 30, 2006 from $61.6 million for the corresponding periods of 2005. The increase mainly comprised a $22.0 million increase from the growth of existing marketing relationships and adding new marketing partner relationships since the nine months ended September 30, 2005. Our marketing expenses largely comprise payments to on-line advertisers, search engines and third-party marketing partners based on orders or activations. We incurred approximately $73.7 million of third-party marketing expenses in the nine months ended September 30, 2006. Such expenses were higher than the corresponding period of 2005 due to increased wireless activation competition, and increased rates and volume of advertising, which caused our customer acquisition costs to increase. In addition, advertising placement and search costs also increased. We expect that marketing expenses will continue to represent a significant percentage of our revenue in future periods.

General and Administrative

General and administrative expenses increased 12% to $49.8 million for the nine months ended September 30, 2006 from $44.3 million for the corresponding period of 2005. The expense increase of $5.5 million was mainly composed of the following: $3.5 million related to increased payroll expenses from a larger

workforce; $6.6 million related to legal, consulting, rebate processing and other expenses including but not limited to costs incurred related to the District of Columbia attorney general’s action and increased temporary help; $0.7 million due to a settlement with A1 Wireless; and $0.3 million related to increased facilities costs and telecommunication related expenses. Offsetting these increases were decreases in stock-based compensation and severance expenses of $5.6 million for the period. For the nine months ended September 30, 2005, stock-based compensation included $6.7 million related to the modification of option grant and awards of two employees that were terminated. Absent this, stock-based compensation expense would have increased approximately $1.1 million as a result of compensation expense from options and stock awards granted after the third quarter of 2005 and the impact of the adoption of SFAS No. 123(R).

General and administrative expenses for the nine months ended September 30, 2006 included $3.8 million related to expenses from evaluating and researching rebate matters associated with the District of Columbia attorney general’s action. Such costs were comprised of rebate processing and exit costs and fees of $1.9 million; legal expenses of $1.3 million and full-time and temporary labor staffing costs of $0.6 million.

Depreciation and Amortization

Depreciation and amortization expenses, which are amortized over periods ranging from 18 months to 7 years, increased 88% to $12.0 million for the nine months ended September 30, 2006 from $6.4 million for the nine months ended September 30, 2005. The increase was primarily due to the costs associated with developing new functionality related to our websites, product offerings and amortization expense related to VMC and FC acquisitions on April 26, 2005 and May 26, 2005, and normal fixed asset depreciation on an increased amount of capital expenditures as compared to the corresponding period of 2005. In addition, 2005 expenses were reduced by a $0.7 million adjustment to correct a computational error in the fixed asset subledger that caused depreciation expense to be overstated.

Restructuring

During 2006, we implemented a restructuring plan related to changes in our management and operational structure. For the nine months ended September 30, 2006, we recognized $2.1 million related to the termination of our former president and chief operating officer and thirteen other senior executives and employees. Of this amount, $0.6 million related to severance benefits that will be paid out in cash to the recipients on a monthly or bi-monthly basis over the terms of their respective severance agreements and $1.3 million related to severance expenses incurred as a result of the modification of stock-based compensation awards under which vesting of 50% of unvested restricted share and option awards were accelerated for three of the former employees. An additional $0.2 million was incurred for the relocation of certain employees.

Loss from continuing operations

Loss from continuing operations increased to $13.9 million for the nine months ended September 30, 2006 from $12.9 million for the corresponding period in 2005. Although we experienced significant revenue growth, cost of revenue and operating expenses both increased as described above in order to support the revenue growth we experienced along with increases in costs for the rebate settlement and related expenses.

Net Loss

Net loss increased to $14.0 million for the nine months ended September 30, 2006 from $13.6 million for the same period of 2005.

Liquidity and Capital Resources

Since inception, we have funded our operations principally through the sale of equity securities and to a lesser extent, through subordinated debt, credit facilities, capital leases and lines of credit. In addition, certain of our vendors from whom we purchase handsets and other wireless equipment that we sell to our customers allow us to purchase up to approximately $35 million of such equipment on extended payment terms. The significant components of our working capital are inventory and liquid assets such as cash and cash equivalents, short-term investments and trade accounts receivable, reduced by accounts payable, accrued expenses and deferred revenue.

Our future capital and operating requirements will depend on many factors, including the level of our revenues, the expansion of our sales and marketing activities, the cost of our fulfillment operations, potential investments in businesses or technologies and continued market acceptance of our products. Additionally, poor financial results, unanticipated expenses, acquisitions of technologies or business or strategic investments could give rise to additional financing requirements sooner than we expect. In the event that cash on hand and borrowings drawn on our new term loan are not sufficient to fund working capital requirements that are not satisfied through net cash provided by operating activities or future cash requirements, we could be required, or could elect, to seek additional funding through a public or private equity or debt financing in the future.

As of September 30, 2006, we had cash and cash equivalents of $57.5 million and debt and capital lease obligations of $20.6 million. As of December 31, 2005, we had cash and cash equivalents of $70.8 million, and debt and capital lease obligations of $15.8 million.

Consolidated Cash Flows


	Nine Months Ended September 30,
	2005			2006
	(amounts in thousands)
Net cash used in operating activities	$	(15,581	)	$	(332	)
Net cash used in investing activities		(24,952	)		(18,196	)
Net cash provided by financing activities		21,073			5,282

Change in cash and cash equivalents	$	(19,460	)	$	(13,246	)

Net cash used in operating activities was $0.3 million for the nine months ended September 30, 2006 compared to net cash used in operating activities of $15.6 million for the nine months ended September 30, 2005. For the nine months ended September 30, 2006, net income after adjustments for items to reconcile net loss to net cash provided by operating activities was approximately $8.4 million. Such items include depreciation and amortization, non-cash interest expense and stock-based compensation.

Changes in operating assets and liabilities from December 31, 2005 decreased net cash used in operating activities by approximately $8.7 million. Changes in working capital balances included an increase of current assets of approximately $21.0 million, excluding cash and cash equivalents, short-term investments and cash collected from notes receivable related to discontinued operations. The increase in these current assets was primarily the result of increased accounts receivable balances from December 31, 2005. The accounts receivable increase at September 30, 2006 was primarily the result of higher commission balances owed to us by the carriers as a result of increased revenue and the timing of collections at the end of the month of September.

Current liabilities, excluding debt and capital lease balances and acquisition earn-out obligations accrued during the period increased $12.3 million from December 31, 2005. The increase was mainly the result of an increase in accounts payable offset by decreases in accrued liabilities and deferred revenue. The increase in accounts payable and line of credit balances at September 30, 2006 was the result of the timing of cash collections at the end of the month of September, as explained above, which slowed our payments to certain of

our vendors; and higher inventory levels for which payment was not yet due and borrowings undertaken in the period specifically used to paydown accounts payable balances. Accrued expenses decreased as a result of reductions in accrued consumer liabilities and cash amounts paid to fund the VMC earnout payment made in May 2006. Deferred revenue decreased as a result of MVNE contract deliveries for which we were able to recognize revenue and an improvement in our deactivation rates.

In addition to the net cash provided by operating activities, we had trade borrowings of $6.4 million under our line of credit to improve payment terms on inventory purchases. These borrowings are shown as net cash provided by financing activities in the Statement of Cash Flows. When considering these trade borrowings with our cash provided by operating activities, total cash provided by our operations would have been $6.0 million.

Net cash used in investing activities for the nine months ended September 30, 2006 and 2005 was $18.2 million and $25.0 million, respectively. The $6.8 million decrease in net cash used in investing activities was due to a decrease of $4.7 million of cash paid for acquisitions, and a decrease of $2.3 million in cash paid for intangible assets, a decrease of $5.0 million used in the cash used for the purchase of short-term investments, and an increase of $1.1 million in proceeds from the sale of assets of discontinued operations. These increases were partially offset by an increase of $6.8 million in the purchase of property and equipment and capitalized labor costs, primarily associated with enhancing our operating infrastructure and E-commerce platform to enable expanded and new functionality. Capital expenditures for the nine months ended September 30, 2006 comprised $13.2 million of software and web site development and $3.0 million of other property and equipment.

Net cash provided by financing activities was $5.3 million for the nine months ended September 30, 2006 compared to net cash provided by financing activities of $21.1 million for the nine months ended September 30, 2005. Financing activities consisted of borrowings on our line of credit of $6.4 million and proceeds from the exercise of options of $1.2 million, partially offset by cash used to repurchase common stock of $0.5 million and principal payments on our line or credit and capital leases of $1.8 million.

Borrowings Under Line of Credit and Vendor Trade Credit.Through November 7, 2006, we maintained a revolving operating line of credit with Comerica Bank which allowed for aggregate borrowing of up to $25.0 million subject to certain limits based on accounts receivable and inventory levels. As of September 30, 2006, we had an aggregate principal amount of $19.9 million outstanding under the facility, however no further borrowing capacity under the facility was available as of September 30, 2006 based on the limits described above.

On November 7, 2006, we executed a $100 million aggregate amount senior secured term loan bearing a fixed rate of interest of nine percent per annum and secured by substantially all our assets. The term loan matures in November 2011. Beginning in November 2009, we have the ability to repay principal on the loan without penalty and conversely, the lenders have the right to call the remaining outstanding principal of the debt without penalty. As additional consideration, we also granted the lenders warrants to purchase 1,250,000 shares of our common stock at an exercise price of $0.01 per share. We received $75.0 million of the term loan proceeds on November 7, 2006, and have the option to withdraw the remaining amount at a later date. Proceeds from the term loan will be used to repay all indebtedness under the existing credit facility, fund share repurchases of our common stock, and for general corporate and working capital needs. In conjunction with the loan transaction above, we terminated our credit facility with Comerica Bank and used proceeds from the term loan to repay the outstanding principal obligation of $19.9 million plus accrued interest.

We have customary trade terms with many of our vendors including the carriers and original equipment manufacturers that provide wireless devices to us for sale to our customers. Based upon our vendor trade credit programs with the providers of our inventory, we had approximately $35.0 million of credit available to us for the purchase of wireless devices as of October 31, 2006.

Common Stock Repurchase Program. Our board of directors has authorized us to repurchase shares of our common stock up to an aggregate amount of $30.0 million. During the nine months ended September 30, 2006 we repurchased an aggregate of 62,761 shares of our common stock for approximately $0.5 million. The program ended August 17, 2006.

Contractual Obligations

The following table summarizes our significant contractual obligations, including interest on capital leases, and the expected effect on liquidity and cash flows as of September 30, 2006.


	Total		Less than 1 year		1 - 3 years		4 - 5 years		Over 5 years
	(amounts in thousands)
Line of credit (a)	$	19,924	$	19,924	$	—	$	—	$	—
Capital leases		788		384		404		—		—
Operating leases		4,460		1,805		2,655		—		—
Obligation to purchase certain advertising (b)		4,544		4,544		—		—		—
Obligations under VMC APA (c)		—		—		—		—		—

	$	29,716	$	26,657	$	3,059	$	—	$	—

(a)	On November 7, 2006, we entered into a new term loan and repaid all amounts outstanding under the line of credit with Comerica Bank. Our borrowings of $75.0 million under the new term loan mature in November 2011.

(b)	We have a commitment to purchase a minimum level of advertising and media services from a vendor by March 31, 2007. Such commitment period may be extended at the option of the vendor.

(c)	Under the VMC Asset Purchase Agreement, we may be obligated to pay shareholders of VMC an additional $1.8 million in cash upon achieving certain future monthly operating targets. This potential obligation has not been included in the table above.

Recent Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157,Fair Value Measurements (“SFAS No. 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement, and states that a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. SFAS 157 will become effective for our fiscal year beginning January 1, 2008. We do not believe the adoption of this pronouncement will have any material effects on our consolidated financial position, results of operations, or cash flows.

In September 2006, the Securities and Exchange Commission (“SEC”) released Staff Accounting Bulletin No. 108,Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements(“SAB 108”). SAB 108 provides guidance on how the effects of the carryover or reversal of prior year financial statement misstatements should be considered in quantifying a current year misstatement. Prior practice allowed the evaluation of materiality on the basis of (1) the error quantified as the amount by which the current year income statement was misstated (rollover method) or (2) the cumulative error quantified as the cumulative amount by which the current year balance sheet was misstated (iron curtain method). Reliance on either method in prior years could have resulted in misstatement of the financial statements. The guidance provided in SAB 108 requires both methods to be used in evaluating materiality. Immaterial prior year errors may be corrected with the first filing of prior year financial statements after adoption. The cumulative effect of the correction would be reflected in the opening balance sheet with appropriate disclosure of the nature and amount of each individual error corrected in the cumulative adjustment, as well as a disclosure of the cause of the error and that the error had been deemed to be immaterial in the past. We do not believe the adoption of this pronouncement will have any material effects on our consolidated financial position, results of operations, or cash flows.

In June, 2006, the FASB issued FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 will apply to fiscal years beginning after December 15, 2006, with earlier adoption permitted. We are currently evaluating the impact of the adoption of this pronouncement, if any, on our consolidated financial position, results of operations, or cash flows.

In November 2004, the FASB issued SFAS No. 151,Inventory Costs that is an amendment to ARB No. 43, Chapter 4 (“SFAS No. 151”), amends chapter 4 “Inventory Pricing” of ARB No. 43 and paragraph A3 of SFAS No. 144. Previously, ARB 43 did not define the term so abnormal which could lead to unnecessary incomparable financial reporting. SFAS No. 151 clarifies that abnormal costs related to idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as period costs. SFAS No. 151 is effective for fiscal year beginning after June 15, 2005. We adopted the pronouncement effective January 1, 2006. There was no material effect on our financial position, cash flows or result of operations as a result of this adoption.

In May 2005, the FASB issued SFAS No. 154,Accounting Changes and Error Corrections (“SFAS No. 154”), a replacement of APB Opinion No. 20,Accounting Changes, and SFAS No. 3,Reporting Accounting Changes in Interim Financial Statements. SFAS No. 154 changes the requirements for the accounting for, and reporting of, a change in accounting principle. Previously, voluntary changes in accounting principles were generally required to be recognized by way of a cumulative effect adjustment within net income during the period of the change. SFAS No. 154 requires retrospective application to prior periods’ financial statements of changes in accounting principles, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS No. 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005; however, the statement does not change the transition provisions of any existing accounting pronouncements. We adopted the pronouncement effective January 1, 2006. There was no material effect on our financial position, cash flows or results of operations as a result of this adoption.

Application of Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated condensed financial statements which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making the judgments about our revenue, cost of revenue and the carrying values of assets and liabilities that are not readily apparent from other sources. Because this can vary in each situation, actual results may differ from the estimates under different assumptions and conditions.

The following is a summary of the most critical of these estimates. For additional information, see Item 7, Part II, “Management Discussion and Analysis of Financial Condition and Results of Operations—Application of Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005. Although we believe that our estimates, assumptions, and judgments are reasonable, they are based upon information currently available. Actual results may differ significantly from these estimates under different assumptions, judgments, or conditions

Revenue Recognition

Activation and Services—We generate revenue primarily from wireless carriers, as well as a satellite television carrier, who pay commissions and volume and performance-based bonuses, for activating wireless services and features on their networks. We recognize commissions from wireless carriers upon shipment of activated devices to the customer. In addition to activation commissions, under certain conditions, certain carriers pay us a monthly residual fee for as long as a customer we activate for the carrier continues to be its subscriber, or for a fixed period of time depending on the carrier. We purchase satellite activation certificates evidencing activation rights in advance of their resale to customers. Revenue from satellite television customers includes sales of these satellite activation certificates, net of the certificate cost, since we are acting as an agent in the transaction.

Our revenue is reduced for estimated deactivations of the wireless services by customers prior to the expiration of a time period that ranges 90 to 180 days from the date of activation, depending on the wireless carrier. We estimate deactivations based on historical experience, which we have developed based on our experience with carriers, customer behavior and sources of customers, among other factors, allowing us to accrue estimates with what we believe is a high degree of certainty. Any increase or decrease in the deactivation amount will cause a corresponding dollar-for-dollar increase or decrease in revenue. As an example, the impact of a 1% change in the deactivation rate applied to the quarter ended September 30, 2006 would have an increase or decrease in revenue and the corresponding reserve of $0.9 million. Any decrease in revenue resulting from an increase in deactivations would also be offset, in part, by returns of wireless devices. Our reserves for deactivations are included in accounts receivable and deferred revenue on our balance sheet. If we determine that we cannot accurately predict future deactivation experience, we may be required to defer 100% of our carrier commission revenue until the expiration of the appropriate chargeback period. New channels for which we have insufficient historical data to adequately estimate deactivation experience will be deferred through the expiration period for a period of 24 months, until such time as we can accurately estimate the deactivation experience for the new channel.

In addition to receiving commissions for each wireless subscriber activated, we earn performance bonuses from the wireless carriers based on negotiated performance targets. The most significant bonus we earn is the quarterly volume bonus, which we bill wireless carriers for on a monthly basis, based on current month activations. We record these bonuses as deferred revenue at the time of billing until we achieve the quarterly targets. We earn other quarterly bonuses from certain carriers for maintaining low customer churn and signing up customers for certain additional monthly “features” such as data service or text messaging. Wireless carriers also periodically offer bonuses for achieving monthly volume and other performance targets and also formerly provided some bonus compensation under annual volume based plans. We recognize these monthly bonuses as earned in accordance with the provisions of SAB No. 104. Revenue is recognized only when all of the following criteria are met: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred or services have been rendered; (3) the seller’s price to the buyer is fixed or determinable, and (4) collectibility is reasonably assured. Amounts collected in cash prior to meeting the above criteria are recorded as deferred revenue. Through 2005, commission revenue earned from the activation of carrier features had been deferred until the contractual chargeback period had lapsed. Beginning in 2006, we began to estimate commission revenue earned from feature activations based on historical experience which we have developed based on our experience with carriers and customer behavior over a period of time in excess of 24-months. This allows us to accrue estimates with what we believe is a high degree of certainty in accordance with SAB 104.

Equipment revenue—Revenue from the sale of devices and accessories in a multiple-element arrangement with services is recognized at the time of sale in accordance with EITF No. 00-21. Customers have the right to return devices within a specific period of time or usage, whichever occurs first. We provide an allowance for estimated returns on devices based on historical experience. In connection with our wireless activations, we sell the customer the wireless device at a significant discount, which may be in the form of a rebate. Rebates are recorded as a reduction of revenue and as a current liability until paid. We recognize rebate amounts based on the

historical experience of rebates claimed. Future rebate experience could vary based upon rates of consumers redeeming rebates.

As of the most recent quarter ended September 30, 2006, our handset return rate was 10.5% of handset revenue. We have recorded handset return rates of 10.4% and 11.2% for the years ended December 31, 2005 and 2004, respectively. Any increase or decrease in the actual handset return experience will cause a corresponding dollar-for-dollar decrease or increase in revenue. The impact of a 1% change in the handset returns rate applied to the quarter ended September 30, 2006 would have resulted in an increase or decrease in revenue of approximately $0.1 million with a corresponding increase or decrease in our cost of revenue.

Inventory Valuation

Our inventory consists of wireless devices and accessories. The carrying value of inventory is stated at the lower of cost or market value. Cost is determined using a method which approximates the first-in-first-out accounting method. We write down inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value or replacement cost based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected, additional inventory write-downs may be required. Historically, we have not experienced significant write-offs, with the exception of returned, unmarketable inventory.

Stock-based Compensation

We adopted SFAS No. 123(R) on January 1, 2006 using the modified prospective application (“MPA”) method. SFAS No. 123(R) established standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. SFAS No. 123(R) requires us to measure the cost of employee services received in exchange for an award of equity instruments usually stock options or unvested (restricted) stock awards based on the grant date fair value of the award. That cost is recognized over the period during which an employee is required to provide service in exchange for the award—the requisite service period (usually the vesting period). The amount of compensation expense recognized using the fair value method requires us to exercise judgment and make assumptions relating to the factors that determine the fair value of our stock option grants.

Provision for Income Taxes

We have historically reported net losses and, in accordance with accounting principles generally accepted in the United States, have not recorded any income tax benefits from those losses. Although we intend to utilize net operating loss carryforwards to offset taxable income that may be generated in 2006, we expect alternative minimum tax amounts to be payable primarily due to the net operating loss carryforward limitations associated with the alternative minimum tax calculation. We continue to maintain a valuation allowance against our deferred tax assets, consisting primarily of net operating loss carryforwards, and we may recognize deferred tax assets in future periods when they are estimated to be realizable provided they are not subject to ownership change limitations. To the extent we report taxable income in future periods, we intend to use our net operating loss carryforwards to the extent available to offset taxable income and reduce cash outflows for income taxes. Certain of these net operating losses obtained through our acquisitions are not included in the components of the deferred tax assets, as the use of these losses will be significantly limited under Section 382 of the Internal Revenue Code.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We currently do not hedge interest rate exposures and have not used derivative financial instruments for speculation or trading purposes. At September 30, 2006, our debt financing consisted primarily of amounts outstanding under our credit facility.

Senior Secured Debt, Variable Rate Debt:

The borrowings outstanding under our credit facility are secured by substantially all of our assets. The credit facility debt is held by one lender. Borrowings under our credit facility are sensitive to changes in interest rates. Given the existing level of debt of $19.9 million at September 30, 2006, a 0.5% change in the weighted-average interest rate would have an interest expense impact of approximately $8,302 each month.


Principal Balance	Fair Value		Weighted-Average Interest Rate		Scheduled Maturity
$19.9 million	$	19.9 million	7.28	%	July 2007

The $19.9 million of borrowings under our credit facility was repaid on November 7, 2006 with proceeds from a new $100 million senior secured term loan. The senior secured term loan matures in November 2011 and bears a fixed rate of interest of nine percent per annum.

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Our management, including our principal executive and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2006. Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed in this quarterly report on Form 10-Q has been appropriately recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive and principal financial officers, to allow timely decisions regarding required disclosure. Based on that evaluation, our principal executive and principal financial officer have concluded that our disclosure controls and procedures are effective at the reasonable assurance level.

Internal Controls over Financial Reporting

There has been no change in our internal controls over financial reporting identified in connection with the evaluation of such controls that occurred during our last fiscal year, which have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting for this current period.

PART II

ITEM 1. LEGAL PROCEEDINGS

Legal Matters

On August 5, 2004, Avesair, Inc., one of the companies the assets of which we acquired, filed suit against us demanding, among other matters, that we issue to Avesair shares of our common stock valued at approximately $4.0 million as of June 30, 2004. The stock demanded by Avesair represents the maximum value of shares that they could have earned for achieving certain performance-based targets under the asset purchase agreement. We believe the performance-based targets were not achieved and intend to vigorously contest this matter. However, any adverse resolution of this matter could have a material adverse impact on our financial results if we are required to issue additional shares and would result in dilution to our stockholders.

On July 25, 2005, the Federal Communications Commission (FCC) issued a Notice of Apparent Liability, asserting that we registered with the FCC and reported and contributed to the Universal Service Fund (USF) and the Telecommunications Relay Service Fund later than required by FCC rules. The FCC has preliminarily proposed to fine us approximately $0.8 million for late payment of such fees. In a letter dated August 24, 2005 we responded to the FCC’s preliminary finding and asserted that no fine is appropriate under the circumstances. However, any adverse resolution of this matter could have a material adverse impact on our financial results.

The federal lawsuits are in an early stage. We intend to vigorously defend these actions but cannot predict their outcome.

From time to time we are party to other disputes or legal proceedings. We do not believe that any of the pending proceedings are likely to have a material adverse effect on our business.

ITEM 1A. RISK FACTORS

There are a number of important factors that could cause our actual results to differ materially from those that are indicated by forward-looking statements. These factors include, without limitation, those listed below and elsewhere in this Quarterly Report on Form 10-Q.

Risks Related to Our Business

Our limited operating history makes it difficult for us to accurately forecast future revenue and appropriately plan our expenses.

We commenced operations in 1999 and have a limited operating history. As a result, it is difficult for us to predict future revenue and operating expenses. Many of our expenses, such as compensation for employees and lease payments for facilities and equipment, are relatively fixed. We base these expense levels, in part, on our expectations of future revenue. A softening in demand for our product and service offerings, whether caused by changes in consumer spending, consumer preferences, weakness in the U.S. or global economies or other factors, may result in decreased revenue, significant changes in our operating results from period to period and may cause our net losses to increase.

We have historically incurred significant losses and may not be profitable in the future.

We have experienced significant net losses each year since our inception. For the year ended December 31, 2005 we had net losses of $38.2 million. As of September 30, 2006, we had an accumulated deficit of $178.7 million. We may continue to incur net losses, and we cannot assure you that we will be profitable in future periods. We may not be able to adequately control costs and expenses or achieve or maintain adequate operating margins. Our financial results may also be impacted by stock-based compensation charges and possible limitations on the amount of net operating loss carryforwards that we can utilize annually in the future to offset any taxable income. Our ability to achieve and sustain profitability will depend on our ability to generate and sustain substantially higher revenue while maintaining reasonable cost and expense levels. If we fail to generate sufficient revenue or achieve profitability, we will continue to incur significant losses. We may then be forced to reduce operating expenses by taking actions not contemplated in our business plan, such as discontinuing sales of certain of our wireless services and devices, curtailing our marketing efforts or reducing the size of our workforce.

We expect our financial results to fluctuate, which may lead to volatility in our stock price.

Our revenue and operating results may vary significantly from period to period due to a number of factors, including:

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economic conditions specific to online commerce and the wireless communications industry;

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the timing of introduction of popular devices by mobile phone manufacturers and our ability to accurately forecast and procure an adequate supply of such devices;

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timing of bonuses paid to us by other wireless carriers;

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seasonal fluctuations in both Internet usage and purchases of wireless services and devices;

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our ability to attract visitors to our websites and our ability to convert those visitors into customers;

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our ability to retain existing customers;

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delays in market acceptance or adoption by consumers of our services, including our MVNE services;

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delays in our development and offering of new wireless services and devices;

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changes in our use of sales and distribution channels;

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our ability to obtain wireless devices at competitive prices;

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our ability to manage our procurement and delivery operations and their related costs;

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the amount of our marketing and other advertising costs;

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our or our competitors’ pricing and marketing strategies;

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our competitors’ introduction of new or enhanced products and services;

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the extent to which overall Internet use is affected by spyware, viruses, and “phishing,” spoofing and other spam emails directed at Internet users, viruses and “denial of service” attacks directed at Internet companies and service providers, and other events; and

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the amount and timing of operating costs relating to expansion of our operations.

If we are unable to maintain strong relationships with wireless carriers, our business would be adversely affected.

We depend upon a small number of wireless carriers for a substantial portion of our revenue and the loss of any one of these relationships could cause our revenue to decline substantially. In addition, the increasing consolidation in the wireless industry, as evidenced by Cingular’s acquisition of AT&T Wireless and Sprint’s merger with Nextel, will cause the number of wireless carriers to continue to decline and result in further revenue and pricing pressure. For the fiscal year 2005 and 2004, revenue from Cingular, T-Mobile and Sprint/Nextel each represented greater than 10% of our total revenue and an aggregate of 67% and 76%, respectively. Our wireless carriers could terminate their agreements with us without penalty and with little notice. Our agreements with these carriers are non-exclusive, and they have entered into similar agreements with our competitors, which may be on more favorable terms. Our revenue may decline if:

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one or more of the wireless carriers terminates its agreement with us or we are unable to negotiate extensions of these agreements on acceptable terms; or

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there is a downturn in the business of any of these wireless carriers; or

•

there is continued significant consolidation in the wireless services industry.

In addition, if the wireless carriers were to discontinue allowing us to sell and activate wireless service plans on their networks and instead were to provide these activation services exclusively themselves, this would have a significant adverse effect on our revenue.

Ongoing consolidation among wireless carriers could result in revenue and pricing pressure and adversely impact our results of operations.

In recent years, there has been a trend in the wireless industry toward consolidation of wireless carriers. In 2005 for instance, Cingular Wireless acquired AT&T Wireless, and Sprint merged with Nextel. March 5, 2006 AT&T Corporation announced a merger with Bell South. Ongoing consolidation among the wireless carriers would reduce the number of companies whose wireless services we offer, which could adversely affect our results of operations. We rely on the leading wireless carriers for a substantial portion of our revenue, and we expect this to continue for the foreseeable future. We may be subject to pricing pressures that may result from a further consolidation among wireless carriers, which could have an adverse effect on our operations. If consolidation continues, the commissions and bonuses paid to us by wireless carriers could decrease or the prices charged to us for the supply of wireless devices could increase, resulting in a decrease in our gross margin.

A failure to continue to improve our customer experience could adversely affect our operating results.

We operate in a very competitive environment and we believe that maintaining high overall customer satisfaction is a critical part of our ongoing efforts to promote the use of our own branded websites, as well as the private-labeled websites that we create and manage for our marketers, and to improve our operating results. We have had certain problems with our customer support operations and in fulfillment of orders and experienced some customer satisfaction issues related to rebates. If the efforts we have undertaken to improve our customer experience are unsuccessful, we could be subject to additional customer complaints, litigation, and investigations

by state and federal regulatory authorities, which could be costly, could divert the attention of our management from our core business and could damage our reputation. If these issues are not resolved, our revenues and results of operations could be adversely affected.

A decrease in the growth rate of our wireless service activations could adversely affect our operating results.

A substantial portion of our revenue consists of commissions we earn from the wireless carriers for the activation of new customer accounts. We may also receive bonuses for meeting volume and other performance based targets. If the growth rate in the number of new activations declines or the customer churn rates increase, we may not earn these additional bonuses and our revenue could decline in the future.

We may require additional cash to upgrade and expand our operations, which may not be available on terms acceptable to us, or at all.

Since our inception, our operating and investing activities have used more cash than they have generated. We expect our uses of cash over the next 12 months to include funding our operations, expanding our customer base, maintaining and enhancing our e-commerce platform and focusing on customer service. As of September 30, 2006, we had cash and cash equivalents of $57.5 million, including borrowings under our line of credit of $19.9 million. While we believe that our current cash and cash equivalents, short-term investments, and amounts available under our bank line of credit and trade credit available from wireless carriers and handset manufacturers will be sufficient to fund our working capital and capital expenditures through the foreseeable future, our revenue may not meet our expectations, we may be unable to control costs or we may incur additional expenses, including capital expenditures. In addition, we were not in compliance with certain of the covenants under our former line of credit with Comerica Bank for recent quarters ended prior to September 30, 2006 which included June 30, 2005, September 30, 2005 and December 31, 2005. Although we received waivers from Comerica Bank of our non-compliance with each of these covenants, there is no assurance that we will be in compliance with the covenants under our current line of credit, which replaced the line of credit with Comerica Bank, in the future, and if not in compliance, that we will receive a waiver. To remain competitive, we must continue to use cash to enhance and improve the functionality and features of our e-commerce platform and the websites we create and manage. If competitors introduce new services embodying new technologies, or if new industry standards and practices emerge, we may have to spend resources on the purchase or development of new functionalities or technologies. If we incur additional expenses or experience a revenue shortfall, our current resources may not be sufficient. We may then find it necessary to obtain additional financing. In the event that additional financing is required, we may not be able to raise it on terms acceptable to us, if at all.

The market for our services is becoming increasingly competitive with the emergence of additional retail and online distributors of wireless services and devices, which could adversely affect our business.

We face substantial competition in the wireless services industry. We expect competition to intensify as a result of the entrance of new competitors and the development of new technologies, products and services. We compete with wireless carriers’ retail stores and online websites, as well as other retail stores and online businesses that provide similar products and services in competition with us. All of our agreements with wireless carriers and wireless device suppliers are non-exclusive, and these parties may provide the same or similar services and devices to our competitors on terms more favorable than ours. Due to the low barriers to entry in this industry, with sufficient time and capital, it would be possible for additional competitors to replicate our services.

Many of our existing and potential competitors have substantially greater financial, technical and marketing resources than we do. Additionally, many of these companies have greater name recognition and more established relationships in many of our market segments. These competitors may be able to adopt more aggressive pricing policies and offer customers more attractive terms than we can. We may face increasing price pressure from the wireless carriers. In addition, current and potential competitors have established, or may establish, cooperative relationships among themselves or with third parties to compete more effectively.

Increasing costs of online advertising and or misjudgments in making advance commitments to purchase online advertising could have an adverse affect on our financial results.

Online advertising, the cost of which continues to increase, composes a significant portion of our marketing expenses. If the effectiveness of our online advertising does not keep pace with the increased costs, our financial results could be adversely affected. In addition, in order to secure more favorable terms or advertising placement, we sometimes make significant advanced financial commitments for advertising purchases based upon our anticipated needs. If our actual needs do not match such financial commitments, our results could be adversely affected.

We depend on Internet search engines to attract a substantial portion of the customers who use our websites, and losing these customers would adversely affect our revenue and financial results.

Many consumers access our services by clicking through on search results displayed by Internet search engines. Internet search engines typically provide two types of search results, algorithmic listings and purchased listings. Algorithmic listings cannot be purchased, and instead are determined and displayed solely by a set of formulas designed by the search engine. Purchased listings can be purchased by advertisers in order to attract users to their websites. We rely on both algorithmic and purchased listings to attract and direct consumers to our websites. Search engines revise their algorithms from time to time in an attempt to optimize their search results. If one or more search engines which we rely on for algorithmic listings modifies its algorithms, resulting in fewer consumers clicking through to our websites, we would need to increase our marketing expenditures or we would experience a reduction in our revenue, which would adversely affect our financial results. If one or more of the search engines which we rely on for purchased listings modifies or terminates its relationship with us, our expenses could rise and our financial results may suffer.

Any unanticipated increase in our rate of deactivation of active accounts could result in a decrease in our revenue.

Under our agreements with wireless carriers, commissions are not earned if the customer’s service is deactivated with the carrier before a pre-determined period of time, usually between 90 and 180 calendar days. We maintain a reserve to cover the commissions lost through deactivations based upon our historical experience. We monitor a number of factors in determining this reserve. For example, our experience has been that customers who participate in a promotion that allows them to obtain a phone and activate an account with no up-front payment have a higher deactivation rate than customers who pay amounts in advance. If the rate of our deactivations increases in excess of our historical experience, we would have to increase our deactivation reserve, which, in turn, would cause our revenue to decline. Further, if our estimates vary materially for a future period or periods in relation to revenue and/or net income so that we conclude that our method of determining estimates is not sufficiently accurate, we may be required to change our method of accounting for these estimates. While a change in accounting for deactivations would have no impact on our cash flow, any such change may negatively impact our net income for particular periods and cause a decline in stock price. An increase in our deactivation rate could also cause carriers to modify the commission terms with us or even terminate our agreements.

If we do not continue to attract customers through our existing online marketing programs, our revenue may be affected adversely and our marketing expenses may increase.

We obtain a large portion of our customers through incentive-based online marketing programs. We engage third parties to acquire customers through different marketing initiatives, including the use of websites that we create and manage under our marketers’ brands. We also use online advertising and other forms of direct marketing. Our marketers may not continue to participate in our marketing programs if the programs do not provide sufficient value, our competitors offer better terms, the third parties elect to provide these products and services directly or the market for incentive-based advertising decreases. If our marketers do not market our services to their customers, our revenues will not grow as anticipated and our marketing expenses may increase.

We face inventory risk.

We are exposed to inventory risks as a result of seasonality, new product launches by equipment manufacturers, rapid changes in product cycles and changes in consumer tastes with respect to wireless devices. In order to be successful, we must accurately predict these trends and avoid overstocking or under-stocking wireless devices. Demand for wireless devices, however, can change significantly between the time we order the wireless devices and the date we sell these to customers.

The acquisition of certain types of inventory, or inventory from certain sources, may require significant lead-time and prepayment, and such inventory may not be returnable. We carry a broad selection of wireless devices and maintain significant inventory levels of certain popular devices and we may be unable to sell products in sufficient quantities or during the relevant selling seasons.

Any one of the inventory risk factors set forth above may adversely affect our operating results.

Announcements and delays relating to the release of new wireless devices could adversely affect our revenue.

From time to time, the wireless industry is significantly affected by the introduction of new wireless devices that quickly capture a large share of the market. Announcements of new devices can result in customers deferring purchase decisions until such devices are available. Likewise, our ability to have access to a sufficient supply of such devices when available is important in order for us to meet customer demand. If customers delay purchases due to the announcement of new products or if we do not have access to a sufficient supply of new products to meet demand, it could have an adverse affect in our revenues and results of operations.

An interruption in the supply of wireless devices could hinder our ability to fulfill customer orders and cause a decline in our revenue.

We rely on wireless carriers and wireless device suppliers in fulfilling customer orders for wireless devices. These suppliers may experience difficulty in providing us sufficient wireless devices to meet our needs or they may terminate or fail to renew contracts for supplying us these devices on terms we find acceptable. Our agreements with these suppliers are non-exclusive, and these suppliers have entered into similar agreements with our competitors, which may be on more favorable terms. From time to time, we may experience delays in receiving shipments of wireless devices from one or more of the wireless device suppliers, thereby preventing us from offering a wireless device until the shipment is received. Any significant interruption in the supply of any of these devices could hinder our ability to fulfill customer orders and result in the loss of customers, causing a decline in our revenues.

If our distribution operations are interrupted for any significant period of time, our business and results of operations would be substantially harmed.

Our success depends on our ability to successfully receive and fulfill orders and to promptly deliver our products to our customers. Our packaging, labeling and product return processes are performed both internally through our own distribution operations and to a lesser extent, by a third party. Our distribution operations are located in a single facility that is susceptible to damage or interruption from human error, fire, flood, power loss, telecommunications failure, theft, terrorist attacks and similar events. In 2003, we experienced a one-day interruption in our distribution operations due to Hurricane Isabel. Any future interruptions in our distribution center operations for a significant period of time could damage our reputation and substantially harm our business and results of operations.

Interruptions or delays in service from third parties could impair our service offerings.

We rely on third parties for both our primary network operations hosting center and our back-up facility. Any disruption of our access to Internet service could result in delays in our ability to receive information or transact business. We also rely on third-party software, suppliers and wireless carriers to process applications for

credit approval and to bill our customers. If we are unable to process credit applications in a timely manner or if our billing software fails and we are unable to bill customers on a timely basis, our business will be affected adversely. While we do have backup systems for certain aspects of our operations, our systems are not fully redundant and our disaster recovery planning may not be sufficient for all eventualities. From time to time we have experienced interruptions in these or other third-party services and if such disruptions were to occur in the future or their performances were to deteriorate, it could impair the quality of our services. If our arrangement with any of these third parties was terminated or if a third party ceased operations, discontinued business or altered the terms on which it does business with us, we might not be able to find an alternative provider on a timely basis or on reasonable terms, which would adversely affect our operating results.

We have grown rapidly, and we must manage additional growth and the demands on our resources and personnel in order to be successful.

We began operations in October 1999 and have grown rapidly since that time. Our growth has resulted, and any future growth will result, in increased responsibility for our management and increased demands on our resources. Our business strategy is based on the assumption that we will continue to retain qualified personnel who can expand our customer base and continue to develop and deliver innovative customer-driven solutions. We must continue to enhance and expand our business processes, information systems and operations to accommodate this growth. To manage future growth, we will need to:

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implement additional management information systems;

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retain qualified personnel to manage our operating, administrative, financial and accounting systems;

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maintain and expand our wireless service and device activation capacity;

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continue to train, motivate, manage and retain our existing employees and attract and integrate new employees;

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expand our sales force to sell our new and existing offerings; and

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maintain close coordination among our executive, information technology, accounting and finance, sales and operations organizations.

If we are unable to manage future expansion, our ability to provide a high quality customer experience could be harmed, which would damage our reputation and substantially harm our business and results of operations.

If we do not adequately protect our intellectual property, others could copy aspects of our services and operational technology, which could force us to become involved in expensive and time-consuming litigation.

Our ability to compete and continue to provide technological innovation is substantially dependent upon our technology. We rely on a combination of intellectual property laws and confidentiality agreements to protect our technology. We generally enter into confidentiality and nondisclosure agreements with our employees, consultants and prospective and existing marketers. In addition, we seek to control access to our proprietary information. Despite our efforts to protect our intellectual property, unauthorized parties may attempt to copy or otherwise obtain and use our services or technology. Although we are not aware of any unauthorized use of our intellectual property to date, effectively policing against the unauthorized use of our technology is time consuming and costly, and we cannot assure you that the steps taken by us will prevent misappropriation of our technology. Our failure to adequately protect our intellectual property rights could harm our business by making it easier for others to duplicate our services.

If we are unable to maintain the integration of our services with the wireless carriers’ existing credit and activation systems, we will be unable to process orders in a timely manner and our business may suffer.

To activate wireless services for customers, we rely on access to the wireless carriers’ proprietary credit and activation systems through direct data, online and telephone interfaces. If, as a result of technology enhancements

or upgrades of these systems by the wireless carriers, we are unable to integrate our services with these systems, we could be required to redesign or upgrade our information systems or software which could be costly and negatively affect our operating results. If we are unable to gain access to these systems, we would be unable to process orders, the wireless carriers could terminate their underlying agreements with us, and our business may suffer.

Our failure to protect our customers’ confidential information and our network against security breaches could damage our reputation and substantially harm our business and results of operations.

A significant barrier to online commerce is concern regarding the secure transmission of confidential information over public networks. Currently, a majority of our wireless service activations and device sales are billed to our customers’ credit card accounts directly. We rely on encryption and authentication technology licensed from third parties to securely transmit confidential information, including credit card numbers. Advances in computing capabilities, new discoveries in the field of cryptography or other developments may result in a compromise or breach of the technology used by us to protect customer transaction data. Although we are not aware of any security breaches, any compromise of our security could damage our reputation and expose us to a risk of loss or litigation and possible liability which would substantially harm our business and results of operations. Although we carry general liability insurance, our insurance may not cover potential claims of this type or may not be adequate to cover all costs incurred in defense of potential claims or to indemnify us for all liability that may be imposed. In addition, anyone who is able to circumvent our security measures could misappropriate proprietary information or cause interruptions in our operations. We may need to expend significant resources to protect against security breaches or to address problems caused by breaches.

If the technology we use infringes upon the proprietary rights of others, we may be forced to seek expensive licenses, reengineer our services, engage in expensive and time-consuming litigation or stop selling our services.

If we were to discover that our services violated or potentially violated the proprietary rights of others, we might not be able to obtain licenses to continue offering those services without substantial reengineering. Any reengineering effort may not be successful, nor can we be certain that any licenses would be available on commercially reasonable terms. Although we have not been named a party in any litigation concerning the infringement of another party’s rights, a claim of infringement against us, with or without merit, could be time consuming and expensive to litigate or settle, and could divert management’s attention from executing our business plan. An adverse determination against us could prevent us from offering our services. From time to time, we receive notices from others claiming we have infringed upon their intellectual property rights. The number of these claims may increase. Responding to these claims may require us to seek expensive licenses, reengineer our services, engage in expensive and time-consuming litigation or stop selling our services.

If we are unable to attract and retain management and key personnel, we may not be able to implement our business plan.

We believe that the successful implementation of our business plan will depend on our management team, particularly the chairman of our board of directors and our chief executive officer, David A. Steinberg. Losing the services of one or more members of our management team could adversely affect our business and our expansion efforts, and possibly prevent us from further improving our information management, financial and operational systems and controls. As we continue to grow, we may need to hire and retain qualified sales, marketing, administrative, operating and technical personnel with knowledge of the wireless services industry and online marketing, and to train and manage new personnel. We may not be able to identify and hire qualified personnel due to competition for such personnel. The failure to hire and retain these personnel would have an adverse effect on our business.

Our failure to identify and integrate successfully any businesses or technologies that we acquire may increase our costs and reduce our revenue.

As part of our business strategy, we continue to seek to expand our service offerings through investments in, or acquisitions of, other businesses or technologies that we believe are complementary to our business. Although we regularly engage in discussions relating to potential acquisitions, we may not be able to identify, negotiate or finance any future acquisitions. If we do identify acquisitions, it may be necessary for us to raise additional funds to finance those acquisitions. Additional funds may not be available on terms that are favorable to us, or at all. If we issue our stock as consideration, our stockholders would experience dilution of their percentage ownership in our stock. Upon completion of any acquisitions, we may be unsuccessful in integrating and operating such acquired businesses profitably or otherwise implementing our strategy successfully. If we are unable to integrate any newly-acquired entities or technologies effectively, our business and results of operations could suffer. The time and expense associated with finding suitable and compatible businesses, technologies or services could also disrupt our ongoing business and divert our management’s attention. In addition, we may be required to reduce the carrying amount on our balance sheet of any acquired intangible assets; this reduction would adversely affect our financial results in the period in which it occurs.

Vendors in India support our call center activities. Any difficulties experienced with these services could result in additional expense or loss of customers and revenue.

We have outsourcing agreements with vendors in India to provide additional call center support. As a result, we rely on these vendors to provide customer service and interface with our customers. If these vendors are unable to perform satisfactory customer service, we could lose customers and would have to pursue alternative strategies to provide these services, which could result in delays, interruptions, additional expense and loss of customers. A variety of proposed federal and state legislation, if enacted, could restrict or discourage U.S. companies from outsourcing their services to companies outside the U.S. This legislation, if enacted, may impact our ability to use internationally outsourced services to support our call center activities.

Risks Related to Our Industry

If the online market for wireless services and devices does not gain widespread acceptance, our business would suffer.

Our success will depend in part on our ability to attract consumers who have historically purchased wireless services and devices through traditional retail stores. Furthermore, we may have to incur significantly higher and more sustained advertising and promotional expenditures or price our products more competitively than we currently anticipate in order to attract additional online consumers and sell wireless services and devices to more customers. Specific factors that could deter consumers from purchasing wireless services and devices from us include:

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concerns about buying wireless devices without a face-to-face interaction with sales personnel and the ability to physically handle and examine the devices;

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pricing that does not meet their expectations;

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concerns about the security of online transactions and the privacy of personal information;

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delivery time associated with Internet orders;

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delayed shipments or shipments of incorrect or damaged products;

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inconvenience associated with returning or exchanging purchased items;

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inability to maintain good standing with business rating services;

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failure to provide a positive customer experience for consumers; and

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possible disruptions, computer viruses or other damage to the Internet servers or to the consumers’ computers.

We may be exposed to risks associated with credit card fraud and identity theft that could cause us to incur unexpected expenditures and loss of revenue.

Under current credit card practices, a merchant is liable for fraudulent credit card transactions when, as is the case with the transactions we process, that merchant does not obtain a cardholder’s signature. Any failure to prevent fraudulent credit card transactions would adversely affect our business and our revenue. We do not currently carry insurance to protect us against this risk. We do not receive any revenue from fraudulently placed orders. We bear the risk of future losses as a result of orders placed with fraudulent credit card data or fraudulent identity information, even though the associated financial institution approved payment of the orders.

Our net sales may be negatively affected if we are required to charge taxes on purchases.

We are not required to collect or are not subject to sales or other taxes related to the products we sell, except for certain corporate level taxes and sales taxes with respect to purchases by customers located in a limited number of states. However, one or more states or foreign countries may seek to impose sales or other tax collection obligations on us in the future. A successful assertion by one or more states or foreign countries that we should be collecting sales or other taxes on the sale of our products could result in substantial tax liabilities for past sales, discourage customers from purchasing products from us, decrease our ability to compete with traditional retailers or otherwise substantially harm our business and results of operations. Currently, decisions of the U.S. Supreme Court restrict the imposition of obligations to collect state and local sales and use taxes with respect to sales made over the Internet. However, a number of states, as well as the U.S. Congress, have been considering various initiatives that could limit or supersede the Supreme Court’s position regarding sales and use taxes on Internet sales. If any of these initiatives addressed the Supreme Court’s constitutional concerns and resulted in a reversal of its current position, we could be required to collect sales and use taxes in additional states. The imposition by state and local governments of various taxes upon Internet commerce could create administrative burdens for us, put us at a competitive disadvantage if they do not impose similar obligations on all of our online competitors and decrease our future sales.

Our ability to utilize net operating loss carryforwards to offset future taxable income may be limited.

As of September 30, 2006, we had approximately $138.7 million of federal and state net operating loss carryforwards. Under the provisions of the Internal Revenue Code, substantial changes in our ownership may limit the amount of net operating loss carryforwards that can be utilized annually in the future to offset taxable income. If such a change in our ownership occurs, our ability to use our net operating loss carryforwards in any fiscal year may be significantly limited under these provisions.

Government regulation of the Internet and e-commerce is evolving and unfavorable changes could substantially harm our business and results of operations.

We are subject to general business regulations and laws as well as regulations and laws specifically governing the Internet and e-commerce. Existing and future laws and regulations may impede the growth of the Internet or other online services. These regulations and laws may cover taxation, restrictions on imports and exports, customs, tariffs, user privacy, data protection, pricing, content, copyrights, distribution, electronic contracts and other communications, consumer protection, the provision of online payment services, broadband residential Internet access and the characteristics and quality of products and services. It is not clear how existing laws governing issues such as property ownership, sales and other taxes, libel and personal privacy apply to the Internet and e-commerce. Laws or regulations may be enacted that prohibit use of mass emails or similar marketing activities. We may not be able to support the marketing of our products and services by mass email or other online means if such activities are adverse to our business. Even if no relevant law or regulation is enacted, we may discontinue use or support of these activities if we become concerned that customers deem them intrusive or they otherwise adversely affect our goodwill. Unfavorable resolution of these issues may substantially harm our business and results of operations.

The wireless services industry may experience a decline in new subscriber growth rate.

The wireless services industry has faced an increasing number of challenges, including a slowdown in new subscriber growth. According to The Yankee Group, an independent research firm, the wireless subscriber market in the United States has grown an average of almost 18% per year from 1998 through 2005. The Yankee Group forecasts this growth rate will fall to an average of almost 5% per year through 2009. If the wireless services industry experiences a decline in subscribers, our business may suffer.

We may be unable to effectively market our wireless services if wireless carriers do not deliver acceptable wireless networks and service plans, which would cause our revenues to decline.

The success of our business depends on the capacity, affordability and reliability of wireless voice and data access provided by wireless carriers. Growth in demand for wireless voice and data services may be limited if wireless carriers fail to maintain sufficient capacity to meet demand for these services, delay the expansion of their wireless networks and services, fail to offer and maintain reliable wireless network services or fail to market their services effectively. We also depend on wireless carriers to provide credit verification and approval to activate wireless service for customers. If wireless carriers are unable to verify credit information in a timely manner, we may lose marketers and customers.

Use of wireless devices may pose health risks or cause injuries, which could increase our exposure to litigation and result in increased operating expenses.

Radio frequency emissions from wireless devices may be linked to various health concerns, including cancer, and may interfere with various electronic medical devices, including hearing aids and pacemakers. In addition, there have been recent reports that people have been injured by explosions of refurbished batteries in wireless devices. The actual or perceived risk of radio frequency emissions from wireless devices or the potential for battery explosions or other injuries could adversely affect our business through a decline in sales of wireless services and increased exposure to potential litigation.

Other Risks

The market price of our common stock has been and will likely continue to be subject to fluctuation.

We have a relatively short operating history and a rapidly evolving and unpredictable business model. The trading price of our common stock fluctuates significantly. Trading prices of our common stock may fluctuate in response to a number of events and factors, such as:

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quarterly and seasonal variations in operating results;

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changes in financial estimates and ratings by securities analysts;

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announcements by us or our competitors of new product and service offerings, significant contracts, acquisitions or strategic relationships;

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publicity about our company, our products and services, our competitors or e-commerce in general;

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additions or departures of key personnel;

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any future sales of our common stock or other securities; and

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stock market price and fluctuations in trading volume of publicly-traded companies in general and Internet-related companies and specialty retailers in particular.

The trading prices of Internet-related companies and e-commerce companies have been especially volatile. In the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities. We may be the target of similar litigation in the future. Securities

litigation could result in significant costs and divert management’s attention and resources, which could substantially harm our business and results of operations.

If securities or industry analysts do not continue to publish research or reports about our business, our stock price and trading volume could decline.

The trading market for our common stock will depend in part on the research and reports that securities or industry analysts publish about us or our business. If one or more of the analysts who covers us downgrades our stock, our stock price would likely decline. If one or more of these analysts ceases coverage of our company or fails to regularly publish reports on us, interest in the purchase of our stock could decrease, which could cause our stock price or trading volume to decline.

Anti-takeover provisions and other restrictions in our certificate of incorporation, bylaws and applicable law might discourage, delay or prevent a change of control of our company or changes in our management that our stockholders might find desirable.

Our certificate of incorporation and bylaws provide for, among other things:

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a classified board of directors;

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restrictions on the ability of our stockholders to call special meetings of stockholders;

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restrictions on the ability of our stockholders to act by written consent;

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restrictions on the ability of our stockholders to remove any director or the entire board of directors without cause;

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restrictions on the ability of our stockholders to fill a vacancy on the board of directors; and

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advance notice requirements for stockholder proposals.

These provisions may have the effect of delaying or preventing an acquisition of us or changes in our management, even if stockholders of our company deem such changes to be advantageous. In addition, our board of directors is permitted to authorize the issuance of undesignated capital stock without any vote or further action by the stockholders. Because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which prohibits us from engaging in a business combination with an interested stockholder for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. These provisions and other provisions of the Delaware General Corporation Law applicable to us may restrain large stockholders, in particular those owning 15% or more of our outstanding voting stock, from consummating a merger or business combination with us without the approval of the board of directors, even if doing so would benefit our stockholders.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND ISSUER PURCHASES OF EQUITY SECURITIES

During the quarter ended September 30, 2006, we issued the following securities that were not registered under the Securities Act of 1933:

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On August 24, 2006, we issued 214,899 shares of our common stock to RR Holding, Inc. (formerly known as VMC Satellite Inc.) in connection with the fulfillment of certain earn-out targets set forth in the Asset Purchase Agreement dated April 25, 2005 by and among InPhonic Inc.; CAIS Acquisition II, LLC, RR Holding, Inc. and Rick Rahim, as amended. We issued the common stock in reliance upon the exemptions provided for in Section 4(2) of the Securities Act, relating to sales not involving any public offering, and Rule 506 of the Securities Act relating to sales to accredited investors.

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On November 7, 2006 we issued warrants for the purchase of an aggregate of 1,250,000 shares of our common stock at an exercise price of $0.01 per share to our lenders in connection with our senior secured term loan.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS


Exhibit No.		Description
10.1	(1)	Cingular Wireless Non-Exclusive Dealer Agreement and Cingular Wireless Internet Dealer and master Dealer Addendum (the “Agreements”) with Cingular Wireless II, LLC (“Cingular”), effective October 1, 2006

10.2	(2)	Seventh Amendment to Third Amended and Restated Loan and Security Agreement entered into as of September 28, 2006 by and between Comerica Bank, InPhonic, Inc., SimIpc Acquisition Corp., Star Number, Inc., Mobile Technology Services, LLC and CAIS Acquisition II, LLC.

31.1		Rule 13a-14(a) Certification of Principal Executive Officer.

31.2		Rule 13a-14(a) Certification of Principal Financial Officer.

32.1		Section 1350 Certification of Chief Executive Officer.

32.2		Section 1350 Certification of Chief Financial Officer.

(1)	Confidential treatment requested as to certain portions of this Exhibit pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended, which portions are omitted and filed separately with the Securities and Exchange Commission.

(2)	Previously filed as an Exhibit to our Current Report on Form 8-K filed on October 4, 2006.

SIGNATURES

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


INPHONIC, INC.

By:		/s/ DAVID A. STEINBERG
		David A. Steinberg Chairman of the Board and Chief Executive Officer

By:		/s/ LAWRENCE S. WINKLER
		Lawrence S. Winkler Chief Financial Officer, Executive Vice President and Treasurer

Date: November 9, 2006

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Inphonic (INPC) Inactive 10-Q2006 Q3 Quarterly report

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