Local (LOCMQ) 10-Q 2006 Q1 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period endedMarch 31, 2006

o TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE EXCHANGE ACT

For the transition period from                      to                     

Commission File Number: 000-50989

INTERCHANGE CORPORATION

(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of
incorporation or organization) 33-0849123
(I.R.S. Employer
Identification No.)

One Technology Drive, Building G
Irvine, CA 92618
(Address of principal executive offices)

(949) 784-0800
(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant is 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 o                Accelerated filer o                Non-accelerated filer þ

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

Number of shares outstanding at April 30, 2006: Common: 9,232,509
Preferred:      0

INTERCHANGE CORPORATION
TABLE OF CONTENTS

	Page
PART I – FINANCIAL INFORMATION
Item 1.Financial Statements.
Consolidated Balance Sheets as of March 31, 2006 (Unaudited) and December 31, 2005		3
Consolidated Statements of Operations for the three months ended March 31, 2006 and 2005 (Unaudited)		4
Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2006 and 2005 (Unaudited)		5
Consolidated Statements of Cash Flows for the three months ended March 31, 2006 and 2005 (Unaudited)		6
Notes to Consolidated Financial Statements (Unaudited)		7
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations.		14
Item 3.Quantitative and Qualitative Disclosures About Market Risk.		17
Item 4.Controls and Procedures.		18
PART II – OTHER INFORMATION
Item 1.Legal Proceedings.		19
Item 1A.Risk Factors.		19
Item 2.Unregistered Sales of Equity Securities and Use of Proceeds.		28
Item 3.Defaults Upon Senior Securities.		28
Item 4.Submission of Matters to a Vote of Security Holders.		28
Item 5.Other Information.		28
Item 6.Exhibits		28
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1

2

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements.

INTERCHANGE CORPORATION

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

	March 31,			December 31,
	2006			2005
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	1,752		$	1,075
Restricted cash		10			10
Marketable securities		10,270			13,244
Accounts receivable, net of allowances of $15 and $30, respectively		1,198			1,138
Prepaid expenses and other current assets		376			377
Total current assets		13,606			15,844
Property and equipment, net		2,497			2,772
Intangible assets, net		3,523			3,760
Goodwill		12,445			12,445
Long-term restricted cash		166			166
Deposits		47			47
Total assets	$	32,284		$	35,034
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	1,552		$	1,798
Accrued compensation		386			347
Deferred rent		543			575
Accrued royalties		478			496
Other accrued liabilities		776			631
Notes payable		56			84
Deferred revenue		332			295
Total liabilities, all current		4,123			4,226
Minority interest		(1	)		(1	)
Commitments and contingencies
Stockholders’ equity:
Convertible preferred stock, $0.00001 par value; 10,000,000 shares authorized; none issued and outstanding for all periods presented		—			—
Common stock, $0.00001 par value; 30,000,000 shares authorized; 9,232,509 and 9,171,944 issued and outstanding, respectively		—			—
Additional paid-in capital		49,826			48,706
Accumulated comprehensive loss		(135	)		(151	)
Accumulated deficit		(21,529	)		(17,746	)
Stockholders’ equity		28,162			30,809
Total liabilities and stockholders’ equity	$	32,284		$	35,034

See accompanying notes to the consolidated financial statements.

3

INTERCHANGE CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(Unaudited)

	Three months ended
	March 31,
	2006			2005
Revenue	$	3,151		$	5,911
Operating expenses:
Search serving		1,580			3,176
Sales and marketing		2,467			1,338
General and administrative		1,804			961
Research and development		950			556
Amortization of intangibles		237			51
Total operating expenses		7,038			6,082
Operating loss		(3,887	)		(171	)
Interest and other income		105			314
Income (loss) before income taxes		(3,782	)		143
Provision for income taxes		1			12
Net income (loss)	$	(3,783	)	$	131
Per share data:
Basic net income (loss) per share	$	(0.41	)	$	0.02
Diluted net income (loss) per share	$	(0.41	)	$	0.01
Basic weighted average shares outstanding		9,211,044			7,989,608
Diluted weighted average shares outstanding		9,211,044			9,765,291

See accompanying notes to the consolidated financial statements.

4

INTERCHANGE CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)

(Unaudited)

	Three months ended
	March 31,
	2006			2005
Net income (loss)	$	(3,783	)	$	131
Other comprehensive income (loss):
Foreign currency translation adjustments		(6	)		(1	)
Unrealized gain (loss) on marketable securities		22			(117	)
Total comprehensive income (loss)	$	(3,767	)	$	13

See accompanying notes to the consolidated financial statements.

5

INTERCHANGE CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

	Three months ended
	March 31,
	2006			2005
Cash flows from operating activities:
Net income (loss)	$	(3,783	)	$	131
Adjustments to reconcile net income (loss) to cash (used in ) provided by operating activities:
Depreciation and amortization		522			180
Provision for doubtful accounts		(15	)		5
Non-cash stock based compensation		915			9
Non-cash interest income		(1	)		(3	)
Changes in operating assets and liabilities:
Accounts receivable		(45	)		70
Prepaid expenses and other		1			(136	)
Other non-current assets		—			(1	)
Accounts payable and accrued liabilities		(112	)		270
Deferred revenue		37			(12	)
Net cash (used in) provided by operating activities		(2,481	)		513
Cash flows from investing activities:
Capital expenditures		(10	)		(1,557	)
Purchases of marketable securities		—			(6,982	)
Proceeds from sales of marketable securities		2,997			3,032
Acquisition, net of cash acquired		—			(13,743	)
Net cash provided by (used in) investing activities		2,987			(19,250	)
Cash flows from financing activities:
Proceeds from issuance of common stock from exercise of options		170			218
Proceeds from issuance of common stock from exercise of warrants		38			—
Payment of notes payable		(28	)		—
Payment of financing related costs		(3	)		(112	)
Net cash provided by financing activities		177			106
Effect of currency changes on cash		(6	)		(1	)
Net increase (decrease) in cash and cash equivalents		677			(18,632	)
Cash and cash equivalents, beginning of period		1,075			24,617
Cash and cash equivalents, end of period	$	1,752		$	5,985
Supplemental cash flow information:
Interest paid	$	2		$	—
Income taxes paid	$	1		$	—

See accompanying notes to the consolidated financial statements.

6

INTERCHANGE CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of presentation

The unaudited interim consolidated financial statements as of March 31, 2006 and for the three months ended March 31, 2006 and 2005, included herein, have been prepared by the Company, without audit, pursuant to rules and regulations of the Securities and Exchange Commission, and, in the opinion of management, reflect all adjustments (consisting of only normal recurring adjustments), which are necessary for a fair presentation. The results of operations for the three months ended March 31, 2006 are not necessarily indicative of the results for the full year. The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2005 included in the Company’s Form 10-KSB filed with the Securities and Exchange Commission.

Certain reclassifications have been made to the prior year’s consolidated financial statements to conform to current year’s presentation. Non-cash equity based expense of $9,000 for the three months ended March 31, 2005, is included in general and administrative expense. Payroll taxes payable of $34,000 as of December 31, 2005, is included in accrued compensation.

2. Significant accounting policies

Principles of consolidation

The Company’s consolidated financial statements include the accounts of Interchange Corporation, its wholly owned subsidiaries, Interchange Europe Holding Corporation, Interchange Internet Search GmbH, Inspire Infrastructure 2i AB, and Inspire Infrastructure (UK) Limited, along with its majority owned subsidiary Inspire Infrastructure Espana SL. All intercompany balances and transactions have been eliminated.

Foreign currency translation

The Company measures the financial statements for its foreign subsidiaries using the local currency as the functional currency. Current assets and current liabilities of these subsidiaries are translated at the exchange rate as of the balance sheet date, while long-term items are translated at historical rates. Revenues, costs and expenses are translated at the rates prevailing during the year. Translation adjustments from this process are included in stockholders’ equity. Any gains or losses from foreign currency transactions are included in other income.

Intangible assets

Developed technology arising from acquisitions is recorded at cost and amortized on a straight-line basis over five years. Accumulated amortization at March 31, 2006 was $483,817.

Non-compete agreements arising from acquisitions are recorded at cost and amortized on a straight-line basis over three years. Accumulated amortization at March 31, 2006 was $93,150.

Purchased technology arising from acquisitions is recorded at cost and amortized on a straight-line basis over three years. Accumulated amortization at March 31, 2006 was $333,906.

Goodwill

Goodwill representing the excess of the purchase price over the fair value of the net tangible and intangible assets arising from acquisitions and purchased domain name are recorded at cost. Intangible assets, such as goodwill and domain name, which are determined to have an indefinite life, are not amortized in accordance with SFAS No. 142,Goodwill and Other Intangible Assets. The Company performs annual impairment reviews during the fourth fiscal quarter of each year, or earlier, if indicators of potential impairment exist. The Company performed its annual impairment analysis in December 2005 and determined that no impairment existed. Future impairment reviews may result in charges against earnings to write-down the value of non-amortized assets.

7

Stock-based compensation

In December 2004, the Financial Accounting Standard Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123R,Share-Based Payment, which addresses the accounting for employee stock options. SFAS No. 123R requires that the cost of all employee stock options, as well as other equity-based compensation arrangements, be reflected in the financial statements based on the estimated fair value of the awards. That cost will be 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 Company adopted SFAS No. 123R on January 1, 2006, the beginning of its first quarter of fiscal 2006, using the modified-prospective transition method. Under the modified-prospective transition method prior periods of the Company’s financial statements are not restated for comparison purposes. In addition, the measurement, recognition and attribution provisions of SFAS No. 123R apply to new grants and grants outstanding on the adoption date. Estimated compensation expense for outstanding grants at the adoption date will be recognized over the remaining vesting period using the compensation expense calculated for the pro forma disclosure purposes under SFAS No. 123,Accounting for Stock-Based Compensation.

Total stock-based compensation expense recognized for the three months ended March 31, 2006 is as follows (in thousands, except per share amount):

	Three months ended
	March 31, 2006
Sales and marketing	$	172
General and administrative		670
Research and development		73
Total stock-based compensation expense	$	915
Basic and diluted net compensation expense per share	$	0.10

The fair values of these options were estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions:

Risk-free interest rate		4.47	%
Expected lives (in years)		8.3
Expected dividend yield	None
Expected volatility		83.83	%

Prior to the adoption of SFAS No. 123R the Company accounted for stock-based employee compensation under the recognition and measurement principles of Accounting Principles Board Opinion (APB) No. 25,Accounting for Stock Issued to Employeesand the disclosure requirements of SFAS No. 123 and related SFAS No. 148,Accounting for Stock-Based Compensation – Transition and Disclosure.

8

The following table illustrates the pro forma effect of the fair value recognition of stock-based compensation on net income (loss) and net income (loss) per share for the three months ended March 31, 2005 (in thousands, except per share amounts):

	Three months ended
	March 31, 2005
Net income, as reported	$	131
Add: Stock-based compensation expense recorded in accordance with APB No. 25		—
Deduct: Additional stock-based employee compensation expense determined under the fair value based method for all awards, net of tax effects		(1,096	)
Pro forma net loss	$	(965	)
Net income (loss) per share:
Basic – as reported	$	0.02
Basic – pro forma	$	(0.12	)
Net income (loss) per share:
Diluted – as reported	$	0.01
Diluted – pro forma	$	(0.12	)

Net income (loss) per share

SFAS No. 128,Earnings per Share, establishes standards for computing and presenting earnings per share. Basic net income (loss) per share is calculated using the weighted average shares of common stock outstanding during the periods. Diluted net income (loss) per share is calculated using the weighted average number of common and potentially dilutive common shares outstanding during the period, using the as-if converted method for convertible preferred stock, convertible secured debentures and convertible secured promissory notes, and the treasury stock method for options and warrants.

For the three months ended March 31, 2006, potentially dilutive securities, which consist of options to purchase 1,519,841 shares of common stock at prices ranging from $0.40 to $16.59 per share and warrants to purchase 1,228,184 shares of common stock at prices ranging from $2.00 to $25.53 per share were not included in the computation of diluted net income per share because such inclusion would be antidilutive.

For the three months ended March 31, 2005, potentially dilutive securities, which consist of options to purchase 264,900 shares of common stock at prices ranging from $11.37 to $16.59 per share and warrants to purchase 164,400 shares of common stock at $25.53 per share were not included in the computation of diluted net income per share because such inclusion would be antidilutive.

9

The following table sets forth the computation of basic and diluted net income (loss) per share for the periods indicated (in thousands, except per share amounts):

	Three months ended
	March 31,
	2006			2005
Numerator:
Net income (loss)	$	(3,783	)	$	131
Denominator:
Denominator for basic calculation weighted average shares		9,211			7,990
Dilutive common stock equivalents:
Options		—			799
Warrants		—			976
Denominator for diluted calculation weighted average shares		9,211			9,765
Net income (loss) per share:
Basic net income (loss) per share	$	(0.41	)	$	0.02
Diluted net income (loss) per share	$	(0.41	)	$	0.01

3. Composition of certain balance sheet captions

Property and equipment consisted of the following (in thousands):

	March 31,			December 31,
	2006			2005
Furniture and fixtures	$	195		$	195
Office equipment		94			93
Computer equipment		1,756			1,754
Computer software		1,176			1,169
Leasehold improvements		580			580
		3,801			3,791
Less accumulated depreciation and amortization		(1,304	)		(1,019	)
Property and equipment, net	$	2,497		$	2,772

Intangible assets consisted of the following (in thousands):

	March 31,			December 31,
	2006			2005
Developed technology	$	2,233			2,233
Non-compete agreements		261			261
Purchased technology		1,239			1,239
Domain name		701			701
		4,434			4,434
Less accumulated amortization		(911	)		(674	)
Intangible assets, net	$	3,523		$	3,760

10

4. Operating segment information

SFAS No. 131,Disclosures about Segments of an Enterprise and Related Information(SFAS No. 131), requires that public business enterprises report certain information about operating segments. The Company manages its business in two geographic segments: United States and Europe. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the Company’s chief operating decision-maker, or decision-making group, in deciding how to allocate resources and in assessing performance. Management believes that revenue and operating income are appropriate measures of evaluating the operational performance of the Company’s segments.

The following table presents summary operating segment information (in thousands):

	Three month ended
	March 31,
	2006			2005
Revenue by segment:
United States	$	3,092		$	5,810
Europe		59			101
Total revenue	$	3,151		$	5,911
Operating income (loss) by segment:
United States	$	(3,766	)	$	(192	)
Europe		(121	)		21
Total operating income (loss)	$	(3,887	)	$	(171	)

	March 31,		December 31,
	2006		2005
Total assets by segment:
United States	$	32,111	$	34,843
Europe		173		191
Total assets	$	32,284	$	35,034

5. Stock option plans

1999 Plan

In March 1999, the Company adopted the 1999 Equity Incentive Plan (1999 Plan). The 1999 Plan provides for the grant of non-qualified and incentive stock options to employees, directors and consultants of options to purchase share of the Company’s stock. Options are granted at exercise prices equal to the fair market value of the common stock on the date of grant. Generally, twenty-five percent of the options are available for exercise at the end of nine months, while the remainder of the grant is exercisable ratably over the next twenty-seven month period, provided the optionee remains in service to the Company. The Company has reserved 500,000 shares for issuance under the 1999 Plan, of which 183,404 were outstanding and 27,924 were available for future grant at March 31, 2006.

2000 Plan

In March 2000, the Company adopted the 2000 Equity Incentive Plan (2000 Plan). The 2000 Plan provides for the grant of non-qualified and incentive stock options to employees, directors and consultants of options to purchase shares of the Company’s common stock. Options are granted at exercise prices equal to the fair market value of the common stock on the date of grant. Generally, twenty-five percent of the options are available for exercise at the end of nine months, while the remainder of the grant is exercisable ratably over the next twenty-seven month period, provided the optionee remains in service to the Company. The Company has reserved 500,000 shares for issuance under the 2000 Plan, of which 334,308 were outstanding and 30,915 were available for future grant at March 31, 2006.

11

2004 Plan

In January 2004, the Company adopted the 2004 Equity Incentive Plan (2004 Plan), in August 2004, the Company amended the 2004 Plan and in September 2004, the stockholders of the Company approved the 2004 Plan, as amended. The 2004 Plan provides for the grant of non-qualified and incentive stock options to employees, directors and consultants of options to purchase shares of the Company’s common stock. Options are granted at exercise prices equal to the fair market value of the common stock on the date of grant. Generally, twenty-five percent of the options are available for exercise at the end of nine months, while the remainder of the grant is exercisable ratably over the next twenty-seven month period, provided the optionee remains in service to the Company. The Company has reserved 600,000 shares for issuance under the 2004 Plan, of which 432,148 were outstanding and 72,422 were available for future grant at March 31, 2006.

2005 Plan

In August 2005, the Company adopted and the stockholders of the Company approved the 2005 Equity Incentive Plan (2005 Plan). The 2005 Plan provides for the grant of non-qualified and incentive stock options to employees, directors and consultants of options to purchase shares of the Company’s common stock. Options are granted at exercise prices equal to the fair market value of the common stock on the date of grant. Generally, thirty-three percent of the options are available for exercise at the end of one year, while the remainder of the grant is exercisable ratably quarterly over the next eight quarters, provided the optionee remains in service to the Company. The Company has reserved 1,000,000 shares for issuance under the 2005 Plan, of which 569,981 were outstanding and 418,019 were available for future grant at March 31, 2006.

Stock option activity under the plans during the three months ended March 31, 2006 is as follows:

				Weight Average
	Shares			Exercise Price
Outstanding at December 31, 2005		1,339,360		$	5.95
Granted		327,417			4.62
Exercised		(42,293	)		4.01
Cancelled		(104,643	)		6.49
Outstanding at March 31, 2006		1,519,841		$	5.68
Exercisable at March 31, 2006		804,298		$	5.06

12

Stock option summary information for the plans at March 31, 2006 is as follows:

	Options Outstanding						Options Exercisable
			Weighted
			Average		Weighted				Weighted
			Remaining		Average				Average
			Contractual		Exercise				Exercise
Range of Exercise Prices	Shares		Life		Price		Shares		Price
$0.00 – $1.00		26,250		1.8	$	0.40		26,250	$	0.40
$1.01 – $2.00		175,000		6.8	$	2.00		175,000	$	2.00
$2.01 – $3.00		170,278		7.7	$	2.25		120,973	$	2.25
$3.01 – $4.00		356,309		6.9	$	3.93		210,392	$	4.00
$4.01 – $5.00		55,000		9.9	$	4.21		—	$	—
$5.01 – $6.00		204,250		9.5	$	5.63		88,841	$	5.66
$6.01 – $7.00		134,064		9.5	$	6.39		42,593	$	6.38
$7.01 – $8.00		186,500		9.4	$	7.52		—	$	—
$8.01 – $10.00		70,000		9.2	$	9.17		54,996	$	9.21
$15.01 – $16.59		142,190		8.2	$	15.49		85,253	$	15.46
		1,519,841		8.1	$	5.68		804,298	$	5.06

6. Warrants

Warrant activity during the three months ended March 31, 2006 is as follows:

				Weight Average
	Shares			Exercise Price
Outstanding at December 31, 2005		1,279,575		$	8.13
Exercised		(34,099	)		3.77
Expired		(17,292	)		3.61
Outstanding at March 31, 2006		1,228,184		$	8.31
Exercisable at March 31, 2006		1,228,184		$	8.31

Warrant summary information at March 31, 2006 is as follows:

	Warrants Outstanding						Warrants Exercisable
			Weighted
			Average		Weighted				Weighted
			Remaining		Average				Average
			Contractual		Exercise				Exercise
Range of Exercise Prices	Shares		Life		Price		Shares		Price
$0.00 – $2.99		750		0.1	$	2.00		750	$	2.00
$3.00 – $3.99		443,283		2.3	$	3.56		443,283	$	3.56
$4.00 – $5.99		289,001		1.2	$	4.00		289,001	$	4.00
$8.00 – $9.99		15,000		1.5	$	8.00		15,000	$	8.00
$10.00 – $19.99		315,750		3.6	$	10.00		315,750	$	10.00
$20.00 – $25.53		164,400		3.8	$	25.53		164,400	$	25.53
		1,228,184		2.5	$	8.31		1,228,184	$	8.31

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

This Quarterly Report on Form 10-Q or certain information included or incorporated by reference in this report, contains or may contain forward-looking statements that involve risks, uncertainties and assumptions. All statements, other than statements of historical fact, are statements that could be deemed “forward- looking statements” within the meaning of the federal securities laws. In addition, important factors to consider in evaluating such forward-looking statements include changes or developments in social, economic, market, legal or regulatory circumstances, changes in our business or growth strategy or an inability to execute our strategy due to changes in our industry or the economy generally, the emergence of new or growing competitors, the actions or omissions of third parties, including customers, competitors and governmental authorities, and various other factors. Should any one or more of these risks or uncertainties materialize, or the underlying estimates or assumptions prove incorrect, our actual results could differ materially from those expressed in the forward-looking statements and there can be no assurance that the forward-looking statements contained in this report will in fact occur.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the attached consolidated financial statements and related notes thereto, and with the audited consolidated financial statements and related notes thereto as of December 31, 2005 and for the year ended December 31, 2005 included in our Annual Report on Form 10-KSB filed with the Securities and Exchange Commission on March 22, 2006.

Overview

We provide paid-search advertising services to local and national businesses on the Internet. Our services enable businesses to list their products and services in our distributed Internet search results. Our sponsored listings are derived from our Advertiser Network, which includes our direct advertisers as well as indirect advertisers from other paid-search and directory companies. We supply these aggregated sponsored listings to our own Local.com web site and our Distribution Network, which is a network of web sites and search engines that integrate our search results into their web sites, in response to targeted keyword searches performed by Internet users on those web sites.

On March 7, 2006, we issued a press release announcing that we have retained investment banking firm Merriman Curhan Ford & Co. to assist in reviewing strategic alternatives available to us in connection with our national search business. Merriman Curhan Ford & Co. will help our Board of Directors analyze options including, but not limited to, the combination, sale or merger of the national search business with another entity. Our resources are currently being utilized almost entirely on developing our products and services to address the needs of the local search market.

Stock-based compensation

In December 2004, the Financial Accounting Standard Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123R,Share-Based Paymentwhich addresses the accounting for employee stock options. SFAS No. 123R requires that the cost of all employee stock options, as well as other equity-based compensation arrangements, be reflected in the financial statements based on the estimated fair value of the awards. That cost will be 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).

We adopted SFAS No. 123R on January 1, 2006, the beginning of our first quarter of fiscal 2006, using the modified-prospective transition method. Under the modified-prospective transition method prior periods of our financial statements are not restated for comparison purposes. In addition, the measurement, recognition and attribution provisions of SFAS No. 123R apply to new grants and grants outstanding on the adoption date. Estimated compensation expense for outstanding grants at the adoption date will be recognized over the remaining vesting period using the compensation expense calculated for the pro forma disclosure purposes under SFAS No. 123,Accounting for Stock-Based Compensation.

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Total stock-based compensation expense recognized for the three months ended March 31, 2006 is as follows (in thousands, except per share amount):

	Three months ended
	March 31, 2006
Sales and marketing	$	172
General and administrative		670
Research and development		73
Total stock-based compensation expense	$	915
Basic and diluted net compensation expense per share	$	0.10

Results of Operations

The following table sets forth our historical operating results as a percentage of revenue for the periods indicated and is derived from our unaudited financial statements, which, in the opinion of our management, reflect all adjustments that are of a normal recurring nature, necessary to present such information fairly:

	Three months ended
	March 31,
	2006			2005
Revenue		100.0	%		100.0	%
Operating expenses:
Search serving		50.1			53.7
Sales and marketing		78.3			22.6
General and administrative		57.3			16.3
Research and development		30.1			9.4
Amortization of intangibles		7.5			0.9
Total operating expenses		223.3			102.9
Operating loss		(123.3	)		(2.9	)
Interest and other income		3.3			5.3
Income (loss) before income taxes		(120.0	)		2.4
Provision for income taxes		0.0			0.2
Net income (loss)		(120.0	)%		2.2	%

Three months ended March 31, 2006 and 2005

Revenue

Revenue was $3.2 million and $5.9 million for the three months ended March 31, 2006 and 2005, respectively, representing a decrease of $2.8 million or 46.7%.

Revenue from our national business was $2.0 million or 63.7% of our total revenue, revenue from our local business was $1.1 million or 34.4% of our total revenue and revenue from our local international business was $59,000 or 1.9% of our total revenue for the three months ended March 31, 2006.

Revenue from our national business was $5.8 million or 96.8% of our total revenue, revenue from our local business was $87,000 or 1.5% of our total revenue and revenue from our local international business was $101,000 or 1.7% of our total revenue for the three months ended March 31, 2005.

We derived 28.4% of our revenue from direct advertisers and 71.6% of our revenue from our Advertiser Network partners during the three months ended March 31, 2006, as compared to 57.1% of our revenue from direct advertisers and 42.9% from Advertiser Network partners during the three months ended March 31, 2005. Our national Advertiser Network partner, LookSmart, represented 24.7% and 29.5% of our total revenue for the three months ended March 31, 2006 and 2005, respectively, and our local Advertising Network partner, Yahoo, represented 27.8% and 0% of our total revenue for the three months ended March 31, 2006 and 2005, respectively.

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No Distribution Network partner represented greater than 10% of our revenue for the three months ended March 31, 2006 or 2005.

The decrease in our total revenue was primarily due to a decreased number of revenue-generating click-throughs from our national business as a result of our efforts to improve traffic quality by applying more stringent filtering criteria to click-throughs from our national Distribution Network. The decrease was partially offset by an increase in click-throughs from our local business as a result of our launch of Local.com in August 2005. Additionally, national advertisers have reduced overall spending with us resulting in lower revenue for the three months ended March 31, 2006. We expect revenue from our national business to continue to decline, revenues from our local business to increase, the percentage of revenue from our Advertiser Network partners to increase and the percentage of revenue from our direct advertisers to decrease as we continue to transition away from national services in order to focus on local search. We derive 100% of our local revenue from our Advertiser Network partners.

Search serving

Search serving expenses were $1.6 million and $3.2 million for the three months ended March 31, 2006 and 2005, respectively, representing a decrease of $1.6 million or 50.3%. As a percentage of revenue, search serving expenses were 50.1% and 53.7% for the three months ended March 31, 2006 and 2005, respectively. The decrease in search serving expense was due to decreased payments to our Distribution Network partners associated with our lower national business revenue in the current period.

Sales and marketing

Sales and marketing expenses were $2.5 million and $1.3 million for the three months ended March 31, 2006 and 2005, respectively, representing an increase of $1.1 million or 84.4%. As a percentage of revenue, sales and marketing expenses were 78.3% and 22.6% for the three months ended March 31, 2006 and 2005, respectively. The increase in absolute dollars was primarily due to an increase in advertising expenses for our Local.com web site along with the non-cash stock based compensation expense as a result of the adoption of SFAS No. 123R.

General and administrative

General and administrative expenses were $1.8 million and $961,000 for the three months ended March 31, 2006 and 2005, respectively, representing an increase of $843,000 or 87.7%. As a percentage of revenue, general and administrative expenses were 57.3% and 16.3% for the three months ended March 31, 2006 and 2005, respectively. The increase in absolute dollars was primarily due to the non-cash stock based compensation expense as a result of the adoption of SFAS No. 123R.

Research and development

Research and development expenses were $950,000 and $556,000 for the three months ended March 31, 2006 and 2005, respectively, representing an increase of $394,000 or 70.9%. As a percentage of revenue, research and development expenses were 30.1% and 9.4% for the three months ended March 31, 2006 and 2005, respectively. The increase in absolute dollars was primarily due to an increase in salaries and related personnel costs as a result of an increase in research and development headcount to develop and support our local search services along with the non-cash stock based compensation expense as a result of the adoption of SFAS No. 123R.

Amortization of intangibles

Amortization of intangibles expense was $237,000 and $51,000 for three months ended March 31, 2006 and 2005, respectively. This includes the amortization of developed technology and non-compete agreements associated with the Inspire acquisition, along with the amortization of purchased technology associated with the Atlocal asset purchase.

Interest and other income

Interest and other income was $105,000 and $314,000 for the three months ended March 31, 2006 and 2005, respectively, representing a decrease of $209,000. This decrease was due to lower interest income as a result of less cash to invest.

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Provision for income taxes

Provision for income taxes was $1,000 and $12,000 for the three months ended March 31, 2006 and 2005 respectively. These amounts represent the minimum amounts required for state income taxes.

Net income (loss)

We had a net loss of $(3.8 million) and net income of $131,000 for the three months ended March 31, 2006 and 2005, respectively.

Liquidity and Capital Resources

We have funded our business, to date, primarily from issuances of equity and debt securities. Cash and cash equivalents were $1.8 million as of March 31, 2006 and $1.1 million as of December 31, 2005. Marketable securities were $10.3 million as of March 31, 2006 and $13.2 million as of December 31, 2005. We had working capital of $9.2 million as of March 31, 2006 and $11.6 million as of December 31, 2005.

Net cash (used in) provided by operations was $(2.5 million) and $513,000 for the three months ended March 31, 2006 and 2005, respectively. The decrease in cash provided by operations was due to a decrease in net income partially offset by an increase in non-cash stock option expense.

Net cash provided by (used in) investing activities was $3.0 million and $(19.3 million) for the three months ended March 31, 2006 and 2005, respectively. Investing activity for the three months ended March 31, 2005 included the acquisition of Inspire Infrastructure 2i AB.

Net cash provided by financing activities was $177,000 and $106,000 for the three months ended March 31, 2006 and 2005, respectively. During the three months ended March 31, 2006, we raised gross proceeds of $170,000 from the exercise of stock options and $38,000 from the exercise of warrants.

Management believes, based upon projected operating needs, that our working capital is sufficient to fund our operations for at least the next 12 months.

Inspire Infrastructure 2i AB acquisition

On February 28, 2005, we completed the acquisition, through a wholly owned subsidiary, of all of the outstanding capital stock of Inspire Infrastructure 2i AB (Inspire), a Swedish Internet and wireless local-search technology company. Under the terms of the acquisition, Inspire shareholders received $15.0 million in cash and cash acquisition costs of $409,000. Under the terms of the acquisition, Inspire shareholders can receive additional consideration consisting of up to 447,067 shares of our common stock, valued at $7.5 million based upon a 30-day moving average at the date of acquisition, which is payable upon the achievement of certain future business performance criteria.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to our investors.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

We are exposed to market risk relating to interest rate changes and foreign currency fluctuations.

Interest Rate Risk

Our exposure to interest rate changes relates to our marketable securities. We invest our excess cash in debt instruments of the U. S. government.

Investments in fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due to these factors, our future investment income may fall

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short of expectations due to changes in interest rates or we may suffer losses in principal if forced to sell securities which have declined in market value due to changes in interest rates. A hypothetical 1.00% (100 basis-point) increase in interest rates would have resulted in a decrease in the fair values of our marketable securities of approximately $2.4 million and $3.2 million at March 31, 2006 and December 31, 2005.

Foreign Currency Risk

We have minimal risk related to foreign currency fluctuations. Less than 2% of our revenues are from sources outside the United States and all sales in the United States are denominated in U.S. dollars. We have subsidiaries in Sweden, Austria, Spain and the United Kingdom; therefore, we are subject to exchange rate risk related to the translation and consolidation of our subsidiaries’ financial statements.

Item 4. Controls and Procedures

We maintain disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and that our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by Rule 13a-15(b) and 15d-15(b) under the Exchange Act, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the fiscal quarter covered by this Report. Based upon the foregoing, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective in reaching a level of reasonable assurance in achieving our desired control objectives.

There have been no significant changes in our internal controls over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings.

None

Item 1A. Risk Factors.

Investing in our common stock involves a high degree of risk. You should carefully consider the risks described below with all of the other information included or incorporated by reference in this Report when evaluating our business or making a decision to invest in our stock. If any of the possible adverse events described below actually occur, our business, results of operations or financial condition would likely suffer. In such an event, the market price of our common stock could decline and you could lose all or part of your investment. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may also adversely affect our business, results of operations or financial condition.

If we are not successful with our transition from national search to local search, our financial condition will be materially affected.

Prior to 2005, we provided search services that benefited national advertisers which accounted for 100% of our revenue. During 2005, we began to transition away from national search services and to focus on local search. In 2005, our national business accounted for 93% of our revenue and our local business accounted for 7% of our revenue.

On March 7, 2006, we issued a press release announcing that we have retained investment banking firm Merriman Curhan Ford & Co. to assist in reviewing strategic alternatives available to us in connection with our national search business. Merriman Curhan Ford & Co. will help the Board of Directors analyze options including, but not limited to, the combination, sale or merger of the national search business with another entity. Our resources are currently being utilized almost entirely on developing our products and services to address the needs of the local search market.

By selling or discontinuing our national search business, our revenue will significantly decrease. If the revenue from our local search business is not sufficient to compensate for the decline, our financial condition will be materially affected.

If we are not successful with our Local.com initiative, our future financial performance may be affected.

In March 2005, we purchased the Local.com domain name. On August 9, 2005, we launched Local.com, a consumer facing destination web site specializing in local search. This site is our first consumer facing business and we intend to invest significant amounts of time and resources on Local.com We cannot assure you that we will be successful in growing revenue from local search, in attracting consumers or advertisers to Local.com, or in achieving a positive impact on our operational and financial performance with Local.com. If we are unable to attract consumers and/or advertisers to Local.com, our financial performance may be adversely affected.

We have historically incurred losses and expect to incur losses in the future, which may impact our ability to implement our business strategy and adversely affect our financial condition.

We have a history of losses. Although we achieved a net income of $1.5 million for the year ended December 31, 2004, we had a net loss of $6.5 million for the year ended December 31, 2005 and a net loss of $3.8 million for the three months ended March 31, 2006. We also had an accumulated deficit of $21.5 million at March 31, 2006 and expect to have a net loss for at least the next quarter. We have significantly increased our operating expenses by expanding our operations and increasing our level of capital expenditures in order to grow our business and further develop and maintain our services. Such increases in operating expense levels and capital expenditures may adversely affect our operating results if we are unable to immediately realize benefits from such expenditures. We cannot assure you that we will be profitable or generate sufficient profits from operations in the future. If our revenue does not grow, we may experience a loss in one or more future periods. We may not be able to reduce or maintain our expenses in response to any decrease in our revenue, which may impact our ability to implement our business strategy and adversely affect our financial condition.

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We face intense competition from larger, more established companies, as well as our own Advertiser Network partners, and we may not be able to compete effectively, which could reduce demand for our services.

The online paid-search market is intensely competitive. Our primary current competitors include Yahoo! Inc., Google Inc., our own Advertiser Network partners and online directories, such as Switchboard. Although we currently pursue a strategy that allows us to partner with a broad range of web sites and search engines, our current and future partners may view us as a threat to their own internal paid-search services. Nearly all of our competitors have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial, marketing and other resources than we do. Our competitors may secure more favorable revenue sharing arrangements with network distributors, devote greater resources to marketing and promotional campaigns, adopt more aggressive growth strategies and devote substantially more resources to web site and systems development than we do. In addition, the search industry has experienced consolidation, including the acquisitions of companies offering paid-search services. Industry consolidation has resulted in larger, more established and well-financed competitors with a greater focus on paid-search services. If these industry trends continue, or if we are unable to compete in the paid-search market, our financial results may suffer.

Additionally, larger companies such as Google and Microsoft Corporation may implement technologies into their search engines or software that make it less likely that consumers can reach, or execute searches on, Local.com or our Distribution Network partners’ web sites and less likely to click-through on our Advertiser Network partners’ sponsored listings. The implementation of such technologies could result in a decline in click-throughs to our advertisers’ sponsored listings, which would decrease our revenues. If we are unable to successfully compete against current and future competitors or if our current Advertising Network partners choose to rely more heavily on their own distribution networks in the future, our operating results will be adversely affected.

We rely on our Advertiser Network partners to provide us access to their advertisers, and if they do not, it could have an adverse impact on our business.

We rely on our Advertiser Network partners to provide us with advertiser listings so that we can distribute these listings to Local.com or our Distribution Network partners in order to generate revenue when a consumer click-through occurs on our Advertiser Network partners’ sponsored listings. For the three months ended March 31, 2006, 72% of our revenue was derived from our Advertiser Network partners. In addition, 100% of our revenues from Local.com are derived from our Advertiser Network partners. Most of our agreements with our Advertiser Network partners are short-term, and, as a result, they may discontinue their relationship with us or negotiate new terms that are less favorable to us, at any time, with little or no notice. Our success depends, in part, on the maintenance and growth of our Advertiser Network partners. If we are unable to develop or maintain relationships with these partners, our operating results and financial condition will suffer.

We are dependent on our Distribution Network partners to provide us with search traffic, and if they do not, our business could be harmed.

We rely on our Distribution Network partners, a network of web sites and search engines with which we have contracts, to provide us with consumer search traffic. Historically, nearly all of our search traffic has come from our Distribution Network partners. Our Distribution Network partners are very important to our revenue and results of operations. Any adverse change in our relationships with key Distribution Network partners could have a material adverse impact on our revenue and results of operations because our sponsored listings would be placed on fewer web sites and search engines in response to consumer search requests. Our agreements with these Distribution Network partners are short-term, and as a result, our Distribution Network partners may discontinue their relationship with us or negotiate new terms that are less favorable to us, at any time, with little or no notice. If we are unable to maintain relationships with our current Distribution Network partners or develop relationships with prospective Distribution Network partners, our operating results and financial condition will suffer. In addition, if our Distribution Network does not grow and improve over time, current and prospective advertisers may reduce or terminate their business with us. Any decline in the number of our Distribution Network partners could adversely affect the value of our services.

Our executive officers and certain key personnel are critical to our success, and the loss of these officers and key personnel could harm our business.

Our performance is substantially dependent on the continued services and performance of our executive officers and other key personnel. We have employment agreements with our three executive officers: Heath B. Clarke (Chief Executive Officer and Chairman of the Board), Stanley B. Crair (President and Chief Operating Officer) and Douglas S. Norman (Chief Financial Officer and Secretary) and five of our key personnel. Each of Messrs. Clarke, Crair and Norman’s employment agreements may be terminated with 30 days notice by either the executive or us. No key man

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life insurance has been purchased on any of Messrs. Clarke, Crair or Norman. Our performance also depends on our ability to retain and motivate our officers and key employees. The loss of the services of any of our officers or other key employees could have a material adverse effect on our business, prospects, financial condition and results of operations. Our future success also depends on our ability to identify, attract, hire, train, retain and motivate other highly skilled technical, managerial and marketing personnel. Competition for such personnel is intense, and we cannot assure you that we will be successful in attracting and retaining such personnel. The failure to attract and retain our officers or the necessary technical, managerial and marketing personnel could have a material adverse effect on our business, prospects, financial condition and results of operations.

The market for Internet and local search advertising services is in the early stages of development, and if the market for our services decreases it will have a material adverse effect on our business, prospects, financial condition and results of operations.

Internet marketing and advertising, in general, and paid-search, in particular, are in the early stages of development. Our future revenue and profits are substantially dependent upon the continued widespread acceptance, growth, and use of the Internet and other online services as effective advertising mediums. Many of the largest advertisers have generally relied upon more traditional forms of media advertising and have only limited experience advertising on the Internet. Local search, in particular, is still in an early stage of development and may not be accepted by consumers for many reasons including, among others, that consumers may conclude that local search results are less relevant and reliable than non-paid-search results, and may view paid-search results less favorably than search results generated by non-paid-search engines. If consumers reject our paid-search services, or commercial use of the Internet generally, and the number of click-throughs on our sponsored listings decreases, the commercial utility of our search services could be adversely affected.

We expect that our anticipated future growth, including through potential acquisitions, may strain our management, administrative, operational and financial infrastructure, which could adversely affect our business.

We anticipate that significant expansion of our present operations will be required to capitalize on potential growth in market opportunities. This expansion has placed, and is expected to continue to place, a significant strain on our management, operational and financial resources. We expect to add a significant number of additional key personnel in the future, including key managerial and technical employees who will have to be fully integrated into our operations. In order to manage our growth, we will be required to continue to implement and improve our operational and financial systems, to expand existing operations, to attract and retain superior management, and to train, manage and expand our employee base. We cannot assure you that we will be able to effectively manage the expansion of our operations, that our systems, procedures or controls will be adequate to support our operations or that our management will be able to successfully implement our business plan. If we are unable to manage growth effectively, our business, financial condition and results of operations could be materially adversely affected.

On February 28, 2005, we completed the acquisition, through a wholly owned subsidiary, of all of the outstanding capital stock of Inspire Infrastructure 2i AB, a Swedish Internet and wireless local-search technology company. In the future, we may choose to expand our operations or market presence by pursuing acquisitions of complementary business, services or technologies or engage in other strategic alliances with third parties. Any such transactions would be accompanied by the risks commonly encountered in such transactions, including, among others, the difficulty of assimilating operations, technology and personnel of the combined companies, the potential disruption of our ongoing business, the inability to retain key technical and managerial personnel, the inability of management to maximize our financial and strategic position through the successful integration of acquired businesses, additional expenses associated with amortization of acquired intangible assets, the maintenance of uniform standards, controls and policies and the impairment of relationships with existing employees and customers. We have limited experience in these types of acquisitions, and we may not be successful in overcoming these risks or any other potential problems. As a result, any acquisition may have a material adverse effect on our business, prospects, financial condition and results of operations.

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On February 28, 2005, we completed the acquisition, through a wholly-owned subsidiary, of all of the outstanding capital stock of Inspire Infrastructure 2i AB, a Swedish Internet and wireless local-search technology company. We may not be able to successfully integrate Inspire Infrastructure 2i AB’s operations with our own or realize the anticipated benefits of the transaction.

On February 28, 2005, we acquired Inspire Infrastructure 2i AB in a share purchase transaction. Under the terms of the agreement, we paid Inspire shareholders $15 million in cash plus additional consideration consisting of up to 447,067 shares of Interchange common stock which are payable upon the achievement of certain business performance criteria in the future. Achieving the benefits we expect from the acquisition will depend in large part on integrating our technology, operations and personnel in a timely and efficient manner to minimize the impact on customers, employees and management. Integrating Inspire Infrastructure 2i AB into our business will be a complex, time consuming and costly process. Failure to timely and successfully integrate the two companies may have a material adverse effect on the combined company’s business, financial condition and results of operations. The difficulties of combining the companies has presented challenges to the combined company’s management, including:

• coordinating expanded business operations in additional geographic areas;

• integrating personnel with diverse backgrounds and organizational cultures;

• coordinating sales and marketing functions;

• retaining key employees, customers or suppliers;

• preserving the other important relationships of Inspire 2iAB and Interchange; and

• consolidating other corporate and administrative functions.

The combined company is exposed to other risks that are commonly associated with transactions similar to the acquisition, such as unanticipated liabilities and costs, some of which may be material, and diversion of management’s attention. As a result, we cannot assure you that we will realize any of the anticipated benefits of the acquisition, including anticipated cost savings, and failure to do so could adversely affect the business of the combined company.

We may incur impairment losses related to goodwill and other intangible assets which could have a material and adverse effect on our financial results.

As a result of our acquisition of Inspire Infrastructure 2i AB, the purchase of Local.com domain name, and the Atlocal asset purchase, we have recorded substantial goodwill and intangible assets in our consolidated financial statements. During the year ended December 31, 2005, due to the deterioration of revenues in Europe since the acquisition of Inspire in February 2005, we believed that the carrying amount for customer contracts and relationships was impaired. The carrying amount of customer contracts and relationships exceeded the sum of the undiscounted cash flows expected and as a result, we wrote-down the remaining unamortized balance of $337,000. We are required to perform impairment reviews of our goodwill and other intangible assets, which are determined to have an indefinite life and are not amortized. Such reviews are performed annually or earlier if indicators of potential impairment exist. We performed our annual impairment analysis in December 2005 and determined that no impairment existed. Future impairment reviews may result in charges against earnings to write-down the value of intangible assets.

We may be subject to intellectual property claims that create uncertainty about ownership of technology essential to our business and divert our managerial and other resources.

There has been a substantial amount of litigation in the technology industry regarding intellectual property rights. We cannot assure you that third parties will not, in the future, claim infringement by us with respect to our current or future services, trademarks or other proprietary rights. Our success depends, in part, on our ability to protect our intellectual property and to operate without infringing on the intellectual property rights of others in the process. There can be no guarantee that any of our intellectual property will be adequately safeguarded, or that it will not be challenged by third parties. We may be subject to patent infringement claims or other intellectual property infringement claims that would be costly to defend and could limit our ability to use certain critical technologies.

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We may also become subject to interference proceedings conducted in the patent and trademark offices of various countries to determine the priority of inventions. The defense and prosecution, if necessary, of intellectual property suits, interference proceedings and related legal and administrative proceedings is costly and may divert our technical and management personnel from their normal responsibilities. We may not prevail in any of these suits. An adverse determination of any litigation or defense proceedings could cause us to pay substantial damages, including treble damages if we willfully infringe, and, also, could put our patent applications at risk of not being issued.

Furthermore, because of the substantial amount of discovery required in connection with intellectual property litigation, there is a risk that some of our confidential information could be compromised by disclosure during this type of litigation. In addition, during the course of this kind of litigation, there could be public announcements of the results of hearings, motions or other interim proceedings or developments in the litigation. If investors perceive these results to be negative, it could have an adverse effect on the trading price of our common stock.

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

We may be exposed to risks associated with our international operations, which may adversely affect our business.

Our business strategy includes expanding our operations internationally, particularly relating to our Local.com services. We have very limited prior experience operating in foreign jurisdictions. Conducting international operations subjects us to new risks that we have not generally faced in the United States. These risks and uncertainties include:

• localization of our services, including translation into foreign languages;

• unexpected changes in foreign regulatory requirements, including Internet and technology regulations;

• longer accounts receivable payment cycles and difficulties in collecting accounts receivable;

• difficulties managing and staffing international operations;

• potentially adverse tax consequences, including foreign tax systems and restrictions on the repatriation of earnings;

• maintaining and servicing computer hardware in distant locations;

• complying with a wide variety of foreign laws and different legal standards; and

• reduced or varied protection for intellectual property rights in some countries.

The occurrence of any one of these risks could negatively affect our proposed international business and, consequently, our results of operations.

We may be subject to lawsuits for information displayed on our web sites and the web sites of our advertisers, which may affect our business.

Laws relating to the liability of providers of online services for activities of their advertisers and for the content of their advertisers’ listings are currently unsettled. It is unclear whether we could be subjected to claims for defamation, negligence, copyright or trademark infringement or claims based on other theories relating to the information we publish on our web sites or the information that is published across our Distribution Network. These types of claims have been brought, sometimes successfully, against online services as well as other print publications in the past. We may not successfully avoid civil or criminal liability for unlawful activities carried out by our advertisers. Our potential liability for unlawful activities of our advertisers or for the content of our advertisers’ listings could require us to implement measures to reduce our exposure to such liability, which may require us, among other things, to spend substantial resources or to discontinue certain service offerings. Our insurance may not adequately protect us against these types of claims and the defense of such claims may divert the attention of our management from our operations. If we are subjected to such lawsuits, it may adversely affect our business.

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Government and legal regulations may damage our business.

We are not currently subject to direct regulation by any government agency, other than regulations generally applicable to Internet businesses, and there are currently few significant laws or regulations directly applicable to access to or commerce on the Internet. It is possible, however, that a number of laws and regulations may be adopted with respect to the Internet, covering issues such as the positioning of sponsored listings on search results pages. For example, the Federal Trade Commission, or FTC, has recently reviewed the way in which search engines disclose paid-search practices to Internet users. In 2002, the FTC issued guidance recommending that all search engine companies ensure that all paid-search results are clearly distinguished from non-paid results, that the use of paid-search is clearly and conspicuously explained and disclosed and that other disclosures are made to avoid misleading users about the possible effects of paid-search listings on search results. The adoption of laws or regulations relating to placement of paid search advertisements or user privacy, defamation or taxation may inhibit the growth in use of the Internet, which in turn, could decrease the demand for our services and increase our cost of doing business or otherwise have a material adverse effect on our business, prospects, financial condition and results of operations. Any new legislation or regulation, or the application of existing laws and regulations to the Internet or other online services, could have a material adverse effect on our business, prospects, financial condition and results of operations.

If we do not deliver traffic that converts into revenue for advertisers, then the advertisers may pay us less for their listing or discontinue listings with us.

For our services to be successful, we need to deliver consumers to advertisers’ web sites that convert into sales for the advertiser. If we do not meet advertisers’ expectations by delivering quality traffic, then they may reduce their bid prices or cease doing business with us, which may adversely affect our business and financial results.

If we fail to detect click-through fraud, we could lose the confidence of our advertisers, thereby causing our business to suffer.

We are exposed to the risk of fraudulent or illegitimate clicks on our sponsored listings. If fraudulent clicks are not detected, the affected advertisers may experience a reduced return on their investment in our advertising programs because the fraudulent clicks will not lead to revenue for the advertisers. As a result, our advertisers may become dissatisfied with our advertising programs, which could lead to loss of advertisers and revenue.

Failure to adequately protect our intellectual property and proprietary rights could harm our competitive position.

Our success is substantially dependent upon our proprietary technology, which relates to a variety of business and transactional processes associated with our paid-search advertising model, our Keyword DNA technology and our LocalConnect search and advertising platform. We rely on a combination of patent, trademark, copyright and trade secret laws, as well as confidentiality agreements and technical measures, to protect our proprietary rights. Although we have filed patent applications and provisional patents on certain parts of our technology, much of our proprietary information may not be patentable, and we do not currently possess any patents. We cannot assure you that we will develop proprietary technologies that are patentable or that any pending patent applications will be issued or that their scope is broad enough to provide us with meaningful protection. We have registered the trademark ePilot and have applied for trademark registration of the LocalSense, Pay Per Connect and Keyword DNA trademarks in the United States and may claim trademark rights in, and apply for trademark registrations in the United States for a number of other marks. We cannot assure you that we will be able to secure significant protection for these marks. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our services or to obtain and use information that we regard as proprietary. We cannot assure you that our means of protecting our proprietary rights will be adequate or that our competitors will not independently develop similar technology or duplicate our services or design around patents issued to us or our other intellectual property rights. If we are unable to adequately protect our intellectual property and proprietary rights, our business and our operations could be adversely affected.

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We may experience downward pressure on our bid prices if advertisers do not obtain a competitive return on investment, which could have a material and adverse effect on our financial results.

We may experience downward pressure on our bid prices if advertisers do not obtain a favorable return on investment from our paid-search services in comparison to our competitors’ services or other advertising methods. We compete with other web search services, online publishers and high-traffic web sites, as well as traditional media such as television, radio and print, for a share of our advertisers’ total advertising expenditures. Many potential advertisers and advertising agencies have only limited experience advertising on the Internet and have not devoted a significant portion of their advertising expenditures to paid-search. Acceptance of paid-search marketing among advertisers will depend, to a large extent, on its perceived effectiveness and the continued growth of commercial usage of the Internet. If we experience downward pricing pressure for our services in the future, our financial results may suffer.

Two of our Advertiser Network partners have provided a substantial portion of our revenue; the loss of either of these partners may have a material adverse effect on our operating results.

Our Advertiser Network partner LookSmart, Ltd. represented 25% of our total revenue for the three months ended March 31, 2006. Our Advertiser Network partner Yahoo Inc. represented 28% of our total revenue for the three months ended March 31, 2006. It is difficult to predict whether LookSmart and Yahoo will continue to represent such a significant portion of our revenue in the future. Either partner may choose not to renew our agreement in the future or may choose to reduce the use of our paid-search services, in which case our business and financial results may be harmed.

Two customers account for a significant portion of our accounts receivable, and the failure to collect from those customers would harm our financial condition and results of operations.

While most of our customers pay for our services in advance, some do not. Two of our customers that do not pay in advance, LookSmart and Yahoo, have and will likely continue for the foreseeable future to account for a significant portion of our accounts receivable. At March 31, 2006, LookSmart represented 19% and Yahoo represented 48%, of our total accounts receivable. LookSmart’s and Yahoo’s accounts have been, and will likely continue to be, unsecured and any failure to collect on those accounts would harm our financial condition and results of operations.

Problems with our computer and communication systems may harm our business.

A key element of our strategy is to generate a high volume of traffic across our network infrastructure to and from our Advertiser and Distribution Network partners. Accordingly, the satisfactory performance, reliability and availability of our software systems, transaction-processing systems and network infrastructure are critical to our reputation and our ability to attract and retain advertising customers, as well as maintain adequate customer service levels. We may experience periodic systems interruptions. Any substantial increase in the volume of traffic on our software systems or network infrastructure will require us to expand and upgrade our technology, transaction-processing systems and network infrastructure. We cannot assure you that we will be able to accurately project the rate or timing of increases, if any, in the use of our network infrastructure or timely expand and upgrade our systems and infrastructure to accommodate such increases.

We rely on third party technology, server and hardware providers, and a failure of service by these providers could adversely affect our business and reputation.

We rely upon third party data center providers to host our main servers and expect to continue to do so. In the event that these providers experience any interruption in operations or cease operations for any reason or if we are unable to agree on satisfactory terms for continued hosting relationships, we would be forced to enter into a relationship with other service providers or assume hosting responsibilities ourselves. If we are forced to switch hosting facilities, we may not be successful in finding an alternative service provider on acceptable terms or in hosting the computer servers ourselves. We may also be limited in our remedies against these providers in the event of a failure of service. In the past, we have experienced short-term outages in the service maintained by one of our current co-location providers. We also rely on third party providers for components of our technology platform, such as hardware and software providers, credit card processors and domain name registrars. A failure or limitation of service or available capacity by any of these third party providers could adversely affect our business and reputation.

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State and local governments may be able to levy additional taxes on Internet access and electronic commerce transactions, which could result in a decrease in the level of usage of our services.

Beginning in 1998, the federal government imposed a moratorium on state and local governments’ imposition of new taxes on Internet access and eCommerce transactions, which has now expired. State and local governments may be able to levy additional taxes on Internet access and eCommerce transactions unless the moratorium is reinstituted. Any increase in applicable taxes may make eCommerce transactions less attractive for businesses and consumers, which could result in a decrease in eCommerce activities and the level of usage of our services.

The market price of our common stock has been and is likely to continue to be highly volatile, which could cause investment losses for our stockholders and result in stockholder litigation with substantial costs, economic loss and diversion of our resources.

Prior to our initial public offering, which was completed on October 22, 2004, there was no public trading market for our common stock. We cannot predict the extent to which investor interest will support an active and liquid trading market for our common stock.

In addition, the trading price of our common stock has been and is likely to continue to be highly volatile and could be subject to wide fluctuations as a result of various factors, many of which are beyond our control, including:

• developments concerning proprietary rights, including patents, by us or a competitor;

• market acceptance of our new and existing services and technologies;

• announcements by us or our competitors of significant contracts, acquisitions, commercial relationships, joint ventures or capital commitments;

• actual or anticipated fluctuations in our operating results;

• continued growth in the Internet and the infrastructure for providing Internet access and carrying Internet traffic;

• introductions of new services by us or our competitors;

• enactment of new government regulations affecting our industry;

• changes in the number of our Advertising and Distribution Network partners;

• seasonal fluctuations in the level of Internet usage;

• loss of key employees;

• institution of intellectual property litigation by or against us;

• success of our international expansion;

• changes in the market valuations of similar companies; and

• changes in our industry and the overall economic environment.

Due to the short-term nature of our Advertiser Network and Distribution Network partner agreements and the emerging nature of the paid-search market, we may not be able to accurately predict our operating results on a quarterly basis, if at all, which may lead to volatility in the trading price of our common stock. In addition, the stock market in general, and the Nasdaq Capital Market and the market for online commerce companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of the listed companies. These broad market and industry factors may seriously harm the market price of our common stock, regardless of our operating performance. In the past, following periods of volatility in the market, securities class action litigation has often been instituted against these companies. Litigation against us, whether or not

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a judgment is entered against us, could result in substantial costs, and potentially, economic loss, and a diversion of our management’s attention and resources. As a result of these and other factors, you may not be able to resell your shares above the price you paid and may suffer a loss on your investment.

Future sales of shares of our common stock that are eligible for sale by our stockholders may decrease the price of our common stock.

We had 9,232,509 shares of common stock outstanding on March 31, 2006. Of these shares, 1,518,616 are held by directors, executive officers and other affiliates and will be subject to volume limitations under Rule 144 under the Securities Act. In addition, there were outstanding options to purchase 1,519,841 shares of our common stock and warrants to purchase 1,228,184 shares of our common stock. Actual sales, or the prospect of sales by our present stockholders or by future stockholders, may have a negative effect on the market price of our common stock.

Anti-takeover provisions may limit the ability of another party to acquire us, which could cause our stock price to decline.

Our amended and restated certificate of incorporation, our amended and restated bylaws and Delaware law contain provisions that could discourage, delay or prevent a third party from acquiring us, even if doing so may be beneficial to our stockholders. In addition, these provisions could limit the price investors would be willing to pay in the future for shares of our common stock. The following are examples of such provisions in our amended and restated certificate of incorporation and in our amended and restated bylaws:

• special meetings of our stockholders may be called only by our Chief Executive Officer, by a majority of the members of our board of directors or by the holders of shares entitled to cast not less than 10% of the votes at the meeting;

• stockholder proposals to be brought before any meeting of our stockholders must comply with advance notice procedures;

• our board of directors is classified into three classes, as nearly equal in number as possible;

• newly-created directorships and vacancies on our board of directors may only be filled by a majority of remaining directors, and not by our stockholders;

• a director may be removed from office only for cause by the holders of at least 75% of the voting power entitled to vote at an election of directors;

• our amended and restated bylaws may be further amended by our stockholders only upon a vote of at least 75% of the votes entitled to be cast by the holders of all outstanding shares then entitled to vote generally in the election of directors, voting together as a single class; and

• our board of directors is authorized to issue, without further action by our stockholders, up to 10,000,000 shares of undesignated preferred stock with rights and preferences, including voting rights, designated from time to time by our board of directors.

We are also subject to Section 203 of the Delaware General Corporation Law, which provides, subject to enumerated exceptions, that if a person acquires 15% or more of our voting stock, the person is an “interested stockholder” and may not engage in “business combinations” with us for a period of three years from the time the person acquired 15% or more of our voting stock.

Our ability to utilize our net operating loss carryforwards and certain other tax attributes may be limited.

Under Section 382 of the Internal Revenue Code, if a corporation undergoes an “ownership change” (generally defined as a greater than 50% change (by value) in its equity ownership over a three-year period), the corporation’s ability to use its pre-change net operating loss carryforwards and other pre-change tax attributes against its post-change income may be limited. We believe that with our initial public offering, our recent private placement and other transactions that have occurred over the past three years, we have triggered an “ownership change” limitation. We have performed an analysis to determine to what extent our ability to utilize our net operating loss carryforwards is limited. We determined that our Section 382 limitation is $1.1 million a year. We may also experience ownership change in the

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future as a result of subsequent shifts in our stock ownership. As of December 31, 2005 we have net operating loss carryforwards of approximately $19.3 million and $19.2 million for federal and state income tax purposes, respectively.

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

In January 2006, we issued 3,080 shares of common stock for the net issuance exercise of 10,120 warrants held by an accredited and sophisticated investor.

In February 2006, we issued 3,712 shares of common stock for the net issuance exercise of 12,500 warrants held by an accredited and sophisticated investor.

The issuances of securities in the transactions described above were deemed exempt from registration under the Securities Act in reliance on Section 4(2).

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
Number	Description
31.1	Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	INTERCHANGE CORPORATION
May 12, 2006	/s/ Heath B. Clarke
Date	Heath B. Clarke
	Chief Executive Officer and Chairman
	/s/ Douglas S. Norman
	Douglas S. Norman
	Chief Financial Officer and Secretary

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EXHIBITS FILED WITH THIS REPORT

Exhibit
Number	Description
31.1	Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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