e10vq

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


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

For the quarterly period ended June 30, 2006


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

Commission File Number: 0-23137

aQuantive, Inc.

(Exact name of registrant as specified in its charter)


		Washington (State of Incorporation)		91-1819567 (I.R.S. Employer Identification Number)

821 Second Avenue, 18th Floor
Seattle, Washington 98104
(Address of principal executive offices)
(206) 816-8800
(Registrant’s telephone number, including area code)

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

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

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

The number of shares of the registrant’s Common Stock outstanding as of August 2, 2006 was 77,048,424.

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AQUANTIVE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
(unaudited)


	June 30,		December 31,
	2006		2005
Assets
Current assets:
Cash and cash equivalents	$	275,032	$	77,272
Short-term investments		32,580		35,617
Accounts receivable, net of allowances of $3,672 and $3,146, respectively		183,104		160,370
Other receivables		2,222		968
Prepaid expenses and other current assets		4,715		2,108
Deferred tax asset		5,416		5,416

Total current assets		503,069		281,751
Property and equipment, net		31,111		27,370
Goodwill		191,403		141,075
Other intangible assets, net		35,062		32,078
Other assets		1,067		1,245
Deferred financing costs, net		1,126		1,386
Deferred tax assets, net		23,964		23,755

Total assets	$	786,802	$	508,660

Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable	$	99,136	$	94,327
Accrued liabilities		47,794		38,976
Pre-billed media		36,175		18,254
Deferred rent, current portion		606		670
Deferred revenue		12,366		14,310

Total current liabilities		196,077		166,537
Long-term accrued liabilities		505		430
Notes payable		80,000		80,000
Deferred rent, less current portion		4,917		4,753

Total liabilities		281,499		251,720

Shareholders’ equity:
Common stock, $0.01 par value; 200,000 shares authorized 76,791 and 66,495 shares issued and outstanding, respectively		768		665
Paid-in capital		497,066		269,382
Retained earnings (accumulated deficit)		7,034		(12,918	)
Accumulated other comprehensive income (loss)		435		(189	)

Total shareholders’ equity		505,303		256,940

Total liabilities and shareholders’ equity	$	786,802	$	508,660

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

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE INCOME
(in thousands except per share amounts)
(unaudited)


	Three Months ended					Six Months ended
	June 30,					June 30,
	2006		2005			2006		2005
Revenue	$	105,629	$	77,189		$	197,814	$	142,186

Costs and expenses:
Cost of revenue		15,258		9,246			28,636		17,266
Client support		47,184		35,859			93,052		66,302
Product development		3,608		2,166			7,288		4,133
Sales and marketing		7,331		3,894			13,971		7,187
General and administrative		10,984		9,988			19,546		17,702
Amortization of intangible assets		2,149		1,803			4,185		3,606
Client reimbursed expenses		1,242		959			2,110		1,637

Total costs and expenses		87,756		63,915			168,788		117,833

Income from operations		17,873		13,274			29,026		24,353
Interest and other income, net		3,746		257			5,445		527
Interest expense		582		583			1,164		1,173

Income before provision for income taxes		21,037		12,948			33,307		23,707
Provision for income taxes		8,700		5,188			13,355		9,537

Net income	$	12,337	$	7,760		$	19,952	$	14,170

Basic net income per share	$	0.16	$	0.12		$	0.28	$	0.22

Diluted net income per share	$	0.15	$	0.11		$	0.25	$	0.20

Shares used in computing basic net income per share		76,157		63,438			72,207		63,020

Shares used in computing diluted net income per share		87,448		75,677			83,667		74,895

Comprehensive income:
Net income	$	12,337	$	7,760		$	19,952	$	14,170
Items of comprehensive income (loss)		640		(110	)		624		(129	)

Comprehensive income	$	12,977	$	7,650		$	20,576	$	14,041

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

AQUANTIVE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)


	Six months ended
	June 30,
	2006			2005
Cash flows from operating activities:
Net income	$	19,952		$	14,170
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		12,524			8,878
Stock-based compensation expense		9,625			46
Stock option income tax benefit		—			5,461
Excess tax benefit from stock-based compensation		(10,774	)		—
Foreign currency transaction loss		116			—
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable, net		(22,112	)		(27,856	)
Other receivables, prepaid expenses and other current assets		(3,805	)		(406	)
Other assets		186			(148	)
Accounts payable		4,741			8,480
Accrued liabilities		(825	)		4,150
Pre-billed media		17,920			157
Deferred rent		(63	)		375
Deferred revenue		(2,120	)		(1,266	)
Deferred taxes		10,490			3,186

Net cash provided by operating activities		35,855			15,227

Cash flows from investing activities:
Purchases of property and equipment		(10,988	)		(10,290	)
Proceeds from (purchases of) short term investments, net		2,499			(626	)
Acquisitions and acquisition earn-out payments, less cash received of $86 in 2006		(47,958	)		(1,573	)

Net cash used in investing activities		(56,447	)		(12,489	)

Cash flows from financing activities:
Proceeds from equity offering, net of issuance costs		198,317			—
Proceeds from exercises of common stock options and issuance of common stock under the ESPP		9,143			5,330
Excess tax benefit from stock-based compensation		10,774			—

Net cash provided by financing activities		218,234			5,330

Effect of exchange rate on cash and cash equivalents		118			—
Net increase in cash and cash equivalents		197,642			8,068
Cash and cash equivalents, beginning of period		77,272			24,555

Cash and cash equivalents, end of period	$	275,032		$	32,623

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

AQUANTIVE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2006
(in thousands except per share amounts)
(unaudited)

1. Organization and Operations of the Company

aQuantive, Inc., a Washington corporation, is a digital marketing services and technology company.

aQuantive is organized into three business units:

Digital Marketing Services (DMS). The DMS segment consists of Avenue A | Razorfish and DNA. Avenue A | Razorfish is an interactive agency which provides a full-service offering, including website development, interactive marketing and creative development and branding. Recently-acquired DNA, located in London, is also an interactive agency. Avenue A | Razorfish and DNA help clients use the Internet as an integrated online business channel to build one-to-one relationships with their customers — ranging from consumers and business customers, to partners and employees.

Digital Marketing Technologies (DMT). The DMT segment consists of Atlas, a provider of digital marketing technologies and expertise. Atlas’ software suite enables agencies and enterprise marketers to manage their entire digital marketing effort, including planning campaigns, displaying ads, and optimizing their websites. In addition, select publishers utilize Atlas to manage digital advertising inventory.

Digital Performance Media (DPM). The DPM segment consists of DRIVEpm, U.K.-based MediaBrokers and Franchise Gator. Both DRIVEpm and MediaBrokers are performance media and behavioral targeting businesses. They serve as intermediaries between online publishers and advertisers by procuring online advertising inventory from publishers and reselling that inventory to advertisers on a highly targeted basis. Recently-acquired Franchise Gator is an extension of the performance media business, focused on the franchise industry, which addresses clients’ needs for online leads. Franchise Gator helps franchise marketers generate leads by presenting prospective franchisees with profiles of franchise opportunities and businesses from a variety of industry sectors, and in turn, providing franchisors with a cost-effective mode of franchise marketing.

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

These statements reflect all adjustments, consisting only of normal, recurring adjustments that, in the opinion of the Company’s management, are necessary for a fair presentation of the results of operations for the periods presented. Operating results for the three and six months ended June 30, 2006 and 2005 are not necessarily indicative of the results that may be expected for any subsequent quarter or for the year ending December 31, 2006. Certain information and footnote disclosures normally included in financial statements prepared in conformity with generally accepted accounting principles (GAAP) in the United States have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (SEC).

These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s audited financial statements and the accompanying notes for the years ended December 31, 2005, 2004, and 2003, as included in the Company’s Annual Report on Form 10-K filed with the SEC.

Reclassifications

Certain prior year amounts have been reclassified to conform to the 2006 presentation.

Use of Estimates in the Preparation of Financial Statements

The preparation of the consolidated financial statements requires management to make a number of estimates and assumptions relating to the reported amounts of assets and liabilities and 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 reporting period. Significant items subject to such estimates and assumptions include revenue, stock-based compensation expense, the carrying amount of property and equipment, intangible assets and goodwill, valuation allowances for receivables, deferred income tax assets and liabilities, state and city taxes, contingencies and obligations related to employee benefits. Actual results could differ from those estimates.

Change in Contingent Tax Liability

The Company’s estimated business tax contingent liability decreased by $1,900 during the first quarter of 2006 primarily due to a settlement with the City of Seattle for a business tax obligation for the fiscal years 1999 through 2002. During the three months ended March 31, 2006, a settlement payment of $527 was made and the remaining contingent liability was reversed and included as a component of general and administrative expense in the Condensed Consolidated Statement of Operations and Comprehensive Income. The Company is no longer under audit by the City of Seattle; however, certain periods are still open under the statute of limitations.

Revenue Recognition

The Company follows Staff Accounting Bulletin (SAB) 101, “Revenue Recognition in Financial Statements,” as updated by SAB 104, “Revenue Recognition” which outlines the basic criteria that must be met to recognize revenue and provides guidance for presentation of revenue and for disclosure related to revenue recognition policies in financial statements filed with the SEC. In addition, SAB 104 integrates the guidance in Emerging Issues Task Force Issue (EITF) 00-21, “Revenue Arrangements with Multiple Deliverables.” The Company also follows SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts”. In addition, the Company follows the final consensus reached by the EITF in July 2000 on EITF 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent.”

Digital Marketing Services. The Company’s digital marketing services business line, Avenue A | Razorfish, is an interactive advertising agency that helps its clients use the Internet as an integrated online business channel. Avenue A | Razorfish provides the following digital marketing services: customer-focused websites, enterprise websites, interactive marketing and creative development and branding.

Revenue from website development services are derived from either fixed fee consulting contracts or from time and materials consulting contracts. Revenues derived from fixed-fee consulting contracts are recognized as services are rendered using the percentage-of-completion method with progress-to-complete measured using labor hour inputs. Cost estimates on percentage-of-completion contracts are reviewed periodically with adjustments recorded in the period in which the revisions are made. Any anticipated losses on contracts are charged to operations as soon as they are determinable. Billings on uncompleted contracts may be greater than or less than the revenues recognized in the accompanying condensed consolidated financial statements. If billings are less than revenue recognized, they are recorded as unbilled receivables (an asset) and if billings are more than revenue recognized, they are recorded as deferred revenue (a liability). Revenues derived from time and materials consulting contracts are recognized as the services are performed. Unbilled receivables totaled $11,336 and $10,035 at June 30, 2006 and December 31, 2005, respectively.

Interactive marketing includes online media, search engine, email and analytics services. Avenue A | Razorfish earns fees for online media in three different ways depending on the contractual terms with the client. The majority of revenue is earned based on the dollar amount of advertising space purchased on behalf of its clients. The Company recognizes this revenue over the period of the campaign at the rate at which the advertising is delivered. Certain other contractual agreements with clients are structured such that interactive marketing services are priced and earned on an hourly rate which is applied to the hours worked on each client. In this case, revenue is recognized over the period of the campaign at the rate at which hours are worked. Revenue can also be earned based on a fixed fee consulting arrangement, which is earned based on the percentage-of-completion method described above.

In accordance with EITF 99-19, the Company recognizes most of its online media revenue under the net method, excluding the cost of media purchased for its clients. To generate revenue under the net method, the Company buys advertising space from publisher websites on behalf of its clients as an agent and earns fees based on the dollar amount of advertising space the Company purchases. Under net method contracts, the Company is only financially liable to the publishers for the amount collected from its clients. This creates a sequential liability for media purchases made on behalf of clients.

In December 2005, the Company acquired UK-based DNA. DNA recognizes online media revenue under the gross method, which consists of the gross value of DNA’s billings to its clients and includes the price of the advertising space that DNA purchases from websites to resell to its clients. This revenue is recorded under the gross method because, under its contracts with clients and publisher websites, DNA is the primary obligor to the arrangements and does not have sequential liability for media purchases. The price of advertising space purchased by DNA from websites to resell to its clients is also recorded as cost of revenue. The Company is currently in the process of renegotiating these contracts so that DNA will purchase media on behalf of its clients as an agent and will only be financially liable to the publishers for the amount collected from its clients in future periods. If the Company can successfully renegotiate these contracts, DNA will report revenue under the net method in future periods.

E-mail services are volume based, and revenue is generally recognized when impressions are delivered. The Company recognizes revenue from search engine marketing programs based on either volume or as a subscription. Revenue from the volume-based service is generally recognized when impressions are delivered and revenue from the subscription-based service is recognized ratably over the service period. Revenue is generally recognized for analytics services under a proportional performance method of accounting. It is the Company’s policy to recognize any loss on services as soon as management estimates indicate a loss will occur.

Digital Marketing Technologies. Atlas offers digital marketing technology solutions for advertising agencies, enterprise marketers (large companies who manage their own marketing programs) and publishers. Atlas provides agencies and enterprise marketers with online advertising campaign management, rich media, search engine marketing, and website optimization tools and services through the proprietary Atlas Digital Marketing Suite, which includes Atlas Media Console, Atlas Rich Media, Atlas Search and Atlas Site Optimization. Atlas Publisher is a technology product that enables select publishers to increase revenue by utilizing lower value and remnant inventory. Such services are recognized based on either volume or subscription except for Atlas Site Optimization which is recognized using a proportional performance method of accounting. Revenue from the volume-based services is recognized based on the volume in the period of usage. Revenue from subscription-based services is recognized ratably over the service period.

Digital Performance Media. DRIVEpm and MediaBrokers are online advertising networks that serve as intermediaries between online publishers and advertisers by procuring online advertising inventory primarily from publishers and reselling the inventory to advertisers on a highly-targeted basis.

DRIVEpm and MediaBrokers provide a broad array of variables that advertisers can use to target potential customers. The targeting offering is sold primarily on a Cost Per Thousand Impressions (CPM) basis. DRIVEpm and MediaBrokers also provide clients the ability to reach their customers on a Cost Per Action (CPA), Cost Per Click (CPC), CPM or a hybrid pricing structure.

Revenue for these offerings is volume-based and generally recognized based on the volume in the period of usage. In accordance with EITF 99-19, revenue generated from digital performance media is recognized under the gross method, which consists of the gross value of digital performance media’s billings to clients. This revenue is recorded under the gross method because under its contracts with clients and publisher websites, DRIVEpm and MediaBrokers are the primary obligors to the arrangements and do not have sequential liability for media purchases.

In May 2006, the Company acquired Franchise Gator, an extension of the performance media business which addresses clients’ needs for online leads in the franchise industry. Franchise Gator helps franchise marketers generate leads by presenting prospective franchisees with profiles of franchise opportunities and businesses from a variety of industry sectors, and in turn, providing franchisors with a mode of franchise marketing. Revenue for this offering is subscription-based and recognized ratably over the service period.

All Segments. For each of the Company’s lines of business, revenue is deferred in cases where the Company has not yet earned revenue but has billed the customer or received payment from the customer prior to providing the services. Revenue is recognized only when collection of the resulting receivable is reasonably assured.

Revenue also includes any reimbursements received from our clients related to expenses incurred by our employees in servicing our clients. Such expenses include airfare, mileage, meals and hotel stays. All reimbursable project expenses billed to customers are recorded as a component of revenues and all reimbursable project expenses incurred are recorded as a component of operating expenses.

The percentages of sales to customers representing 10% or more of consolidated revenues are as follows:


	For the three months						For the six months
	ended June 30,						ended June 30,
	2006			2005			2006			2005
Customer A		10	%		12	%		11	%		12	%

The customer that represents sales of 10% or more of consolidated revenues is included in the digital marketing services and digital marketing technologies segments, as defined by SFAS No. 131 “Disclosures about Segment of an Enterprise and Related Information.” At June 30, 2006 and 2005, there were no customers representing 10% or more of consolidated accounts receivable.

Stock-Based Compensation

The Company has adopted the provisions of SFAS No. 123(R), “Share-Based Payment” effective January 1, 2006. Prior to the adoption of SFAS No. 123(R), the Company applied Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (APB No. 25) and related interpretations, as permitted by SFAS No. 123, “Accounting for Stock-Based Compensation” in accounting for its stock option and employee stock purchase plans. Prior to the adoption of SFAS No. 123(R), stock-based compensation cost was recognized in the Statement of Operations when options granted under those plans had an exercise price less than the market value of the underlying common stock on the date of grant. The Company has adopted the fair value recognition provisions of SFAS No. 123(R) using the modified-prospective-transition method. Under that transition method, compensation cost recognized beginning January 1, 2006 includes (a) compensation cost for all stock-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all stock-based payments granted subsequent to January 1, 2006, 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 and we have not recorded a cumulative effect of change in accounting principle.

Prior to the adoption of SFAS No. 123(R), the Company presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows in the Statement of Cash Flows. SFAS No. 123(R) requires the cash flows from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows.

In November 2005, the Financial Accounting Standards Board (FASB) issued FASB Staff Position FAS No. 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards” (FSP FAS 123(R)-3). FSP FAS 123(R)-3 provides a practical exception to accounting requirements when a company adopts SFAS No. 123(R). SFAS No. 123(R) requires the calculation of a pool of excess tax benefits available to absorb tax deficiencies recognized subsequent to adopting SFAS No. 123(R) (the APIC Pool), assuming the company had been following the recognition provisions prescribed by SFAS No. 123. The Company has elected to adopt the guidance in FSP FAS 123 (R)-3 to calculate the APIC Pool effective January 1, 2006. The adoption of this guidance did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

As a result of adopting SFAS No. 123(R), the Company’s income before income taxes and net income for the three months ended June 30, 2006 was $4,876 and $2,974 lower, respectively, and for the six months ended June 30, 2006 was $9,625 and $5,871 lower, respectively, than if it had continued to account for share-based compensation under APB No. 25. Basic and diluted earnings per share for the three months ended June 30, 2006 is $0.04 and $0.03 lower, respectively, and $0.08 and $0.07 lower, respectively, for the six months ended June 30, 2006 than if the company had continued to account for share-based compensation under APB No. 25.

Recently Issued Accounting Pronouncements

In June 2006, FASB issued FASB Interpretation No. (FIN) 48, “Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109”, which 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 will be effective beginning January 1, 2007. We have not yet evaluated the impact of implementation on our consolidated financial statements.

3. Acquisition

Effective May 16, 2006, the Company acquired 100% of the outstanding interests of Franchise Gator, a performance media business focused on the franchise industry, located in Roswell, GA. The Company purchased Franchise Gator to extend its performance media business and address clients’ needs for online leads versus online sales. The Company purchased Franchise Gator for approximately $21,745 of which $19,655 was paid in cash upon closing and $2,090 will be paid one year from the acquisition once indemnity obligations are satisfied. The Company incurred $50 in transaction costs and acquired $86 in cash related to the acquisition. Additionally, subsequent to June 30, 2006, the Company paid the former owner of Franchise Gator $43 due to a post-closing requirement. Based on our preliminary purchase price allocation, the intangible assets acquired consist of $3,551 in tradename and $3,810 in customer relationships. Beginning May 16, 2006, the results of Franchise Gator are included in the consolidated results of the Company and the Franchise Gator service offering is included in the digital performance media segment.

4. Goodwill

Changes in the carrying amount of goodwill for the six months ended June 30, 2006 by segment are as follows:


			Acquisition/
			Purchase
			Accounting
			Adjustments/
			Foreign
	Balance as of		Currency		Balance as of
	June 30,		Translation		December 31,
	2006		Adjustments		2005
Digital marketing services	$	155,040	$	34,165	$	120,875
Digital marketing technologies		17,548		1,582		15,966
Digital performance media		18,815		14,581		4,234

	$	191,403	$	50,328	$	141,075

The net increase in goodwill during the six months ended June 30, 2006 is primarily due to the goodwill recorded in the digital marketing services segment as a result of a final contingency payment of $26,460 made to the former owner of i-Frontier during the three months ended March 31, 2006. Goodwill in the digital marketing service segment also increased by $7,603 due to the recognition of a contingent payment owed to the former owners of DNA in April 2006. The payment is due in September 2006 and is currently accrued on the Condensed Consolidated Balance Sheet as of June 30, 2006. Additionally, $14,411 of goodwill was recorded in the digital performance media segment as a result of the acquisition of Franchise Gator during the three months ended June 30, 2006.

5. Stock-Based Compensation

Stock Option Plans

The Company’s stock option plans consist of the 1998 Stock Incentive Compensation Plan, the 1999 Stock Incentive Compensation Plan, and the 2000 Stock Incentive Compensation Plan (the Plans). Shares reserved under the Plans consist of 126 shares in the 2000 Stock Incentive Compensation Plan, 13,336 shares in the 1999 Stock Incentive Compensation Plan, and 2,036 shares in the 1998 Stock Incentive Compensation Plan. Any shares of common stock available for issuance under the 1998 Stock Incentive Compensation Plan that are not issued under that plan may be added to the aggregate number of shares available for issuance under the 1999 Stock Incentive Compensation Plan. The Company’s Board of Directors or a committee thereof grants options at an exercise price of not less than the fair market value of the Company’s common stock at the date of grant. In addition, the Company determined that the 2000 Stock Incentive Plan will terminate when all awards outstanding under the 2000 Stock Incentive Compensation Plan as of December 11, 2002 have been exercised or have terminated or expired according to their terms. Accordingly, no new options will be granted under the 2000 Stock Incentive Compensation Plan. The Company has a policy of issuing new shares to satisfy option exercises and share awards.

Options granted under the Plans are exercisable at such times and under such conditions as determined by the Board of Directors, but the term of the options and the right of exercise may not exceed ten years from the date of grant. The stock options typically vest 20% after the first year and ratably over the following twelve quarters.

Nonvested Share Award

Under terms of a share award agreement with its CEO, the Company awarded a nonvested share grant of 115 shares of common stock in January 2006, which will vest over a period of 60 months based on his continued employment with the Company.

Employee Stock Purchase Plan

In 1999, the Board of Directors and shareholders approved the adoption of the Company’s 1999 Employee Stock Purchase Plan (the 1999 Purchase Plan). The Company has authorized a total of 2,540 shares of common stock for issuance under the 1999 Purchase Plan. The shares under the 1999 Purchase Plan increase annually starting on the first day of the Company’s fiscal year beginning in 2001 by an amount equal to the lesser of (i) 750 shares of common stock, (ii) 2% of the adjusted average common shares outstanding of the Company used to calculate fully diluted earnings per share for the preceding year, or (iii) a lesser amount determined by the Board of Directors. The 1999 Purchase Plan permits eligible employees to acquire shares of the Company’s common stock through periodic payroll deductions of up to 20% of base cash compensation. The price at which the common stock may be purchased is 85% of the lesser of the fair market value of the Company’s common stock on the first day of the applicable semi-annual offering period or on the last day of the respective purchase period. During the six months ended June 30, 2006 and 2005, employees purchased 164 and 193 shares, respectively, under the 1999 Purchase Plan. As of June 30, 2006, there were 966 shares available for purchase under the 1999 Purchase Plan.

Valuation of Awards

The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model. Expected volatilities were based on historical volatility of the Company’s stock and implied volatility from traded options on the Company’s stock. The expected term of options granted was derived from the analysis of various hypothetical settlement scenarios and represents the period of time that options granted are expected to be outstanding. The risk-free interest rate was the zero-coupon rate corresponding to the expected term of the option.

The fair value for options and share awards granted under the Company’s stock option plans was estimated at the date of grant using the Black-Scholes option-pricing model, assuming the following weighted average assumptions:


	Three Months ended						Six Months ended
	June 30,						June 30,
	2006			2005			2006			2005
Weighted average risk-free interest rate		4.90	%		3.91	%		4.48	%		3.98	%
Expected term, in years		4.1-7.2			4.5-8			4.1-7.2			4.5.-8
Weighted average expected volatility		61	%		99	%		63	%		102	%
Dividend yield		—			—			—			—

The fair value of the shares granted under the Company’s employee stock purchase plan was estimated using the Black-Scholes option-pricing model with the following assumptions:


	Six Months ended
	June 30,
	2006			2005
Weighted average risk-free interest rate		4.53	%		2.36	%
Expected lives (in years)		0.5-1			0.5-1
Weighted average expected volatility		47.0	%		54.3	%
Dividend yield		—			—

As required under SFAS No. 123(R), stock-based compensation expense is recognized over the service period, net of estimated forfeitures. Forfeiture estimates are based on historical data. To the extent actual results or revised estimates differ from the estimates used, such amounts will be recorded as a cumulative adjustment in the period that estimates are revised. Prior to the adoption of SFAS No. 123(R), forfeitures were recognized on an actual basis as allowed under SFAS No. 123.

Pro Forma Information for Periods Prior to the Adoption of SFAS No. 123(R)

Prior to the adoption of SFAS No. 123(R), the Company had elected to apply the disclosure-only provisions of SFAS No. 123 and SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure, an amendment of SFAS No. 123.” In accordance with the provisions of SFAS No. 123, the Company applied APB No. 25 and related interpretations in accounting for its stock option and employee stock purchase plans. Stock-based compensation expense of $28, net of tax, was recognized in the Condensed Consolidated Statement of Operations and Comprehensive Income for the three and six months period ended June 30, 2005

due to the accelerated vesting of certain options. All options granted for the three and six months ended June 30, 2005 had an exercise price equal to the market value of the underlying common stock on the date of grant.

The following table summarizes relevant information as to reported results under the Company’s intrinsic value method of accounting for stock awards, with supplemental information as if the fair value recognition provisions of SFAS No. 123 had been applied. For purposes of this pro forma disclosure, the value of the options is estimated using a Black-Scholes option-pricing model and amortized as expense over the option’s vesting periods.


	Three Months			Six Months ended
	ended June 30, 2005			June 30, 2005
Net income, as reported	$	7,760		$	14,170
Add: Stock-based employee compensation expense included in reported net income, net of tax		28			28
Deduct: Total stock-based compensation determined under fair value based method for all awards, net of tax effect of $1,669 and $2,706, respectively		(2,610	)		(4,233	)

Pro forma net income, fair value method for all stock-based awards	$	5,178		$	9,965

Basic net income per share:
As reported	$	0.12		$	0.22
Pro forma	$	0.08		$	0.16
Diluted net income per share:
As reported	$	0.11		$	0.20
Pro forma	$	0.07		$	0.14

Impact of the Adoption of 123(R)

The Company has adopted the provisions of SFAS No. 123(R), “Share-Based Payment” effective January 1, 2006. Accordingly, stock-based compensation expense was recognized for all option grants, nonvested stock awards and shares granted under the employee stock purchase plan prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and all grants and awards subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R). Stock-based compensation expense is amortized on a straight-line basis over the remaining vesting period. Prior to the adoption of SFAS No. 123(R), stock-based compensation expense was amortized using an accelerated method.

The impact on results of continuing operations of recording stock-based compensation expense was as follows:


	Three Months		Six Months ended
	ended June 30, 2006		June 30, 2006
Cost of revenue	$	143	$	286
Client support		2,452		4,759
Product development		385		959
Sales and marketing		381		751
General and administrative		1,515		2,870

Total stock-based compensation expense		4,876		9,625
Total income tax benefit recognized for stock-based compensation expense		1,902		3,754

Total stock-based compensation expense, net of tax	$	2,974	$	5,871

Impact on net income per share:
Basic	$	0.04	$	0.08
Diluted	$	0.03	$	0.07

As of June 30, 2006, the total unrecognized compensation expense related to nonvested option grants, nonvested stock awards and shares granted under the employee stock purchase plan was $32,047, which is expected to be recognized over a weighted-average period of 2.1 years.

Award Activity

Option activity under the Plans was as follows:


						Weighted
				Weighted		Average
				Average		Remaining		Aggregate
	Options			Exercise		Contractual Term		Intrinsic
	Outstanding			Price		(Years)		Value
Balance, December 31, 2005		13,169		$	7.17
Granted		1,519			24.79
Exercised		(1,396	)		4.85
Forfeited and expired		(359	)		12.19

Balance, June 30, 2006		12,933			9.35		6.13	$	207,410

Exercisable at June 30, 2006		6,957			5.31		4.98	$	139,527

The aggregate intrinsic value in the table above represents the total pretax intrinsic value (i.e., the difference between the Company’s closing stock price on June 30, 2006 and the exercise price, times the number of shares) that would have been received by the option holders had all option holders exercised their options on June 30, 2006. The total intrinsic value of options exercised during the three months ended June 30, 2006 and 2005 were $16,044 and $11,148, respectively. The total intrinsic value of options exercised during the six months ended June 30, 2006 and 2005 was $29,473 and $15,227, respectively. The weighted average grant-date fair value of options granted during the three months ended June 30, 2006 and 2005 were $13.37 and $9.31, respectively. The weighted average grant-date fair value of options granted during the six months ended June 30, 2006 and 2005 was $13.22 and $9.46, respectively.

Cash received from option exercises was $6,771 for the six months ended June 30, 2006. The actual tax benefit realized from option exercises totaled $11,233 for the six months ended June 30, 2006.

Nonvested share activity under the Plans was as follows:


	Nonvested Shares
	Outstanding
Nonvested at December 31, 2005		—
Granted		115
Vested		(7	)
Forfeited and expired		—

Nonvested at June 30, 2006		108

The weighted average grant date fair value of nonvested shares outstanding as of June 30, 2006 was $25.24. The total fair value of share awards vested during the three and six months ended June 30, 2006 was $32 and $169, respectively.

6. Shareholders’ Equity

On March 15, 2006, the Company completed an equity offering of 7,500 shares of common stock at a purchase price of $24.00 per share. The total net proceeds from the equity offering were $172,300 after deduction of applicable issuance costs. In connection with the offering, the Company granted the underwriters an over-allotment option to purchase an additional 1,125 shares, which was exercised in full and closed on April 13, 2006. The total net proceeds from the offering, including net proceeds of $25,900 from the underwriters’ over-allotment shares, were approximately $198,200, after deducting applicable issuance costs. Changes in our shareholders’ equity during the six months ended June 30, 2006 were as follows:

7. Net Income Per Share

The following is a reconciliation of the numerators and denominators used in computing basic and diluted net income per share:


	Three Months ended					Six Months ended
	June 30,					June 30,
	2006			2005		2006			2005
Net income (numerator for basic)	$	12,337		$	7,760	$	19,952		$	14,170
Add: Interest expense on convertible notes, net of tax		354			355		707			714

Adjusted net income (numerator for diluted)	$	12,691		$	8,115	$	20,659		$	14,884

Shares (denominator for basic and diluted):
Gross weighted average common shares outstanding		76,266			63,438		72,316			63,020
Less: weighted average shares issued and unvested		(109	)		—		(109	)		—

Shares used in computation of basic net income per share		76,157			63,438		72,207			63,020
Add: Dilutive effect of employee stock options and stock awards		5,128			6,076		5,337			5,712
Add: Dilutive effect of convertible debt		6,163			6,163		6,163			6,163

Shares used in computation of diluted net income per share		87,448			75,677		83,667			74,895

Basic net income per share	$	0.16		$	0.12	$	0.28		$	0.22
Diluted net income per share	$	0.15		$	0.11	$	0.25		$	0.20

Using the “treasury stock method,” during the three months ended June 30, 2006 and 2005, 1,695 and 365, respectively, and during the six months ended June 30, 2006 and 2006, 1,279 and 819, respectively, weighted average common stock equivalent shares related to stock options were excluded from the calculation of diluted net income per share, as their effect is anti-dilutive.


	Digital		Digital		Digital		Unallocated
	Marketing		Marketing		Performance		Corporate
	Services		Technologies		Media		Expenses			Total
	Three Months ended June 30, 2005
Revenue	$	48,252	$	22,482	$	6,455	$	—		$	77,189
Costs and expenses:
Cost of revenue		—		5,378		3,676		192	(2)		9,246
Client support		34,836		—		1,023		—			35,859
Product development		—		2,166		—		—			2,166
Sales and marketing		1,082		2,618		194		—			3,894
General and administrative		4,223		2,295		409		3,061			9,988
Amortization of intangible assets		—		—		—		1,803			1,803
Client reimbursed expenses		959		—		—		—			959

Total costs and expenses		41,100		12,457		5,302		5,056			63,915

Income (loss) from operations	$	7,152	$	10,025	$	1,153	$	(5,056	)	$	13,274


	Digital			Digital		Digital		Unallocated
	Marketing			Marketing		Performance		Corporate
	Services			Technologies		Media		Expenses (3)			Total
	Six Months ended June 30, 2006
Revenue	$	119,276	(1)	$	57,352	$	21,186	$	—		$	197,814
Costs and expenses:
Cost of revenue		1,981	(1)		14,662		11,323		670	(2)		28,636
Client support		86,612			—		1,681		4,759			93,052
Product development		—			5,955		—		1,333			7,288
Sales and marketing		2,986			7,552		2,682		751			13,971
General and administrative		4,993			5,000		948		8,605			19,546
Amortization of intangible assets		—			—		—		4,185			4,185
Client reimbursed expenses		2,110			—		—		—			2,110

Total costs and expenses		98,682			33,169		16,634		20,303			168,788

Income (loss) from operations	$	20,594		$	24,183	$	4,552	$	(20,303	)	$	29,026


	Digital		Digital		Digital		Unallocated
	Marketing		Marketing		Performance		Corporate
	Services		Technologies		Media		Expenses			Total
	Six Months ended June 30, 2005
Revenue	$	87,339	$	43,123	$	11,724	$	—		$	142,186
Costs and expenses:
Cost of revenue		—		9,994		6,888		384	(2)		17,266
Client support		64,563		—		1,739		—			66,302
Product development		—		4,133		—		—			4,133
Sales and marketing		2,175		4,605		407		—			7,187
General and administrative		7,361		4,090		649		5,602			17,702
Amortization of intangible assets		—		—		—		3,606			3,606
Client reimbursed expenses		1,637		—		—		—			1,637

Total costs and expenses		75,736		22,822		9,683		9,592			117,833

Income (loss) from operations	$	11,603	$	20,301	$	2,041	$	(9,592	)	$	24,353

1)		DNA, acquired in December 2005, generates revenue that is recognized under the gross method of accounting. Accordingly, both revenue and cost of revenue include the cost of media purchased for DNA clients.

(2)		For both the three and six months ended June 30, 2006 and 2005, cost of revenue classified as unallocated corporate expenses included $192 and $384, respectively, related to the amortization of developed technology resulting from the acquisition of GO TOAST and NetConversions.

(3)		Unallocated corporate expenses include stock-based compensation expense. This expense is not allocated to our segments, as it is centrally managed at the corporate level and not reviewed by the Company’s chief operating decision maker in evaluating results by segment. For the three and six months ended June 30, 2006, stock-based compensation expense was as follows:


	Three Months		Six Months ended
	ended June 30, 2006		June 30, 2006
Cost of revenue	$	143	$	286
Client support		2,452		4,759
Product development		385		959
Sales and marketing		381		751
General and administrative		1,515		2,870

Total stock-based compensation expense	$	4,876	$	9,625

(4)

For the six months ended June 30, 2006, general and administrative expense for the digital marketing services line of business included the $1,900 reversal of a contingent business tax liability. See Footnote 2 for additional information about this change in contingent tax liability.

The Company recorded $20,722 and $38,312 of revenue to international customers during the three and six months ended June 30, 2006 compared to $15,318 and $23,272 during the three and six months ended June 30, 2005, respectively.

Pursuant to SFAS No. 131, total segment assets have not been disclosed as this information is not reported to or used by the chief operating decision maker.

9. Legal Proceedings

The Company is currently the subject of a consolidated lawsuit alleging violations of the federal securities laws in connection with disclosures contained in the Company’s prospectus dated February 28, 2000, for its initial public offering of common stock. SBI.Razorfish is also similarly the subject of this consolidated lawsuit relating to its initial public offering in April 1999. The lawsuit generally relates to underwriting practices and disclosure of commissions to be earned by the underwriters. The parties have entered into a settlement agreement relating to this lawsuit, which would not require any payment by the Company. The settlement agreement has received preliminary approval from the Court but remains subject to a number of procedural conditions. The Company may be subject to additional suits in the future regarding alleged violations of the federal securities laws, regarding its use of intellectual property or regarding its collection and use of Internet user information. Any future claim made by a government entity or other third party against the Company regarding alleged violations of the federal securities laws, regarding its use of intellectual property or regarding its collection and use of Internet user information could seriously harm the Company’s business.

10. Subsequent Events

In July 2006, the Company acquired 100% of the outstanding shares of Amnesia, an interactive advertising agency located in Sydney, Australia. The Company purchased Amnesia to provide Avenue A | Razorfish with a presence within the Asia Pacific market. In connection with the acquisition, the Company paid approximately $3,760 and will pay an additional $750 in July 2007 in cash in exchange for 100% of the stock of Amnesia. The purchase agreement also includes a future contingent payment which will be paid in 2009 based upon the earnings of Amnesia through July 2009. In the event that Amnesia achieves earnings results consistent with management’s current forecasts, the Company estimates that the future payment will range from $11,100 to $22,800 with a maximum amount specified in the agreement. However, this payment will be calculated based on actual earnings and will only be recorded when determined due to the uncertainty of achieving these results. The Amnesia service offering will be included in the digital marketing services segment.

In August 2006, the Company acquired 100% of the outstanding shares of Neue Digitale, a creative digital marketing agency located in Frankfurt, Germany. The Company purchased Neue Digital to increase the presence of Avenue A | Razorfish in Europe. The Company paid approximately $1,282 upon completion of the acquisition and will pay an additional amount of approximately $4,360 over the three years subsequent to the acquisition date. The purchase agreement also includes a future contingent payment which will be based on the earnings of Neue Digitale through August 2009. In the event that Neue Digitale achieves earnings results consistent with managements current forecasts, the Company estimates that the future contingent payment will range from $2,400 to $7,500. However, this payment will be calculated based on actual earnings and will only be recorded when determined due to the uncertainty of achieving these results. The Neue Digitale service offering will be included in the digital marketing services segment.

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

This Quarterly Report contains forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “estimates,” “may,” “will” and similar expressions are intended to identify forward-looking statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. Our actual results could differ materially and adversely from those discussed in any forward-looking statements as a result of various factors. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section entitled “Risk Factors,” included in our Annual Report on Form 10-K, for the year ended December 31, 2005 as filed with the SEC. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. We undertake no obligation to revise any forward-looking statements in order to reflect events or circumstances that may subsequently arise. Readers are urged to carefully review and consider the various disclosures made in this report and in our other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks and factors that may affect our business, prospects and results of operations.

The information presented in this Quarterly Report on Form 10-Q includes financial information prepared in accordance with generally accepted accounting principles (GAAP), as well as other financial measures that may be considered non-GAAP financial measures. Generally, a non-GAAP financial measure is a numerical measure of a company’s performance, financial position or cash flows that either excludes or includes amounts that are not normally excluded or included in the most directly comparable measure calculated and presented in accordance with GAAP. As described more fully below, management believes these non-GAAP measures provide meaningful additional information about our performance. The non-GAAP financial measures should be considered in addition to, but not as a substitute for, the information prepared in accordance with GAAP.

We begin Management’s Discussion and Analysis of Financial Condition and Results of Operations with an introduction to aQuantive’s lines of business. In this section we discuss our results of operations for the three and six months ended June 30, 2006 compared to the three and six months ended June 30, 2005. We then provide an analysis of changes in our cash flows, and discuss our financial commitments in the section titled “Liquidity, Capital Resources and Commitments”.

Overview

We are a digital marketing services and technology company that helps marketers acquire, retain and grow customers across digital media. We are organized into three lines of business: digital marketing services, digital marketing technologies and digital performance media.

Acquisitions and Comparability of Operations

Our results of operations for the three and six months ended June 30, 2006 include the results of Franchise Gator, an extension of the performance media business, focused on the franchise industry acquired in May 2006 and DNA, an interactive advertising agency acquired in December 2005. Franchise Gator’s and DNA’s operating results for the three and six months ended June 30, 2006 should be factored into any comparison of our 2006 results of operations to 2005 results.

Digital Marketing Services (DMS)

The DMS segment consists of Avenue A | Razorfish and DNA. Avenue A | Razorfish is an interactive agency which provides a full-service offering, including website development, interactive marketing and creative development and branding. Recently-acquired DNA, located in London, is also an interactive agency. Avenue A | Razorfish and DNA help clients use the Internet as an integrated online business channel to build one-to-one relationships with their customers — ranging from consumers and business customers, to partners and employees.

Digital Marketing Technologies (DMT)

The DMT segment consists of Atlas, a provider of digital marketing technologies and expertise. Atlas’s software suite enables agencies and enterprise marketers to manage their entire digital marketing effort, including planning campaigns, displaying ads, and optimizing their websites. In addition, select publishers utilize Atlas to manage digital advertising inventory.

Digital Performance Media (DPM)

The DPM segment consists of DRIVEpm, U.K.-based MediaBrokers and Franchise Gator. Both DRIVEpm and MediaBrokers are performance media and behavioral targeting businesses. DRIVEpm and MediaBrokers serve as intermediaries between online publishers and advertisers by procuring online advertising inventory from publishers and reselling that inventory to advertisers on a highly targeted basis. Recently-acquired Franchise Gator is an extension of our performance media business segment, focused on the franchise industry, which addresses clients’ needs for online leads. Franchise Gator presents prospective franchisees with profiles of franchise opportunities and businesses from a variety of industry sectors, and in turn, provides franchisors with a cost-effective mode of franchise marketing.

Recent Developments

Public Offering of Common Stock

In March 2006, we completed a follow-on offering of our common stock which raised $172.3 million that will be used for working capital, general corporate purposes and may also be used to acquire or invest in businesses, products or technologies. In April 2006 we raised an additional $25.9 million as a result of the exercise in full of the over-allotment option granted to the underwriters of our follow on public offering.

Critical Accounting Policies and Judgments

The preparation of financial statements in conformity with GAAP in the United States requires estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities in the consolidated financial statements and accompanying notes. The SEC has defined a company’s most critical accounting policies as the ones that are most important to the portrayal of the company’s financial condition and results of operations, and that require management’s most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Although we believe that our estimates and assumptions are reasonable, they are based upon information presently available. Actual results may differ significantly from these estimates under different assumptions or conditions.

There have been no changes to our critical accounting policies during the six months ended June 30, 2006 as compared to what was previously disclosed in our Form 10-K for the year ended December 31, 2005, except for the adoption of SFAS 123(R), discussed as follows:

Accounting for Stock-Based Compensation

We have adopted the provisions of SFAS No. 123(R), “Share-Based Payment” effective January 1, 2006. Prior to the adoption of SFAS No. 123(R), we applied Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, as permitted by SFAS No. 123, “Accounting for Stock-Based Compensation” in accounting for our stock option and employee stock purchase plans. Prior to the adoption of SFAS No. 123(R), we recognized an immaterial amount of stock-based compensation cost, in the Statement of Operations. All options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. We have adopted the fair value recognition provisions of SFAS No. 123(R) using the modified-prospective-transition method. Under that transition method, compensation cost recognized beginning January 1, 2006 includes (a) compensation cost for all stock-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all stock-based payments granted subsequent to January 1, 2006, 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 and we have not recorded a cumulative effect of change in accounting principle.

The fair value of each option grant, nonvested stock award and shares issued under the employee stock purchase plan were estimated on the date of grant using the Black-Scholes option pricing model. Expected volatilities were based on historical volatility of the Company’s stock and implied volatility from traded options on our stock. Prior to the adoption of SFAS No. 123 (R), volatility was calculated based only on historical volatility of our stock. The expected term was derived from the analysis of various hypothetical settlement scenarios and represents the period of time that grants and awards are expected to be outstanding. The risk-free interest rate was the zero-coupon rate corresponding to the expected term of the option, and dividends were assumed to be zero.

Stock-based compensation expense, as determined using the Black-Scholes option pricing model, is recognized on a straight line basis over the service period, net of estimated forfeitures. Forfeiture estimates are based on historical data. To the extent actual results or revised estimates differ from the estimates used, such amounts will be recorded as a cumulative adjustment in the period that estimates are revised. Prior to the adoption of SFAS No. 123(R), stock-based compensation expense was recognized over the service period using an accelerated method and forfeitures were recognized on an actual basis as allowed under SFAS No. 123.

As of June 30, 2006, the total unrecognized compensation expense related to nonvested option grants, nonvested stock awards and shares granted under the employee stock purchase plan was $32.0 million which is expected to be recognized over a weighted-average period of 2.1 years.

Estimates and Assumptions Related to Financial Statements

The discussion and analysis of our financial condition and results of operations is based upon our unaudited condensed consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those affecting revenues, obligations related to employee benefits, stock-based compensation expense, the allowance for doubtful accounts, allowance for sales credits, intangible assets, goodwill, state, local and federal income taxes and legal contingencies. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form our basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Results of Operations

The following table presents statements of operations data for each of our lines of business for the three and six months ended June 30, 2006 and 2005. Our discussion of revenue and cost of revenue for our digital marketing services segment during the six months ended June 30, 2006 also provides revenue and cost of revenue as if cost of media purchases for DNA were excluded (net revenue). Net revenue and cost of revenue, net of media purchases are non-GAAP financial measures. We believe this net revenue and cost of revenue presentation facilitates a better comparison of the results of our digital marketing services line of business due to the different

methods under which Avenue A | Razorfish and DNA record online media revenue. The results of any period are not necessarily indicative of results for any future period.


				Three Months ended June 30, 2006
	Digital			Digital		Digital		Unallocated
	Marketing			Marketing		Performance		Corporate
	Services			Technologies		Media		Expenses (3)			Total
	(amounts in thousands)
Revenue	$	64,064	(1)	$	29,683	$	11,882	$	—		$	105,629
Costs and expenses:
Cost of revenue		1,254	(1)		7,625		6,044		335	(2)		15,258
Client support		43,793			—		939		2,452			47,184
Product development		—			3,031		—		577			3,608
Sales and marketing		1,397			3,837		1,716		381			7,331
General and administrative		3,489			2,562		536		4,397			10,984
Amortization of intangible assets		—			—		—		2,149			2,149
Client reimbursed expenses		1,242			—		—		—			1,242

Total costs and expenses		51,175			17,055		9,235		10,291			87,756

Income (loss) from operations	$	12,889		$	12,628	$	2,647	$	(10,291	)	$	17,873

Interest and other income, net												3,746
Interest expense												582
Provision for income taxes												8,700

Net income											$	12,337


			Three Months ended June 30, 2005
	Digital		Digital		Digital		Unallocated
	Marketing		Marketing		Performance		Corporate
	Services		Technologies		Media		Expenses			Total
	(amounts in thousands)
Revenue	$	48,252	$	22,482	$	6,455	$	—		$	77,189
Costs and expenses:
Cost of revenue		—		5,378		3,676		192	(2)		9,246
Client support		34,836		—		1,023		—			35,859
Product development		—		2,166		—		—			2,166
Sales and marketing		1,082		2,618		194		—			3,894
General and administrative		4,223		2,295		409		3,061			9,988
Amortization of intangible assets		—		—		—		1,803			1,803
Client reimbursed expenses		959		—		—		—			959

Total costs and expenses		41,100		12,457		5,302		5,056			63,915

Income (loss) from operations	$	7,152	$	10,025	$	1,153	$	(5,056	)	$	13,274

Interest and other income, net											257
Interest expense											583
Provision for income taxes											5,188

Net income										$	7,760


				Six months ended June 30, 2006
	Digital			Digital		Digital		Unallocated
	Marketing			Marketing		Performance		Corporate
	Services			Technologies		Media		Expenses (3)			Total
	(amounts in thousands)
Revenue	$	119,276	(1)	$	57,352	$	21,186	$	—		$	197,814
Costs and expenses:
Cost of revenue		1,981	(1)		14,662		11,323		670	(2)		28,636
Client support		86,612			—		1,681		4,759			93,052
Product development		—			5,955		—		1,333			7,288
Sales and marketing		2,986			7,552		2,682		751			13,971
General and administrative		4,993			5,000		948		8,605			19,546
Amortization of intangible assets		—			—		—		4,185			4,185
Client reimbursed expenses		2,110			—		—		—			2,110


			Six months ended June 30, 2006
	Digital		Digital		Digital		Unallocated
	Marketing		Marketing		Performance		Corporate
	Services		Technologies		Media		Expenses (3)			Total
	(amounts in thousands)
Total costs and expenses		98,682		33,169		16,634		20,303			168,788

Income (loss) from operations	$	20,594	$	24,183	$	4,552	$	(20,303	)	$	29,026

Interest and other income, net											5,445
Interest expense											1,164
Provision for income taxes											13,355

Net income										$	19,952


			Six months ended June 30, 2005
	Digital		Digital		Digital		Unallocated
	Marketing		Marketing		Performance		Corporate
	Services		Technologies		Media		Expenses			Total
	(amounts in thousands)
Revenue	$	87,339	$	43,123	$	11,724	$	—		$	142,186
Costs and expenses:
Cost of revenue		—		9,994		6,888		384	(2)		17,266
Client support		64,563		—		1,739		—			66,302
Product development		—		4,133		—		—			4,133
Sales and marketing		2,175		4,605		407		—			7,187
General and administrative		7,361		4,090		649		5,602			17,702
Amortization of intangible assets		—		—		—		3,606			3,606
Client reimbursed expenses		1,637		—		—		—			1,637

Total costs and expenses		75,736		22,822		9,683		9,592			117,833

Income (loss) from operations	$	11,603	$	20,301	$	2,041	$	(9,592	)	$	24,353

Interest and other income, net											527
Interest expense											1,173
Provision for income taxes											9,537

Net income										$	14,170


1)		DNA, acquired in December 2005, generates revenue that is recognized under the gross method of accounting and includes the cost of media purchased for DNA clients.

(2)		For the three and six months ended June 30, 2006 and 2005, cost of revenue classified as unallocated corporate expenses included $192 and $384, respectively, related to the amortization of developed technology resulting from the acquisition of GO TOAST and NetConversions.

(3)		Unallocated corporate expenses include stock-based compensation expense. This expense is not allocated to our segments, as it is centrally managed at the corporate level and not reviewed by our chief operating decision maker in evaluating results by segment. For the three and six months ended June 30, 2006, stock-based compensation expense was as follows:


	Three Months ended		Six Months ended
	June 30, 2006		June 30, 2006
Cost of revenue	$	143	$	286
Client support		2,452		4,759
Product development		385		959
Sales and marketing		381		751
General and administrative		1,515		2,870

Total stock-based compensation expense	$	4,876	$	9,625

(4)

For the six months ended June 30, 2006, general and administrative expense for the digital marketing services line of business includes a $1,900 reversal of contingent business tax liability. See Footnote 2 in the Notes to Condensed Consolidated Financial Statements for additional information about this change in contingent tax liability.

Revenue

Avenue A | Razorfish recognizes revenue under the net method, which excludes the cost of media purchased for our Avenue A | Razorfish clients. However, DNA generates revenue that is recognized under the gross method of accounting and includes the cost of

media purchased for DNA clients. We are currently in the process of renegotiating both client and publisher contracts and if successful, DNA will report revenue under the net method in future periods.

The following table provides a reconciliation of revenue as reported during the three and six months ended June 30, 2006 and 2005 to net revenue, which excludes the cost of media purchased for our digital marketing services clients (in thousands):


	Total					Digital Marketing Services
	Three Months ended June 30,					Three Months ended June 30,
	2006			2005		2006			2005
Revenue, as reported	$	105,629		$	77,189	$	64,064		$	48,252
Less cost of media purchases		(1,254	)		—		(1,254	)		—

Revenue, net of digital marketing services media purchases	$	104,375		$	77,189	$	62,810		$	48,252


	Total					Digital Marketing Services
	Six Months ended June 30,					Six Months ended June 30,
	2006			2005		2006			2005
Revenue, as reported	$	197,814		$	142,186	$	119,276		$	87,339
Less cost of media purchases		(1,981	)		—		(1,981	)		—

Revenue, net of digital marketing services media purchases	$	195,833		$	142,186	$	117,295		$	87,339

Revenue, net of digital marketing services media purchases, was $104.4 million and $195.8 million during the three and six months ended June 30, 2006, respectively, and $77.2 million and $142.2 million during the three and six months ended June 30, 2005, respectively. This increase in revenue is primarily due to the growth in demand for digital marketing services and technologies, new client wins and increased spending from existing clients.

Revenue from digital marketing services, net of media purchases, increased to $62.8 million and $117.3 million during the three and six months ended June 30, 2006, from $48.3 million and $87.3 million for the three and six months ended June 30, 2005. The increase in revenue, net of media purchases, is primarily attributable to the web development business as it experienced an increase in its client base and in clients’ advertising budgets leading to larger web development projects. DNA, which was acquired in December 2005 contributed $4.5 million and $8.1 million of revenue, net of media purchases, during the three and six months ended June 30, 2006. Additionally, revenue increased due to increased online media spending by our existing clients as a result of increased volumes of media utilized in advertising campaigns.

Revenue from digital marketing technologies increased to $29.7 million and $57.4 million for the three and six months ended June 30, 2006 from $22.5 million and $43.1 million for the three and six months ended June 30, 2005. The increase in revenue is primarily the result of increased use of the Atlas Digital Marketing Suite and increased volumes of advertisements displayed over the Internet by existing customers, combined with a consistent increase in client base of both agencies and direct advertisers around the world. Atlas Rich Media has also contributed to revenue growth due to an increase in demand for rich media advertisements and customer response to the integration of Atlas Rich Media in the Atlas Digital Marketing Suite. Additionally, increased penetration of the Atlas business in the U.K. market has contributed to revenue growth.

Revenue from digital performance media was $11.9 million and $21.2 million during the three and six months ended June 30, 2006 and $6.5 million and $11.7 million during the three and six months ended June 30, 2005, respectively. MediaBrokers and DRIVEpm report revenue under the gross method of accounting. The increase in revenue was primarily due to our increased client base and an increase in spending from existing clients at both MediaBrokers and DRIVEpm. Additionally, Franchise Gator,which was acquired in May 2006, contributed to the increase in revenue.

Cost of Revenue

Avenue A | Razorfish recognizes revenue under the net method and therefore cost of revenue excludes the cost of media purchased for our Avenue A | Razorfish clients. However, DNA recognizes revenue under the gross method and therefore cost of revenue includes the cost of media purchased for DNA’s clients. During the three and six months ended June 30, 2006, cost of revenue associated with the digital marketing services line of business relates entirely to DNA.

The following table provides a reconciliation of cost of revenue as reported during the three and six months ended June 30, 2006 and 2005 to cost of revenue that excludes the cost of media purchased for our digital marketing services clients (in thousands):


	Total					Digital Marketing Services
	Three Months ended June 30,					Three Months ended June 30,
	2006			2005		2006			2005
Cost of revenue, as reported	$	15,258		$	9,246	$	1,254		$	—

Less cost of media purchases		(1,254	)		—		(1,254	)		—

Cost of revenue, net of digital marketing services media purchases	$	14,004		$	9,246	$	—		$	—


	Total					Digital Marketing Services
	Six months ended June 30,					Six months ended June 30,
	2006			2005		2006			2005
Cost of revenue, as reported	$	28,636		$	17,266	$	1,981		$	—
Less cost of media purchases		(1,981	)		—		(1,981	)		—

Cost of revenue, net of digital marketing services media purchases	$	26,655		$	17,266	$	—		$	—

Cost of revenue, net of digital marketing services media purchases, was $14.0 million and $26.7 million during the three and six months ended June 30, 2006 and $9.2 million and $17.3 million during the three and six months ended June 30, 2005, respectively. Cost of revenue increased primarily due to the overall growth of our digital marketing technologies and digital performance media lines of business.

Cost of revenue associated with our digital marketing technologies line of business consists primarily of the salaries and related expenses of the digital marketing technologies’ client support personnel and personnel directly supporting the maintenance of our technology used to display advertisements over the Internet. In addition, cost of revenue includes bandwidth and technology infrastructure costs associated with delivering advertisements over the Internet. Cost of revenue associated with digital marketing technologies increased to $7.6 million and $14.7 million for the three and six months ended June 30, 2006 from $5.4 million and $10.0 million for the three and six months ended June 30, 2005. Cost of revenue has increased primarily due to an increase of depreciation expense related to capital investments in our technology infrastructure due to the build out of new data centers. To support both the growing technology infrastructure demands and client service needs associated with additional product offerings, client support and technology personnel were added resulting in an increase of salary related expenses. As of June 30, 2006, there were 91 client support personnel associated with digital marketing technologies, compared to 72 as of June 30, 2005 and there were 40 production support personnel as of June 30, 2006 compared to 35 as of June 30, 2005. Additionally, the increase in cost of revenue was due to increased bandwidth costs related to increased volume of advertisements delivered over the Internet.

Cost of revenue associated with our digital performance media line of business was $6.0 million and $11.3 million for the three and six months ended June 30, 2006 and $3.7 million and $6.9 million for the three and six months ended June 30, 2005, respectively, and relates to the cost of the advertising space purchased from websites to resell to our clients. The increase in cost of revenue is primarily due to increased volumes of advertising space sold as a result of an increased client base and increased spending levels from our existing clients.

Client Support

Client support expenses associated with our digital marketing services line of business consist primarily of salaries and related expenses for client support personnel for our interactive advertising agency, Avenue A | Razorfish. Client support also includes expenses for contractors retained for their specialized skill sets to work on client projects. Client support expenses associated with digital marketing services increased to $43.8 million and $86.6 million for the three and six months ended June 30, 2006 from $34.8 million and $64.6 million for the three and six months ended June 30, 2006, respectively. The increase in client support expenses was primarily due to an increase in client support personnel to support increased web development project activity in the digital marketing services business. DNA, which was acquired in December 2005, contributed $3.3 million and $5.8 million of client support expenses during the three and six months ended June 30, 2006. Additionally, facilities expenses contributed to the increased client support expenses due to new Avenue A | Razorfish office locations and an increase in office space at existing locations over the past several quarters. As of June 30, 2006 there were 1,140 support personnel in our digital marketing services line of business, including 72 at DNA, compared to 855 as of June 30, 2005.

Client support expenses associated with our digital performance media line of business consist primarily of salaries and related expenses for client support personnel for DRIVEpm and MediaBrokers. Client support expenses associated with digital performance media were $0.9 million and $1.7 million during the three and six months ended June 30, 2006 and $1.0 million and $1.7 million

during the three and six months ended June 30, 2005. Client support expenses have remained consistent due to lower sales commissions earned by DRIVEpm client support personnel offset by increased salaries and related expenses contributed by Franchise Gator which was acquired in May 2006. Over the past several quarters, DRIVEpm has shifted its sales efforts from internal clients to external clients and has established a dedicated sales team. This shift in sales efforts resulted in decreased commission expenses earned by DRIVEpm client support personnel. As of June 30, 2006 there were 30 client support personnel in our digital performance media line of business, including 6 at Franchise Gator compared to 26 as of June 30, 2005. We expect client support expenses to increase throughout the remainder of 2006 as we are actively recruiting additional client support personnel.

Unallocated client support expenses for the three and six months ended June 30, 2006 include stock-based compensation expense of $2.5 million and $4.8 million, respectively, as a result of the adoption of SFAS 123(R). This expense is not allocated to our segments, as it is centrally managed at the corporate level and not reviewed by the our chief operating decision maker in evaluating results by segment.

Product Development

Product development expenses consist primarily of salaries and related expenses for product development personnel associated with our digital marketing technologies line of business. In addition, product development expenses include the costs of software development for new technologies and the costs incurred in preparing new versions of our Atlas Digital Marketing Suite for marketing to external clients. Product development expenses increased to $3.0 million and $6.0 million for the three and six months ended June 30, 2006 compared to $2.2 million and $4.1 million for the three and six months ended June 30, 2005. The increase in expense was primarily due to an increase in product development personnel necessary to support the continued development of Atlas Publisher and Atlas Search, enhance our existing Atlas Digital Marketing Suite and invest in new technologies. As of June 30, 2006 there were 97 product development personnel in our digital marketing technologies line of business compared to 78 as of June 30, 2005.

Unallocated product development expenses for the three and six months ended June 30, 2006 also includes stock-based compensation expense of $0.4 million and $1.0 million, respectively as a result of the adoption of SFAS 123(R). This expense is not allocated to our segments, as it is centrally managed at the corporate level and not reviewed by the our chief operating decision maker in evaluating results by segment.

Sales and Marketing

Sales and marketing expenses associated with our digital marketing services line of business consist primarily of salaries and commissions and related expenses for personnel dedicated entirely to the sales and marketing efforts of our interactive agency, Avenue A | Razorfish. In addition, sales and marketing expenses include professional service fees and marketing costs such as trade shows, the costs of advertising our services in trade publications and the cost of client and publisher summits. Sales and marketing expenses associated with digital marketing services increased to $1.4 million and $3.0 million for the three and six months ended June 30, 2006, respectively, from $1.1 million and $2.2 million for the three and six months ended June 30, 2005. The increase in sales and marketing expenses consist primarily of sales and marketing expenses contributed by DNA which was acquired in December 2005, and an increase in commissions expenses for Avenue A | Razorfish sales and marketing personnel. As of June 30, 2006, there were 20 sales and marketing personnel in our digital marketing services line of business, including 3 at DNA, compared to 18 as of June 30, 2005.

Sales and marketing expenses associated with our digital marketing technologies line of business consist primarily of salaries and commissions and related expenses for our sales force. In addition, these expenses include salaries of sales and marketing personnel and marketing costs such as trade shows and the costs of advertising our services on the Internet. Sales and marketing expenses associated with digital marketing technologies increased to $3.8 million and $7.6 million during the three and six months ended June 30, 2006, from $2.6 million and $4.6 million for the three and six months ended June 30, 2005. This increase was primarily due to the addition of sales personnel to support increased sales and marketing efforts primarily related to Atlas Rich Media and Atlas Search. As of June 30, 2006 there were 53 sales and marketing personnel in our digital marketing technologies line of business compared to 43 as of June 30, 2005.

Sales and marketing expenses associated with our digital performance media line of business consist primarily of salaries and commissions and related expenses for our DRIVEpm and MediaBrokers sales forces. Over the past year, the digital performance media line of business, particularly DRIVEpm, increased the number of sales personnel significantly. Sales and marketing expense associated with our digital performance media line of business was $1.7 million and $2.7 million for the three and six months ended

June 30, 2006 from $0.2 million and $0.4 million for the three and six months ended June 30, 2005, respectively. Additionally, Franchise Gator, which was acquired in May 2006, contributed $0.5 million of sales and marketing support for the three and six months ended June 30, 2006, respectively. As of June 30, 2006 there were 26 sales and marketing personnel in our digital performance media line of business, including 7 at Franchise Gator, compared to 8 as of June 30, 2005.

Unallocated sales and marketing expenses for the three and six months ended June 30, 2006 include stock-based compensation expense of $0.4 million and $0.8 million, respectively, as a result of the adoption of SFAS 123(R). This expense is not allocated to our segments as it is centrally managed at the corporate level and not reviewed by the our chief operating decision maker in evaluating results by segment.

General and Administrative

General and administrative expenses consist of the salaries and related expenses for executive, legal, finance, human resource, corporate IT and administrative personnel, professional fees, insurance and other general corporate expenses such as rent for our corporate headquarters in Seattle. General and administrative expenses included in our digital marketing services, technologies, and performance media lines of business consist primarily of a direct allocation of these corporate costs based on several allocation methods including headcount and the percentage of revenue generated by the respective entity. General and administrative expenses increased to $11.0 million and $19.5 million for the three and six months ended June 30, 2006 from $10.0 million and $17.7 million for the three and six months ended June 30, 2005. The increase in general and administrative expenses was primarily due to stock-based compensation expense of $1.5 million and $2.9 million for the three and six months ended June 30, 2006, respectively, as a result of the adoption of SFAS 123(R). In addition, corporate headcount increased to support the growth of our operating units along with costs associated with continued development and support of our corporate financial systems. As of June 30, 2006, there were 155 general and administrative personnel compared to 119 as of June 30, 2005. The increase in general and administrative expenses for the three months ended June 30, 2006 from the three months ended June 30, 2005 was partially offset by an accrual of $0.8 million made during the three months ended June 30 2005 for a change in business tax estimate. The increase in general and administrative costs for the six months ended June 30, 2006 from the six months ended June 30, 2005 was partially offset by an accrual of $0.8 million made during the three months ended June 30, 2005 for a change in business tax estimate and by the reversal of a business tax accrual of $1.9 million during the three months ended March 31, 2006. The reversal of the accrual was due to the settlement of the audit with the City of Seattle during the three months ended March 31, 2006. These tax estimates were recorded in the digital marketing services line of business.

Amortization of Intangible Assets

Amortization of intangible assets relates primarily to customer relationships purchased through various acquisitions. Amortization of intangible assets was $2.1 million and $4.2 million during the three and six months ended June 30, 2006 compared to $1.8 million and $3.6 million during the three and six months ended June 30, 2005. The increase in expense is due to the amortization of intangible assets related to DNA which was acquired in December 2005 and Franchise Gator which was acquired in May 2006. In addition, amortization of intangible assets associated with purchased technology is recorded as a cost of revenue and was $0.2 million and $0.4 million during the three and six months ended June 30, 2006, respectively and $0.2 million and $0.4 million ended June 30, 2005, respectively.

Client Reimbursed Expenses

Client reimbursed expenses include all reimbursable project expenses that are billable to our clients. These reimbursable project expenses are also recorded as a component of revenue. We recorded $1.2 million and $2.1 million of client reimbursed expenses for the three and six months ended June 30, 2006, respectively, compared to $1.0 million and $1.6 million for the three and six months ended June 30, 2005. The increase in client reimbursed expenses is primarily due to increased project expenses incurred to support new clients and increased spending by existing clients in the creative and web development business.

Interest and Other Income, Net

Net interest and other income consists primarily of earnings on our cash, cash equivalents, short-term investments and foreign currency transaction exchange gains and losses. Net interest and other income was $3.7 million and $5.4 million for the three and six months ended June 30, 2006 compared to $0.3 million and $0.5 million for the three and six months ended June 30, 2005. The

increase in net interest and other income was a result of interest income earned from the investment of proceeds from the equity offering which was completed in March 2006 and the proceeds from the exercise of the over-allotment option in April 2006 and higher interest rates that we have received on invested cash balances. Foreign currency transaction exchange gains and losses were immaterial for the three and six months ended June 30, 2006 and 2005.

Interest Expense

Interest expense was $0.6 million and $1.2 million during the three and six months ended June 30, 2006 and $0.6 and $1.2 million during the three and six months ended June 30, 2005. Interest expense relates to the outstanding convertible debt bearing an annual interest rate of 2.25 percent.

Provision for Income Taxes

The provision for income taxes was $8.7 million and $13.4 million during the three and six months ended June 30, 2006 and $5.2 million and $9.5 million during the three and six months ended June 30, 2005. During the three and six months ended June 30, 2006 we recorded a provision for income taxes based on an effective tax rate of 41% and 40%, respectively. During the three and six months ended June 30, 2005 we recorded an effective tax rate of 40%. Our effective tax rate for the three months ended June 30, 2006 increased compared to our effective tax rate of 38% for the three months ended March 31, 2006. The increase in the effective tax rate is due to a change in our projected expenditures that are not deductible for tax purposes for the year ending December 31, 2006.

Income from Operations

During the three and six months ended June 30, 2006, the digital marketing services line of business generated $12.9 million and $20.6 million of income from operations, or 20% and 17% of digital marketing services revenue, compared to $7.2 million and $11.6 million, or 15% and 13% of digital marketing services revenue, during the three and six months ended June 30, 2005. The digital marketing services line of business experienced an increase in income from operations as a percentage of digital marketing services revenue during the three months ended June 30, 2006 compared to the three months ended June 30, 2005 primarily due to client support expenses increasing at a slower rate than revenue was generated in addition to an accrual of $0.8 million made during the three months ended June 30, 2005 for a change in business tax estimate. The digital marketing services line of business experienced an increase in income from operations as a percentage of digital marketing services revenue during the six months ended June 30, 2006 compared to the six months ended June 30, 2005 primarily due to client support expenses increasing at a slower rate than revenue was generated, the reversal of a $1.9 million business tax accrual during the three months ended March 31, 2006 and an accrual of $0.8 million made during the three months ended June 30, 2005 for a change in business tax estimate.

The digital marketing technologies line of business generated $12.6 million and $24.2 million of income from operations, or 42% and 43% of digital marketing technologies revenue, during the three and six months ended June 30, 2006 compared to $10.0 million and $20.3 million, or 45% and 47% of digital marketing technologies revenue, during the three and six months ended June 30, 2005, respectively. The decrease in operating margins was primarily due to increased sales and marketing personnel needed to support the increase in sales and marketing initiatives. Additionally, increased cost of revenue, primarily due to additional client support personnel, contributed to the decrease in operating margins.

The digital performance media line of business generated $2.6 million and $4.6 million of income from operations, or 22% and 22% of digital performance media revenue during the three and six months ended June 30, 2006 compared to income from operations of $1.2 million and $2.0 million, or 18% and 17% of revenue during the three and six months ended June 30, 2005. The increase in income from operations as a percentage of digital performance media revenue is primarily due to improved performance of our advertising campaigns. Campaign performance has improved as the result of a reduction in the cost of media purchased as a percentage of revenue generated by advertising campaigns during the three and six months ended June 30, 2006. While an increase in client base and spending from existing clients in our digital performance media line of business contributed to growth in revenue, client support expenses remained consistent. In order to support the continued growth of this business, we expect to hire additional client support and sales and marketing personnel during the remainder of 2006.

Liquidity, Capital Resources and Commitments

Since our inception, we have financed our operations primarily through the net proceeds from private sales of equity securities, which raised $30.4 million through December 31, 1999 and our initial public offering of common stock, which raised $132.5 million during the first quarter of 2000. In July 2004, we issued $74.7 million in convertible debt to the sellers of SBI.Razorfish in connection

with the acquisition in July 2004. This was subsequently paid off with the proceeds from the issuance in August and September 2004 of $80.0 million in convertible senior subordinated notes due in 2024. In March 2006, we completed a follow-on offering of our common stock which raised net proceeds of $172.3 million In April 2006, we raised an additional $25.9 million as a result of the exercise in full of the over-allotment option granted to the underwriters of our follow-on public offering. Net proceeds from the equity offering will be used for working capital, general corporate purposes and may also be used to acquire or invest in businesses, products or technologies.

As of June 30, 2006, we had cash and cash equivalents of $275 million, short-term investments of $33 million, and $80 million of convertible debt on our condensed consolidated balance sheet.

Net Cash from Operating Activities

Net cash provided by operating activities was $35.9 million and $15.2 million during the six months ended June 30, 2006 and 2005, respectively. Our net cash provided by operating activities is primarily a result of our net income adjusted by non-cash expenses such as depreciation and amortization, stock-based compensation expense and changes in working capital components, which are influenced by the timing of cash collections from our clients and cash payments for purchases of media and other expenses.

Significant changes in working capital components consist primarily of accounts receivable and pre-billed media. Our accounts receivable balance was $183.1 million on June 30, 2006 compared to $160.4 million on December 31, 2005 and $134.5 million on June 30, 2005 compared to $106.7 million on December 31, 2004. The increase in accounts receivable is primarily due to the growth of the business, the timing of cash collections from clients, the acquisition of DNA in December 2005 and an increase in pre-billed media during the six months ended June 30, 2006. Our pre-billed media was $36.2 million on June 30, 2006 compared to $18.3 million on December 31, 2005. The increase in pre-billed media is primarily due to increased interactive campaign activity for certain clients that are billed in advance for advertising space they plan to use for advertising campaigns during the remainder of 2006.

Net Cash from Investing Activities

Our investing activities include the purchase and sale of short-term investments, purchases of property and equipment, and the funding of acquisitions. Net cash used in investing activities was $56.4 million and $12.5 million for the six months ended June 30, 2006 and 2005, respectively.

In accordance with our investment policy, we purchase primarily investment-grade marketable securities. Net cash from investing activities relates primarily to the timing of the purchases and sales of these marketable securities. During the six months ended June 30, 2006, we had net proceeds of marketable securities of $2.5 million due to the timing of maturities of our investments. During the six months ended June 30, 2005 we had net purchases of marketable securities of $0.6 million.

Capital expenditures relate primarily to the purchase of computers and software for general operational purposes, including our ad serving capabilities, the development of our proprietary technology and leasehold improvements for our facilities. During the six months ended June 30, 2006 and 2005, capital expenditures were $11.0 million and $10.3 million, respectively.

The following table summarizes cash used to fund various acquisitions during the six months ended June 30, 2006 and 2005. Amounts represent cash consideration paid, including transaction costs, post closing requirements and contingency payments earned, net of cash acquired.


	Six months ended June 30,
	2006		2005
	(In thousands)
iFRONTIER	$	26,460	$	176
Franchise Gator		19,583		—
TechnologyBrokers/Media Brokers		—		758
NetConversions		582		188
GO TOAST		1,333		500
SBI.Razorfish		—		(49	)

Total cash payments	$	47,958	$	1,573

Many of our recent acquisitions have related purchase agreements that provide for future contingent payments. These payments are determined based on either the revenue or operating performance or combination of both for the acquired entities over a stated period of time. These payments are recorded when the actual amounts are determined, due to the uncertainty of achieving the financial results. The following table summarizes our estimates of future contingency payments in the period of expected payment by acquisition should actual results be consistent with management’s estimates.


	Six months ending				Year ending December 31,
(in thousands)	December 31,
	2006				2007				2008				2009

	Low		High		Low		High		Low		High		Low		High


TechnologyBrokers/Media Brokers⁽¹⁾	$	39,000	$	45,000	$	—	$	—	$	—	$	—	$	—	$	—
DNA⁽²⁾		9,400		9,400		—		—		—		—		26,000		43,000

Total	$	48,400	$	54,400	$	—	$	—	$	—	$	—	$	26,000	$	43,000


⁽¹⁾		The TechnologyBrokers and MediaBrokers future contingent payment will be determined based on certain earnings thresholds through July 31, 2006. There is no maximum payment specified in the agreement.

⁽²⁾		The DNA payment due in 2006 includes an amount based on DNA’s earnings through March 31, 2006 of approximately $7,603 and a guaranteed payment of $1,816. Both amounts are accrued on the consolidated balance sheet as of June 30, 2006. The future contingent payment due in 2009 will be determined based on actual earnings results of DNA through December 5, 2008. There is no maximum payment specified in the agreement.

Net Cash from Financing Activities

Our financing activities primarily relate to the proceeds from issuance of common stock through public stock offerings and our stock option and employee stock purchase plans.

On March 15, 2006, we completed a follow-on offering of 7.5 million shares of common stock at a purchase price of $24.00 per share. The total net proceeds from the offering were $172.3 million after deducting applicable issuance costs. The follow-on offering of common stock also included an underwriter’s over-allotment option to sell an additional 1.125 million shares. The exercise of the underwriter’s over-allotment option of 1.125 million shares was completed on April 13, 2006. The total net proceeds from the offering, including net proceeds of $25.9 million from the underwriters’ over-allotment shares, were approximately $198.2 million, after deducting applicable issuance costs and expenses. As of June 30, 2006, $0.1 million of applicable issuance costs were accrued on the condensed consolidated balance sheet as they had not yet been paid.

Proceeds from the exercises of common stock options and issuance of common stock through our employee stock purchase plan were $9.1 million and $5.3 million for the six months ended June 30, 2006 and 2005, respectively. The increase in proceeds was due to the increase in the price of our common stock, increased volume of stock option exercises and an increased employee base participating in our employee stock purchase plan.

The tax benefit related to excess stock-based compensation deductions was $10.8 million and $5.5 million for the six months ended June 30, 2006 and 2005, respectively. The increase in tax benefit was due to the increase in the price of our common stock and increased volume of stock options exercises. Prior to the adoption of SFAS No. 123(R), we presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows. SFAS No. 123(R) requires the cash flows from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows.

We believe that our current cash, cash equivalents and short-term investments, together with cash from operating activities, will be sufficient to meet our anticipated cash needs for working capital, capital expenditures, debt service, and future contingent payments for our acquired businesses for at least the next 12 months.

Commitments and Contingencies

As of June 30, 2006, we had material commitments related to our convertible debt and operating leases for office space and office equipment. In addition, we had material obligations related to ad content delivery services. The following are our contractual commitments and obligations as of June 30, 2006 (in thousands):


	Six Months
	ending		Year ending December 31,
	December 31,								2010 and
	2006		2007		2008		2009		Thereafter		Total
Commitments:
Operating leases	$	5,194	$	10,085	$	9,051	$	8,499	$	33,896	$	66,725
Ad content delivery services		773		734		—		—		—		1,507
Convertible debt (including interest payments)		900		1,800		1,800		1,800		107,000		113,300

Total commitments	$	6,867	$	12,619	$	10,851	$	10,299	$	140,896	$	181,532

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to market risk includes interest income sensitivity, which is affected by changes in the general level of U.S. interest rates, particularly because the majority of our investments are in short-term, investment-grade debt securities issued by corporations and U.S. government agencies. We place our investments with high-quality issuers and limit the amount of credit exposure to any one issuer. Due to the nature of our short-term investments, we believe that we are not subject to any material market risk exposure.

We maintain bank accounts with balances denominated in British Pounds to support our U.K.-based operations. We are subject to foreign currency exchange rate risk on these accounts. Based on the balance of foreign funds at June 30, 2006 of £6.9 million, an assumed 5%, 10% and 20% increase of the US dollar against the British Pound would result in fair value declines of $0.6 million, $1.3 million and $2.5 million, respectively.

Several of our recent acquisitions have related purchase agreements that provide for future payments that are denominated in foreign currencies. We are subject to foreign exchange risk on these future payments. Based on our current estimates of the amount of these future contingent payments, an assumed 5%, 10% and 20% decline of the US dollar against these currencies would result in additional cash payments of $3.7 million to $4.8 million, $7.5 million to $9.6 million and $14.9 million to $19.2 million, respectively. We have accrued for certain contingent payments on the Condensed Consolidated Balance Sheet at June 30, 2006. Foreign currency fluctuations between June 30, 2006 and the date the payment is made for these accrued amounts will be recorded as a foreign currency gain or loss in the Condensed Consolidated Statement of Operations and Comprehensive Income. For those contingent payments that have not been accrued, any additional payment amounts resulting from foreign exchange rate fluctuations will be recorded in Goodwill.

We do not use derivative financial instruments to manage interest rate risk, to reduce our exposure to changes in foreign currency exchange rates, or for speculative trading purposes.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

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

Changes in Internal Controls

No change was made to our internal controls over financial reporting for the six months ended June 30, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1A. RISK FACTORS

The following risk factor supplements the Company’s risk factors as previously disclosed in Item 1A included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005, which was filed with the SEC on March 2, 2006.

Our operating results and the growth of our business could be harmed if we do not successfully manage our international operations.

We have offices in a number of countries, including Australia, Germany and the United Kingdom, and we market, sell and distribute our products and services in a number of other countries internationally. We have limited experience in managing foreign operations, in developing localized versions of our products, and in marketing, selling and distributing our products and services internationally. Our foreign operations subject us to foreign currency exchange risks. We currently do not utilize hedging instruments to mitigate foreign currency exchange risks.

Our international expansion will require management’s attention and resources. We cannot assure you that we will be successful in our efforts overseas. International operations are subject to other inherent risks, including but not limited to:

•

difficulties and costs of staffing and managing foreign operations;

•

uncertain demand for our products and services;

•

changes in and differences between regulatory requirements, including those relating to data protection;

•

reduced protection for intellectual property rights in a number of countries;

•

potentially adverse tax consequences;

•

the impact of recessions in economies outside the United States;

•

political and economic instability; and

•

seasonal reductions in business activity.

Our failure to address these risks adequately could materially and adversely affect our business, results of operations and financial condition.

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

We held our Annual Meeting of Shareholders on May 10, 2006. 62,821,319 shares were represented in person or by proxy constituting 93.32 percent of the outstanding shares and entitled to vote at the annual meeting.

Proposal Number 1 — Election of Directors, to serve until the 2009 Annual Meeting of Shareholders, or until their respective successors are elected and qualified:


Nominee	For		Withheld

Richard P. Fox		60,026,565		2,794,754

Michael B. Slade		60,505,801		2,315,518

Three continuing directors, Peter M. Neupert, Linda J. Srere and Jaynie M. Studenmund, have terms that expire in 2007 and continuing directors, Nicolas J. Hanauer, Brain P. McAndrews and Dr. Jack Sansolo, have terms that expire in 2008.

Proposal Number 2 — Ratification of KPMG LLP to act as independent registered public accounting firm for fiscal year 2006:


For			62,200,712
Against			178,614
Abstain			441,993
Broker non-votes			4,498,395

ITEM 6. EXHIBITS

10.1		Amended 1999 Employee Stock Purchase Plan .

31.1		Certification of Brian P. McAndrews Pursuant to Rule 13a-14(a) of the Securities and Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of M. Wayne Wisehart Pursuant to Rule 13a-14(a) of the Securities and Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1		Certification of Brian P. McAndrews Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2		Certification of M. Wayne Wisehart Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002


		Page
PART I. FINANCIAL INFORMATION

Item 1.	Condensed Consolidated Financial Statements		3
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		18
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		30
Item 4.	Controls and Procedures		30
PART II. OTHER INFORMATION

Item 1A.	Risk Factors		31
Item 4.	Submission of Matters to a Vote of Security Holders		31
Item 6.	Exhibits		31
EXHIBIT 10.1
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2


	AQUANTIVE, INC.
	By:	/s/ M. WAYNE WISEHART
		M. Wayne Wisehart
		Chief Financial Officer (Authorized Officer and Principal Financial Officer)

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