Form 10-QSB/A

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

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

For the quarterly period ended September 30, 2004

OR

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

For the transition period from to

For Quarter Ended		Commission File Number 001-32442

CGI Holding Corporation

(Exact name of registrant as specified in its charter)

Nevada		87-0450450
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

5 Revere Drive, Suite 510, Northbrook, Illinois		60062
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code (847) 562-0177

(Former name, former address and former fiscal year, if changed since last report.)

Check whether the registrant (1) filed all reports required to be filed by Section 13 of 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ý No o

Number of shares outstanding of the issuer’s common stock, as of November 8, 2004 was 27,100,761 shares.

Transitional Small Business Disclosure Format

Yes o No ý

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

CGI HOLDING CORPORATION
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2004

	As Amended
Assets
Current Assets
Cash and Cash Equivalents	$	2,529,723
Restricted Cash	726,866
Accounts Receivable	1,008,020
Allowance for Doubtful Accounts	(75,601		)
Notes Receivable – Related Party	280,175
Deferred Tax Asset	133,547
Prepaid Expenses	524,030
Other Current Assets	29,202
Total Current Assets	5,155,962
Property and Equipment, net	1,001,890
Other Assets
Deferred Tax Asset	1,757,812
Goodwill	7,044,492
Intangible Assets	1,177,617
Other Assets	97,550
Total Other Assets	10,077,471
Total Assets	$	16,235,323

Liabilities and Shareholders’ Equity
Current Liabilities
Current Portion of Long-Term Debt	$	539,157
Accounts Payable	241,021
Deferred Revenue	1,433,605
Client Prepaid Media Buys	670,671
Accrued Expenses and Other Current Liabilities	460,573
Total Current Liabilities	3,345,027

Long-Term Liabilities	709,209
Shareholders’ Equity
Preferred Stock, $.001 par value:
Authorized Shares – 5,000,000 – none issued or outstanding	0
Common Stock, $.001 par value:
Authorized Shares – 100,000,000
Issued Shares – 29,600,761
Outstanding Shares – 27,100,761	29,600
Additional Paid in Capital	16,684,370
Accumulated Deficit	(3,992,883		)
Treasury Stock	(540,000		)
Total Shareholders’ Equity	12,181,087
Total Liabilities and Shareholders’ Equity	$	16,235,323

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

CGI HOLDING CORPORATION
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME, as amended
NINE AND THREE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003

	Nine Months Ended						Three Months Ended
	2004			2003			2004			2003
Net Revenue	$	11,506,893		$	3,476,681		$	5,203,780		$	1,572,164
Cost of Revenue	2,532,125			675,262			1,188,988			279,606
Gross Profit	8,974,768			2,801,419			4,014,792			1,292,558
Operating Expenses
Selling, General and Administrative	7,163,331			3,522,522			2,798,925			1,695,048
Amortization of Purchased Intangibles	31,497			0			31,497
Income (Loss) from Operations	1,779,940			(721,102		)	1,184,370			(402,490		)

Other Income (Expenses)
Interest Income	1,913			6,247			1,657			23
Interest Expense	(31,944		)	(54,518		)	(3,844		)	(16,195		)
Other Income (Expense)	38,155			0			(24,750		)
Income (Loss) before Income Taxes	1,788,063			(769,373		)	1,157,432			(418,662		)
Provision for Income Taxes	690,563						454,377
Income (Loss) From Continuing Operations	1,097,500			(769,373		)	703,055			(418,662		)
Discontinued Operations
Net Loss from Disposition (Net of Taxes)	0			(1,125,508		)	0			(1,125,508		)
Net Income (Loss)	$	1,097,500		$	(1,894,881	)	$	703,055		$	(1,544,170	)

Income (Loss) Per Share From Continuing Operations
Basic	$	0.05		$	(0.04	)	$	0.03		$	(0.02	)
Fully Diluted	$	0.04		$	(0.04	)	$	0.02		$	(0.02	)

Loss Per Share From Discontinued Operations
Basic	$	0.00		$	(0.06	)	$	0.00		$	(0.06	)
Fully Diluted	$	0.00		$	(0.06	)	$	0.00		$	(0.05	)

Net Income (Loss) Per Share
Basic	$	0.05		$	(0.11	)	$	0.03		$	(0.08	)
Fully Diluted	$	0.04		$	(0.10	)	$	0.02		$	(0.07	)

Weighted Average Shares (Basic)	22,966,379			17,974,822			24,804,913			19,711,213
Weighted Average Shares (Fully Diluted)	28,672,940			19,620,166			30,511,474			22,335,282

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

CGI HOLDING CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY, As Amended

	Shares	Amount		Paid In Capital		Accumulated Deficit			Treasury Stock			Shareholders’ Equity

Balance at January 1, 2004	20,889,458	$	23,389	$	5,655,760	$	(5,090,383	)	$	(540,000	)	$	48,766

Exercise of Stock Options, Net	282,978	283		42,885								43,168

Purchase Transactions, Net	2,004,762	2,005		4,260,495								4,262,500

Sale of Common Stock, Net	3,923,563	3,923		6,725,230								6,729,153

Net Income, September 30, 2004						1,097,500						1,097,500

Balance at September 30, 2004	27,100,761	$	29,600	$	16,684,370	$	(3,992,883	)	$	(540,000	)	$	12,181,087

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

CGI HOLDING CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003

	2004, as amended			2003, as amended
Operating Activities
Net Income (Loss)	$	1,097,500		$	(1,894,881	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and Amortization	124,589			14,296
Provision for Doubtful Accounts	323,208			387,951
Deferred Compensation	0			160,000
Insurance Settlement	0			1,125,508
Deferred Taxes	547,786			0
Loss on Deposit	75,000			0
Change in operating assets and liabilities:
Restricted Cash	(628,032		)	0
Accounts Receivable	(787,737		)	(435,374		)
Prepaid Expenses and Other Assets	(218,829		)	2,500
Accounts Payable	(341,365		)	(51,109		)
Deferred Revenue	7,283			731,412
Client Prepaid Media Buys	670,671			0
Other Accrued Liabilities	453,891			169,857
Net cash provided by operating activities	1,323,966			210,160

Investing Activities
Purchases of property and equipment	(801,248		)	(475		)
Cash in Acquisitions, Net	535,995			0
Other Investing Activities	(11,305		)	(11,803		)
Net cash used in investing activities	(276,559		)	(12,279		)

Financing Activities
Principal Payments Made	(2,198,305		)	(173,602		)
Proceeds from Notes Payable	140,000			95,000
Change in Line of Credit	0			(25,485		)
Proceeds from issuance of common stock, net of issuance costs	3,228,771			100,769
Net cash provided by (used in) financing activities	1,170,466			(3,318		)
Net Cash Change	2,217,874			194,563
Cash Balance, January 1	311,849			68,945
Cash Balance, September 30	$	2,529,723		$	263,508
Supplemental Information
Interest Paid	$	31,944		$	54,518
Income Taxes Paid	$	99,827		$	0

Non Cash Investing and Financing Activities

On June 4, 2004, the Company entered into an asset purchase agreement in which it issued 100,000 shares of the Company’s common stock valued at $262,500.

On August 19, 2004 the Company purchased the stock of WebCapades, Inc. The purchase was financed by the sale and issuance of stock in the amount of $7,500,000 and notes payable of $1,151,413. The Company received net tangible assets of $660,306 and intangible assets totaling $7,991,106.

On August 30, 2004 the Company issued 25,000 shares of restricted common stock valued at $43,550 for a six month contract with CEOcast, Inc.

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

CGI HOLDING CORPORATION
FOOTNOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2004 AND 2003

Basis of Presentation

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

The accompanying condensed consolidated financial statements are unaudited. These financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to such SEC rules and regulations; nevertheless, the Company believes that the disclosures are adequate to make the information presented not misleading. These financial statements and the notes hereto should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-KSB/A for the year ended December 31, 2004 which was originally filed June 23, 2005 and will be reissued concurrently with this filing, including the Company’s amended 2003 consolidated financial statements, and reflecting the matters described under the following section “Correction of Error”. In the opinion of the Company’s management, the condensed consolidated financial statements for the unaudited interim periods presented include all adjustments, including normal recurring adjustments necessary to fairly present the results of such interim periods and the financial position as of the end of said period. The results of operations for the interim period are not necessarily indicative of the results for the full year.

Correction of Error

As disclosed by press release on November 1, 2005, the Company began a review of its accounting for revenue recognition for its search engine enhancement services at its Websourced, Inc. subsidiary. This review was completed and the Company determined that the manner in which we applied the proportional performance revenue recognition model: (1) did not adequately rely on objective evidence of the value of services performed, and (2) did not have enough evidence to be reasonably assured of the collectibility of the accelerated revenue recognition provided for when utilizing the proportional performance model.

The cumulative effect as of January 1, 2004 of the correction of the error would have decreased retained earning as of that date by $1.3 million, net of tax. The effect of the error was material to the year ended December 31, 2003 and respective quarters.

2004

	As Amended					Previously Reported
	Nine Months		Three Months			Nine Months		Three Months
	Ended September 30, 2004					Ended September 30, 2004
Revenue	$	11,506,893	$	5,203,780		$	14,121,105	$	5,721,669
Cost of Sales	2,532,125		1,188,988			5,685,502		2,160,940
Gross Profit	8,974,768		4,014,792			8,435,603		3,560,729
Selling, General and administrative	7,194,828		2,830,422			4,856,523		2,079,670
Other Income (Expense)	8,124		(26,937		)	8,122		(26,938		)
Income Before Taxes	1,788,063		1,157,432			3,587,202		1,454,120
Income Tax Provision	690,563		454,377			1,371,973		571,112
Net Income	$	1,097,500	$	703,055		$	2,215,229	$	883,008

Earnings Per Share
Basic	$	0.05	$	0.03		$	0.10	$	0.04
Fully Diluted	$	0.04	$	0.02		$	0.08	$	0.03

2003

	As Amended						Previously Reported
	Nine Months			Three Months			Nine Months			Three Months
	Ended September 30, 2003						Ended September 30, 2003
Revenue	$	3,476,681		$	1,572,164		$	4,404,628		$	2,084,230
Cost of Sales	675262			279,606			1,942,184			768,189
Gross Profit	2,801,419			1,292,558			2,462,444			1,316,041
Selling, General and administrative	3,522,522			1,695,048			2,137,047			1,044,440
Other Income (Expense)	(48,271		)	(16,172		)	(48,271		)	(16,173		)
Income (Loss) Before Taxes	(769,373		)	(418,662		)	277,126			255,428
Income Tax Provision	0			0						0
Income (Loss) From Continuing Operations	(769,373		)	(418,662		)	277,126			255,428
Discontinued Operations (Net of Tax)	(1,125,508		)	(1,125,508		)	(1,200,000		)	(1,200,000		)
Net Income (Loss)	$	(1,894,881	)	$	(1,544,170	)	$	(922,874	)	$	(944,572	)

Income (Loss) per share before discontinued operations
Basic	$	(0.04	)	$	(0.02	)	$	0.02		$	0.01
Fully Diluted	$	(0.04	)	$	(0.02	)	$	0.01		$	0.01

Loss per share from discontinued operations
Basic	$	(0.06	)	$	(0.06	)	$	(0.07	)	$	(0.06	)
Fully Diluted	$	(0.06	)	$	(0.05	)	$	(0.05	)	$	(0.05	)

Loss Per Share
Basic	$	(0.11	)	$	(0.08	)	$	(0.05	)	$	(0.05	)
Fully Diluted	$	(0.11	)	$	(0.07	)	$	(0.04	)	$	(0.04	)

	September 30, 2004
	As Reported		Adjustment			As Restated
Summarized Consolidated Balance Sheet
Total Current Assets	$	7,761,428	$	(2,605,466	)	$	5,155,962
Total Other Assets	9,910,780		1,168,581			11,079,361
Total Assets	$	17,672,208	$	(1,436,885	)	$	16,235,323

Total Current Liabilities	$	2,376,841	$	968,186		$	3,345,027
Total Long-Term Liabilities	709,210		(1		)	709,209
Shareholders’ Equity	14,586,157		(2,405,070		)	12,181,087
Total Liabilities and Shareholders’ Equity	$	17,672,208	$	(1,436,885	)	$	16,235,323

Reclassification

For comparability, the 2003 financial statements reflect reclassifications where appropriate to conform to the financial statement presentation used in 2004.

Use of Estimates

The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses in the reporting period. The Company regularly evaluates estimates and assumptions related to allowances for doubtful accounts, goodwill and purchased intangible asset valuations and deferred income tax asset valuation allowances. The Company bases its estimates and assumptions on current facts, historical experience and on various other factors that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The actual results experienced by the

Company may differ materially and adversely from management’s estimates. To the extent there are material differences between the estimates and the actual results, future results of operations will be affected.

Revenue Recognition

Websourced, Inc.

The Company recognizes revenues in the period that they are deemed to be earned and collectible using the straight line method over the term of the contract.

Cherish, Inc.

The Company’s Cherish, Inc. subsidiary recognizes income on monthly and multi- monthly subscription contracts on a straight line basis over the term of the contract.

Property and Equipment

Property and equipment are carried at cost less accumulated depreciation. Depreciation and amortization are expensed using the straight-line method over each asset’s estimated remaining useful life, ranging from four to seven years. Depreciation of leasehold improvements is computed using the shorter of the lease term or the economic life using the straight line method. The carrying value of property and equipment at September 30, 2005 was:

Furniture & Fixtures	$	247,926
Equipment	641,234
Software	334,481
Leasehold Improvements	36,414
Subtotal	$	1,260,055
Accumulated Depreciation	(258,164)
Net Property & Equipment	$	1,001,890

Notes Payable

The Company currently has notes payable relating to the acquisition of WebCapades, Inc. on August 19, 2004. The original amount of these notes was recorded as $1,151,413. The notes provide for 24 monthly payments of an aggregate $50,000 principal and interest at an implied rate of 4.00% as the notes provided for an interest rate of 0.0%. These notes are payable to the former owners of WebCapades, Inc. and their agent.

Goodwill and Purchased Intangible Assets

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

The Company experienced no impairment loss relating to its intangible assets in 2004 and no indicators of future impairment losses exist as of September 30, 2004.

We amortize our identifiable intangible assets, which result from our acquisitions accounted for under the purchase method of accounting, using the straight-line method over their estimated useful lives.

Stock-Based Compensation

The Company has granted non-qualified incentive stock options to employees and non-qualified stock options to employees, non-employee members of the board of directors and other persons not employed by the Company or its subsidiaries. Each option is subject to vesting periods that range from immediate to a period of three years. The maximum term of the various outstanding options is ten years. The Company accounts for stock-based awards granted to employees in accordance with Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”) and related interpretations, and has adopted the disclosure-only alternative of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS 123”) and SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure.

In accordance with APB 25, stock-based compensation expense is not recorded in connection with stock options granted with exercise prices equal to or greater than the fair market value of the Company’s common stock on the date of grant, unless certain modifications are subsequently made. No compensation expense was recorded under the Company’s option arrangements with employees in 2004 and 2003.

In accordance with the requirements of the disclosure-only alternative of SFAS 123, set forth below are the assumptions used and a pro forma illustration of the effect on net income and net income per share computed as if the Company had valued stock-based awards to employees using the Black-Scholes option pricing model instead of applying the guidelines provided by APB 25.

	Nine Months Ended September 30, 2004				Nine Months Ended September 30, 2003
	Options		Weighted Average Exercise Price		Options	Weighted Average Exercise Price
Outstanding at beginning of period	4,138,026		$	0.23	690,519	$	0.34
Granted	366,256		2.43		3,281,783	0.18
Forfeited	(9,230	)	0.75		0	N/A
Exercised	(15,650	)	0.73		0	N/A
Outstanding at end of period	4,479,402		$	0.50	3,972,302	$	0.20

The weighted average grant date fair value of options granted during the third quarter of 2004 was $0.44.

The following table summarizes information about stock options outstanding at September 30, 2004.

Options Outstanding
Range of Exercise Prices	Options Outstanding	Weighted Average remaining contractual life	Weighted Average Exercise Price
$0.13 -$0.13	2,830,000	8.83	$	0.13
$0.14 - $0.20	397,288	4.42	$	0.17
$0.21 - $0.50	487,774	2.73	$	0.31
$0.51 - $3.80	764,340	5.13	$	2.16
Total	4,479,402	7.15	$	0.50

The following table summarizes the options exercisable on September 30, 2004.

Options Exercisable
Range of Exercise Prices	Options Exercisable	Weighted Average Exercise Price
$0.13 - $0.13	2,830,000	$	0.13
$.014 - $0.20	397,288	$	0.17
$0.21 - $0.50	404,912	$	0.28
$0.51 - $3.80	213,488	$	1.28
Total Options Exercisable at September 30, 2004	3,845,688	$	0.21

The per share fair values of stock awards granted in connection with stock incentive plans and rights granted in connection with the employee stock purchase plan have been estimated with the following weighted average assumptions:

	September 30, 2004		December 31, 2003
Expected Life(in years)	3.00		2.90
Volatility	61.0	%	61.0	%
Risk Free Interest Rate	2.74	%	3.33	%
Dividend Yield	0.0	%	0.0	%

The following table compares net income and earnings per share as reported to the pro forma amounts that would be reported had compensation expense been recognized for our stock-based compensation plans on a fair value basis for the three and nine months ended September 30, 2004 and September 30, 2003:

	Three Months Ended			Nine Months Ended			Three Months Ended			Nine Months Ended
	September 30, 2004, as amended						September 30, 2003, as amended
Net Income, as reported	$	703,055		$	1,097,500		$	(1,544,170	)	$	(1,894,881	)
Deduct: Stock-based employee compensation expense determined under fair value based method for all awards, net of tax	(17,912		)	(27,482		)	(68,567		)	(73,525		)
Pro forma net income	$	685,143		$	1,070,018		$	(1,612,737	)	$	(1,968,406	)
Earnings per share, as reported:
Basic	$	0.03		$	0.05		$	(0.08	)	$	(0.11	)
Fully Diluted	$	0.02		$	0.04		$	(0.07	)	$	(0.09	)
Pro forma earnings per share:
Basic	$	0.03		$	0.05		$	(0.08	)	$	(0.11	)
Fully Diluted	$	0.02		$	0.04		$	(0.07	)	$	(0.10	)

For purposes of this illustration, the value of each stock award has been estimated as of the date of grant using the Black-Scholes model, which was developed for use in estimating the value of traded options that have no vesting restrictions and that are freely transferable. The Black-Scholes model considers, among other factors, the expected life of the option and the expected volatility of a company’s stock price. Because it does not consider other factors important to stock-based awards, such as continued employment and periodic vesting requirements and limited transferability, the fair value generated by the Black-Scholes option pricing model may not be indicative of the actual fair value of the Company’s stock-based awards. For pro forma illustration purposes, the Black-Scholes value of the Company’s stock-based awards is assumed to be amortized on a straight-line basis over their respective vesting periods.

Contingent Consideration

In connection with certain of the Company’s acquisitions, the Company has agreed to pay the former owners additional consideration if certain future internal performance goals are later satisfied. Any additional consideration paid will be allocated to goodwill and stock-based compensation expense. The measurement, recognition and allocation of contingent consideration are accounted for using the following principles:

Measurement and Recognition

In accordance with SFAS No. 141, Business Combinations (“SFAS 141”) contingent consideration is recorded when a contingency is satisfied and additional consideration is issued or becomes issuable. The Company records the additional consideration issued or issuable in connection with the relevant acquisition when a specified internal performance goal is met.

Amount Allocated to Goodwill

In accordance with EITF Issue No. 95-8, Accounting for Contingent Consideration Paid to the Shareholders of an Acquired Enterprise in a Purchase Business Combination (“EITF 95-8”) and FIN 44, the portion of additional consideration issuable to holders of unrestricted (i.e., not subject to risk of forfeiture) common stock and fully vested

options as of the acquisition date is recorded as additional purchase price, as the consideration is unrelated to continuing employment with the Company. Such portion is allocated to goodwill.

Amount Allocated to Stock-Based Compensation Expense

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

Net Income Per Share

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

The following reconciles the denominators of basic and fully diluted earnings per share:

	Three months	Nine Months	Three Months	Nine Months
	Ended September 30, 2004		Ended September 30, 2003
Denominator – Shares
Basic weighted-average shares	24,804,913	22,966,379	19,711,213	17,974,822
Effect of dilutive securities	5,706,561	5,706,561	2,624,069	1,645,344
Fully Diluted weighted-average shares	30,511,474	28,672,940	22,335,282	19,620,166

Intangible Assets and Goodwill

During 2004 to date, the Company entered into two purchase agreements in which it allocated a total of $8,253,606 of the purchase price to intangible assets. The following is a schedule of the Company’s intangible assets, by segment, as of September 30, 2004:

ONLINE DATING

	Term	Initial Value		Accumulated Amortization		Net Carrying Value
Goodwill		$	6,956,992	$	0	$	6,956,992
Client List	7 Years	260,000		3,095		256,905
Website Code and Development	5 Years	729,114		12,152		716,962
Client Relations	6 Months	45,000		7,500		37,500
Totals		$	7,991,106	$	22,747	$	7,968,359

SEARCH ENGINE OPTIMIZATION

	Term	Initial Value		Accumulated Amortization		Net Carrying Value
Web Application Tools	5 Years	$	175,000	$	8,750	$	166,250
Goodwill		87,500		0		87,500
Totals		$	262,500	$	8,750	$	253,750

COMPANY TOTALS

	Initial Value		Accumulated Amortization		Net Carrying Value
Goodwill	$	7,044,492	$	0	$	7,044,492
Other Intangibles	1,209,114		31,497		1,177,617

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

2004	$	76,991
2005	232,966
2006	217,966
2007	217,966
2008	217,966
Thereafter	213,762
Total	$	1,177,617

Long Term Liabilities

The long term liabilities consisted of the following as of September 30, 2004:

Notes Payable, Net of Current Portion	$	566,094
Deferred Rent	141,817
Deposits	1,298
Total	$	709,209

Acquisitions

On August 19, 2004, the Company acquired 100 percent of the outstanding common shares of WebCapades, Inc. The results of WebCapades operations have been included in the consolidated financial statements since that date.

WebCapades, Inc. was formed in 1998 and its primary focus is to provide online dating and matchmaking services tailored to specific interests. The Company is located in Clearwater, Florida and operates websites that have been ranked as some of the most popular in the world, including www.eroticy.com. The Company’s primary reasons for the acquisition were to expand its market share in the relevant online dating market, reduce the time required to develop new technologies and bring it to market, incorporate enhanced functionality into its existing websites, and to enhance its technological capabilities.

The aggregate purchase price was $8,651,413, comprised of $3,500,000, notes payable of $1,151,413, and common stock valued at $4,000,000. The number of shares issued was determined based on the closing market price on the day preceding the consummation of the acquisition.

The amount of purchase price allocated to goodwill was $6,956,992 of which none will be deductible for tax purposes. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition.

The Company calculated the fair value of the tangible and intangible assets acquired to allocate the purchase prices in accordance with SFAS 141.

At August 19, 2004

Current Assets	$	966,530
Property and Equipment	212,844
Intangible Assets	1,034,114
Goodwill	6,956,992

Total Assets Acquired	$	9,170,480
Liabilities	519,067

Net Assets Acquired	$	8,651,413

The results of operations for the above acquisitions are included from the date of acquisition in the consolidated financial statements of the Company.

The Company is in the process of valuing certain intangible assets related to these acquisitions and thus the allocation of the purchase price has not been completed.

Accounting for Contingent Consideration

In connection with its prior acquisition, the merger consideration may be increased as the former shareholder is entitled to earn payments in cash contingent upon the satisfaction of certain future internal performance goals set forth in the applicable merger agreement. Future consideration which may be earned by the former shareholder of each entity will be treated as additional purchase price and allocated to goodwill. The respective maximum amount of such future consideration which may be earned by the former shareholder is as follows:

	Maximum Future Cash Consideration		Maximum Future Stock Consideration		Maximum Earnout Consideration

Acquired Entity
WebCapades	$	500,000	$	—	$	500,000

In addition, the former shareholders of the above acquisition were granted a total of 150,000 options which if and when vested will be charged to stock based compensation expense (see stock based compensation).

Pro Forma Financial Information (unaudited)

During the nine months ended September 30, 2004, the Company acquired the following business in a transactions that was accounted for using the purchase method of accounting: WebCapades, Inc. The following table summarizes the pro forma results of the Company’s operations for the nine months ended September 30, 2004 and 2003 as if the acquisitions had occurred on January 1, 2004 and 2003, instead of their respective later acquisition dates:

	Nine Months Ended September 30, 2004, as amended				Nine Months Ended September 30, 2003, as amended
	Historical		Pro Forma Combined		Historical			Pro Forma Combined
Revenues	$	11,506,893	$	15,771,500	$	3,476,681		$	6,649,402
Net Income	$	1,097,500	$	2,218,499	$	(1,894,881	)	$	(697,676	)
Basic Earnings Per Share	$	0.05	$	0.10	$	(0.11	)	$	(0.04	)
Diluted Earnings Per Share	$	0.04	$	0.08	$	(0.10	)	$	(0.04	)

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

Segment Analysis

The Company’s operations are divided into operating segments using individual products or services or groups of related products and services. The Chief Executive Officer of each Company’s subsidiaries reports to the Chief Executive Officer of the Company, who makes decisions about performance assessment and resource allocation for all segments. The Company had two operating segments as of September 30, 2004: search engine enhancement and online dating The Company evaluates the performance of each segment using pre-tax income or loss from continuing operations.

Listed below is a presentation of sales, operating profit and total assets for all reportable segments. The “other” category in the “Total Assets By Industry Segment” table consists of assets that the Company owns that are not otherwise allocated to a particular segment.

NET SALES BY INDUSTRY SEGMENT

	Nine Months ended September 30, 2004, as amended			Nine Months ended September 30, 2003, as amended
	Amount		Percent	Amount		Percent
Search engine enhancement	$	10,770,630	93.60	$	3,476,681	100.00
Online Dating	736,263		6.40	0		0.00
Total	$	11,506,893	100.00	$	3,476,681	100.00
	Three Months ended September 30, 2004, as amended			Three Months ended September 30, 2003, as amended
	Amount		Percent	Amount		Percent
Search engine enhancement	$	4,467,517	85.85	$	1,572,164	100.00
Online Dating	736,263		14.15	0		0.00
Total	$	5,203,780	100.00	$	1,572,164	100.00

PRE TAX PROFIT (LOSS) FROM CONTINUING OPERATIONS

	Nine Months ended September 30, 2004, as amended			Nine Months ended September 30, 2003, as amended
Search engine enhancement	$	1,854,403		$	(379,698	)
Online Dating	127,653			0
Other	(193,993		)	(389,675		)
Total	$	1,788,063		$	(769,373	)
	Three Months ended September 30, 2004, as amended			Three Months ended September 30, 2003, as amended
Search engine enhancement	$	1,073,691		$	(120,930	)
Online Dating	127,653			0
Other	(43,912		)	(297,732		)
Total	$	1,157,432		$	(418,662	)

TOTAL ASSETS BY INDUSTRY SEGMENT

	September 30, 2004, as amended			September 30, 2003, as amended
	Amount		Percent	Amount		Percent
Search engine enhancement	$	5,055,874	31.14	$	741,110	33.29
Online Dating	9,263,549		57.06	0		0.00
Other	1,915,900		11.80	1,484,868		66.71
Total	$	16,235,323	100.00	$	2,225,978	100.00

Item 2. Management Discussion and Analysis or Plan of Operation

Certain statements in this “Management’s Discussion and Analysis or Plan of Operation” and elsewhere in this quarterly report on Form 10-QSB constitute “forward-looking statements” within the meaning of the Federal Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that are not historical, including statements regarding management’s intentions, beliefs, expectations, representations, plans or predictions of the future and are typically identified by words such as “believe,” “expect,” “anticipate,” “intend,” “estimate,” “may,” “will,” “should” and “could.” These forward-looking statements involve numerous risks and uncertainties that could cause our actual results to be materially different from those set forth in the forward-looking statements including, without limitation, our lack of profitable operating history, changes in our business, need for additional capital and the other additional risks and uncertainties identified under the caption “Risk Factors,” beginning on page 20 and elsewhere in this quarterly report or in any amendment we may file. The following discussion should also be read in conjunction with the Financial Statements and Notes thereto appearing elsewhere in this quarterly report on Form 10-QSB.

Change in Accounting

In the third quarter of 2005, we changed our method for recognizing revenues for our WebSourced, Inc. subsidiary relating to our Search Engine Enhancement services. Effective with this change, retroactively applied to all periods that we performed such services, we recognize revenue on the straight line basis over the term of the contract.

Overview

We were incorporated in the State of Nevada in October 1987. From 1993 until 1997 we essentially had no operations. In 1997, we acquired two private companies that we subsequently divested. In March 2001, we acquired WorldMall.com which was reincorporated in June 2002 as WebSourced, Inc.

Through an acquisition completed in 2004, we now operate our businesses through two direct wholly owned subsidiaries: WebSourced, Inc., and Cherish, Inc.

Critical Accounting Policies and Estimates

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

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

• Search Engine Enhancement Services. We recognize revenues in the period that they are deemed to be earned and collectible under the accrual method of accounting using the straight-line basis over the term of the contract.

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

• Online Dating Segment. We recognize income on monthly and multi-monthly subscription contracts on a straight line basis over the term of the contract.

• In connection with our Search Engine Enhancement services we enter into contracts with customers, and give those customers two payment options. The customer can make one payment in advance of services, or installment over four, six or twelve month periods.

• If payment is received when a contract is signed, we record the receipt of the payment along with an offsetting liability recorded as deferred revenue for the entire amount of the contract. Each month, revenue is recognized straight line over the term of the contract by debiting deferred revenue and crediting revenue.

• If a customer elects to pay in installments, the total amount of the contract is recorded as a debit to installment contracts receivable and a credit to deferred revenue. We then debit accounts receivable when we send an invoice and credit installment contracts receivable. Each month, revenue is recognized straight line over the term of the contract by debiting deferred revenue and crediting revenue. For financial statement purposes, installment contracts receivable is netted with deferred revenue and the amount is listed under deferred revenue on our balance sheet.

• All assets are depreciated over their estimated useful life using the straight line method. Intangible assets are amortized over their estimated lives using the straight line method. Goodwill is tested for impairment annually per FAS 142.

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

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

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

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

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

• We have granted incentive stock options to employees and non-qualified stock options have been granted to employees, non-employee members of the board of directors and other persons. We account for stock-based awards to employees in accordance with Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”) and related interpretations, and have adopted the disclosure-only alternative of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS 123”) and SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure. The fair value of options granted to non-employees, as defined under SFAS 123, has been expensed in accordance with SFAS 123. In accordance with APB 25, stock-based compensation expense is not recorded in connection with stock options granted with exercise prices equal to or greater than the fair market value of our common stock on the date of grant, unless certain modifications are subsequently made. We record deferred compensation in connection with stock options granted with exercise prices less than the fair market value of our common stock on the date of grant. The amount of such deferred compensation per share is equal to the excess of such fair market value over the exercise price.

Comparison of Financial Condition at September 30, 2004 and December 31, 2003

Our total assets as of September 30, 2004 were approximately $16.2 million compared to approximately $3.7 million as of December 31, 2003. This increase was attributable to many factors. During the first nine months of 2004 we acquired WebCapades, Inc. As a result of this acquisition, we acquired approximately $8.0 million in intangible assets and allocated approximately $7.0 million to goodwill. Our accounts receivable increased approximately $560,000, from approximately $450,000 on December 31, 2003 to $1.01 million on September 30, 2004. Our cash and cash equivalents increased from approximately $300,000 on December 31, 2003 to $2.5 million on September 30, 2004. The increase in total cash resulted from the sale of stock in the first nine months of 2004 and the Company generating positive cash flow from operations during this time period. Also, the Company invested approximately $800,000 in additional equipment associated with the Company’s relocation and expansion.

Our total liabilities as of September 30, 2004 were approximately $4.05 million compared to approximately $3.65 million as of December 31, 2003. Total debt at September 30, 2004 was approximately $1.1 million, compared to $2.0 million on December 31, 2003. During the current year the company paid the entire amount of the outstanding debt as of December 31, 2003 with proceeds from the sale of the Company’s common stock in March 2004. Subsequent to that, the Company incurred approximately 1.1 million in debt in relation to the acquisition of WebCapades, Inc. in August.

Shareholders’ Equity was approximately $12.2 million at September 30, 2004 compared to approximately $50,000 at December 31, 2003. This increase resulted from our issuing an aggregate of 6,211,303 shares of our common stock in connection with acquisitions, exercising of stock options and the sale of our common stock and the Company generating approximately $1.1 million of net income during the nine months ended September 30, 2004.

Comparison of Operating Results for Nine Months ended September 30, 2004 and September 30, 2003

Sales for the nine months ended September 30, 2004 increased 231% to approximately $11.5 million from the same period in the prior fiscal year. Sales from our search engine enhancement segment increased from approximately $3.5 million to approximately $10.8 million during this period. This increase was due to the addition of new customers over the past year primarily as a result of the continued increase in our sales force. Additionally, during 2004 as a result of our acquisition, we entered into the online dating segment. Sales from this segment were approximately $740,000 during the first nine months of 2004. We did not enter this segment until August of 2004. We expect to continue to grow as we acquire and integrate new businesses and expand our current businesses.

The gross profits for the nine months ended September 30, 2004 were approximately $9.0 million (78% of sales). In contrast the gross profits for the equivalent period in 2004 were approximately $2.8 million (81% of sales). The decrease in our gross profit as a percentage of revenues was in part due to the increase in our operations, engineering and production department to better serve our client base in our search engine enhancement segment.

General and administrative expenses were approximately $7.2 million (63% of sales) for the nine months ended September 30, 2004. For the same period last year, the expenses totaled approximately $3.5 million (100% of sales). The percentage decrease in relation to sales is due to our increased sales covering our fixed operating and overhead costs. We expect to continue this trend as we further integrate our acquisitions and continue increasing our revenue in advance of our fixed operating costs.

Our net income for the nine months ended September 30, 2004 was approximately $1.1 million compared to a net loss of approximately $1.9 million for the nine months ended September 30, 2003. Basic earnings per common share for the nine months ended September 30, 2004 were $0.05 and ($0.11) for the nine months ended September 30, 2003. Fully diluted earnings per share for nine months ended September 30, 2004 was $0.04 versus ($0.09) for the nine months ended September 30, 2003.

Comparison of Operating Results for Three Months Ended September 30, 2004 and September 30, 2003

Sales for the quarter ended September 30, 2004 increased 231% to approximately $5.2 million from the same period in the prior fiscal year. Sales from our search engine enhancement segment were $4.5 million for the quarter ended September 30, 2004 compared to $1.6 million for the equivalent quarter from 2003. Additionally, during the third quarter 2004, as a result of our acquisition, we entered into the online dating segment. Sales from this segment were approximately $740,000 during the third quarter of 2004. We expect to continue to grow as we acquire and integrate new businesses and expand our current businesses.

The gross profits for the quarter ended September 30, 2004 were approximately $4.0 million (77% of sales). In contrast the gross profits for the equivalent period in 2003 were approximately $1.3 million (82% of sales). The decrease in our gross profit as a percentage of revenues was in part due to the increase in our operations, engineering and production department to better serve our client base in our search engine enhancement segment.

General and administrative expenses were approximately $2.8 million (54% of sales) for the quarter ended September 30, 2004. For the same period last year, the expenses totaled approximately $1.7 million (108% of sales). We expect our general and administrative expenses to decrease as a percentage of sales as we further integrate our acquisitions and continue increasing our revenue in advance of our fixed operating costs.

Our net income for the quarter ended September 30, 2004 was approximately $700,000 compared to a net loss of approximately $1.5 million for the quarter ended September 30, 2003. Basic earnings per common share for the quarter ended September 30, 2004 were $0.03 versus ($0.08) for the quarter ended September 30, 2003. Fully diluted earnings per share for the quarter ended September 30, 2004 was $0.02 versus ($0.07) for the quarter ended September 30, 2003.

Liquidity and Capital Resources

This section describes our balance sheet and liquidity and capital commitments. Our most liquid asset is cash and cash equivalents, which consists of cash and short-term investments. Cash and cash equivalents at September 30, 2004 and December 31, 2003 were approximately $2.5 million and $300,000, respectively. The increase in total cash resulted from the sale of stock in the first nine months

of 2004 and the Company generating positive cash flow from operations during this time period. Also, the Company invested approximately $800,000 in additional equipment associated with the Company’s relocation and expansion.

Cash and cash equivalents consist of cash and short-term investments with original maturities of 90 days or less. Our cash deposits exceeded FDIC-insured limits by approximately $1.65 million at various financial institutions. We have not experienced any losses in such accounts and believe we are not exposed to any significant credit risk on cash.

Cash Flows from Operating Activities

We provided, on a net basis, approximately $1.3 million in cash from operating activities during the nine months ended September 30, 2004, as compared to generating approximately $200,000 during the same period for the fiscal year ended December 31, 2003. This increase in cash from operating activities is primarily a result of the profit generated.

Cash Flows from Investing Activities

We used, on a net basis, approximately $275,000 of cash in investing activities during the first nine months of 2004 as compared to using approximately $12,000 during the first nine months of 2003. This decrease was due primarily to the addition of fixed assets relating to the relocation and expansion of our Websourced division amounting to $800,000. The Company also acquired approximately $500,000 in cash with its acquisition in the third quarter of 2004.

We expect to continue our growth in 2005 by expanding our current operations and through acquisitions. We expect that we will incur future capital expenditures relating to this growth. If usage of our websites substantially increases, we may need to purchase additional servers and networking equipment to maintain adequate data transmission speeds, the availability of which may be limited or the cost of which may be significant.

Cash Flows from Financing Activities

We generated approximately $1.2 million cash in financing activities during the nine months ended September 30, 2004, as compared to using approximately $3,000 during the same period in 2003. The primary source of cash generated from financing activities during the six months ended June 30, 2004, was proceeds, totaling approximately $3.23 million, from the sale of our common stock. The primary use of cash from financing activities during the nine months ended September 30, 2004 was to repay principal on outstanding installment. During the nine months ended September 30, 2004 we repaid principal on debt totaling $2.2 million. The source of cash generated from financing activities during the nine months of 2003 was proceeds, totaling approximately $100,000, from the sale of common stock and from notes payable of $95,000. These proceeds were offset by cash used to repay principal on outstanding debt totaling approximately $200,000.

Segment Analysis

The Company’s operations are divided into operating segments using individual products or services or groups of related products and services. The Chief Executive Officer of each Company’s subsidiaries reports to the Chief Executive Officer of the Company, who makes decisions about performance assessment and resource allocation for all segments. The Company had two operating segments as of September 30, 2004: search engine enhancement and online dating. The Company evaluates the performance of each segment using pre-tax income or loss from continuing operations.

NET SALES BY INDUSTRY SEGMENT

	Nine Months ended September 30, 2004, as amended			Nine Months ended September 30, 2003, as amended
	Amount		Percent	Amount		Percent
Search engine enhancement	$	10,770,630	93.60	$	3,476,681	100.00
Online Dating	736,263		6.40	0		0.00
Total	$	11,506,893	100.00	$	3,476,681	100.00
	Three Months ended September 30, 2004, as amended			Three Months ended September 30, 2003, as amended
	Amount		Percent	Amount		Percent
Search engine enhancement	$	4,467,517	85.85	$	1,572,164	100.00
Online Dating	736,263		14.15	0		0.00
Total	$	5,203,780	100.00	$	1,572,164	100.00

PRE TAX PROFIT (LOSS) FROM CONTINUING OPERATIONS

	Nine Months ended September 30, 2004, as amended			Nine Months ended September 30, 2003, as amended
Search engine enhancement	$	1,854,403		$	(379,698	)
Online Dating	127,653			0
Other	(193,993		)	(389,675		)
Total	$	1,788,063		$	(769,373	)
	Three Months ended September 30, 2004, as amended			Three Months ended September 30, 2003, as amended
Search engine enhancement	$	1,073,691		$	(120,930	)
Online Dating	127,653			0
Other	(43,912		)	(297,732		)
Total	$	1,157,432		$	(418,662	)

TOTAL ASSETS BY INDUSTRY SEGMENT

	September 30, 2004, as amended			September 30, 2003, as amended
	Amount		Percent	Amount		Percent
Search Engine Enhancement	$	5,055,874	31.14	$	741,110	33.29
Online Dating	9,263,549		57.06	0		0.00
Other	1,915,900		11.80	1,484,868		66.71
Total	$	16,235,323	100.00	$	2,225,978	100.00

Risk Factors

An investment in our common stock involves a high degree of risk and should be considered a speculative investment. Should we fail to achieve any of the matters specified below in this “Risk Factors” section, such failure could result in material, adverse harm to us and our business.

We have lost money prior to 2003. We had net losses for the years ended December 31, 2002 and 2001. Alth ough we earned money in 2003 and the first half of 2004, our future operations may not be profitable. If we are not profitable in the future, the value of our common stock may fall and we could have difficulty obtaining funds to continue our operations.

The market price of our common stock is highly volatile. The market price of our common stock has been and is expected to continue to be highly volatile. Many factors beyond our control could impact our stock price, including: announcements of changes in search engine algorithms; technological innovations by other companies; government regulations; marketing, pricing or other actions by competitors; emergence of new competitors; new products or procedures; concerns about our financial position or operating results; litigation; disputes relating to agreements, patents or proprietary rights; loss of key employees; and many other factors. In addition, the potential dilutive effects of future sales of shares of common stock by stockholders and by us, and the exercise of outstanding warrants and options and subsequent sales of our common stock, could have a material adverse effect on the price of our common stock.

We may not be a ble to identify, negotiate, finance or close acquisitions. We intend to pursue one or more acquisitions of companies engaged in businesses that may or may not be similar to our WebSourced, Inc. and Cherish, Inc. subsidiaries. We may not be able to identify or negotiate such acquisitions on acceptable terms or at all. If such acquisitions are successfully identified and negotiated,

the terms thereof may require us to incur additional indebtedness or issue equity. We may not be able to obtain such financing on acceptable terms or at all.

The terms and conditions of acquiring businesses could adversely affect the price of our common stock. In order to consummate acquisitions, we may be required to take action that could adversely affect the price of our stock, such as: issuing common stock, convertible preferred stock, convertible subordinated debt or other equity-linked securities, potentially resulting in the dilution of existing shareholders or having other adverse effects upon existing shareholders; undertaking a reverse stock split; changing the name, Board of Directors, or officers of our com pany; entering into new lines of business; forming business combinations or strategic alliances with potential business partners; or taking other actions. Any one or more of these actions may adversely affect us and our common stock. Also, our shareholders and other potential investors may not like the management or businesses of the companies we acquire, or the terms of such acquisitions, which may adversely affect our Company, the price of our stock, and our ability to raise capital and close acquisitions in the future.

We may be unable to successfully integrate acquired businesses. We may acquire other businesses in the future, which may significantly complicate the management of our Company. We may need to integrate widely dispersed operations with different corporate cultures, operating margins, competitive environments, computer systems, compensation schemes, business plans and growth potential. Such integration efforts may not succeed, or may distract our management from servicing our existing clients. Any failure to manage acquisitions successfully could seriously harm our operating results. Also, the acquisition costs could cause our quarterly operating results to vary significantly.

We cannot assure you that we will effectively manage our growth. We have experienced rapid growth and demand for all of our services since their inception. The growth and expansion of our business, including new service offerings and new geographic markets, places a continuous significant strain on our management, operational and financial resources. We are required to manage multiple relationships with various strategic partners, technology licensors, members and other third parties. In the event of further growth of our operations or in the number of our third-party relationships, we may not be able to manage any such growth effectively. To effectively manage our growth, we must continue to implement and improve our infrastructure of people and information systems, operational plans, and strate gies, and to continuously expand, train, manage and retain our employee base. We cannot guarantee that we can successfully manage our growth, nor that such growth can be achieved and managed without deterioration in our profit margins.

We depend on the availability of skilled labor, which is difficult to attract and retain. The success of our growth strategy will depend to a significant extent upon our ability to attract, train and retain skilled operational, technical, fin ancial, management, sales and marketing personnel. Competition for skilled personnel is intense. We may not be successful in attracting and retaining the personnel necessary to conduct our business successfully. If we are unable to attract, hire, assimilate, and retain such personnel, it could have a material adverse effect on our business, financial condition and results of operations. Moreover, even if we are to expand our employee base, the resources required to attract and retain such employees may adversely affect our operating margins.

Our growth heavily depends on our key personnel, the loss of whom would materially a dversely affect our business. We believe that our success will depend on the continued employment of certain key personnel, including Gerard M. Jacobs, our President and Chief Executive Officer, S. Patrick Martin, the President and Chief Executive Officer of our WebSourced, Inc. subsidiary, and Scott Mitchell, the President of our Cherish, Inc., subsidiary. If one or more of our key management personnel were unable or unwilling to continue their present positions, such persons would be very difficult to replace and our business could be seriously harmed. In addition, we expect that we will find it necessary to offer such key personnel and the independent members of our Board of Directors

compensation in the form of stock options and warrants. In addition, if any of WebSourced, Inc.’s key employees joins a competitor or forms a competing company, some of our clients might choose to use the services of that competitor or new company instead of ours.

Weak general economic and business conditions may adversely affect our revenues and operating margins. Weak general economic and business conditions, international tension and wars, terrorism and epidemics, globally, nationally, regionally or locally, may have a significant adverse effect on our revenues and operating margins.

< i>We lack long-term contracts with clients. Few if any of our clients retain us under contracts longer than 12 months. As a result, our revenues may be difficult to predict. Because we sometimes incur costs based on expectations of future revenues, our failure to predict future revenues accurately may seriously harm our financial condition and results of operations.

There is a lack of brand awareness of our services. Due to lack of marketing resources, we have not been able to develop any widespread awareness of our brand name. Any increase in our advertising and marketing expenditures could cause our operating margins to decline. In addition, our WebSourced, Inc. subsidiary has hired a public relations firm and we have retained an investor relations firm. The cost of such firms impacts our results of operations. Moreover, our brand may be closely associated with the business success or failure of some of our Internet clients, some of whom are pursuing unproven business models in competitive markets. As a result, the failure or difficulties of one of our clients may damage our reputation. If we fail to successfully promote and maintain our brand name or incur significant related expenses, our operating margins and our growth may decline.

A failure by us to meet client expectations could result in losses and negative publicity. Any failure to meet our clients’ expectations could result in delayed or lost revenues due to factors such as: adverse client reactions; requirements to provide additional services to clients at no charge; negative publicity regarding our services, which could adversely affect our ability to attract or retain clients; and claims for damages against us, regardless of o ur responsibility for such failure. We cannot be sure that our contracts will protect us from liability for damages in the event we are sued. Also, if we are sued, the legal fees involved in defending a lawsuit may exceed the amount of the claim in question.

Our business depends in part on the growth and maintenance of the Internet infrastructure. The success of our business will depend in part on the continued growth and maintenance of the Internet infrastructure. This includes maintenance of a reliable network backbone with the necess ary speed, data capacity and security for providing reliable Internet services. Internet infrastructure may be unable to support the demands placed on it if the number of Internet users continues to increase, or if existing or future Internet users access the Internet more often or increase their bandwidth requirements. We also have no control over the third-party telecommunications, cable or other providers of access services to the Internet that our clients and customers rely upon. There have been instances where regional and national telecommunications outages have caused our online dating business to experience service interruptions during which our users could not access our subscription-based services. Any additional interruptions, delays or capacity problems experienced with any points of access between the Internet and our websites could adversely affect our ability to provide services reliably to the users of our websites. The temporary or permanent loss of all or a portion of our services on the Internet, the Internet infrastructure generally, or our users’ ability to access the Internet could disrupt our business activities, harm our business reputation, and result in a loss of revenue.

We face risks associated with our dependence on computer and telecommunications infrastructure. Our services are dependent upon the use of the Internet and telephone and broadband communications to provide high-capacity data transmission without system downtime. ; For example, there have been instances where regional and national telecommunications outages have caused our

online dating business to experience systems interruptions. Any additional interruptions, delays or capacity problems experienced with the telephone connection could adversely affect our ability to provide services to our customers. The temporary or permanent loss of all or a portion of the telecommunications system, or significant delays, could cause disruption of our business activities and result in a loss of revenue. Additionally, the telecommunications industry is subject to regulatory control. Amendments to current regulations could disrupt or adversely affect the profitability of our business. In addition, if any of our current agreements with telecommunications providers are terminated, we may not be able to replace the terminated agreement with an equally beneficial arrangement. There can be no assurance that we will be able to renew any of our current agreements when they expire or, if we are able to do so, that such renewals will be available on acceptable terms. We also do not know whether we will be successful in entering into additional agreements or that any relationships, if entered into, will be on terms favorable to us.

Our success depends upon increased adoption of the Internet and the use of search engines as a means for commerce. Our success depends heavily on the continued use and acceptance of the Internet and of search engines as a means for commerce. The widespread acceptance and adoption of the Internet and search engines for conducting business is likely only in the event that the Internet and search engines provide businesses with greater efficiencies and improvements. If commerce on the I nternet and on search engines does not continue to grow, or grows more slowly than expected, our business would be seriously harmed. Consumers and businesses may reject the Internet or search engines as a viable commercial medium or marketing tool for a number of reasons, including: taxes; potentially inadequate network infrastructure; difficulties or dissatisfaction with search engine algorithms; delays in the development of Internet and search engine enabling technologies and performance improvements; delays in the development or adoption of new standards and protocols required to handle increased levels of Internet and search engine activity; delays in the development of security and authentication technology necessary to affect secure transmission of confidential information over the Internet; changes in, or insufficient availability of, telecommunications services to support the Internet and search engines; problems associated with computer hackers and viruses; decrea sed use of search engines; increased popularity of alternative Internet marketing techniques and strategies; and failure of companies to meet their customers’ expectations in delivering goods and services over the Internet.

We face competition from many small and various large companies worldwide, some of whom are more established and better capitalized than we are. Competition in technology service markets is intense. If we fail to compete successfully against c urrent or future competitors, our business, financial condition and operating results would be seriously harmed. Because relatively low barriers to entry characterize our current and many prospective markets, we expect other companies to enter our markets. In addition, some of our competitors may develop services that are superior to, or have greater market acceptance than, the services that we offer. Also, if our market sectors appear attractive, then numerous existing companies that have greater financial and human resources may be expected to enter those markets. The superior financial and marketing resources of those potential competitors may provide a substantial advantage to those competitors over us.

We face strong and growing competition in SEM services. We believe that the principal bases of competition in Search Engine Marketing (SEM) services are the knowledge base of the competitive companies and the ability of companies to attract prospective customers. The rapidly evolving nature of the markets in which we will compete may attract new entrants as they perceive opportunities, and our competitors may foresee the course of market developments more accurately than we. In addition, our competitors may develop products or services that are superior to and less expensive than ours or may adapt more quickly than we do to new technologies or evolving customer requirements. We expect competition to increase in the future as demand for SEM services increases. There can be no assurance that we will be able to comp ete successfully with existing competitors or with new competitors. We presently compete primarily with other relatively small search engine optimization firms. As the market

continues to grow, larger, better capitalized companies may emerge within this market and command a large share of it. In addition, we have experienced limited competition to date from traditional advertising agencies, which tend to dominate the business of larger corporate accounts. It is possible that over time, traditional advertising agencies will look to develop this capability in-house, which could make them significant competitors of ours and the other current players in the market. The search engines themselves may also in the future become competitors of ours.

We face strong and growing competition in our online dating business. We expect competition in the online dating business to continue to increase because there are no substantial barriers to entry. We believe that our ability to compete in the online dating business depends upon many factors both within and beyond our control, including the following: (1) the size and diversity of our registrants and member bases; (2) the timing and market acceptance of products and services, including the developments and enhancements to those products and s ervices, offered by us or our competitors; (3) customer service and support efforts; (4)selling and marketing efforts; (5) ease of use, performance, price and reliability of solutions developed either by us or our competitors; and (6) our brand strength relative to our competitors. Our online dating business competes with traditional dating and personals services, as well as with newspapers, magazines and other traditional media companies that provide dating and personals services. We also compete with large Internet information hubs, or portals, such as Yahoo!, as well as online personals companies such as Match.com. Many of our current and potential competitors have longer operating histories, significantly greater financial, technical, marketing and other resources and larger customer bases than we do. These factors may allow our competitors to respond more quickly than we can to new or emerging technologies and changes in customer requirements. These com petitors may engage in more extensive research and development efforts, undertake more far-reaching marketing campaigns and adopt more aggressive pricing policies which may allow them to build larger registrant and membership bases than we have. Our competitors may develop products or services that are equal or superior to our products and services or that achieve greater market acceptance than our products and services. This could attract registrants away from our websites and reduce our market share. In addition, current and potential competitors are making, and are expected to continue to make, strategic acquisitions or establish cooperative, and, in some cases, exclusive relationships with significant companies or competitors to expand their businesses or to offer more comprehensive products and services. To the extent these competitors or potential competitors establish exclusive relationships with major portals, search engines and ISPs, our ability to reach potential members through o nline advertising may be restricted. Any of these competitors could cause us difficulty in attracting and retaining registrants and converting registrants into members and could jeopardize our existing affiliate program and relationships with portals, search engines, ISPs and other Internet properties.

Search Engine Optimization may become more difficult or less desirable over time. A major goal of a search engine optimization company like ours is to cause our clients’ websites to obtain high rankings on various search engines. The search engi nes generally seek to rank websites based upon their degree of relevancy to the key words in question. The search engines are frequently changing their algorithms and criteria in order to try to prevent their rankings from being manipulated for the benefit of undeserving websites. This therefore creates a risk that over time the search engines may succeed in limiting the efficacy of our services either through continued refinement of their ranking system or in some other way hindering search engine optimization efforts. The search engine optimization industry is relatively new, with limited technological barriers to entry. Increased competition over time may reduce the overall efficiency of our efforts as other competitors effect similar results for their clients. Search engines are increasing the number of “pay per click” listings in their search results. This could generally lessen the desirability of our SEO services. While we perform “pay per click” campa ign management as well, there can be no assurance that the revenues from our “pay per click” campaign management will be able to offset any decline in demand for our SEO services.

Increasing government regulations or taxation could adversely affect our business. We are affected not only by regulations applicable to businesses generally, but also by federal, state, local and

foreign laws, rules, regulations and taxes directly applicable to electronic communications, telecommunications, the Internet and eBusiness. New laws and regulations governing such matters could be enacted or amendments may be made to existing regulations at any time that could adversely impact our services. Any such new laws, regulations or amendments to existing regulations could disrupt or adversely affect the profitability of our business, or could dampen the growth of the Internet and decrease its acceptance as a communications and commercial medium. If such a decline occurs, companies may decide in the future not to use our services. Any such decrease in the demand for our services would seriously harm our business and operating results. Any new laws, regulations and taxes may govern, restrict, tax or affect any of the following issues: user privacy ; the pricing and taxation of goods and services offered over the Internet; the content of websites; access to websites; linking of websites; outgoing email solicitations; consumer protection; and the characteristics and quality of products and services offered over the Internet. In particular, our WebCapades subsidiary operates websites which display adult content, and laws restricting the use of adult content could adversely impact the profitability or ongoing viability of such a subsidiary.

Legal uncertainties affecting the Internet could adversely affect our business. Legal uncertainties surrounding domestic and foreign government regulations regarding the Internet could increase our costs of doing business, require us to revise our services, prevent us from delivering our services over the Internet or slow the growth of the Internet, any of which could increase our expenses, reduce our revenues or cause our revenues to grow at a slower rate than expected and materially adversely affect our business, financial condition and results of operations. Laws and regulations related to Internet communications, security, privacy, intellectual property rights, commerce, taxation, entertainment, recruiting and advertising are becoming more prevalent, and new laws and regulations are under consideration by the United States Congress, state legislatures and foreign governments. Any legislation enacted or restrictions arising from current or future go vernment investigations or policy could dampen the growth in use of the Internet generally and decrease the acceptance of the Internet as a communications, commercial, entertainment, recruiting and advertising medium. In addition to new laws and regulations being adopted, existing laws may be applied to the Internet. Many areas of law affecting the Internet remain unsettled, even in areas where there has been some legislative action. It may take years to determine whether and how existing laws such as those governing consumer protection, intellectual property, libel and taxation apply to the Internet.

Our limited operating h istory and relatively new business model in emerging and rapidly evolving markets make it difficult to evaluate our future prospects. We commenced operations within the past few years, and we have only a short operating history with our business model. As a result, we have very little operating history for you to evaluate in assessing our future prospects. Also, our online dating business derives nearly all of its net revenues from online subscription fees, which is an early-stage business model that has undergone rapid and dramatic changes. We are an early-stage company in new and rapidly evolving markets. We may not be able to successfully assess or address all of the significant and changing risks and difficulties inherent in these new and rapidly evolving markets, which could materially harm our business and operating results.

The ability of our online dating business to generate positive cash flow and operating profits as a relatively new company in a new and evolving business will depend upon a number of factors that are difficult to predict. These factors which are difficult to predict include the following: (1) the level of acceptance of online dating services; (2) our ability to create and increase brand awareness and attract and retain a large number of members and subscribers, including our ability to convert members into paying subscribers; (3) ;the level of usage of the Internet and traffic to our websites; (4) our ability to maintain current, and develop new, relationships with portals, search engines, ISPs and other Internet properties and entities capable of attracting individuals who might subscribe to our fee-generating services; (5) our ability to implement our expansion plans or integrate newly acquired companies, including controlling the costs associated with such expansion or acquisitions; (6) our ability to control

costs related to general infrastructure including the amount and timing of operating and capital expenditures; (7) our ability to introduce new websites, features and functionality on a timely basis; (8) our ability to scale technological and other infrastructure across our various websites; (9) our ability to protect our data from loss or electronic or magnetic corruption; (10) our ability to provide for failure and disaster recovery programs; (11) our ability to upgrade our technologies and protect our sites from technology failures, which could cause revenue loss and allow affiliates to terminate their agreements with us; (12) our ability to attract, retain and motivate qualified personnel; (13) our ability to expand and compete internationally; (14) the introduction of new products or services by our competitors; and (15) our ability to anticipate and adapt to the changing Internet business and any changes in government regulation.

If the efforts of our online dating business to attract a large number of registrants, to convert registrants into paying members and to retain our paying members are not successful, our revenues and operating results would suffer. The future growth of our online dating business depends on our ability to attract a large number of registrants, to convert registrants into paying members and to retain our paying members. This in turn depends on our ability to deliver a high-quality online dating experience to these registrants and members. Our competitors are d eveloping highly targeted content as well as innovations in technology, online advertising, and the providing of information. As a result, we must continue to invest significant resources in order to enhance our existing products and services and to introduce new high-quality products and services that people will use. If we are unable to predict user preferences or industry changes, or if we are unable to modify our products and services on a timely basis, we may lose existing members and we may fail to attract new registrants. Our operating results would also suffer if our innovations are not responsive to the needs of our members or are not brought to market in an effective or timely manner.

The member acquisition costs of our online dating business vary depending upon prevailing market conditions, and may increase significantly in the future. The member acquisition costs of our online dating business are dependent in part upon our ability to purchase advertising at a reasonable cost. Our advertising costs vary over time, depending upon a number of factors, some of which are beyond our control. Historically, we have used online advertising as the primary means of marketing our services. In general, the costs of online advertising have recently increased substantially and these costs are expected to continue to increase as long as the demand for online advertising remains robust.

Our online dating business must keep pace with rapid technological change to remain competitive; our services are not well-suited to many alternate Internet access devices. Our online dating business operates in a market characterized by rapidly changing technology, evolving industry standards, frequent new product and service announcements, enhancements, and changing customer demands. Accordingly, our success will depend on our ability to adapt to rapidly changing technologies and industry standards, and our ability to continually improve the speed, performance, features, ease of use and reliability of services in response to both evolving d emands of the marketplace and competitive service and product offerings. Introducing new technology into our systems involves numerous technical challenges, substantial amounts of capital and personnel resources, and often takes many months to complete. We may not be successful in integrating new technology into our websites on a timely basis, which may degrade the responsiveness and speed of our websites. Such technology, once integrated, may not function as expected. In addition, the number of people who access the Internet through devices other than desktop and laptop computers, including mobile telephones and other handheld computing devices, has increased dramatically in the past few years, and we expect this growth to continue. The lower resolution, functionality and memory currently associated with such mobile devices makes the use of our online dating services through such mobile devices more difficult and generally impairs the member experience relative to access via desktop and la ptop computers. If we are unable to attract and retain a substantial number of such mobile device users to our online dating services

or if we are unable to develop services that are more compatible with such mobile communications devices, our growth could be adversely affected.

Our online dating business depends on our server and network hardware and software and our ability to obtain network capacity, and we cannot guarantee that we can prevent an interruption of use of our services. The performance of our server and networking hardware and software infrastructure is critical to our business and reputation and our ability to attract Internet users, advertisers, members and e-commerce partners to our websites and to convert members to subscribers. An unexpected a nd/or substantial increase in the use of our websites could strain the capacity of our systems, which could lead to a slower response time or system failures. Although we have not had any significant delays, any slowdowns or system failures could adversely affect the speed and responsiveness of our websites and would diminish the experience for our members and visitors. We face risks related to our ability to scale up to our expected customer levels while maintaining superior performance. If the usage of our websites substantially increases, we may need to purchase additional servers and networking equipment to maintain adequate data transmission speeds, the availability of which may be limited or the cost of which may be significant. Any system failure that causes an interruption in service or a decrease in the responsiveness of our websites could reduce traffic on our websites and, if sustained or repeated, could impair our reputation and the attractiveness of our brands as well as reduce revenue and negatively impact our operating results. Furthermore, we rely on many different software applications, some of which have been developed internally. If these hardware and software systems fail, it would adversely affect our ability to provide our services. If we receive a significant unexpected increase in usage and are not able to rapidly expand our transaction-processing systems and network infrastructure without any systems interruptions, it could seriously harm our business and reputation. We have experienced occasional systems interruptions in the past as a result of unexpected increases in usage, and we cannot assure you we will not incur similar or more serious interruptions in the future.

The failure to establish and maintain affiliate agreements and relationships could limit the growth of our online dating business. We have entered into, and expect to continue to enter into, arrangements with affiliates to increase our member base, bring traffic to our websites and enhance our brands. If any of the current agreements are terminated, we may not be able to replace the terminated agreement with an equally beneficial arrangement. We cannot assure you that we will be able to renew any of our current agreements when they expire or, if we are able to do so, that such renewals will be available on acceptable terms. We also do not know whether we will be successful in entering into additional agreements or that any relationships, if e ntered into, will be on terms favorable to us.

Our online dating business relies on a number of third-party providers, and their failure to perform or termination of our relationships with them could harm our business. We rely on third parties to provide important services and technologies to our online dating business, including third parties that manage and monitor our onsite data center, ISPs and credit card processors. In addition, we license technologies from third parties to facilitate our ability to provide our services. Any failure on our p art to comply with the terms of these licenses could result in the loss of our rights to continue using the licensed technology, and we could experience difficulties obtaining licenses for alternative technologies. Furthermore, any failure of these third parties to provide these and other services, or errors, failures, interruptions or delays associated with licensed technologies, could significantly harm our business. Any financial or other difficulties our providers may face may have negative effects on our business, the nature and extent of which we cannot predict.

Our online dating business may be sued in regard to information retri eved from or transmitted over the Internet. We may be sued for alleged defamation, civil rights infringement, negligence, copyright or trademark infringement, invasion of privacy, personal injury, product liability or other legal claims relating to information that is published or made available on our websites and other websites linked to it. These types of claims have been brought, sometimes successfully, against online service

providers in the past. Our online dating business also offers email services, which may subject us to potential risks, such as liabilities or claims in regard to unsolicited email or spamming, lost or misdirected messages, security breaches, illegal or fraudulent use of email or interruptions or delays in email service. Our insurance does not specifically provide for coverage of these types of claims and therefore may not adequately protect us against these types of claims. In addition, we could incur significant costs in investigating and defending such claims, even if we ultimately are found not liable. If any of these events occur, our revenues could be materially adversely affected and the value of our common stock may decline.

Our online dating business, located in Florida, could be significantly impacted by the occurrence of natural disasters such as hurricanes and other catastrophic events. Our online dating business is located in Clearwater, Florida. Our operations depend upon our ability to maintain and protect our data center, which is also located in Florida and is managed by a third party. Our business is therefore susceptible to hurricanes and other catastrophic events, including acts of terr orism. We currently lack adequate redundant hardware and software systems supporting our services at an alternate site. We may not be able to prevent outages and downtime caused by natural disasters and other events out of our control, which could adversely affect our reputation, brands and business.

The percentage of canceling members of our online dating business in comparison to other subscription businesses requires that we must continually seek new members to maintain or increase our current level of revenue. Internet users in general, and users of online personals services specifically, freely navigate and switch among a large number of websites. We cannot assure you that we will be able to maintain our member churn, and it may increase in the future. This makes it difficult for us to have a stable member base and requires that we constantly attract new members at a faster rate than member terminations to maintain or increase our current level of revenue. If we are unable to attract new members on a cost-effective basis, our business will not grow and our profitability will be adversely affected.

The display of adult content on our websites could be restricted by regulation. Regulation of adult content could prevent us from making our WebCapades subsidiary’s content available in various jurisdictions or otherwise could have a material adverse effect on its business. Various governmental agencies are considering a number of legislative and regulatory proposals which may lead to laws or regulations concerning various aspects of the Internet, including online content, intellectual property rights, user privacy, taxation, access charges, liability for third-party activities and jurisdiction. Regulation of the Internet could materially adversely affect our business, financial condition or results of operations by reducing the overall use of the Internet, reducing the demand for our services or increasing our cost of doing business.

We face certain risks related to the physical and emotional safety of the users of our online dating websites. We cannot control the offline behavior of users of our websites. There is a possibility that one or more of the users of our websites could be physically or emotionally harmed following interaction with another user of our websites. We do not and cannot screen the users of our web sites, and given our lack of physical presence, we do not take any action to ensure personal safety on a meeting arranged following contact initiated via our websites. If an unfortunate incident were to occur in a meeting of people following contact initiated on one of our websites or a website of one of our competitors, any resulting negative publicity could materially and adversely affect the online dating industry in general. Any such incident involving one of our websites could damage our reputation and our brands. This, in turn, could adversely affect our revenues. In addition, the affected users of our websites might initiate legal action against us, which could cause us to incur significant expense, whether or not the legal action is defended successfully, and could cause further damage to our reputation.

We are subject to risks in regard to the handling of personal information. In the normal course of our business, our online dating business handles personally identifiable information pertaining to our members and visitors residing in the United States as well as foreign countries. In recent years, many of these countries have adopted privacy, security, and data protection laws and regulations intended to prevent improper uses and disclosures of personally identifiable information. In addition, some jurisdictions impose database registration requirements for which significant monetary and other penalties may be imposed for noncomplianc e. These laws may impose costly administrative requirements, limit our handling of information, and subject us to increased government oversight and financial liabilities. Privacy laws and regulations in the United States and foreign countries are subject to change and may be inconsistent, and additional requirements may be imposed at any time. These laws and regulations, the costs of complying with them, administrative fines for noncompliance and the possible need to adopt different compliance measures in different jurisdictions could increase our expenses.

Security breaches and inappropriate Internet use could damage our busines s. Concerns over the security of transactions conducted on the Internet and the privacy of users may inhibit the growth of the Internet and other online services generally, and online commerce in particular. Our failure to successfully prevent security breaches could significantly harm our business, reputation and results of operations, and might expose us to lawsuits by state and federal consumer protection agencies, and by consumers. Anyone who is able to circumvent our security measures could misappropriate proprietary information, including customer credit card and personal data, cause interruptions in our operations, or damage our brand and reputation. Such breach of our security measures could involve the disclosure of personally identifiable information and could expose us to a material risk of litigation, liability or a gover nment enforcement proceeding. We cannot assure you that our financial systems and other technology resources are completely secure from security breaches or sabotage, and we have occasionally experienced security breaches and attempts at “hacking”. We may be required to incur significant additional costs to protect against security breaches or to alleviate problems caused by breaches. Any well-publicized compromise of our security or the security of any other Internet provider could deter people from using our services or the Internet to conduct transactions that involve transmitting confidential information or downloading sensitive materials, which might adversely affect our online dating business.

Computer viruses could damage our business. Computer viruses, worms and similar programs may cause our systems to incur delays or other service interruptions and could damage our reputation and affect our ability to provide our services and adversely affect our revenues. The inadvertent transmission of computer viruses could also expose us to a material risk of loss or litigation and possible liability. Moreover, if a computer virus affecting our system is highly publicized, our reputation could be significantly damaged resulting in the loss of current and future members and subscribers.

We are exposed to risks associated with credit card fraud and credit payment. We depend on continuing availability of credit card usage to process contract payments and subscriptions, and this availability in turn depends on acceptable levels of chargebacks and fraud performance. Our online dating business has suffered losses and may continue to suffer losses as a result of membership orders placed with fraudulent credit card data, even though the associated financial institution approved payment. Under current credit card practices, a merchant is liable for fraudulent credit card transactions when, as is the case with the transactio ns processed by our online dating business, that merchant does not obtain a cardholder’s signature. A failure to adequately control fraudulent credit card transactions would result in significantly higher credit card-related costs.

We may be unable to protect our intellectual property. We cannot guaranty that we can safeguard or deter misappropriation of our intellectual property. In addition, we may not be able to detect unauthorized use of our intellectual prop erty and take appropriate steps to enforce our rights. If former employees or third parties infringe or misappropriate our trade secrets, copyrights, trademarks or other

proprietary information or intellectual property, our business could be seriously harmed. In addition, although we believe that our proprietary rights do not infringe the intellectual property rights of others, other parties may assert infringement claims against us or claim that we have violated their intellectual property rights. Such claims, even if not true, could result in significant legal and other costs and may be a distraction to our management.

We are unlikely to collect all of the money owed to us by The Voice and Data Group, Inc. We terminated our merger agreement with The Voice and Data Group, Inc., among other things, because certain conditions to the consummation of the merger could not be met. There is no guarantee that The Voice and Data Group, Inc. will be able to repay the $100,000 unsecured loan made by us to them in connection with the merger agreement. As of September 30, 2004, we have written off $75,000 of that $100,000 unsecured loan to The Voice and Data Gr oup, Inc.

We may be subject to litigation in regard to the activities of our former subsidiaries. Our former subsidiaries were involved in a wide variety of activities, including general contracting, asbestos abatement, and demolition activities. These activities may result in litigation of some nature against us. We have previously been sued and have settled a lawsuit by paying $1,000,000 in regard to an indemnity agreement signed by us in connection with a construction project in O’Fallon, Missouri, the general contractor of which was originally one of our former subsidiaries. We have signed an indemnity agreement in regard to performance and payment bonds issued by a surety covering a construction project in St. Ann, Missouri, the general contractor of which is one of our former subsidiaries. Although our management does not currently anticipate litigation in regard to the St. Ann construction project, and although our former chairman and chief executive officer, John Giura, has agreed to indemnify and hold us harmless against any such litigation, we cannot guarantee that litigation of some type will not occur. Other litigation relating to our former subsidiaries is possible.

A significant portion of our stock is owned by insiders. Our current Directors and officers and those of our subsidiaries, as a group, together with their affiliates and other parties well known to them, beneficially own a significant percentage of our outstanding shares of common stock. Accordingly, these stockholders will have substantial influence over our policies and management. Voting control over a significant portion of these stockholders’ shares and of the shares owned by Mr. John Giura (former chairman and chief executive officer) have been transferred, pursuant to irrevocable proxies, to Gerard M. Jacobs, our President and Chief Executive Officer.

We have not paid dividends since our inception and do not expect to do so in the foreseeable future. As a result, our stockholders will not be able to receive any return on their investment without selling their shares. We presently anticipate that all earnings, if any, will be retained for development of our business and acquisitions of new businesses. Any future dividends will be subject to the discretion of the Board of Directors and will depend on, among other things, our future earnings, operating and financial condition, capital requirements and general business conditions.

< p style="color:#000033;margin:0in 0in .0001pt;">

Nevada laws may discourage investor purchases of, or mergers or other transactions involving, our stock. Certain Nevada laws limit the circumstances under which a person or entity may acquire a controlling interest in the stock of a Nevada corporation or may cause a merger, consolidation or other “combination” to occur involving a Nevada corporation. These laws may discourage companies or persons interested in acquiring a significant interest in or control of our company, or delay or make such an acquisition or transaction more difficult or expensive to consummate, regardless of whether such an acquisition or transaction may be in the best interest of our stockholders.

We may need additional capital in the future. It may be necessary for us to raise additional capital to fund the cash portion of future acquisitions. If it is determined that additional capital is needed, it will be raised by selling additional equity or raising debt from third party sources. The sale of additional

equity or convertible debt securities could result in dilution to current stockholders. In addition, debt financing, if available, could involve restrictive covenants, which could adversely affect operations. There can be no assurance that any of these financing alternatives, including raising additional capital, will be available in amounts or on terms acceptable to us. If we are unable to raise any needed additional capital, we could be required to significantly alter our operating plan, which could have a material adverse effect on our business, financial condition and results of operations.

If we issue additional shares of our Common Stock in connection with any future acquisitions of businesses, the value of your shares could be diluted. We may make additional acquisitions of businesses. We may make payment for such acquisitions by issuing shares of our Common or Preferred Stock or by payment in cash. If we choose to make payment in the form of shares of our Common or Preferred Stock, our existing shareholders may experience a dilution in their ownership interest in us. If we elect to make payment in the form of cash, we would have to de termine whether we will use available cash or obtain additional cash from traditional bank financing, sources other than banks or the proceeds of the sale of our Common or Preferred Stock. While using debt to finance acquisitions may provide greater financial returns, it also brings with it greater risk. Should there be a downturn in the business of the target (due to numerous factors which could include normal downturns in the business cycle, the departure of key employees or key accounts, inability to integrate the target’s operations into our operations, etc.), we may risk loss of our investment. Lenders and/or equity partners also may impose restrictions upon the manner in which we conduct our business.

We intend to indemnify our officers and directors. We intend to indemnify our officers and directors to the fullest extent permissible under the law. Under most circumstances, our officers and directors may not be held liable to us or our equity owners for errors in judgment or other acts or omissions in the conduct of our business unless such errors in judgment, acts or omissions constitute fraud, gross negligence or malfeasance.

Item 3. Control and Procedures

As required by Rule 13a-15(b) under the Exchange Act, we conducted an evaluation, under the supervision and with the participation of our management, including our chief executive officer and the chief financial officer, of the effectiveness and the design and operation of our disclosure controls and procedures as of September 30, 2004, the end of the period covered by this report. This evaluation was subsequently modified due to the identification of items described below. Based on and as of the date of the foregoing evaluation as modified, we determined that our internal controls over revenue recognition for certain of our contracts at our search engine enhancement segment were deficient, and constituted a material weakness, and therefore our disclosure controls and procedures were not effective as of September 30, 2004.

The deficiencies in our internal controls resulted in improper recognition of revenue at our WebSourced subsidiary. The first deficiency at WebSourced was the lack of adequate objective criteria of the value of services provided to customers to support use of the proportional performance model using the pattern in which value is provided to the customer over the term of the contract to recognize revenue generated by WebSourced. The second deficiency at WebSourced related to the lack of sufficient evidence to support the collectibility of amounts recognized under certain contracts on an accelerated basis.

During the fourth quarter of 2005, we began a process to improve upon our internal controls in an effort to remediate these deficiencies, in part by establishing additional policies and procedures related to revenue recognition. Management is implementing compensating controls and procedures, principally manual checks and additional levels of review as it relates to revenue recognition. In addition, our WebSourced subsidiary now performs a credit check at the time it enters into a contract with a client to determine the appropriate payment terms for the client, which provides an objective basis for our belief that the collectibility of amounts recognized as revenue associated with the client is reasonably assured. Additionally, management has directed our internal audit staff, which reports directly to our audit committee and is not involved in the preparation of our financial statements, to focus on evaluating and documenting our disclosure controls and procedures over financial reporting including revenue recognition. Further, on a going forward basis, our audit committee will review a list of all critical accounting policies and estimates with supporting schedules for each pending acquisition prior to closing. Management has approved and intends to hire additional internal audit staff. To date, we have incurred expenses of approximately $25,000 to remediate these deficiencies in our internal controls. These expenses include the costs of the credit checks and a pro rata portion of the time incurred by our internal audit staff to improve our disclosure controls and procedures over financial reporting. In 2006, we expect these expenses to be approximately $35,000. We anticipate that the material weakness in our disclosure controls and procedures caused by the deficiencies set forth above will be fully remediated during the first quarter of 2006 and prior to the filing of our annual report for the year ended December 31, 2005.

There was no change in our internal control over financial reporting that occurred during the fiscal quarter ended September 30, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

EXPLANATORY NOTE
PART I. FINANCIAL INFORMATION
	Item 1.	Financial Statements
	Item 2.	Management Discussion and Analysis or Plan of Operation
	Item 3.	Control and Procedures
Part II. OTHER INFORMATION
	Item 1.	Legal Proceedings
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds
	Item 3.	Defaults Upon Senior Securities
	Item 4.	Submission of Matters to a Vote of Security Holders
	Item 5.	Other Information
	Item 6.	Exhibits
SIGNATURES

	CGI HOLDING CORPORATION (Registrant)

	By:	/s/ Gerard M. Jacobs
		Gerard M. Jacobs, Director, Chief Executive Officer, Treasurer and Secretary

	By:	/s/ Jody Brown
		Jody Brown, Chief Financial Officer

Signed	/s/ Gerard M. Jacobs
Name:	Gerard M. Jacobs
Title:	Chief Executive Officer

Signed	/s/ Jody Brown
Name:	Jody Brown
Title:	Chief Financial Officer

	Signed:	/s/ Gerard M. Jacobs
	Name:	Gerard M. Jacobs
	Title:	Chief Executive Officer
	Date:	December 29, 2005