SEC Filing - Marchex

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Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2008

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

For the transition period from to .

Commission File Number 000-50658

Marchex, Inc.

(Exact name of Registrant as specified in its charter)

Delaware

35-2194038

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

413 Pine Street, Suite 500

Seattle, Washington 98101

(Address of principal executive offices)

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

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

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


Large accelerated filer ¨	Accelerated filer x	Non-accelerated filer ¨	Smaller reporting company ¨
		(Do not check if a smaller reporting company)

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

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


Class		Outstanding at November 7, 2008
Class A common stock, par value $.01 per share		10,959,216
Class B common stock, par value $.01 per share		27,517,985

Marchex, Inc.

Form 10-Q

Table of Contents


		Page
Part I—Financial Information

Item 1.	Condensed Consolidated Financial Statements (unaudited)	3

	Condensed Consolidated Balance Sheets	3

	Condensed Consolidated Statements of Operations	4

	Condensed Consolidated Statements of Cash Flows	5

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	33

Item 4.	Controls and Procedures	33

Part II—Other Information

Item 1.	Legal Proceedings	33

Item 1A.	Risk Factors	33

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	49

Item 6.	Exhibits	49

SIGNATURE		50

Part I—Financial Information

Item 1.

Condensed Consolidated Financial Statements (unaudited)

MARCHEX, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(unaudited)


	December 31, 2007			September 30, 2008
Assets
Current assets:
Cash and cash equivalents	$	36,456,307		$	29,088,528
Accounts receivable, net		18,307,386			19,555,766
Prepaid expenses and other current assets		2,118,390			3,357,625
Refundable taxes		1,693,695			3,717,520
Deferred tax assets		867,465			1,207,027

Total current assets		59,443,243			56,926,466
Property and equipment, net		7,357,903			6,406,618
Deferred tax assets		7,447,315			8,245,650
Intangible and other assets, net		17,381,827			14,584,907
Goodwill		204,766,826			204,785,718
Intangible assets from acquisitions, net		23,797,231			12,892,421

Total assets	$	320,194,345		$	303,841,780

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	11,625,779		$	11,075,737
Accrued expenses and other current liabilities		3,668,342			6,319,468
Deferred revenue		2,906,379			2,323,834

Total current liabilities		18,200,500			19,719,039
Other non-current liabilities		105,370			42,253

Total liabilities		18,305,870			19,761,292
Commitments and contingencies
Stockholders’ equity:
Convertible preferred stock		1,446,649			964,689
Class A common stock		113,717			112,217
Class B common stock		321,061			286,655
Treasury stock		(22,116,275	)		(8,526,660	)
Additional paid-in capital		329,835,529			298,412,133
Accumulated deficit		(7,712,206	)		(7,168,546	)

Total stockholders’ equity		301,888,475			284,080,488

Total liabilities and stockholders’ equity	$	320,194,345		$	303,841,780

See accompanying notes to condensed consolidated financial statements.

MARCHEX, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

(unaudited)


	Nine months ended September 30,						Three months ended September 30,
	2007			2008			2007			2008
Revenue	$	102,382,626		$	111,563,744		$	33,493,588		$	37,157,530

Expenses:
Service costs (1), (2)		50,821,449			51,745,487			18,815,633			15,443,871
Sales and marketing (1), (2)		19,651,548			23,330,681			5,028,698			8,462,898
Product development (1), (2)		8,563,161			13,189,709			3,302,726			4,750,136
General and administrative (1), (2)		12,791,276			15,190,526			4,552,858			5,156,542
Amortization of intangible assets from acquisitions (3)		12,604,730			10,879,203			4,007,342			3,165,566
Facility relocation		121,124			—			—			—

Total operating expenses		104,553,288			114,335,606			35,707,257			36,979,013
Gain on sales and disposals of intangible assets, net		282,079			3,766,608			126,569			1,611,341

Income (loss) from operations		(1,888,583	)		994,746			(2,087,100	)		1,789,858
Other income (expense):
Interest income		2,130,433			599,374			663,513			149,592
Interest and line of credit expense		(5,524	)		(62,490	)		(2,148	)		(28,259	)
Other		(3,243	)		879,740			—			877,885

Total other income, net		2,121,666			1,416,624			661,365			999,218

Income (loss) before provision for income taxes		233,083			2,411,370			(1,425,735	)		2,789,076
Income tax expense		982,077			1,824,396			95,311			1,431,120

Net income (loss)		(748,994	)		586,974			(1,521,046	)		1,357,956
Convertible preferred stock dividends and discount on preferred stock redemption, net		(113,039	)		(32,657	)		16,991			11,928

Net income (loss) applicable to common stockholders	$	(635,955	)	$	619,631		$	(1,538,037	)	$	1,346,028

Basic and diluted net income (loss) applicable to Class A and Class B common stockholders	$	(0.02	)	$	0.02		$	(0.04	)	$	0.04
Shares used to calculate basic net income (loss) per share applicable to common stockholders
Class A		11,614,527			10,965,238			11,559,216			10,959,216
Class B		27,835,316			25,860,205			27,544,679			25,207,357
Shares used to calculate diluted net income (loss) per share applicable to common stockholders
Class A		11,614,527			10,965,238			11,559,216			10,959,216
Class B		39,449,843			37,484,212			39,103,895			36,852,998

(1) Excludes amortization of intangible assets from acquisitions

(2) Includes stock-based compensation as follows:

Service costs	$	302,066		$	414,222		$	151,790		$	188,564
Sales and marketing		836,606			1,443,728			374,448			587,014
Product development		1,543,017			1,360,011			603,073			553,013
General and administrative		5,534,195			5,766,743			1,856,638			1,919,405

Total	$	8,215,884		$	8,984,704		$	2,985,949		$	3,247,996


(3) Components of amortization of intangible assets from acquisitions:

Service costs	$	9,480,510		$	9,528,725		$	3,135,890		$	2,970,010
Sales and marketing		2,145,000			1,116,667			715,000			162,223
General and administrative		979,220			233,811			156,452			33,333

Total	$	12,604,730		$	10,879,203		$	4,007,342		$	3,165,566

See accompanying notes to condensed consolidated financial statements.

MARCHEX, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(unaudited)


	Nine months ended September 30,
	2007			2008
Cash flows from operating activities:
Net income (loss)	$	(748,994	)	$	586,974
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Amortization and depreciation		19,216,650			18,446,956
Facility relocation costs		113,043			2,918
Loss (gain) on sales of fixed assets, net		3,243			(2,874	)
Gain on sales and disposals of intangible assets, net		(282,079	)		(3,766,608	)
Allowance for doubtful accounts and advertiser credits		833,270			2,520,978
Stock-based compensation		8,215,884			8,984,704
Deferred income taxes		(3,988,557	)		(1,137,897	)
Excess tax benefit related to stock options		(2,462,978	)		(60,263	)
Change in certain assets and liabilities, net of acquisitions:
Trade accounts receivable, net		2,411,867			(3,769,358	)
Refundable taxes		1,623,819			(1,739,002	)
Prepaid expenses, other current assets and restricted cash		977,551			(2,405,503	)
Accounts payable		356,279			(372,277	)
Accrued expenses and other current liabilities		799,611			2,677,238
Deferred revenue		510,682			(586,418	)
Other non-current liabilities		(6,822	)		(19,476	)

Net cash provided by operating activities		27,572,469			19,360,092
Cash flows from investing activities:
Purchases of property and equipment		(2,973,292	)		(2,685,493	)
Cash paid, net of recoveries, for acquisitions		(12,945,544	)		(127,522	)
Proceeds from sales of property and equipment		8,115			38,043
Proceeds from sales of intangible assets		686,506			3,918,889
Purchases of intangibles and changes in other non-current assets		(10,573,926	)		(200,245	)

Net cash (used in) provided by investing activities		(25,798,141	)		943,672
Cash flows from financing activities:
Deferred financing costs paid		—			(89,955	)
Capital lease obligation principal payments		(14,872	)		(35,173	)
Excess tax benefit related to stock options		2,462,978			60,263
Preferred stock dividends payments		(56,374	)		(43,314	)
Repurchase of convertible preferred stock		(732,368	)		(408,964	)
Repurchase of Class B common stock for treasury stock		(13,592,482	)		(25,719,732	)
Common stock dividends payments		(2,483,456	)		(2,417,063	)
Proceeds from exercises of stock options		3,672,499			949,055
Proceeds from employee stock purchase plan		60,260			33,340

Net cash used in financing activities		(10,683,815	)		(27,671,543	)

Net decrease in cash and cash equivalents		(8,909,487	)		(7,367,779	)
Cash and cash equivalents at beginning of period		46,105,827			36,456,307

Cash and cash equivalents at end of period	$	37,196,340		$	29,088,528

See accompanying notes to condensed consolidated financial statements.

Marchex, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

(1)

Description of Business and Basis of Presentation

Marchex, Inc. (the “Company”) was incorporated in the state of Delaware on January 17, 2003. The Company is a local search and advertising company and a leading publisher of local content. The Company’s search- and call-based advertising solutions enable tens of thousands of local and national advertisers to reach consumers searching for products and services through a mix of search and shopping engines, search- and call-based marketing services, publisher Web sites and the Company’s own Web sites.

The accompanying unaudited condensed consolidated financial statements of Marchex, Inc. and its wholly-owned subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for annual financial statements. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2008 are not necessarily indicative of the results that may be expected for the year ending December 31, 2008, or for any other period. The balance sheet at December 31, 2007 has been derived from the audited consolidated financial statements at that date but does not include all of the information and notes required by accounting principles generally accepted in the United States of America for complete financial statements. These condensed consolidated financial statements and notes should be read in conjunction with the Company’s audited consolidated financial statements and accompanying notes included in the Annual Report on Form 10-K for the year ended December 31, 2007 filed with the SEC.

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

The Company’s condensed consolidated financial statements presented include the condensed consolidated balance sheets as of December 31, 2007 and September 30, 2008, the condensed consolidated statements of operations for the three and nine months ended September 30, 2007 and 2008 and the condensed consolidated statements of cash flows for the nine months ended September 30, 2007 and 2008.

(2)

Significant Accounting Policies

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

There have been no changes to the Company’s significant accounting policies as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007 filed with the SEC.

Recently Issued Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements (“SFAS 157”), which clarifies the definition of fair value, establishes a framework for measuring fair value and expands the related disclosure requirements. In February 2008, the FASB issued a FASB Staff Position (“FSP”) SFAS 157-2, Effective Date of FASB Statement No. 157, which delays the effective date of SFAS 157 to fiscal years beginning after November 15, 2008, for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). Accordingly, the Company adopted the required provisions of SFAS 157 on January 1, 2008 and the remaining provisions will be adopted by the Company at the beginning of fiscal year 2009. The 2008 fiscal year adoption of the required provisions did not result in a material impact to the Company’s financial statements. The remaining aspects of SFAS 157 for which the effective date was deferred under FSP SFAS 157-2 are currently being evaluated by the Company.

In December 2007, the FASB issued SFAS No. 141R, Business Combinations (“SFAS 141R”), which replaces SFAS 141. SFAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, liabilities assumed and any resulting goodwill in the acquiree. The pronouncement also provides for disclosures to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141R will be effective for the Company on January 1, 2009. The Company is in the process of evaluating the effect that SFAS 141R will have on its financial statements.

In April 2008, the FASB issued FSP SFAS 142-3, Determination of the Useful Life of Intangible Assets (“FSP SFAS 142-3”), which amends the factors that should be considered in developing renewal or extension assumptions used in determining the useful life of a recognized intangible asset. FSP SFAS 142-3 also adds additional disclosures to be included in financial statements. FSP SFAS 142-3 is effective for fiscal years beginning after December 15, 2008 and interim periods within those years. The Company is currently evaluating the impact, if any, that FSP SFAS 142-3 will have on its financial statements.

In June 2008, the FASB issued FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (“FSP EITF 03-6-1”), which addresses whether instruments granted in share-based payment transaction are participating securities prior to vesting and would need to be included in the earnings allocation in computing earnings per share under the two-class method of SFAS No. 128, Earnings per Share. FSP EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008 and interim periods within those years. The Company is currently evaluating the impact, if any, that FSP EITF 03-6-1 will have on its financial statements.

Revenues

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


	Nine months ended September 30,				Three months ended September 30,
	2007		2008		2007		2008
Proprietary Traffic Sources	$	38,611,137	$	50,986,358	$	9,971,511	$	19,719,923
Partner and Other Revenue Sources		63,771,489		60,577,386		23,522,077		17,437,607

Total Revenue	$	102,382,626	$	111,563,744	$	33,493,588	$	37,157,530

The Company’s proprietary traffic revenues are generated from the Company’s portfolio of owned Web sites which are monetized with pay-per-click, cost-per-action listings and graphical ad units that are relevant to the Web sites. When an online user navigates to one of the Company’s owned and operated Web sites and clicks on a particular listing or completes the specified action, the Company receives a fee.

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

(3)

Stock-based Compensation Plans

Under SFAS 123R, Share-Based Payment, the Company recognizes stock-based compensation expense using the straight-line method for all stock awards issued after January 1, 2006.

The per share fair value of stock options granted during the three and nine months ended September 30, 2007 and 2008 was determined on the date of grant using the Black Scholes option-pricing model with the following weighted average assumptions:


	Nine months ended September 30,				Three months ended September 30,
	2007		2008		2007		2008
Expected life (in years)	4.0		4.0		4.0		4.0
Risk-free interest rate	4.15 - 4.91	%	2.34	%	4.15	%	2.63	%
Expected volatility	52	%	53.6	%	52	%	53	%
Expected dividend yield	0.6	%	0.6	%	0.6	%	0.6	%

Stock option activity during the nine months ended September 30, 2008 is summarized as follows:


	Shares		Weighted average exercise price		Weighted average remaining contractual term (in years)	Aggregate intrinsic value
Balance at December 31, 2007	4,872,788		$	12.94	7.61	$	5,881,886
Options granted	1,217,250			10.32
Options exercised	(162,465	)		5.84
Options canceled	(313,972	)		16.57
Options forfeited	(462,981	)		13.72

Balance at September 30, 2008	5,150,620		$	12.25	6.71	$	4,585,139

Restricted stock activity during the nine months ended September 30, 2008 is summarized as follows:


	Shares		Weighted average grant date fair value
Unvested at December 31, 2007	3,240,266		$	12.44
Granted	163,600			10.43
Vested	(629,437	)		12.16
Forfeited	(216,000	)		9.51

Unvested at September 30, 2008	2,558,429		$	12.62

The following table summarizes stock-based compensation expense related to all stock-based awards under SFAS 123R during the three and nine months ended September 30, 2007 and 2008:


	Nine months ended September 30,				Three months ended September 30,
	2007		2008		2007		2008
Total stock-based compensation included in net income (loss)	$	8,216,000	$	8,985,000	$	2,986,000	$	3,248,000
Income tax benefit related to stock-based compensation included in net income (loss)	$	2,148,000	$	2,415,000	$	755,000	$	901,000

(4)

Net Income (Loss) Per Share

We compute net income (loss) per share of Class A and Class B common stock in accordance with SFAS No. 128, Earnings per Share (“SFAS 128”) using the two class method. Under the provisions of SFAS 128, basic net income (loss) per share is computed by dividing net income (loss) applicable to common stockholders by the weighted average number of common shares outstanding during the year. Diluted net income (loss) per share is computed by dividing net income (loss) applicable to common stockholders by the weighted average number of common and dilutive common equivalent shares outstanding during the period. The computation of the diluted net income (loss) per share of Class B common stock assumes the conversion of Class A common stock to Class B common stock, while the diluted net income (loss) per share of Class A common stock does not assume the conversion of those shares.

In accordance with EITF 03-06, Participating Securities and the Two Class Method under FASB Statement No. 128, the undistributed earnings for each year are allocated based on the contractual participation rights of the Class A and Class B common shares as if the earnings for the year had been distributed. Considering the terms of the Company’s charter which provides that, if and when dividends are declared on our common stock in accordance with Delaware General Corporation Law, equivalent dividends shall be and have been paid with respect to the shares of Class A common stock and Class B common stock and that both classes of common stock have identical dividend rights and would share equally in our net assets in the event of liquidation, we have allocated undistributed earnings (losses) on a proportionate basis. Additionally, the Company has paid dividends equally to both classes of common stock since it initiated a quarterly cash dividend in November 2006.

The following table reconciles the Company’s reported net income (loss) to net income (loss) applicable to common stockholders used to compute basic net income (loss) per share for the periods ended:


	Nine months ended September 30,												Three months ended September 30,
	2007						2008						2007						2008
	Class A			Class B			Class A			Class B			Class A			Class B			Class A			Class B
Numerator:
Allocation of net income (loss)	$	(220,513	)	$	(528,481	)	$	174,779		$	412,195		$	(449,625	)	$	(1,071,421	)	$	411,489		$	946,467
Convertible preferred stock dividends		(14,964	)		(35,864	)		(12,010	)		(28,324	)		(5,023	)		(11,968	)		(3,614	)		(8,314	)
Discount on redemption of preferred stock		48,244			115,623			21,734			51,257			—			—			—			—

Net income (loss) applicable to common stockholders	$	(187,233	)	$	(448,722	)	$	184,503		$	435,128		$	(454,648	)	$	(1,083,389	)	$	407,875		$	938,153

Denominator:
Weighted average number of shares outstanding used to calculate basic net income (loss) per share		11,614,527			27,835,316			10,965,238			25,860,205			11,559,216			27,544,679			10,959,216			25,207,357

Basic net income (loss) per share applicable to common stockholders	$	(0.02	)	$	(0.02	)	$	0.02		$	0.02		$	(0.04	)	$	(0.04	)	$	0.04		$	0.04
The following table reconciles the Company’s reported net income (loss) to diluted net income (loss) applicable to common stockholders used to compute diluted net income (loss) per share for the periods ended:
	Nine months ended September 30,												Three months ended September 30,
	2007						2008						2007						2008
	Class A			Class B			Class A			Class B			Class A			Class B			Class A			Class B
Numerator:
Allocation of net income (loss)	$	(220,513	)	$	(528,481	)	$	174,779		$	412,195		$	(449,625	)	$	(1,071,421	)	$	411,489		$	946,467
Convertible preferred stock dividends		(14,964	)		(35,864	)		(12,010	)		(28,324	)		(5,023	)		(11,968	)		(3,614	)		(8,314	)
Discount on redemption of preferred stock		48,244			115,623			—			—			—			—			—			—
Convertible preferred stock dividends on redeemed preferred stock		—			—			1,912			4,509			—			—			—			—
Reallocation of net income (loss) for Class A shares as a result of conversion of Class A to Class B shares		—			(187,233	)		—			164,681			—			(454,648	)		—			407,875

Net income (loss) applicable to common stockholders	$	(187,233	)	$	(635,955	)	$	164,681		$	553,061		$	(454,648	)	$	(1,538,037	)	$	407,875		$	1,346,028


	Nine months ended September 30,										Three months ended September 30,
	2007						2008				2007						2008
	Class A			Class B			Class A		Class B		Class A			Class B			Class A		Class B
Denominator:
Weighted average number of shares outstanding used to calculate basic net income (loss) per share		11,614,527			27,835,316			10,965,238		25,860,205		11,559,216			27,544,679			10,959,216		25,207,357
Weighted average stock options and warrants and common shares subject to repurchase or cancellation		—			—			—		650,358		—			—			—		686,425
Weighted average number of shares from assumed conversion of preferred stock redeemed		—			—			—		8,411		—			—			—		—
Conversion of Class A to Class B common shares outstanding		—			11,614,527			—		10,965,238		—			11,559,216			—		10,959,216

Weighted average number of shares outstanding used to calculate diluted net income (loss) per share		11,614,527			39,449,843			10,965,238		37,484,212		11,559,216			39,103,895			10,959,216		36,852,998

Diluted net income (loss) per share applicable to common stockholders	$	(0.02	)	$	(0.02	)	$	0.02	$	0.02	$	(0.04	)	$	(0.04	)	$	0.04	$	0.04

For the three and nine months ended September 30, 2007, respectively, the net loss applicable to common stockholders used in computing basic and diluted net loss per share applicable to common stockholders included the preferred stock dividends and the discount on the redemption of 0 and 3,734 shares of the Company’s 4.75% convertible exchangeable preferred stock of approximately $0 and $164,000. The discount on the preferred stock redemption is the difference between the carrying value per share of the redeemed preferred shares and the $195 per share (plus commissions) paid by the Company to the preferred stockholders. Total cash consideration paid to the preferred stockholders was approximately $732,000 for the nine months ended September 30, 2007. The weighted average number of shares used to calculate the diluted net loss per share includes the weighted average number of shares from the assumed conversion of Class A common stock to Class B common stock.

For the three and nine months ended September 30, 2008, respectively, the net income applicable to common stockholders used in computing basic net income per share applicable to common stockholders included the preferred stock dividends and the discount on the redemption of 0 and 2,008 shares of the Company’s 4.75% convertible exchangeable preferred stock of approximately $0 and $73,000. The diluted net income applicable to common stockholders excluded the discount on the preferred stock redemption and any convertible stock dividends paid during the period on the redeemed shares. The discount on the preferred stock redemption is the difference between the carrying value per share of the redeemed preferred shares and the $206.72 per share (plus commissions) paid by the Company to the preferred stockholders. Total cash consideration paid to the preferred stockholders was approximately $409,000, for the nine months ended September 30, 2008. The weighted average number of shares used to calculate the diluted net income per share includes the weighted average number of shares from the assumed conversion of the redeemed preferred stock and the assumed conversion of Class A common stock to Class B common stock.

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

•

For the three and nine months ended September 30, 2007 and 2008, respectively, 66,095 shares and 53,285 shares issuable upon conversion of the 4.75% convertible preferred stock issued in connection with the February 2005 follow-on public offering.

•

For the three and nine months ended September 30, 2007, outstanding options to acquire 4,725,577 shares of Class B common stock with a weighted average exercise price of $13.08 per share. For the three months ended September 30, 2008, outstanding options to acquire 4,414,726 shares of Class B common stock with a weighted average exercise price of $13.65 per share. For the nine months ended September 30, 2008, outstanding options to acquire 4,534,243 shares of Class B common stock with a weighted average exercise price of $13.74 per share.

•

For the three and nine months ended September 30, 2007, 3,343,210 shares of unvested Class B restricted common shares at September 30, 2007 issued to employees and in connection with acquisitions. For the three and nine months ended September 30, 2008, 17,354 shares of unvested Class B restricted common shares at September 30, 2008 issued to employees and in connection with acquisitions. Unvested shares were excluded from the computation of basic net loss per share.

(5)

Concentrations

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

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

There were no distribution partners representing more than 10% of consolidated revenue for the three and nine months ended September 30, 2007 and 2008.

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


	Nine months ended September 30,				Three months ended September 30,
	2007		2008		2007		2008
Advertiser A	35	%	12	%	28	%		*
Advertiser B		*	13	%		*	13	%
Advertiser C		*	11	%		*	13	%
Advertiser D		*	12	%		*	16	%

*	Less than 10% of revenue.

Advertiser A is also a distribution partner.

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


	At December 31, 2007		At September 30, 2008
Advertiser A	24	%	11	%
Advertiser B	21	%	27	%
Advertiser C		*	*
Advertiser D		*	11	%
Advertiser E		*	13	%

*	Less than 10% of accounts receivable.

(6)

Segment Reporting and Geographic Information

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

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

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


	Nine months ended September 30,				Three months ended September 30,
	2007		2008		2007		2008
United States	96	%	97	%	97	%	97	%
Canada	1	%	1	%	1	%	2	%
Other countries	3	%	2	%	2	%	1	%

	100	%	100	%	100	%	100	%

(7)

Property and Equipment

Property and equipment consisted of the following:


	December 31, 2007			September 30, 2008
Computer and other related equipment	$	5,914,195		$	7,885,473
Purchased and internally developed software		7,359,058			7,504,914
Furniture and fixtures		371,777			498,530
Leasehold improvements		222,545			303,573

		13,867,575			16,192,490
Less: accumulated depreciation and amortization		(6,509,672	)		(9,785,872	)

Property and equipment, net	$	7,357,903		$	6,406,618

The Company has capitalized certain costs of internally developed software for internal use. The estimated useful life of costs capitalized is evaluated for each specific project. Amortization begins in the period in which the software is ready for its intended use. The Company had $192,000 and $0 of internally developed software costs that had not commenced amortization as of December 31, 2007 and September 30, 2008, respectively.

Depreciation and amortization expense, incurred by the Company, related to property and equipment was approximately $892,000 and $1.1 million for the three months ended September 30, 2007 and 2008, respectively, and $2.5 million and $3.3 million for the nine months ended September 30, 2007 and 2008, respectively.

(8)

Commitments

The Company has commitments for future payments related to office facilities leases, equipment and furniture leases, and other contractual obligations. The Company leases its office facilities under operating lease agreements expiring through 2011. The equipment and furniture leases are financed through capital lease arrangements and are included in property and equipment and the related depreciation is recorded as depreciation expense. The Company also has other contractual obligations expiring over varying time periods through 2012. Other contractual obligations primarily relate to minimum contractual payments due to distribution partners and other service providers. Future minimum payments are as follows:


	Equipment and furniture capital leases			Facilities operating leases		Other contractual obligations		Total
Remainder of 2008	$	13,318		$	402,064	$	743,811	$	1,159,193
2009		45,125			1,626,075		1,063,503		2,734,703
2010		7,695			220,874		41,017		269,586
2011		—			12,973		29,028		42,001
2012		—			—		14,514		14,514

Total minimum payments	$	66,138		$	2,261,986	$	1,891,873	$	4,219,997
Less: amounts representing interest		(8,429	)

Present value of lease obligation		57,709
Less: current portion		(42,985	)

Long-term portion	$	14,724

Rent expense incurred by the Company was approximately $301,000 and $399,000 for the three months ended September 30, 2007 and 2008, respectively, and $913,000 and $1.1 million for the nine months ended September 30, 2007 and 2008, respectively.

(9)

Credit Agreement

In April 2008, the Company entered into a credit agreement providing for a senior secured $30 million revolving credit facility (“Credit Agreement”). The Credit Agreement matures and all outstanding borrowings are due in April 2011. Interest on outstanding balances under the Credit Agreement will accrue at LIBOR plus an applicable margin rate, as determined under the agreement and has an unused commitment fee. The Credit Agreement contains certain customary representations and warranties, financial covenants, events of default and is secured by substantially all of the assets of the Company. As of September 30, 2008, the Company had $30 million of availability under the Credit Agreement.

(10)

Contingencies, Other Income and Taxes

(a) Contingencies

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

(b) Other Income

Other income was $878,000 in the three months ended September 30, 2008 and $880,000 in the nine months ended September 30, 2008. Other income for the three and nine months ended September 30, 2008 was primarily a result of $877,000 of service fees on inactive customer accounts and cash related to a litigation settlement.

(c) Taxes

From time to time, various state, federal and other jurisdictional tax authorities undertake reviews of the Company and its tax filings. In evaluating the exposure associated with various tax filing positions, the Company on occasion accrues charges for probable exposures. The Company believes any adjustments that may ultimately be required as a result of any of these reviews will not be material to the financial statements.

The Company did not have any material amounts of unrecognized tax benefits as of December 31, 2007 and September 30, 2008. Also, the Company did not have any material amounts of unrecognized tax benefits that, if recognized, would affect the Company’s effective tax rate.

The Company files U.S. federal, certain U.S. states, and certain foreign tax returns. Generally, U.S. federal, U.S. state, and foreign tax returns filed for years after 2003 are within the statue of limitations and remain subject to examination.

(11)

Intangible Assets from Acquisitions

Intangible assets from acquisitions consisted of the following:


	December 31, 2007
	Gross Carrying Amount		Accumulated Amortization			Net
Advertiser relationships	$	11,340,000	$	(8,071,418	)	$	3,268,582
Distribution partner relationships		3,100,000		(2,929,032	)		170,968
Non-compete agreements		10,360,000		(9,652,939	)		707,061
Trademarks/domains		42,783,611		(27,031,313	)		15,752,298
Acquired technology		16,900,000		(13,001,678	)		3,898,322

	$	84,483,611	$	(60,686,380	)	$	23,797,231


	September 30, 2008
	Gross Carrying Amount		Accumulated Amortization			Net
Advertiser relationships	$	11,340,000	$	(10,103,085	)	$	1,236,915
Distribution partner relationships		3,100,000		(3,100,000	)		—
Non-compete agreements		10,360,000		(10,059,250	)		300,750
Trademarks/domains		42,619,096		(33,183,647	)		9,435,449
Acquired technology		16,900,000		(14,980,693	)		1,919,307

	$	84,319,096	$	(71,426,675	)	$	12,892,421

Amortizable intangible assets are amortized on a straight-line basis over their useful lives. Amortization expense incurred by the Company for the three months ended September 30, 2007 and 2008, was approximately $4.0 million and $3.2 million, respectively, and for the nine months ended September 30, 2007 and 2008 was approximately $12.6 million and $10.9 million, respectively. Based upon the current amount of intangible assets subject to amortization, the estimated amortization expense for the next five years is as follows: $2.9 million for the remainder of 2008, $5.5 million in 2009, $2.4 million in 2010, $1.2 million in 2011, and $892,000 in 2012 and thereafter.

(12)

Goodwill

Changes in the carrying amount of goodwill for the nine months ended September 30, 2008 are as follows:


Balance as of December 31, 2007	$	204,766,826
Marchex Voice Services acquisition adjustment		48,249
Other		(29,357	)

Balance as of September 30, 2008	$	204,785,718

(13)

Intangible and other assets, net

Intangible and other assets, net consisted of the following:


	December 31, 2007			September 30, 2008
Internet domain names	$	25,285,136		$	25,485,492
Less accumulated amortization		(8,980,143	)		(12,112,545	)

Other intangible assets, net		16,304,993			13,372,947
Other assets:
License fee		4,500,000			4,500,000
Less accumulated amortization		(3,700,255	)		(4,500,000	)

License fee, net		799,745			—
Restricted cash		75,000			20,000
Registration fees, net		—			895,663
Other		202,089			296,297

Total intangibles and other assets, net	$	17,381,827		$	14,584,907

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

Amortization expense for internet domain names for the three months ended September 30, 2007 and 2008, was approximately $1.2 million and $933,000, respectively, and for the nine months ended September 30, 2007 and 2008, was approximately $2.8 million and $3.1 million, respectively. Based upon the current amount of domains subject to amortization, the estimated expense for the next five years is as follows: $975,000 for the remainder of 2008, $3.4 million in 2009, $2.9 million in 2010, $2.4 million in 2011, and $3.7 million in 2012 and thereafter.

(14)

Convertible Preferred Stock and Common Stock

During the nine months ended September 30, 2008, the Company repurchased approximately 2,000 shares of preferred stock for a total cash expenditure of approximately $409,000. The Company recorded a discount on the preferred stock redemption of approximately $0 and $73,000, during the three and nine months ended September 30, 2008, respectively, which is the difference between the carrying value per share of the redeemed preferred shares and the $206.72 per share (plus commissions) paid by the Company to the preferred stockholders. The $73,000 was reflected as convertible preferred stock dividends and discount on preferred stock redemption, net in the Company’s consolidated statements of operations during the nine months ended September 30, 2008. Approximately 4,000 shares of preferred stock remained outstanding as of September 30, 2008. In October 2008, the Company redeemed the remaining outstanding preferred shares for approximately $1.0 million.

In July 2008, the Company’s board of directors declared a quarterly dividend in the amount of $0.02 per share on the Company’s Class A common stock and Class B common stock and $2.97 per share on the Company’s 4.75% convertible exchangeable preferred stock which was paid on August 15, 2008 to the holders of record as of the close of business on August 4, 2008. The aggregate quarterly dividend paid was approximately $804,000, of which $792,000 was for the common stock dividend.

In November 2006, the Company’s board of directors authorized a share repurchase program for the Company to repurchase up to 3 million shares of the Company’s Class B common stock as well as the initiation of a quarterly cash dividend for the holders of the Class A and Class B common stock. In February 2008, the Company’s board of directors authorized an increase in the share repurchase program for the Company to repurchase up to 5 million shares in the aggregate (less shares previously repurchased under the share repurchase program) of the Company’s Class B common stock. In August 2008, the Company’s board of directors authorized an increase in the share repurchase program for the Company to repurchase up to 6 million shares in the aggregate (less shares previously repurchased under the share repurchase program) of the Company’s Class B common stock. Under the share repurchase program, repurchases may take place in the open market and in privately negotiated transactions and at times and in such amounts as the Company deems appropriate. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements, capital availability, and other market conditions. This stock repurchase program does not have an expiration date and may be limited or terminated at any time without prior notice. During the year ended December 31, 2007, the Company repurchased approximately 2.2 million shares of Class B common stock for $22.1 million under this repurchase program and was recorded as treasury stock in the consolidated balance sheet.

During the nine months ended September 30, 2008, the Company repurchased 2.6 million shares of Class B common stock for approximately $25.7 million at an average stock price of $10.84 per share. Of the 2.6 million shares, 948,000 shares have been recorded as treasury stock in the condensed consolidated balance sheet as of September 30, 2008.

During the nine months ended September 30, 2008, the Company’s board of directors approved the retirement of approximately 3.9 million shares of treasury stock. The excess of purchase price over par value of $39.3 million was recorded as a deduction to additional paid in capital on the condensed consolidated balance sheet.

(15)

Subsequent Events

In October 2008, the Company’s board of directors declared a regular quarterly dividend in the amount $0.02 per share on the Company’s Class A and Class B common stock. The Company will pay these dividends on November 17, 2008 to the holders of record as of the close of business on November 6, 2008. The Company expects to pay approximately $770,000 for these quarterly dividends.

Item 2.

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

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We use words such as “believes”, “intends”, “expects”, “anticipates”, “plans”, “may”, “will” and similar expressions to identify forward-looking statements. All forward-looking statements, including, but not limited to, statements regarding our future operating results, financial position, and business strategy, expectations regarding our growth and the growth of the industry in which we operate, and plans and objectives of management for future operations, are inherently uncertain as they are based on our expectations and assumptions concerning future events. Any or all of our forward-looking statements in this report may turn out to be inaccurate. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. They may be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties, including but not limited to the risks, uncertainties and assumptions described in this report, in Part II, Item 1A. under the caption “Risk Factors” and elsewhere in this report and in our Annual Report on Form 10-K for the year ended December 31, 2007 and those described from time to time in our future reports filed with the SEC. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this report may not occur as contemplated, and actual results could differ materially from those anticipated or implied by the forward-looking statements. All forward-looking statements in this report are made as of the date hereof, based on information available to us as of the date hereof, and we assume no obligation to update any forward-looking statement.

The following discussion and analysis provides information that we believe is relevant to an assessment and understanding of our results of operation and financial condition. You should read this analysis in conjunction with the attached condensed consolidated financial statements and related notes thereto, and with our audited consolidated financial statements and the notes thereto, included in our Annual Report on Form 10-K for the year ended December 31, 2007.

Overview

We are a local search and advertising company and a leading publisher of local content. Our search- and call-based advertising solutions enable tens of thousands of local and national advertisers to efficiently reach consumers searching for products and services through our exclusive mix of high quality distribution points, including: (1) our proprietary Local Search Network, which we believe helps millions of consumers each month make better, more informed local decisions, (2) leading search engines such as Google, MSN, and Yahoo!, and (3) vertical publisher Web sites.

We have a suite of technology-based products and services that facilitate and support the efficient and cost-effective marketing and selling of goods and services for local and national advertisers who want to sell their products online; and a proprietary, locally-focused Web site network where we help consumers find local information, as well as fulfill our advertiser marketing campaigns:

•

Local Search Network. We believe that our Local Search Network is a significant source of local information online. It includes more than 200,000 of our owned and operated Web sites focused on helping users find and make informed decisions about where to get local products and services. It features listings from more than 15 million local businesses in the U.S and more than 2.9 million expert and user-generated reviews on local businesses across more than 20,000 categories. The more than 200,000 Web sites in our network include more than 75,000 U.S. ZIP code sites, such as 98102.com and 90210.com, covering ZIP code areas nationwide, as well as tens of thousands of other locally-focused sites such as Yellow.com, OpenList.com and geo-targeted sites such as bostonmortgage.com, chicagodoctors.com, seattleautorepairs.com, and others. Traffic to our Local Search Network is primarily monetized with pay-per-click listings that are relevant to the Web sites, as well as other forms of advertising, including call-based ad units, banner advertising and sponsorships.

•

Private-Label Local Online Advertising Platform. Marchex Connect, our private-label local online advertising platform enables aggregators of local advertisers, such as Yellow Pages providers and locally-focused vertical media companies, to sell search marketing and/or call advertising packages through their existing sales channels, which are then fulfilled by us across our distribution network, including leading search engines and our own Local Search Network. By creating a solution for aggregators who have relationships with local advertisers, it makes it easy for local businesses to participate in online advertising. The search marketing services we offer to local advertisers through Marchex Connect include services typically available only to national advertisers, including ad creation, keyword selection, geo-targeting, call tracking, click-to-call services, campaign optimization, and reporting. Marchex Connect has the capacity to support tens of thousands of advertiser accounts. In addition, we offer a private-label platform for publishers, separate and distinct from Marchex Connect, which enables them to monetize their Web sites with contextual advertising from their own customers or from our advertising relationships. Aggregators and publishers generally pay us an agency fee for our platform and services in the form of a percentage of the cost of every click delivered to their advertisers.

•

Pay-Per-Click Advertising. We deliver pay-per-click advertisements to online users in response to their keyword search queries or on pages they visit throughout our distribution network of search engines, shopping engines, certain third party Web sites and our own Local Search Network. In addition to distributing their ads, we offer account management services to help our advertisers optimize their pay-per-click campaigns, including editorial and keyword selection recommendations and report analysis. The pay-per-click advertisements are generally ordered based on the amount our advertisers choose to pay for a placement. Advertisers pay us when a user clicks on their advertisements in our pay-per-click network and we pay publishers or distribution partners a percentage of the revenue generated by the click-throughs on their site(s). In addition, we generate revenue from cost-per-action events that take place on our distribution network. Cost-per-action revenue occurs when the user is redirected from one of our Web sites or a third-party Web site in our distribution network to an advertiser’s Web site and completes a specified action. Additionally, we sell pay-per-click contextual advertising placements on specialized vertical and branded partner or publisher Web sites on a pay-per-click basis. Advertisers can target the placements by category, site- or page-specific basis. We believe our site- and page-specific approach provides publishers with an opportunity to generate revenue from their traffic while protecting their brand. Our approach gives advertisers greater transparency into the source of the traffic and relevancy for their ads and enables them to optimize the return on investment from their advertising campaign. The contextual advertisement placements are prioritized for users by the amount the advertiser is willing to pay each time a user clicks on the advertisement and the relevance of the advertisement, based on historic click-through rates. Advertisers pay us when a user clicks on their advertisements in our network and we pay publishers a percentage of the revenue generated by the click-throughs on their site.

•

Call-Based Advertising Services. We deliver a variety of call-based advertising services for local advertiser aggregators as well as national advertisers. These services include phone number provisioning, call tracking, call analytics, click-to-call, Web site proxying and other phone call-based services that enable aggregators and advertisers to utilize online advertising to drive calls into their businesses as well as clicks and to use call tracking to measure the effectiveness of both their online and offline advertising campaigns. Advertisers pay us a flat fee for each phone number provisioned, and a pre-negotiated rate per minute for each call they receive from call-based ads we distribute on our distribution network.

•

Search Engine Optimization Consulting Services (SEO). We offer consulting services to help advertisers optimize their Web sites for the greatest opportunity for proper indexing and ranking in the organic, or editorial, results of algorithmic search engines. By leveraging our experience in the search industry and our relationships with search engine distribution partners, we have built a unique system for evaluating the opportunity to improve a particular Web site’s ranking in organic search results. We provide specific tactics, either on a consultative or a hands-on basis, to maximize that opportunity, while meeting the major search engine’s ever changing technical standards, and drive increased targeted traffic to their Web sites. Our SEO consulting clients are primarily companies with a large number of products who want to increase their online sales and achieve targeted return on investment metrics. Advertisers pay us consulting fees for SEO services, which are based on the number of Web pages in their sites and the number of products they want indexed.

•

Feed Management Services. We use our proprietary technology to crawl and extract relevant product content from advertisers’ databases and Web sites to create automated and highly-targeted product and service listings, which we deliver into a network of search and shopping engines. When an advertiser’s Web site is crawled by a search engine (usually every 7 to 14 days), many product and service listings can be excluded or quickly become outdated due to the nature of most advertisers’ product databases, which contain complex structures and are dynamically updated. Because we have feed relationships with our distribution partners, we are able to deliver our advertiser’s product listings directly into our partners’ distribution and provide updated content in frequent intervals. This is a significant benefit for our advertisers as it maximizes the number of selling opportunities and for our distribution partners as it increases the accuracy and relevance of their search results. Advertisers generally pay us a fixed price for each click they receive on an advertisement or listing included in the feed.

•

Bid Management Services. We offer advertising campaign management services, commonly known as bid management services. Our bid management services enable our advertisers to consolidate the purchasing, management, optimization and reporting from their search and contextual advertising campaigns across a large number of search engines and pay-per-click networks into one centralized place. Through our partnerships with leading search and product shopping engines, we are able to place and manage our clients’ paid listings directly within their account management systems and provide detailed reporting and conversion tracking that enables advertisers to track the effectiveness of their online advertising campaigns across the different channels. With our bid management services, we may suggest additional channels, search engines or pay-per-click networks as well as editorial guidance that may broaden the reach and improve the effectiveness of our advertisers’ campaigns. Advertisers pay us a pre-negotiated rate for each click they receive on their advertisement placed or managed as part of our bid management services.

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

•

On February 28, 2003, we acquired eFamily together with its direct wholly-owned subsidiary, formerly known as Enhance Interactive. eFamily was incorporated in Utah on November 29, 1999 under the name FocusFilter.com, Inc. Enhance Interactive was recently renamed Marchex Adhere PPC.

•

On October 24, 2003, we acquired TrafficLeader which was incorporated in Oregon on January 24, 2000 under the name Sitewise Marketing, Inc. TrafficLeader was recently renamed Marchex Connect NA.

•

On July 27, 2004, we acquired goClick which was incorporated in Connecticut on October 25, 2000.

•

On February 14, 2005, we acquired certain assets of Name Development which was incorporated in the British Virgin Islands in July 2000.

•

On April 26, 2005, we acquired certain assets of Pike Street Industries, which was incorporated in Washington on March 6, 2002.

•

On July 27, 2005, we acquired IndustryBrains, which was incorporated in New York on January 31, 2002 and which was recently renamed Marchex Adhere SSC.

•

On May 1, 2006, we acquired certain assets of AreaConnect, which was formed in Delaware on June 5, 2002.

•

On May 26, 2006, we acquired certain assets of Open List, which was incorporated in Delaware on November 18, 2003.

•

On September 19, 2007, we acquired VoiceStar, which was incorporated in Pennsylvania on March 21, 1999 under the name TL Solutions, Inc. VoiceStar was recently renamed Marchex Voice Services.

We currently have offices in Seattle, Washington; Eugene, Oregon; Las Vegas, Nevada; Philadelphia, Pennsylvania; New York, New York; and Highlands Ranch, Colorado.

Acquisitions

We have completed the following acquisition since January 1, 2007 which has been accounted for as business combination.

VoiceStar

In September 2007, the Company acquired VoiceStar, Inc. which was recently renamed Marchex Voice Services (“Marchex Voice Services”), a provider of call-based advertising services for local advertisers. The purchase price consideration consisted of:

•

$13.6 million in cash and acquisition costs; plus

•

634,963 shares of restricted Class B common stock that vest over a period of two and one-half years.

The shares of restricted Class B common stock were issued to certain employees of Marchex Voice Services who became employees of the Company and were valued at approximately $5.9 million, which is recorded as compensation expense over the associated employment period during which these shares vest.

Consolidated Statements of Operations

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

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

Presentation of Financial Reporting Periods

The comparative periods presented are for the three and nine months ended September 30, 2007 and 2008.

Revenue

We currently generate revenue through our suite of services, including our Local Search Network, private-label local online advertising platform, pay-per-click advertising and related services, call-based advertising, search engine optimization consulting, feed management and bid management.

Our primary sources of revenue are the performance-based advertising services, which include pay-per-click services, pay-per-phone-call services, cost-per-action services and feed management services. These primary sources amounted to greater than 86% of our revenues in all periods presented. Our secondary sources of revenue are our bid campaign management services, natural search optimization services and outsourced search marketing platforms. These secondary sources amounted to less than 14% of our revenues in all periods presented. We have no barter transactions.

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

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

Performance-Based Advertising Services

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

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

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

Search Marketing Services

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

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

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

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

Outsourced Search Marketing Platforms

We generate revenue from super-aggregator partners and publishers utilizing our Web-based technologies. We are paid a management or agency fee based on the total amount of the purchase made by the advertiser. The partners or publishers engage the advertisers and are the primary obligor, and we, in certain instances, are only financially liable to the publishers in our capacity as a collection agency for the amount collected from the advertisers. We recognize revenue for these fees under the net revenue recognition method.

Industry and Market Factors

We enter into agreements with various distribution partners to provide distribution for the URL strings and advertisement listings of our advertisers. We generally pay distribution partners based on a percentage of revenue or a fixed amount per click-through on these listings. The level of click-throughs contributed by our distribution partners has varied, and we expect it will continue to vary, from quarter-to-quarter and year-to-year, sometimes significantly. Our current growth will be impacted by our ability to increase our distribution, which impacts the number of Internet users who have access to our advertisers’ listings and the rate at which our advertisers are able to convert clicks from these Internet users into completed transactions, such as a purchase or sign up. Our current growth also depends on our ability to continue to increase the number of advertisers who use our services and the amount these advertisers spend on our services.

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

In addition, we believe we will experience seasonality. Our quarterly results have fluctuated in the past and may fluctuate in the future due to seasonal fluctuations in levels of Internet usage and seasonal purchasing cycles of many advertisers. It is generally understood that during the spring and summer months, Internet usage is lower than during other times of the year, especially in comparison to the fourth quarter of the calendar year. The extent to which usage may decrease during these off-peak periods is difficult to predict. Prolonged or severe decreases in usage during these periods may adversely affect our growth rate and results.

Service Costs

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

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user acquisition costs;

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amortization and impairment of intangible assets;

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license and content fees;

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credit card processing fees;

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network operations;

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telecommunication costs, including provisioning of telephone numbers;

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serving our search results;

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maintaining our Web sites;

•

domain name registration renewal fees;

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network fees;

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fees paid to outside service providers;

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delivering customer service;

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

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colocation service charges of our Web site equipment;

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bandwidth and software license fees;

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payroll and related expenses of related personnel; and

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stock-based compensation of related personnel.

User Acquisition Costs

For the periods presented the largest component of our service costs consists of user acquisition costs that relate primarily to payments made to distribution partners for access to their online user traffic. We enter into agreements of varying durations with distribution partners that integrate our services into their Web sites and indexes. The primary payment structure of the distribution partner agreements is a variable payment based on a specified percentage of revenue.

These variable payments are often subject to minimum payment amounts per click-through. Other payment structures that we may use to a lesser degree include:

•

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

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

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

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

Sales and Marketing

Sales and marketing expenses consist primarily of:

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

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advertising and promotional expenditures including online and outside marketing activities;

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

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stock-based compensation of related personnel.

Product Development

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

Our research and development expenses include:

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payroll and related expenses for personnel;

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costs of computer hardware and software;

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

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stock-based compensation of related personnel.

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

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

General and Administrative

General and administrative expenses consist primarily of:

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payroll and related expenses for executive and administrative personnel;

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professional services, including accounting, legal and insurance;

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bad debt provisions;

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facilities costs;

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other general corporate expenses; and

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stock-based compensation of related personnel.

Stock-Based Compensation

As of January 1, 2006, we adopted Statement of Financial Accounting Standards (SFAS) No. 123R, Share-Based Payment (SFAS 123R) and account for stock-based compensation under the fair value method. As a result, stock-based compensation consists of the following:

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all share-based compensation arrangements granted after January 1, 2006 and for any such arrangements that are modified, cancelled, or repurchased after that date; and

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the portion of previous share-based awards for which the requisite service was not rendered as of the adoption date, based on the grant-date estimated fair value of those awards estimated in accordance with the pro forma provisions of SFAS No. 123, Accounting for Stock-Based Compensation.

Stock-based compensation expense has been included in the same lines as compensation paid to the same employees in the consolidated statement of operations in accordance with SEC Accounting Bulletin No. 107, Share-based Payment.

Amortization of Intangible Assets from Acquisitions

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

The intangible assets have been identified as:

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non-competition agreements;

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trade and Internet domain names;

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distributor partner relationships;

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advertising relationships;

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patents; and

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acquired technology.

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

Provision for Income Taxes

For income tax purposes, we utilize the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in results of operations in the period that includes the enactment date. A valuation allowance is recorded for deferred tax assets when it is more likely than not that such deferred tax assets will not be realized. Although realization is not assured, we believe it is more likely than not, based on operating performance and projections of future taxable income, that our net deferred tax assets, excluding certain state net operating loss carryforwards, will be realized. In determining that it is more likely than not that we will realize the deferred tax assets, factors considered include: historical taxable income, historical trends related to advertiser usage rates and projected revenues and expenses. The amount of the net deferred tax assets considered realizable, however, could be reduced in the near term if our projections of future taxable income are reduced or if we do not perform at the levels we are projecting. This could result in increases to the valuation allowance for deferred tax assets and a corresponding increase to income tax expense of up to the entire net amount of deferred tax assets. From time to time, various state, federal, and other jurisdictional tax authorities undertake reviews of us and our filings. We believe any adjustments that may ultimately be required as a result of any of these reviews will not be material to the financial statements.

As of September 30, 2008, we had federal net operating loss (NOL) carryforwards of $1.7 million, which will begin to expire in 2019. The Tax Reform Act of 1986 limits the use of NOL and tax credit carryforwards in certain situations where changes occur in the stock ownership of a company. We believe that such a change has occurred, and that the utilization of the approximately $1.7 million of NOL carryforwards is limited such that substantially all of these federal NOL carryforwards will never be utilized.

As of September 30, 2008, we had certain tax effected state NOL carryforwards of approximately $2.8 million. We do not have a history of taxable income in the relevant state and the state NOL carryforwards will more likely than not expire unutilized. Therefore, we have recorded a 100% valuation allowance on the state NOL carryforwards as of September 30, 2008.

Convertible Preferred Stock

Holders of the preferred stock are entitled to receive cumulative dividends from the date of original issue at the annual rate of 4.75% of the liquidation preference of the preferred stock, payable quarterly on the 15^th day of February, May, August and November, commencing May 15, 2005. Any dividends must be declared by our board of directors and must come from funds which are legally available for dividend payments.

The Company’s board of directors declared the following quarterly dividends in 2007 and 2008 on the Company’s 4.75% convertible exchangeable preferred stock:


Approval Date	Per share dividend		Date of record	Total amount (in thousands)		Payment date
January 2007	$	2.97	February 2, 2007	$	21	February 15, 2007
April 2007	$	2.97	May 4, 2007	$	18	May 15, 2007
July 2007	$	2.97	August 3, 2007	$	18	August 15, 2007
October 2007	$	2.97	November 2, 2007	$	18	November 15, 2007
January 2008	$	2.97	February 4, 2008	$	16	February 15, 2008
April 2008	$	2.97	May 2, 2008	$	15	May 15, 2008
July 2008	$	2.97	August 4, 2008	$	12	August 15, 2008

In October 2008, we redeemed all of our outstanding 4.75% convertible exchangeable preferred stock for approximately $1.0 million.

Results of Operations

The following table presents certain financial data, derived from our unaudited statements of operations, as a percentage of total revenue for the periods indicated. The operating results for the three and nine months ended September 30, 2007 and 2008 and are not necessarily indicative of the results that may be expected for the full year or any future period.


	Nine months ended September 30,				Three months ended September 30,
	2007		2008		2007		2008
Revenue	100.0	%	100.0	%	100.0	%	100.0	%

Expenses:
Service costs	49.6	%	46.4	%	56.2	%	41.6	%
Sales and marketing	19.2	%	20.9	%	15.0	%	22.8	%
Product development	8.4	%	11.8	%	9.9	%	12.8	%
General and administrative	12.5	%	13.6	%	13.6	%	13.9	%
Amortization of intangible assets from acquisitions	12.3	%	9.8	%	12.0	%	8.5	%
Facility relocation	0.1	%	—		—		—

Total operating expenses	102.1	%	102.5	%	106.7	%	99.6	%
Gain on sales and disposals of intangible assets, net	0.3	%	3.4	%	0.4	%	4.3	%

Income (loss) from operations	(1.8	%)	0.9	%	(6.3	%)	4.7	%
Other income (expense):
Interest income	2.1	%	0.5	%	2.0	%	0.4	%
Interest expense	—		(0.1	%)	—		(0.1	%)
Other	—		0.8	%	—		2.4	%

Total other income, net	2.1	%	1.2	%	2.0	%	2.7	%

Income (loss) before provision for income taxes	0.3	%	2.1	%	(4.3	%)	7.4	%
Income tax expense	1.0	%	1.6	%	0.3	%	3.9	%

Net income (loss)	(0.7	%)	0.5	%	(4.6	%)	3.5	%
Convertible preferred stock dividend and discount on preferred stock redemption, net	(0.1	%)	—		0.1	%	—

Net income (loss) applicable to common stockholders	(0.6	%)	0.5	%	(4.7	%)	3.5	%

Comparison of the Three months ended September 30, 2007 to the Three months ended September 30, 2008 and of the Nine months ended September 30, 2007 to the Nine months ended September 30, 2008

Revenue

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


	Nine months ended September 30,				Three months ended September 30,
	2007		2008		2007		2008
Proprietary Traffic Revenues	$	38,611,137	$	50,986,358	$	9,971,511	$	19,719,923
Partner Network and Other Revenues		63,771,489		60,577,386		23,522,077		17,437,607

Total Revenues	$	102,382,626	$	111,563,744	$	33,493,588	$	37,157,530

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

Revenue increased 11%, from $33.5 million for the three months ended September 30, 2007 to $37.2 million in the same period in 2008. The increase in revenues was primarily attributable to proprietary traffic sources, including our portfolio of more than 200,000 Web sites. The majority of the revenues from our proprietary traffic sources are attributable to the Name Development, Pike Street and the AreaConnect portfolios of Web sites. Substantially all of the proprietary traffic revenue increase was attributable to an increase in the average revenue per advertiser. We believe the increase in proprietary revenues is in part attributable to updates and enhancements for certain of the Web sites as well as increased sales, marketing and optimization efforts and expenditures. The partner network and other revenues were affected by our adding more than 30,000 accounts to our local online and call-based advertising platforms which were primarily attributable for an increase of $3.0 million in the revenues we generated from super-aggregator partners related to our local online advertising platform and call-based advertising services. These revenue increases were offset by a $4.6 million decrease attributable to less traffic volume from domain name owners who are distribution partners utilizing our third-party content platform including a net decline of fifteen distribution partners comparing the three months ended September 30, 2008 to the same period in 2007. A portion of the decrease was also attributable to lower pay-per-click revenues due in part to more than 5,000 fewer advertisers spending on our partner network.

Revenue increased 9%, from $102.4 million for the nine months ended September 30, 2007 to $111.6 million in the same period in 2008. This was comprised of $12.4 million increase in proprietary traffic revenues that was primarily attributable to an increase in the average revenue per advertiser. The partner network and other revenues were affected by our adding more than 30,000 accounts to our local online and call-based advertising platforms which were primarily attributable for an increase of $10.0 million in the revenues we generated from super-aggregator partners related to our local online advertising platform and call-based advertising services. These revenue increases were offset by a $6.7 million revenue decrease attributable to less traffic volume from domain name owners who are distribution partners utilizing our third-party content platform including a net decline of seven distribution partners comparing the nine months ended September 30, 2008 to the same period in 2007. The remaining decrease was primarily attributable to lower pay-per-click revenues due in part to more than 5,000 fewer advertisers spending on our partner network.

Our ability to maintain and grow our revenues will depend in part on maintaining and increasing the number of click-throughs and calls performed by users of our service through our distribution partners and proprietary traffic sources and maintaining and increasing the number and volume of transactions and favorable variable payment terms with advertisers and advertising services providers, which we believe is dependent in part on marketing our Web sites and delivering high quality traffic that ultimately results in purchases or conversions for our advertisers and advertising services providers. We may increase our direct monetization of our proprietary traffic sources which may not be at the same rate levels as other advertising providers and could adversely affect our revenues and results of operations. If we do not add new distribution partners, renew our current distribution partner agreements or replace traffic lost from terminated distribution agreements with other sources or if our distribution partners’ search businesses do not grow or are adversely affected, our revenue and results of operations may be materially and adversely affected. Additionally, we use a limited number of communication providers for our call-based services. Furthermore, if any of these significant communication providers are unable to provide the levels of service and dedicated resources over time that we require in our business, we may not be able to replace certain of these communication providers in a manner that is efficient, cost-effective or satisfactory to our customers, and as a result our business could be materially and adversely affected. As revenue grows and the volume of transactions and traffic increases, we will need to expand our network infrastructure. Inefficiencies in our network infrastructure to scale and adapt to higher traffic volumes could materially and adversely affect our revenue and results of operations. We also generated

revenue of 10% or more for the nine months ended September 30, 2008 from each of three advertiser aggregators and resellers primarily for our performance-based pay-per-click advertising services. Although we believe there are other advertisers or providers we could work with in the event of the loss of any of these advertiser aggregators and resellers, because of the volume of revenue we generate from them, we may be adversely affected in the event of a loss of any of them. We also have another advertiser aggregator who generated revenues of more than 10% for the nine months ended September 30, 2008 where we provide services related to our private-label local online advertising platform. The loss of this advertiser aggregator would have a material adverse impact on our revenues and operating results.

The Company anticipates that these variables will fluctuate in the future, affecting our growth rate and our financial results. In particular, it is difficult to project the number of click-throughs we will deliver to our advertisers and how much advertisers will spend with us, and it is even more difficult to anticipate the average revenue per click-through.

Expenses

Expenses were as follows:


	Nine months ended September 30,						Three months ended September 30,
	2007	% of revenue		2008	% of revenue		2007	% of revenue		2008	% of revenue
Service costs	50,821,449	50	%	51,745,487	46	%	18,815,633	56	%	15,443,871	42	%
Sales and marketing	19,651,548	19	%	23,330,681	21	%	5,028,698	15	%	8,462,898	23	%
Product development	8,563,161	8	%	13,189,709	12	%	3,302,726	10	%	4,750,136	13	%
General and administrative	12,791,276	13	%	15,190,526	14	%	4,552,858	14	%	5,156,542	14	%
Amortization of intangible assets from acquisitions	12,604,730	12	%	10,879,203	10	%	4,007,342	12	%	3,165,566	9	%
Facility relocation	121,124	—		—	—		—	—		—	—

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


	Nine months ended September 30,				Three months ended September 30,
	2007		2008		2007		2008
Service costs	$	302,066	$	414,222	$	151,790	$	188,564
Sales and marketing		836,606		1,443,728		374,448		587,014
Product development		1,543,017		1,360,011		603,073		553,013
General and administrative		5,534,195		5,766,743		1,856,638		1,919,405

Total stock-based compensation	$	8,215,884	$	8,984,704	$	2,985,949	$	3,247,996

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

Service Costs. Service costs decreased 18% from $18.8 million in the three months ended September 30, 2007 to $15.4 million in the same period in 2008. The decrease was primarily attributable to a decrease in distribution partner payments, royalty, Internet domain amortization and credit card processing fees of $5.5 million partially offset by increases in facility, co-location, depreciation and amortization, personnel costs, stock compensation and other costs of $2.1 million.

Service costs represented 56% of revenue in the three months ended September 30, 2007 as compared to 42% in 2008. The 2008 decrease as a percentage of revenue in service costs as compared to 2007 was primarily a result of an increase in the proportion of revenue attributable to proprietary traffic revenue as compared to our partner and other revenue sources for which there are related distribution partner payments. Payments to feed management and pay-per-click distribution partners account for higher user acquisition costs as a percentage of revenue relative to our overall service cost percentage.

Service costs increased 2% from $50.8 million in the nine months ended September 30, 2007 to $51.7 million in the same period in 2008. The increase was primarily attributable to an increase in facility, co-location, depreciation and amortization, personnel costs, stock compensation and other costs of $6.2 million, and an increase in Internet domain amortization of $505,000, partially offset by decreases in distribution partner payments, royalty and credit card processing fees of $5.8 million. Service costs represented 50% of revenue in the nine months ended September 30, 2007 as compared to 46% in 2008. The 2008 decrease as a percentage of revenue in service costs as compared to the same period in 2007 was primarily a result of a decrease in amounts for our distribution partner payments offset in part by higher network, infrastructure and communication and personnel costs.

We expect that user acquisition costs and revenue shares to distribution partners are likely to increase prospectively given the competitive landscape for distribution partners. To the extent that payments to feed management and pay-per-click services distribution partners make up a larger percentage of future operations, or the addition or renewal of existing distribution partner agreements are on terms less favorable to us, we expect that service costs will increase as a percentage of revenue. Our proprietary traffic sources have a lower service cost as a percentage of revenue relative to our overall service cost percentage. Our proprietary traffic sources have no corresponding distribution partner payments. To the extent our proprietary traffic sources make up a larger percentage of our future operations, we expect that service costs will decrease as a percentage of revenue. We also expect that service costs will increase in absolute dollars as a result of costs associated with the expansion of our operations and network infrastructure as we scale and adapt to increases in the volume of transactions and traffic and invest in our platforms. We also expect stock-based compensation to increase in absolute dollars.

Sales and Marketing. Sales and marketing expenses increased 68%, from $5.0 million for the three months ended September 30, 2007 to $8.5 million in the same period in 2008. As a percentage of revenue, sales and marketing expenses were 15% and 23% for the three months ended September 30, 2007 and 2008, respectively. The net increase in dollars was related primarily to an increase in personnel costs, amounts for branding related efforts and an increase in online and outside marketing activities. We expect that sales and marketing expenses will increase in absolute dollars in connection with any revenue increase, to the extent that we also increase our marketing activities and correspondingly could increase as a percentage of revenue and as a result of additional stock-based compensation expense. We also expect fluctuations in marketing expenditures as we redirect our online marketing efforts towards more of our updated Web sites and direct monetization of our proprietary traffic sources but expect expenditures related to these efforts to increase in absolute dollars in the long term.

Sales and marketing expenses increased 19%, from $19.7 million for the nine months ended September 30, 2007 to $23.3 million in the same period in 2008. As a percentage of revenue, sales and marketing expenses were 19% and 21% for the nine months ended September 30, 2007 and 2008, respectively. The increase in dollars was related primarily to an increase in personnel costs, amounts for branding related efforts and online and outside marketing efforts.

Product Development. Product development expenses increased 44%, from $3.3 million in the three months ended September 30, 2007 to $4.8 million in the same period in 2008. As a percentage of revenue, product development expenses were 10% and 13% for the three months ended September 30, 2007 and 2008, respectively. The increase in dollars was primarily due to an increase in personnel and consulting costs of $1.3 million. We expect that product development expenses will increase in absolute dollars as we increase the number of personnel and consultants to enhance our service offerings and as a result of additional stock-based compensation expense.

Product development expenses increased 54%, from $8.6 million in the nine months ended September 30, 2007 to $13.2 million in the same period in 2008. As a percentage of revenue, product development expenses were 8% and 12% for the nine months ended September 30, 2007 and 2008, respectively. The increase in dollars was primarily due to an increase in personnel and consulting costs, depreciation and other operating costs of $3.8 million.

General and Administrative. General and administrative expenses increased 13%, from $4.6 million in the three months ended September 30, 2007 to $5.2 million in the same period in 2008. The increase in dollars was primarily due to an increase in personnel costs, professional fees, facility costs, bad debt and other costs of $525,000. As a percentage of revenue, general and administrative expenses was 14% for both the three months ended September 30, 2007 and 2008. We expect that our general and administrative expenses will increase in absolute dollars as a result of additional stock-based compensation expense and to the extent that we expand our operations and incur additional costs in connection with being a public company, including expenses related to professional fees and insurance.

General and administrative expenses increased 19%, from $12.8 million in the nine months ended September 30, 2007 to $15.2 million in the same period in 2008. The increase in dollars was primarily due to an increase in personnel and stock-based compensation costs of $1.1 million and an increase in professional fees, facility costs, depreciation, bad debt and other costs of $1.3 million. As a percentage of revenue, general and administrative expenses were 13% and 14% for the nine months ended September 30, 2007 and 2008, respectively.

Amortization of Intangible Assets from Acquisitions. Intangible amortization expense decreased 21%, from $4.0 million in the three months ended September 30, 2007 to $3.2 million in the same period in 2008. The decrease was associated with certain intangible assets from acquisitions being fully amortized in 2007 and 2008. During the three months ended September 30, 2008, the components of amortization of intangibles were service costs of $3.0 million, sales and marketing of $162,000 and general and administrative of $33,000.

Intangible amortization expense decreased 14%, from $12.6 million in the nine months ended September 30, 2007 to $10.9 million in the same period in 2008. The decrease was associated with certain intangible assets from acquisitions being fully amortized in 2007 and 2008. During the nine months ended September 30, 2008, the components of amortization of intangibles were service costs of $9.5 million, sales and marketing of $1.1 million and general and administrative of $234,000.

Our purchase accounting resulted in all assets and liabilities from our acquisitions being recorded at their estimated fair values on their respective acquisition dates. All goodwill, identifiable intangible assets and liabilities resulting from our acquisitions have been recorded in our financial statements. The identified intangibles amounted to $84.3 million and are being amortized over a range of useful lives of 12 to 84 months. We may acquire identifiable intangible assets as part of future acquisitions, and if so, we expect that our intangible amortization will increase in absolute dollars. Events and circumstances considered in determining whether the carrying value of amortizable intangible assets and goodwill may not be recoverable include, but are not limited to: significant changes in performance relative to expected operating results; significant changes in the use of the assets; significant negative industry or economic trends; or a significant decline in the Company’s stock price and/or market capitalization for a sustained period of time. At various points during the three months ended September 30, 2008, our stock price approached or dropped below the then book value per share. If the our stock price were to trade below book value per share for a extended period of time and/or we experienced continued downward trends in the overall economic environment, changes in the business itself, including changes in projected earnings and cash flows, we may need to recognize an impairment of all or some portion of our goodwill and other intangible assets.

Gain on sales and disposals of intangible assets, net. The gain on sales and disposals of intangible assets, net was $127,000 and $282,000 for the three and nine months ended September 30, 2007, respectively, as compared to $1.6 million and $3.8 million for the three and nine months ended September 30, 2008, respectively, and was primarily attributable to the sales and disposals of Internet domain names and other intangible assets.

Other Income, net. Other income, net was $661,000 in the three months ended September 30, 2007 and $999,000 in the same period in 2008. Other income, net was $2.1 million in the nine months ended September 30, 2007 and $1.4 million in the same period in 2008. The increase in other income, net during the three months ended September 30, 2008 was primarily due to approximately $877,000 for service fees on inactive customer accounts and cash received related to a litigation settlement partially offset by lower interest income as a result of the lower average cash balances, resulting from the Class B common stock repurchases, and lower interest rates. The decrease in other income, net during the nine months ended September 30, 2008 was primarily a result of the lower average cash balances, resulting from the Class B common stock repurchases and lower interest rates partially offset by approximately $877,000 for service fees on inactive customer accounts and cash received related to a litigation settlement.

Income Taxes. The income tax expense in the three months ended September 30, 2007 was $95,000 as compared to $1.4 million in the same period in 2008. In the nine months ended September 30, 2007, income tax expense was $982,000 as compared to $1.8 million in the same period in 2008.

In the three and nine months ended September 30, 2008, the effective tax rate of 51% and 76%, respectively, differed from the expected effective tax rate of 35% due to state income taxes, non-deductible stock-based compensation related to restricted stock and incentive stock options recorded under the fair-value method as prescribed by SFAS 123R and other amounts. The effective tax rate of (7%) and 421% in the three and nine months ended September 30, 2007, respectively, differed from the expected tax rate of 35% due to state income taxes, non-deductible stock-based compensation related to restricted stock and incentive stock options recorded under the fair-value method as prescribed by SFAS 123R and other amounts. A valuation allowance is recorded for deferred tax assets when it is more likely than not that such deferred tax assets will not be realized. Although realization is not assured, we believe it is more likely than not, based on operating performance and projections of future taxable income, that our net deferred tax assets, excluding certain state net operating loss carryforwards, will be realized. In determining that it is more likely than not that we will realize the deferred tax assets, factors considered include: historical taxable income, historical trends related to advertiser usage rates and projected revenues and expenses. The amount of the net deferred tax assets considered realizable, however, could be reduced in the near term if our projections of future taxable income are reduced or if we do not perform at the levels we are projecting. This could result in increases to the valuation allowance for deferred tax assets and a corresponding increase to income tax expense of up to the entire net amount of deferred tax assets.

During the three months ended September 30, 2007 and 2008, as a result of tax deductions from stock option exercises, we recognized tax-effected benefits of approximately $24,000 and $133,000, respectively, which were recorded as credits to additional paid in capital. During the nine months ended September 30, 2007 and 2008, as a result of tax deductions from stock option exercises, we recognized tax-effected benefits of approximately $2.8 million and $274,000, respectively, which were recorded as credits to additional paid in capital.

Convertible Preferred Stock Dividends and Discount on Preferred Stock Redemption, net. The convertible preferred stock dividends and discount on preferred stock redemption, net, decreased from $17,000 in the three months ended September 30, 2007 to $12,000 in the same period in 2008. The decrease was primarily attributable to a decrease in the preferred stock outstanding. The convertible preferred stock dividends, conversion payment and discount on preferred stock redemption, net, decreased from ($113,000) in the nine months ended September 30, 2007 to ($33,000) in the same period in 2008. The decrease was primarily attributable to preferred dividends of $51,000 in 2007 compared to $40,000 in the same period in 2008, and a $164,000 discount on preferred stock redemption in connection with our repurchase of 3,734 shares of preferred stock outstanding at a price of $195.00 per share (plus commissions) in 2007 as compared to a discount of $73,000 for the same period in 2008. Additionally, preferred stock dividends decreased in 2008 as a result of a reduction in preferred stock outstanding compared to the same period in 2007. Preferred stock dividends are based upon a dividend rate of 4.75%.

Net Income (Loss) Applicable to Common Stockholders. Net income (loss) applicable to common stockholders increased from a net loss of $1.5 million for the three months ended September 30, 2007 compared to net income of $1.3 million in the same period in 2008 as a result of the aforementioned factors. Net income (loss) applicable to common stockholders increased from net loss of $636,000 for the nine months ended September 30, 2007 compared to net income of $620,000 in the same period in 2008.

Liquidity and Capital Resources

As of September 30, 2008, we had cash and cash equivalents of $29.1 million and we had contractual obligations of $4.2 million, of which $2.3 million is for rent under our facility leases.

Cash provided by operating activities primarily consists of net income (loss) adjusted for certain non-cash items such as depreciation and amortization, deferred income taxes, stock-based compensation, excess tax benefit related to stock options, facility relocation and changes in working capital. Cash provided by operating activities for the nine months ended September 30, 2008 of approximately $19.4 million consisted primarily of net income of $587,000 adjusted for non-cash items of $28.8 million, including depreciation, amortization of intangible assets, allowance for doubtful accounts and advertiser credits, stock-based compensation, deferred income taxes, and excess tax benefit related to stock options, facility relocation and approximately $10.0 million used for working capital and other activities. Cash provided by operating activities for the nine months ended September 30, 2007 of approximately $27.6 million consisted primarily of net loss of $749,000 adjusted for non-cash items of $21.9 million, including depreciation, amortization of intangible assets, allowance for doubtful accounts and merchant advertiser credits, stock-based compensation, deferred income taxes, and excess tax benefit related to stock options, facility relocation and approximately $6.4 million provided by working capital and other activities.

With respect to a significant portion of our pay-per-click advertising services, we have no corresponding payments to distribution partners related to our proprietary revenues or we receive payment from advertisers prior to our delivery of related click-throughs with the corresponding payments to the distribution partners who provide placement for the listings made only after delivery of related click-throughs. In most cases, the amount payable to the distribution partner will be calculated at the end of a calendar month, with a payment period following the delivery of the click-throughs. This payment structure results in a lag period between the earlier receipt of the cash from the advertisers and the later payment to the distribution partners. These services constituted the majority of revenue in the nine months ended September 30, 2007 and 2008. In certain cases, payments to distribution partners are paid in advance or are fixed in advance based on a guaranteed minimum amount of usage delivered.

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

Cash provided by investing activities for the nine months ended September 30, 2008 of approximately $944,000 was primarily attributable to net purchases for property and equipment of $2.7 million, payments for the Marchex Voice Services acquisition totaling approximately $128,000, and purchases for Internet domain names or Web sites of approximately $200,000, offset by proceeds from the sales of intangible assets of approximately $3.9 million. Cash used in investing activities for the nine months ended September 30, 2007 of approximately $25.8 million was primarily attributable to the payments for the Marchex Voice Services acquisition totaling approximately $12.9 million, purchases for Internet domain names or Web sites of approximately $10.6 million and net purchases for property and equipment of $3.0 million, offset by proceeds from the sales of intangible assets of approximately $687,000. As a result of our acquisitions, we increased our property and equipment purchases for items such as network equipment and software, furniture, software and equipment for our personnel, and systems used to sell to and serve advertisers. As our operations increase, we expect property and equipment purchases will increase as we continue to invest in equipment and software for our systems and personnel. Additionally, we have expended amounts for product development initiatives as well as amounts recorded as part of property and equipment for internally developed software. We expect our expenditures for product development initiatives and internally developed software will increase in absolute dollars as our development activities accelerate and we increase the number of personnel and consultants to enhance our service offerings.

Cash used in financing activities for the nine months ended September 30, 2008 of approximately $27.7 million was primarily attributable to the repurchase of 2.6 million shares of Class B common stock for treasury stock and approximately 2,000 shares of preferred stock totaling approximately $25.7 million and $409,000, respectively, and common stock and preferred stock dividend payments of $2.5 million, partially offset by net proceeds of approximately $982,000 from the sale of stock through employee stock options and employee stock plan purchases and $60,000 of excess tax benefit related to stock options. Cash used in financing activities for the nine months ended September 30, 2007 of approximately $10.7 million was primarily attributable to the repurchase of 1.4 million shares of Class B common stock for treasury stock and approximately 4,000 shares of preferred stock totaling approximately $13.6 million and $732,000, respectively, and common stock and preferred stock dividend payments of $2.5 million, partially offset by net proceeds of approximately $3.7 million from the sale of stock through employee stock options and employee stock purchases and $2.5 million of excess tax benefit related to stock options.

The following table summarizes our contractual obligations as of September 30, 2008, and the effect these obligations are expected to have on our liquidity and cash flows in future periods.


	Total		Less than 1 year		1-3 years		4-5 years
Contractual Obligations:
Operating leases	$	2,261,986	$	402,064	$	1,846,949	$	12,973
Capital leases		66,138		13,318		52,820		—
Other contractual obligations		1,891,873		743,811		1,104,520		43,542

Total contractual obligations (1)	$	4,219,997	$	1,159,193	$	3,004,289	$	56,515

(1)

In February 2005 we entered into agreements with an advertising partner pursuant to which we paid $4.5 million, in an upfront payment and a contingent royalty based on a discounted rate of 3% (3.75% under certain circumstances) of certain of our gross revenues payable on a quarterly basis through December 2016. The upfront license fee has been capitalized and was being amortized ratably over 42 months. The royalty payment is recognized as incurred in service costs and is not included in the above schedule.

During the nine months ended September 30, 2008, we paid approximately $205,000 for the purchase of additional Internet domains. We expect to continue acquiring Internet domains or Web sites in the normal course of business as we grow our proprietary network of Web sites.

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

Under Delaware law, dividends to stockholders may be made only from the surplus of a company, or, in certain situations, from the net profits for the current fiscal year before the dividend is declared by the board of directors. Our ability to pay dividends on our common stock in the future will depend on our financial results, liquidity and financial condition.

In November 2006, our Board of Directors authorized a share repurchase program to repurchase up to 3 million shares of our Class B common stock as well as the initiation of a quarterly cash dividend for the holders of the Class A common stock and Class B common stock. In February 2008, our Board of Directors authorized an increase in the share repurchase program to provide for the repurchase up to 5 million shares in the aggregate (less shares previously repurchased under the share repurchase program) of our Class B common stock. In August 2008, the Company’s board of directors authorized an increase in the share repurchase program for the Company to repurchase up to 6 million shares in the aggregate (less shares previously repurchased under the share repurchase program) of the Company’s Class B common stock. Under the revised share repurchase program, repurchases may take place in the open market and in privately negotiated transactions and at times and in such amounts as we deem appropriate. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements, capital availability, and other market conditions. This stock repurchase program does not have an expiration date and may be limited or terminated at any time without prior notice. During the nine months ended September 30, 2008, approximately 2.6 million shares of Class B common stock were repurchased.

The quarterly cash dividend was initiated at $0.02 per share of Class A common stock and Class B common stock. For 2008, quarterly dividends were paid on February 15, May 15 and August 15 to Class A and Class B common stockholders of record as of the close of business on February 2, May 4 and August 4, respectively. The aggregate quarterly dividend paid in August 2008 was approximately $792,000.

In October 2008, our Board of Directors declared a regular quarterly dividend of $0.02 per share on our Class A common stock and Class B common stock. Marchex will pay these dividends on November 17, 2008 to the holders of record as of the close of business on November 6, 2008.

Although we expect that the annual cash dividend, subject to capital availability, will be $0.08 per common share or approximately $3.1 million for the foreseeable future, there can be no assurance that we will continue to pay dividends at such a rate or at all.

In October 2008, we redeemed the remaining outstanding preferred shares for approximately $1.0 million. Based on our operating plans we believe that our existing credit availability, resources and cash flow provided by ongoing operations, will be sufficient to fund our operations for at least twelve months. Additional equity and debt financing may be needed to support our acquisition strategy, our long-term obligations and our Company’s needs. If additional financing is necessary, it may not be available; and if it is available, it may not be possible for us to obtain financing on satisfactory terms. Failure to generate sufficient revenue or raise additional capital could have a material adverse effect on our ability to continue as a going concern and to achieve our intended business objectives.

Critical Accounting Policies

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

Our consolidated financial statements have been prepared using accounting principles generally accepted in the United States of America. The preparation of these condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and the related disclosures of contingent assets and liabilities. We base our estimates on historical experience and on various assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

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

•

Revenue;

•

Goodwill and intangible assets;

•

Stock-based compensation; and

•

Allowance for doubtful accounts, advertiser and incentive program credits.

Revenue

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

We have entered into agreements with various distribution partners in order to expand our distribution network, which includes search engines, directories, product shopping engines, certain third-party Web sites and our portfolio of Web sites, on which we include our advertisers’ listings. We generally pay distribution partners based on a specified percentage of revenue or a fixed amount per click-through on these listings. We act as the primary obligor in these transactions, and we are responsible for providing customer and administrative services to the advertiser. In accordance with Emerging Issues Task Force Issue (EITF) No. 99-19, Reporting Revenue Gross as a Principal Versus Net as an Agent, the revenue derived from advertisers who receive paid introductions through us as supplied by distribution partners is reported gross based upon the

amounts received from the advertiser. We also recognize revenue for certain agency contracts with advertisers under the net revenue recognition method. Under these specific agreements, we purchase listings on behalf of advertisers from search engines and directories. We are paid an agency fee based on the total amount of the purchase made on behalf of these advertisers. Under these agreements, our advertisers are primarily responsible for choosing the publisher and determining pricing, and the Company, in certain instances, is only financially liable to the publisher for the amount collected from our advertisers. This creates a sequential liability for media purchases made on behalf of advertisers. In certain instances, the Web publishers engage the advertisers directly and we are paid an agency fee based on the total amount of the purchase made by the advertiser.

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

Goodwill and Intangible Assets

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

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

Goodwill is tested annually for impairment and is tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. Events and circumstances considered in determining whether the carrying value of goodwill may not be recoverable include, but are not limited to: significant changes in performance relative to expected operating results; significant changes in the use of the assets; significant negative industry or economic trends; and a significant decline in the Company’s stock price and/or market capitalization for a sustained period of time. At various points during the three months ended September 30, 2008, the Company’s stock price approached or dropped below the then book value per share. If the Company’s stock price were to trade below book value per share for a extended period of time and/or the Company continues to experience adverse effects of a continued downward trend in the overall economic environment, changes in the business itself, including changes in projected earnings and cash flows, the Company may have to recognize an impairment of all or some portion of its goodwill. The Company will perform its annual impairment test on goodwill in the fourth quarter of 2008. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. To date, no impairment charge has been taken for the goodwill related to our acquisitions. If the fair value is lower than the carrying value, a material impairment charge may be reported in our financial results. We exercise judgment in the assessment of the related useful lives of intangible assets, the fair values and the recoverability. In certain instances, the fair value is determined in part based on cash flow forecasts and discount rate estimates. We review our long-lived assets for impairment in accordance with SFAS 144 whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. Recoverability of assets held and used is measured by a comparison of the carrying amount of an asset group to estimated undiscounted future cash flows expected to be generated by the asset group. If such asset group is considered to be impaired, the impairment is to be recognized by the amount by which the carrying amount of the assets exceeds fair value. Assets to be disposed of are separately presented on the balance sheet and reported at the lower of their carrying amount or fair value less costs to sell, and are no longer depreciated.

No impairment of significance of our intangible assets has been indicated to date. To the extent such evaluation indicates that the useful lives of intangible assets are different than originally estimated, the amortization period is reduced or extended and, accordingly, the quarterly amortization expense is increased or decreased.

As a result of the significance of the goodwill and intangible asset carrying values, any impairment charges or changes to the estimated amortization periods could have a material adverse effect on our financial results.

Stock-Based Compensation

On January 1, 2006, we adopted SFAS 123R using the modified prospective transition method and therefore have not restated prior periods’ results. SFAS 123R requires the measurement and recognition of compensation for all stock-based awards made to employees and directors including stock options and restricted stock issuances based on estimated fair values. Under the fair value recognition provisions of SFAS 123R, we recognize stock-based compensation net of an estimated forfeiture rate and therefore only recognize compensation cost for those shares expected to vest over the service period of the award. Prior to SFAS 123R, we accounted for share-based payments under Accounting Principles Board Opinion No. 25 Accounting for Stock Issued to Employees (APB 25) and accordingly, generally recognized compensation expense related to restricted stock awards and stock options with intrinsic value and accounted for forfeitures as they occurred.

Under SFAS 123R, we use the Black-Scholes option pricing model as our method of valuation for stock-based awards. Our determination of the fair value of stock-based awards on the date of grant using an option pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to the expected life of the award, our expected stock price, volatility over the term of the award and actual and projected exercise behaviors. Although the fair value of stock-based awards is determined in accordance with SFAS 123R, the assumptions used in calculating fair value of stock-based awards and the Black-Scholes option pricing model are highly subjective, and other reasonable assumptions could provide differing results. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future. In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. We estimate the forfeiture rate based on historical experience of our stock-based awards that are granted, exercised and cancelled. If our actual forfeiture rate is materially different from our estimate, the stock-based compensation expense could be significantly different from what we have recorded in the current period. See Note 3—”Stock-based Compensation Plans” in the condensed consolidated financial statements for additional information.

Allowance for Doubtful Accounts and Advertiser and Incentive Program Credits

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

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

Recent Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurement (SFAS 157), which clarifies the definition of fair value, establishes a framework for measuring fair value and expands the related disclosure requirements. In February 2008, the FASB issued a FASB Staff Position FSP SFAS 157-2, Effective Date of FASB Statement No. 157, which delays the effective date of SFAS 157 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The FSP defers the effective date of SFAS 157 to fiscal years beginning after November 15, 2008. Accordingly, we adopted the required provisions of SFAS 157 on January 1, 2008 and the remaining provisions will be adopted by us at the beginning of fiscal year 2009. The 2008 fiscal year adoption of the required provisions did not result in a material impact to our financial statements. The remaining aspects of SFAS 157 for which the effective date was deferred under FSP SFAS 157-2 are currently being evaluated by us.

In December 2007, the FASB issued SFAS No. 141R, Business Combinations (SFAS 141R), which replaces SFAS 141. SFAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, liabilities assumed and any resulting goodwill in the acquiree. The pronouncement also provides for disclosures to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141R will be effective for us on January 1, 2009. We are in the process of evaluating the effect that SFAS 141R will have on our financial statements.

In April 2008, the FASB issued FSP SFAS 142-3, Determination of the Useful Life of Intangible Assets (FSP SFAS 142-3), which amends the factors that should be considered in developing renewal or extension assumptions used in determining the useful life of a recognized intangible asset. FSP SFAS 142-3 also adds additional disclosures to be included in financial statements. FSP SFAS 142-3 is effective for fiscal years beginning after December 15, 2008 and interim periods within those years. We are currently evaluating the impact, if any, that FSP SFAS 142-3will have on our financial statements.

In June 2008, the FASB issued FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (FSP EITF 03-6-1), which addresses whether instruments granted in share-based payment transaction are participating securities prior to vesting and would need to be included in the earnings allocation in computing earnings per share under the two-class method of SFAS No. 128, Earnings per Share. FSP EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008 and interim periods within those years. The Company is currently evaluating the impact, if any, that FSP EITF 03-6-1 will have on its financial statements.

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

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

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

Item 4.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures

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

Changes in Internal Controls

During the quarter ended September 30, 2008, no change was made to our internal controls over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Limitations on the Effectiveness of Controls

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

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

Part II—Other Information

Item 1.

Legal Proceedings

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

Item 1A.

Risk Factors

We have updated the risk factors previously disclosed in Part II, Item 1A. under the caption “Risk Factors” of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2008, which was filed with the SEC on August 11, 2008, as set forth below. We do not believe any of the changes constitute material changes to the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2007.

An investment in our Class B common stock involves various risks, including those mentioned below and those that are discussed from time to time in our other periodic filings with the SEC. Investors should carefully consider these risks, along with the other information contained in this report, before making an investment decision regarding our stock. There may be additional risks of which we are currently unaware, or which we currently consider immaterial. All of these risks could have a material adverse effect on our financial condition, our results of operations, and the value of our stock.

Risks Relating to Our Company

Our limited operating history makes evaluation of our business difficult.

We were formally incorporated in January 2003. We acquired Enhance Interactive in February 2003 which was recently renamed Marchex Adhere PPC, TrafficLeader in October 2003, which was recently renamed Marchex Connect NA, and goClick in July 2004. In February and April 2005, we completed the acquisitions of certain assets of Name Development and Pike Street Industries, respectively. In July 2005 we completed the acquisition of IndustryBrains, which was recently renamed Marchex Adhere SSC. In May 2006 we completed the acquisition of certain assets of AreaConnect and Open List. In September 2007, we completed the acquisition of VoiceStar, which was recently renamed Marchex Voice Services.

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

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

We had an accumulated deficit of $7.2 million as of September 30, 2008. Our net expenses may increase based on the initiatives we undertake which for instance, may include increasing our sales and marketing activities, hiring additional personnel, incurring additional costs as a result of being a public company, and acquiring additional businesses. In addition, commencing January 1, 2006, we began expensing the fair value of stock options granted in connection with our adoption of the provisions of Statement of Financial Accounting Standards No. 123R, Share-Based Payment (SFAS 123R).

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

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

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

A relatively small number of distribution partners currently deliver a significant percentage of traffic to our advertiser listings. Yahoo! is our largest distribution partner and delivers traffic to our advertiser listings which collectively represents approximately 6% of our total revenue for the nine months ended September 30, 2008. Separately, Yahoo! was responsible for 12% of our total revenue during the same period principally in respect of the revenues associated with our portfolio of domains.

Our existing agreements with many of our other larger distribution partners permit either company to terminate without penalty on short notice and are primarily structured on a variable-payment basis, under which we make payments based on a specified percentage of revenue or based on the number of paid click-throughs. We intend to continue devoting resources in support of our larger distribution partners, but there are no guarantees that these relationships will remain in place over the short- or long-term. In addition, we cannot be assured that any of these distribution partners will continue to generate current levels of revenue for us or that we will be able to maintain the applicable variable payment terms at their current levels. A loss of any of these distribution partners or a decrease in revenue due to lower traffic or less favorable variable payment terms from any one of these distribution relationships could have an adverse effect on our revenue, and the loss of Yahoo! or any other large distribution partner could have a material adverse effect on our business, financial condition and results of operations.

Companies distributing advertising on the Internet have experienced, and will likely continue to experience, consolidation. This consolidation has reduced the number of partners that control the online advertising outlets with the most user traffic. According to the comScore Media Metrix qSearch report for December 2007, Yahoo! Search accounted for 23% of the online searches in the United States and Google accounted for 58%. As a result, the larger distribution partners have greater control over determining the market terms of distribution, including placement of advertisements and cost of placement. In addition, many participants in the performance-based advertising and search marketing industries control significant portions of the traffic that they deliver to advertisers. We do not believe, for example, that Yahoo! and Google are as reliant as we are on a third-party distribution network to deliver their services. This gives these companies a significant advantage over us in delivering their services, and with a lesser degree of risk.

We rely on certain advertiser aggregators, resellers and agencies, including AT&T, R.H. Donnelley Corporation, Idearc Media Corp., Yellowbook USA Inc., The Cobalt Group and Intelius, Inc., for the purchase of various advertising and marketing services, as well as to provide us with a large number of advertisers. A loss of certain advertiser aggregators, resellers and agencies or a decrease in revenue from these aggregator partners could adversely affect our business. Such advertisers are subject to varying terms and conditions which may result in claims or credit risks to us.

We benefit from the established relationships and national sales teams that certain of our aggregator partners, who are leading aggregators of advertisers and advertising agencies, have in place throughout the country and in local markets. These advertiser aggregators and agencies refer or bring advertisers to us for the purchase of various advertising products and services. We derive a sizeable portion of our total revenue through these advertiser aggregators, resellers and agencies. A loss of certain advertiser aggregators, resellers and agencies or a decrease in revenue from these aggregator partners could adversely affect our business.

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

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

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

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

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

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

We have a large number of distribution partners who display our advertiser listings on their networks. Our advertiser listings are predominantly delivered to our distribution partners in an automated fashion through an XML data feed or data dump. Our distribution partners are contractually required to use the advertiser listings that we provide in accordance with applicable laws and regulations and in conformity with the publication restrictions included in our agreements, which are intended to promote the quality and validity of the traffic provided to our advertisers. Nonetheless, we do not operationally

control or manage these distribution partners and any breach of these agreements on the part of any distribution partner or its affiliates could result in liability for our business. These agreements include indemnification obligations on the part of our distribution partners, but there is no assurance that we would be able to collect against offending distribution partners or their affiliates in the event of a claim under these indemnification provisions.

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

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

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

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

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

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

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

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

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

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

We may require additional funding to meet our ongoing obligations and to pursue our business strategy, which may include the selective acquisition of businesses and technologies. In addition, we have incurred and we may incur certain obligations in the future, including:

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In February 2005, we entered into agreements with Yahoo! (formerly, Overture), pursuant to which we paid $4.5 million in an upfront payment and a contingent royalty based on 3.0% (3.75% under certain circumstances) of certain of our gross revenues payable on a quarterly basis through December 2016.

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In November 2006, our board of directors authorized the repurchase of up to 3.0 million shares of our Class B common stock and the initiation of a quarterly cash dividend to the holders of common stock at an annual rate of $0.08 per common share. In February 2008, our board of directors authorized the repurchase of up to an additional 2.0 million shares of our Class B common stock. In August 2008, our board of directors authorized the repurchase of up to an additional 1.0 million shares of our Class B common stock. To date, we have repurchased approximately 4.6 million of our Class B common shares under the repurchase program.

There can be no assurance that if we were to need additional funds to meet these obligations that additional financing arrangements would be available in amounts or on terms acceptable to us, if at all. Furthermore, if adequate additional funds are not available, we will be required to delay, reduce the scope of, or eliminate material parts of the implementation of our business strategy, including potential additional acquisitions or internally-developed businesses.

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

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

Acquisitions are accompanied by a number of risks that could harm our business, operating results and financial condition:

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

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

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

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

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

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

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

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

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

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

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

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

Further, as of September 30, 2008, Russell C. Horowitz, Ethan A. Caldwell, Peter Christothoulou and John Keister together controlled 92% of the combined voting power of our outstanding capital stock. Their collective voting control is not tied to their continued employment with Marchex. The loss of the services of any member of our senior management, including our founding executive officers, for any reason, or any conflict among our founding executive officers, could harm our current and future operations and prospects.

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

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

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

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

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

New rules, including those contained in and issued under the Sarbanes-Oxley Act of 2002, may make it difficult for us to retain or attract qualified officers and directors, which could adversely affect our business and our ability to maintain the listing of our Class B common stock on the Nasdaq Global Market.

We may be unable to attract and retain qualified officers, directors and members of board committees required to provide for our effective management as a result of the recent and currently proposed changes in the rules and regulations which govern publicly-held companies, including, but not limited to, certifications from executive officers and requirements for financial experts on boards of directors. The perceived increased personal risk associated with these recent changes may deter qualified individuals from accepting these roles. The enactment of the Sarbanes-Oxley Act of 2002 has resulted in the issuance of a series of new rules and regulations and the strengthening of existing rules and regulations by the SEC, as well as the adoption of new and more stringent rules by the Nasdaq Stock Market.

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

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

Effective internal controls are necessary for us to provide reliable and accurate financial reports and effectively prevent fraud. We have devoted significant resources and time to comply with the new internal control over financial reporting requirements of the Sarbanes-Oxley Act of 2002. In addition, Section 404 under the Sarbanes-Oxley Act of 2002 requires that we assess and our auditors attest to the design and operating effectiveness of our controls over financial reporting. Our current and future compliance with the annual internal control report requirement will depend on the effectiveness of our financial reporting and data systems and controls across our operating subsidiaries. We expect these systems and controls to become increasingly complex to the extent that we integrate acquisitions and our business grows. To effectively manage this growth, we will need to continue to improve our operational, financial and management controls and our reporting systems

and procedures. We cannot be certain that these measures will ensure that we design, implement and maintain adequate controls over our financial processes and reporting in the future. Any failure to implement required new or improved controls, or difficulties encountered in their implementation or operation, could harm our operating results or cause us to fail to meet our financial reporting obligations. Inadequate internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our stock and our access to capital.

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

We adopted the provisions of SFAS 123R on January 1, 2006. Thus, our consolidated financial statements for 2007 and 2008 will reflect the fair value of stock options granted to employees as a compensation expense, which has had, and will in the future likely continue to have, a significant adverse impact on our results of operations and net income per share. We rely heavily on stock options to compensate existing employees and to attract new employees. If we reduce or alter our use of stock-based compensation to minimize the recognition of these expenses, our ability to recruit, motivate and retain employees may be impaired, which could put us at a competitive disadvantage in the employee marketplace. In order to prevent any net decrease in their overall compensation packages, we may choose to make corresponding increases in the cash compensation or other incentives we pay to existing and new employees. Any increases in employee wages and salaries would diminish our cash available for marketing, product development and other uses and might cause our GAAP profits to decline. Any of these effects might cause the market price of our Class B common stock to decline.

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

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

We have substantial goodwill and other intangible assets, and we may be required to record a significant charge to earnings in our financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined. Any impairment charges or changes to the estimated amortization periods could have a material adverse effect on our financial results.

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

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

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

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A significant amount of revenue attributed to our network of Web sites comes through our agreement with Yahoo! and its subsidiaries. Under our agreement, Yahoo! has certain limited exclusive and preferential rights with respect to the commercialization of many of these Web sites through paid listings. Yahoo! controls the delivery of a portion of the paid listings to many of these Web sites. As a result, the monetization of these Web sites is presently largely dependent on the revenue from the paid listings allocated by Yahoo! and its subsidiaries to these Web sites. This allocation may depend on Yahoo!’s advertiser base, internal policies in effect from time to time, perceived quality of traffic, origin of traffic, history of performance and conversion, technical and network changes made by Yahoo!, among many factors and determinations which may or may not be controlled by us or known to us. In addition to the aforementioned factors, if our business relationship with Yahoo! is terminated we may not be able to replace it with another large-scale provider of paid listings under terms which allow us to increase or maintain the amount of revenue attributable to our network of Web sites.

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In the ordinary course of business we have been subject to and in the future it is likely that we will continue to be subject to intellectual property infringement claims, including claims of trademark infringement with respect to Internet domain names acquired by us. As a result of these claims, we have lost and in the future it is likely that we will continue to lose domain names from which we derive revenue. We may not be able to recoup any resulting financial losses from the prior domain name owners.

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

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We will need to continue to acquire commercially valuable Internet domain names to grow our proprietary network of Web sites. We will need to continuously improve our technologies to acquire valuable Internet domain names as competition in the marketplace for appropriate Internet domain names intensifies. Our domain name acquisition efforts are subject to rules and guidelines established by registries which maintain Internet domain name registrations and the registrars which process and facilitate Internet domain name registrations. The registries and registrars may change the rules and guidelines for acquiring Internet domains in ways that may prove detrimental to our domain acquisition efforts.

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

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

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

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

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

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

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

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

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

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

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

Regulation could reduce the value of the Internet domain names acquired or negatively impact the Internet domain acquisition process, which could significantly impair the value attributable to our acquisitions of Internet domain names.

The Name Development business includes the registrations of thousands of Internet domain names both in the United States and internationally. Name Development acquired previously-owned Internet domain names that had expired and had been offered for sale by Internet domain name registrars following the period of permitted reclamation by their prior owners. Furthermore, we have separately acquired and intend to continue to acquire in the future additional previously-owned Internet domain names, including in connection with the Pike Street and AreaConnect asset acquisitions.

The acquisition of Internet domain names generally is governed by regulatory bodies. The regulation of Internet domain names in the United States and in foreign countries is subject to change. Regulatory bodies could establish additional requirements for previously-owned Internet domain names or modify the requirements for holding Internet domain names. As a result, we might not acquire or maintain names that contribute to our financial results in the same manner as reflected in the historical financial results of Name Development, Pike Street and AreaConnect. Because certain Internet domain names are important assets, a failure to acquire or maintain such Internet domain names could adversely affect our financial results and our growth. Any impairment in the value of these important assets could cause our stock price to decline.

Risks Relating to Our Business and Our Industry

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

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

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sales to advertisers of pay-per-click services;

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sales to advertisers of feed management services;

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

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

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

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

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local search sales training;

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

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third party domain monetization.

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

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

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

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

•

longer operating histories;

•

more management experience;

•

an employee base with more extensive experience;

•

better geographic coverage;

•

larger customer bases;

•

greater brand recognition; and

•

significantly greater financial, marketing and other resources.

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

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

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

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

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

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

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

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fire;

•

floods;

•

network failure;

•

hardware failure;

•

software failure;

•

power loss;

•

telecommunications failures;

•

break-ins;

•

terrorism, war or sabotage;

•

computer viruses;

•

denial of service attacks;

•

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

•

natural disaster; and

•


Period	Total number of shares purchased		Average price paid per share		Total number of shares purchased as part of publicly announced plans or programs	Maximum number of shares (or approximate dollar value) that may yet be purchased under the plans or programs (1)
July 1, 2008 – July 30, 2008	56,165		$	11.71	56,165	1,116,910
August 1, 2008 – August 31, 2008	378,430		$	11.79	378,430	1,738,480
September 1, 2008 – September 30, 2008	313,280	(2)	$	10.64	305,280	1,433,200

Total Class B Common Shares	747,875		$	11.40	739,875	1,433,200



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

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

32.1††		Certification of CEO pursuant to Section 1350.

32.2††		Certification of CFO pursuant to Section 1350.


MARCHEX, INC.

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


Date: November 10, 2008				/S/ RUSSELL C. HOROWITZ
				Russell C. Horowitz
				Chief Executive Officer (Principal Executive Officer)


Date: November 10, 2008				/S/ MICHAEL A. ARENDS
				Michael A. Arends
				Chief Financial Officer (Principal Financial Officer)