UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2005

OR

o 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: 0-31613

WEBSIDESTORY, INC.

(858) 546-0040
(Registrant’s telephone number, including area code)

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

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

     The number of outstanding shares of the registrant’s common stock, par value $0.001 per share, as of March 31, 2005 was 15,638,279.

WEBSIDESTORY, INC.

FORM 10-Q — QUARTERLY REPORT
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005

TABLE OF CONTENTS

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PART I — FINANCIAL INFORMATION

WEBSIDESTORY, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)

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

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WEBSIDESTORY, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)

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

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WEBSIDESTORY, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

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

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WebSideStory, Inc.

Notes to Condensed Consolidated Financial Statements
(unaudited)

1. The Company

Nature of Business

     WebSideStory, Inc. (the “Company”) was founded and commenced operations in September 1996. The Company is a leading provider of on-demand web analytics services. The Company’s services, including its primary service, HBX, are used by customers to better understand how Internet users respond to website design and content, online marketing campaigns and e-commerce offerings. These services are provided to customers for a fee, which is either fixed or based on the actual number of web sites and total page views and transactions analyzed by the Company’s services. Contracts for subscription services typically range in duration from one to three years.

     The Company’s business consists of a single reportable segment. To pursue the sale of its products and services in international markets, the Company established wholly owned subsidiaries in France (February 2000), the Netherlands (August 2000) and the United Kingdom (April 2003).

2. Summary of Significant Accounting Policies

Basis of Presentation

     The accompanying condensed consolidated balance sheet as of March 31, 2005 and the condensed consolidated statement of operations and cash flows for the three months ended March 31, 2005 and 2004 and the related condensed footnote disclosures are unaudited. These condensed statements and the related condensed notes should be read in conjunction with the audited consolidated financial statements and related notes, together with management’s discussion and analysis of financial position and results of operations, contained in the Company’s annual report on Form 10-K for the year ended December 31, 2004.

     The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). In the opinion of the Company’s management, the unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements included in the Company’s 2004 Annual Report on Form 10-K and include all adjustments necessary for the fair statement of the Company’s financial position as of March 31, 2005, its results of operations for the three months ended March 31, 2005 and 2004 and cash flows for the three months ended March 31, 2005 and 2004. The results for the three months ended March 31, 2005 are not necessarily indicative of the results to be expected for the year ending December 31, 2005.

Use of Estimates

     The condensed consolidated financial statements of the Company have been prepared using accounting principles generally accepted in the United States of America. These principles require management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and reported amounts of revenue and expenses. Actual results could differ from those estimates.

Concentration of Credit Risk and Significant Customers and Suppliers

     The Company’s financial instruments that are exposed to concentrations of credit risk consist primarily of cash and cash equivalents, short-term marketable securities, certain long-term investments and trade accounts receivable. Although the Company deposits its cash with multiple financial institutions, its deposits, at times, may exceed federally insured limits.

     The Company’s accounts receivable and net revenue are derived from a large number of direct customers. Collateral is not required for accounts receivable. The Company maintains an allowance for potential credit losses as considered necessary. At March 31, 2005 and December 30, 2004, the allowance for potential credit losses was $395,000, and $407,000, respectively. The Company

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had no revenue generated from a single customer who accounted for more than 10% of revenue for the three months ended March 31, 2005 or 2004.

     As of March 31, 2005 and December 31, 2004, assets located outside the United States were 12% and 10% of total assets, respectively. Revenue for the three months ended March 31, 2005 and 2004, outside the United States were as follows (in thousands):

Software and Website Development Costs

     The Company capitalizes qualifying software and website development costs, which are incurred during the application development stage, and amortizes them over their estimated useful lives. The Company capitalized $337,000 and $0 during the three months ended March 31, 2005 and 2004, respectively. Capitalized software and website development costs are included in other assets in the accompanying condensed consolidated balance sheets. Amortization expense totaled $33,000 and $9,000 during the three months ended March 31, 2005 and 2004, respectively.

Comprehensive Income

     Comprehensive income consists of accumulated other comprehensive income (loss) and net income. Accumulated other comprehensive income (loss) includes certain changes in equity that are excluded from net income. Specifically, cumulative foreign currency translation adjustments are included in accumulated other comprehensive income (loss). Total comprehensive income consists of the following (in thousands):

Accounting for Stock-Based Compensation

     The Company measures compensation expense for its employee and director stock-based compensation plans using the intrinsic value method and provides pro forma disclosures of net income (loss) as if a fair value method had been applied in measuring compensation expense. Accordingly, compensation expense for stock options is measured as the excess, if any, of the fair value of the Company’s common stock at the date of grant over the amount an employee must pay to acquire the stock. Stock-based compensation is amortized over the related service periods using an accelerated graded method in accordance with Financial Accounting Standards Board (“FASB”) No. 28 Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plan.

     Had compensation expense for employee stock options been determined based on the fair value of the options on the date of grant, the Company’s net income (loss) would have been as follows (in thousands, except per share data):

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     For purposes of the above pro forma calculation, the value of each option granted was estimated on the date of grant using the Black-Scholes pricing model with the following weighted-average assumptions:

Earnings (loss) per share

     In July 2004, the Company adopted Emerging Issues Task Force (“EITF”) No. 03-06, Participating Securities and the Two-Class Method under FASB Statement No. 128, Earnings per Share. The consensus required the use of the two-class method in the calculation and disclosure of basic earnings per share and provided guidance on the allocation of earnings and losses for purposes of calculating basic earnings per share.

     Certain classes of preferred stock previously outstanding were entitled to participate in cash dividends in preference to common stock. For purposes of calculating basic earnings per share, undistributed earnings were allocated first to participating preferred stock up to the stated preferential dividend and any excess dividend distribution is allocated to common and participating preferred shares on a pro rata basis. Basic earnings per share was determined by dividing net income available to common and participating stockholders by the weighted average number of common and participating shares outstanding during the period. Diluted earnings per share reflect the potential dilution that could occur if options to issue common stock or conversion rights of preferred stocks were exercised. In periods in which the inclusion of such instruments was anti-dilutive, the effect of such securities was not given consideration.

     The Company has excluded all convertible redeemable preferred stock, outstanding stock options and unvested common stock subject to repurchase from the calculation of diluted loss per share for the thee months ended March 31, 2004 because such securities are anti-dilutive for that period. The total number of potential common shares excluded from the calculation of diluted loss per share is detailed in the table below:

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     Employee stock options to purchase approximately 66,354 shares of common stock during the three months ended March, 31, 2005 were outstanding but not included in the computation of diluted earnings per share because the option price was greater that than the average market price of the common stock, and therefore, the effect on diluted earnings per share would be anti-dilutive. The following table sets forth the computation of basic and diluted net income (loss) per share for the three months ended March 31, 2005 and 2004, respectively (in thousands, except share and per share data):

Income Taxes

     The Company has provided for income taxes using an estimated effective rate of approximately 5% for the quarter ended March 31, 2005. The Company has not provided for United States income taxes as it believes its deferred tax assets will be sufficient to cover all earnings for the three months ended March, 31, 2005; however, certain changes in ownership may limit the amount of net operating loss carryforwards that can be utilized in the future to offset taxable income. As of March 31, 2005, the Company had provided a valuation allowance on substantially all deferred tax assets. The Company has calculated its estimated effective tax rate based on certain estimated foreign taxes, state taxes and federal alternative minimum taxes.

3. Recently Issued Accounting Pronouncement

     In December 2004, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 123R, Share-Based Payment. This statement is a revision of SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board Opinion No. 25 (“ABP No. 25”), Accounting for Stock Issued to Employees. SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. Such stock option expensing will require the Company to change its accounting policy. The Company currently accounts for stock-based awards to employees in accordance with APB No. 25. Under the Company’s current accounting policy, the Company records stock-based compensation based on the difference between the exercise price of the stock option and the fair market value at the time of grant. To arrive at the fair value for each option grant, SFAS No. 123R requires the use of an option pricing model to evaluate the Company’s stock by factoring in additional variables such as expected life of the option, risk-free interest rate, expected volatility of the stock and expected dividend yield. Subsequently, in May 2005, the Securities and Exchange Commission approved the rule delaying the effective date of SFAS No. 123R to the annual period beginning after June 15, 2005. SFAS No. 123R will be effective for the Company for the quarter ended March 31, 2006. The Company is evaluating the effect this rule will have on its consolidated financial statements and its future results.

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4. Composition of Certain Balance Sheet Captions

Property and Equipment

     The following table sets forth the components of property and equipment, net (in thousands):

     The Company leases certain computer and office equipment under capital leases. Included within property, plant and equipment was $121,000 of such equipments as of March 31, 2005 and December 31, 2004. Accumulated amortization relating to certain computer and office equipment under capital leases totaled $9,000 and $3,000 at March 31, 2005 and December 31, 2004, respectively.

Investments

     Short-term and long-term investments consist of the following (in thousands):

Accrued Liabilities

     The following table sets forth the components of accrued liabilities (in thousands):

5. Subsequent Event

     On May 4, 2005, pursuant to the Agreement and Plan of Merger (“Merger Agreement”), entered into by the Company on February 8, 2005, WSSI Acquisition Company, a California corporation and a direct, wholly-owned subsidiary of the Company (“Merger Sub”) merged with and into Avivo Corporation, a California corporation (“Avivo”). As a result of this transaction (the “Merger”), and

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pursuant to the terms of the Merger Agreement, Avivo is now a wholly-owned subsidiary of the Company and will be merged with and into a wholly-owned subsidiary of the Company within 30 days of the date of the Merger.

     Under the terms of the Merger Agreement, the Company issued 3,123,149 shares of common stock and options and paid $4,199,172 in cash, in exchange for the outstanding capital stock and options of Avivo. Avivo’s shareholders also have the right to receive an earn-out payment based on achievement of certain revenues by Avivo in the fifteen-month period following the closing, with such payment not to exceed $4.1 million.

     In addition, in accordance with the terms of the Merger Agreement and the Escrow Agreement (the “Escrow Agreement”), entered into by the Company on May 4, 2005, approximately nineteen percent of the common stock and cash will be held in escrow for a fifteen-month period (with a portion extended to up to twenty-four months) following closing of the Merger to satisfy possible indemnification claims made by the Company. The Company has also granted, pursuant to its existing equity incentive plan, options to purchase an aggregate of 447,000 shares of Parent common stock to the employees of the Company.

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

     The following discussion contains forward-looking statements, which involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth below under the caption “Risk Factors.” The interim financial statements and this Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the financial statements and notes thereto for the year ended December 31, 2004 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report on Form 10-K for the year ended December 31, 2004.

Caution on Forward-Looking Statements

     Any statements in this report about our expectations, beliefs, plans, objectives, assumptions or future events or performance are not historical facts and are forward-looking statements. This report contains forward-looking statements that are based on our management’s beliefs and assumptions and on information currently available to our management. You can identify these forward-looking statements by the use of words or phrases such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “projects,” “should,” “will,” “would” and similar expressions intended to identify forward-looking statements. Among the factors that could cause actual results to differ materially from those indicated in the forward-looking statements are risks and uncertainties inherent in our business including, without limitation, the risk that our services are not adopted or used by other providers of software or technology services or, if adopted, do not perform to the satisfaction of our partners or customers; our reliance on our Web analytics services for the majority of our revenue; our recent achievement of profitability and the risk that we may not maintain our profitability; the highly competitive markets in which we operate that may make it difficult for us to retain customers; the risk that our customers fail to renew their agreements; the risk that our services may become obsolete in a market with rapidly changing technology and industry standards; and other risks described in our annual report on Form 10-K filed with the Securities and Exchange Commission, or SEC, on March 29, 2005 and in the discussions set forth below under the heading “Risk Factors.” Given these uncertainties, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our management’s beliefs and assumptions only as of the date of this report.

     Except as required by law, we assume no obligation to update these forward-looking statements publicly or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available.

Overview

     We are a leading provider of on-demand web analytics services. Our services collect data from web browsers, process that data and deliver reports of online behavior to our customers on demand. Customers use our services to better understand how Internet users respond to website design and content, online marketing campaigns and e-commerce offerings. We deliver our services over the Internet using a secure, proprietary, scalable application and system architecture, which allows us to concurrently serve a large number of customers and to efficiently distribute the workload across our network of servers.

     Although we commenced operations in September 1996, we did not begin selling our technology services for a fee until August 1999. Prior to that, we provided a basic Internet user behavior information and analysis service solely in exchange for online advertising space that we used or sold. Our revenue from advertising has been steadily declining due to a strategic decision that we

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made in 2001 to de-emphasize free use of web analytics in favor of selling subscriptions to our services. As a result, our revenue from advertising decreased from $8.4 million in 2000 to $126,000 in 2004 and $11,000 for the three months ended March 31, 2005. We introduced the predecessors of our HBX web analytics services in late 1999 and have significantly increased our subscription services revenue since that time. Our revenue from the sale of our subscription services has grown from $5.8 million in 2000 to $22.5 million in 2004 and for three months ended March 31, 2005 was $6.9 million.

     We currently sell our services primarily through our direct sales force to a wide range of organizations in many industries. As of March 31, 2005, our customer base included more than 700 HBX customers, an increase from approximately 180 customers at December 31, 2001. None of our customers accounted for more than 10% of our revenue for the twelve months ended December 31, 2004 or the three months ended March 31, 2005.

     We believe that there are growth opportunities for our HBX services in foreign jurisdictions. In the year ended December 31, 2004 and the three months ended March 31, 2005, we generated approximately 16% and 19% of revenue, respectively, from customers in Europe. We anticipate that the percentage of revenue from international operations will remain consistent or grow as we increase our direct sales force and build brand awareness in foreign markets. We have recently released foreign language versions of our HBX service to facilitate use in certain foreign markets. Although we have not entered into any agreement or understanding for an international acquisition, we have evaluated international acquisition opportunities in the past and will continue to do so in the future.

     On May 4, 2005, pursuant to a merger agreement, or Merger Agreement, entered into by us on February 8, 2005, WSSI Acquisition Company, our wholly-owned subsidiary, or Merger Sub, merged with and into Avivo Corporation, or Avivo. As a result of this transaction, or the Merger, and pursuant to the terms of the Merger Agreement, Avivo is now a wholly-owned subsidiary of us and will be merged with and into another one of our wholly-owned subsidiaries within 30 days of the date of the Merger.

     Under the terms of the Merger Agreement, we issued 3,123,149 shares of common stock and options and paid $4,199,172 in cash, in exchange for the outstanding capital stock and options of Avivo. Avivo’s shareholders also have the right to receive an earn-out payment based on achievement of certain revenues by Avivo in the fifteen-month period following the closing, with such payment not to exceed $4.1 million.

     In addition, in accordance with the terms of the Merger Agreement and an escrow agreement, or Escrow Agreement, entered into by us on May 4, 2005, approximately nineteen percent of the common stock and cash will be held in escrow for a fifteen-month period (with a portion extended to up to twenty-four months) following closing of the Merger to satisfy possible indemnification claims made by us. We have also granted, pursuant to our existing equity incentive plan, options to purchase an aggregate of 447,000 shares of our common stock to the employees of Avivo. The cash used to fund the payment of the Merger cash consideration was paid from the net proceeds from our initial public offering.

Critical Accounting Policies and Estimates

     Management’s Discussion and Analysis of Financial Condition and Results of Operations are based on our condensed consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles. The preparation of our condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, and expense and related disclosures. On an on-going basis, we evaluate estimates, including those related to bad debts, depreciation and life of developed software, fixed assets and impairment of intangible and tangible assets. These estimates are based on historical experience and on various other 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.

     Critical accounting policies are those that, in management’s view, are most important in the portrayal of our financial condition and results of operations and include revenue recognition, allowance for doubtful accounts, accounting for income taxes and stock-based compensation. Management believes there have been no material changes during the three month period ended March 31, 2005 to the critical accounting policies discussed in the Management Discussion and Analysis of Financial Condition and Results of Operations section of our annual report on Form 10-K for the year ended December 31, 2004, as filed with the SEC on March 29, 2005.

Results of Operations

     The following table presents our selected condensed consolidated statements of operations data (as a percentage of revenue) for the periods indicated:

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Three Months Ended March 31, 2005 and 2004

Revenue

     Total revenue increased 38% to $7.0 million for the three months ended March 31, 2005 from $5.0 million for the three months ended March 31, 2004.

     Subscription Revenue. Subscription revenue increased 40% to $6.9 million, or 100% of total revenue for the three months ended March 31, 2005 from $5.0 million, or 99% of total revenue, for the three months ended March 31, 2004. The increase in subscription revenue over the previous year was primarily the result of increasing the number of new customers for our services. We expect subscription revenue to continue to increase in the future as we continue to increase our customer base while considering opportunities to grow the business through strategic acquisitions.

     Advertising Revenue. Advertising revenue declined to $11,000, or less than 1% of total revenue for the three months ended March 31, 2005 from $74,000, or 1% of total revenue, for the three months ended March 31, 2004. This decrease was due to our decision to stop providing our free web analytics service that generated advertising revenue.

Cost of Revenue and Operating Expenses

     Cost of Revenue. Cost of revenue increased $245,000 or 32% to $1.0 million, or 14% of total revenue, for the three months ended March 31, 2005 from $755,000, or 15% of total revenue, for the three months ended March 31, 2004. This increase primarily resulted from an increase in salaries, bonuses and employee-related costs of $169,000 associated with the expansion of our professional services department and an increase in costs associated with network personnel. In addition, we incurred higher rent and utility charges for a combined increase of $29,000, increased bandwidth charges of $19,000 and $12,000 in increased depreciation expense. We expect cost of revenue to increase in absolute dollars but remain constant as a percentage of revenue in future periods.

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     Sales and Marketing Expenses. Sales and marketing expenses increased 36% to $2.9 million, or 42% of total revenue, for the three months ended March 31, 2005 from $2.2 million, or 43% of total revenue, for the three months ended March 31, 2004. This increase was primarily attributable to salaries and wages and related employee benefits for additional sales and marketing personnel of approximately $351,000 and increased sales commissions and bonuses of approximately $180,000 related to increased revenue. Additionally, the increase in sales and marketing personnel and number of customers caused travel and lodging costs to increase approximately $50,000. Sales and marketing expenses as a percentage of total revenue declined primarily due to increased productivity of sales personnel. As our customer base grows and our company expands to meet the increased demands, we will continue to hire additional sales and customer retention personnel in future periods.

     Research and Development Expenses. Research and development expenses decreased 22% to $786,000, or 11% of total revenue, for the three months ended March 31, 2005 from $1.0 million, or 20% of total revenue, for the three months ended March 31, 2004. This decrease was primarily due to internally used software and website development projects for which we were required to capitalize related salaries, wages and employee benefit costs associated with the specific projects. We expect that, research and development expenses will increase in future periods as the amount of costs able to be capitalized decrease and we continue to amortize capitalized research and development expenses.

     General and Administrative Expenses. General and administrative expenses increased 63% to $1.2 million, or 17% of total revenue, for the three months ended March 31, 2005 from $707,000, or 14% of total revenue, for the three months ended March 31, 2004. This increase was largely due to professional fees for accounting and legal services, an overall increase in salaries and wages and an increase in certain insurance coverage offset by a decrease in bad debt expense and general allocated overhead. We expect general and administrative expenses to increase as we add headcount and incur additional costs related to operating as a public company. These costs are expected to include additional accounting, legal, insurance and consulting fees.

Stock-Based Compensation Expenses

     Stock-based compensation expenses decreased 33% to $180,000, or 3% of total revenue, for the three months ended March 31, 2005 from $267,000, or 5% of total revenue, for the three months ended March 31, 2004. During the remainder of 2005, based on the current intrinsic method of stock option valuation, we expect stock-based compensation expenses to decrease. In the first quarter of 2006, when we adopt SFAS No. 123R, we expect stock based compensation expense to increase. We are currently evaluating the impact that the adoption of this rule will have on our results of operations

Other Income, Net

     Other income, net of $181,000 for the three months ended March, 31, 2005 increased $164,000 from $17,000 for the three months ended March 31, 2004. The increase in net interest income was due to interest earned on investments as cash equivalents and investments increased to $31.6 million as of March 31, 2005 from $7.0 million as of March 31, 2004. In 2004, other income, net consists of interest income on investments and interest expense on bank borrowings.

Provision for Income Taxes

     The provision for income taxes increased $23,000 to $53,000 for the three months ended March 31, 2005 from $30,000 for the three months ended March 31, 2004 primarily related to current taxes associated with our foreign operations and alternative minimum taxes associated with our U.S. operations.

Liquidity and Capital Resources

     As of March 31, 2005, we had $7.7 million of cash and cash equivalents, $14.2 million in short-term investments and $17.7 million in working capital, as compared to $5.7 million of cash and cash equivalents, $16.3 million in short-term investments and $17.8 million in working capital as of December 31, 2004. As of March 31, 2005, we had no debt obligations.

     On May 4, 2005, pursuant to the Merger Agreement, entered into by us on February 8, 2005, Merger Sub merged with and into Avivo. As a result of the Merger, and pursuant to the terms of the Merger Agreement, Avivo is now a wholly-owned subsidiary of us and will be merged with and into another one of our wholly-owned subsidiaries within 30 days of the date of the Merger.

     Under the terms of the Merger Agreement, we issued 3,123,149 shares of common stock and options and paid $4,199,172 in cash, in exchange for the outstanding capital stock and options of Avivo. Avivo’s shareholders also have the right to receive an earn-out

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payment based on achievement of certain revenues by Avivo in the fifteen-month period following the closing, with such payment not to exceed $4.1 million.

Cash Flow

     Net cash provided by operating activities was $1.1 million and $1.5 million for the three months ended March 31, 2005 and 2004, respectively. In 2005, net income of $1.0 million was the largest contributor to the cash provided by operations. That amount was increased by non-cash add-backs of $288,000 and $182,000 for depreciation and amortization and stock-based compensation, respectively. Offsetting the positive non-cash items were changes in operating assets and liabilities including increases in accounts receivable of $233,000 and prepaid expenses and other assets of $970,000, which collectively decreased cash provided from operations by $1.2 million. Total accounts payable and accrued liabilities also increased, further increasing cash provided from operating activities by $682,000.

     In 2005, we invested cash in short and long-term investments. In 2004, our investing activities consisted primarily of purchases of fixed assets and investments in software. Net cash provided by the maturity of such investments was $3.1 million during the three months ended March, 31, 2005. Capital expenditures were principally related to our network infrastructure and computer equipment for our employees. Cash provided by investing activities totaled $912,000 for the three months ended March 31, 2005 and cash used by investing activities totaled $349,000 for the three months ended March 31, 2004. We will continue to invest in our network infrastructure and in software development to ensure reliability of our network and to introduce new services and enhancements to our existing services.

     Cash provided by financing activities was $41,000 and, $276,000 for the three months ended March 31, 2005 and 2004, respectively. Our cash provided by financing activities primarily consisted of stock option exercises.

     We anticipate that our future capital uses and requirements will depend upon a variety of factors. These factors include but are not limited to the following:

	•	the costs of serving more customers;
	•	the costs of our network infrastructure;
	•	the costs of our research and development activities to improve our service offerings; and
	•	the extent to which we acquire or invest in other technologies and businesses.

     We believe that we will have sufficient liquidity to fund our business and meet our contractual obligations over a period beyond the next 12 months. However, we may need to raise additional funds in the future if we pursue acquisitions or investments in competing or complementary businesses or technologies or experience operating losses that exceed our expectations. If we raise additional funds through the issuance of equity or convertible securities, our stockholders may experience dilution. If we need additional financing, we may not be able to obtain it on acceptable terms or at all.

     As of March 31, 2005 and all periods prior, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Other than our operating leases for office space and computer equipment, we do not engage in off-balance sheet financing arrangements. In addition, we do not engage in trading activities involving non-exchange traded contracts. Therefore, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships.

Risk Factors

     The following information sets forth factors that could cause our actual results to differ materially from those contained in forward-looking statements we have made in this quarterly report and those we may make from time to time. For a more detailed discussion of the factors that could cause actual results to differ, see the Risk Factors section in our annual report filed on form 10-K with the SEC on March 29, 2005, pursuant to sections 13 or 15(d) of the Securities Exchange Act of 1934 as amended, or the Exchange Act.

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Risks Related to Our Business

We have limited experience in an emerging market with unproven business and technology models, which makes it difficult to evaluate our current business performance and future prospects.

     Although we were formed in September 1996, we did not begin selling our services for a fee until August 1999. Prior to that, we provided a basic Internet user behavior information and analysis service solely in exchange for online advertising space that we used or sold. Our revenue from advertising have been steadily declining due to our decision in 2001 to stop providing our free web analytics service that generated advertising revenue and in December 2003, we stopped providing services in exchange for advertising. As a result, we have limited experience in the subscription web analytics business, and we must sell increasing amounts of services in the future to new customers, while retaining our current customers, in order to grow our business. Many risks and uncertainties are inherent in our business, including securing new customers, attracting and retaining qualified personnel, expanding our operations and developing and upgrading our technology and services. These risks and uncertainties are particularly significant for companies such as ours that operate in rapidly evolving markets for Internet products and services. If businesses are not willing to buy our services, then our revenue will not grow and our operating results will suffer, which may cause our stock price to decline.

Our web analytics services comprise a majority of our revenue, and our business will be harmed if these services do not achieve widespread customer acceptance.

     In late 1999, we introduced the predecessors of our HBX and HitBox Professional services. Since that time, we have made significant changes to these services, including the release of HBX in April 2004. These services and related support represented 100% and 99% of our total revenue for the three months ended March 31, 2005 and 2004, respectively. These new subscription services may not be able to continue to generate or to grow revenue. In addition, our target customers, which are generally medium and large businesses, may have concerns regarding our viability and may prefer to purchase services from one of our larger, more established competitors.

We have only recently become profitable and may not maintain our level of profitability.

     Although we have generated net income for the three months ended December 31, 2003, the twelve months ended December 31, 2004 and the three months ended March 31, 2005, we have not historically been profitable and were not profitable for the year ended December 31, 2003, and we may not be profitable in future periods. We expect that our expenses relating to the sales of our services, technology improvements and general and administrative functions, as well as the costs of operating and maintaining our network, will increase in the future. We may not be able to reduce or maintain our expenses in response to any decrease in our revenue, and our failure to do so would adversely affect our operating results and our level of profitability.

We operate in highly competitive markets, which could make it difficult for us to acquire and retain customers.

     The market for web analytics is rapidly evolving and highly competitive. We expect competition to increase from existing competitors as well as new market entrants. We compete primarily with other application service providers and software vendors on the basis of product functionality, price, timeliness and level of service. Should our competitors consolidate, or if our smaller competitors are acquired by other, larger competitors, they may be able to provide services comparable to ours at a lower price due to their size. We also compete with companies that offer web analytics software bundled with other products or services, which may result in such companies effectively selling these services at prices below the market. Our current principal competitors include:

	•	web analytics application service providers such as Coremetrics, Nedstat and Omniture;
	•	software vendors such as WebTrends and SPSS; and
	•	digital marketing and e-commerce service providers such as aQuantive and Digital River that incorporate web analytics in their services.

     In addition, we face competition from companies that independently develop methods of measuring their own audience. Many companies, including some of our largest potential customers, use internally-developed web analytics software rather than the commercial services or software offered by us or our competitors. These companies may seek to offer their internally-developed software commercially in the future, which would bring us into direct competition with their products. To date, no web analytics service has been adopted as the industry standard for measuring Internet user behavior and preferences. However, if one of our current

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or future competitors is successful in establishing its products and services as the industry standard, it will be difficult for us to retain current customers, or attract additional customers for our services.

     Furthermore, some businesses may require data or reports that are available only in competitors’ products, and potential customers may, therefore, select the products of our competitors. Many of our current and potential competitors have longer operating histories, greater name recognition, access to larger client bases, and substantially greater resources, including sales and marketing, financial, support and other resources than we have. As a result, these competitors may be able to devote more resources to new customer acquisitions or may be able to respond to evolving market needs more quickly than we can. If we are not able to compete successfully against our current and future competitors, it will be difficult to acquire and retain customers, and we may experience limited revenue growth, reduced operating margins, loss of market share and diminished value in our services.

Most of our services are sold pursuant to short-term subscription agreements, and if our customers elect not to renew these agreements, our revenue may decrease.

     Typically, our HBX services are sold pursuant to short-term subscription agreements, which are generally one to three years in length with no obligation to renew these agreements. In addition, our HitBox Professional services are usually cancelable any time with little or no penalty. Many of our customers are new, which makes it difficult for us to predict if they will renew their agreements. Many of our HBX subscription agreements will be subject to renewal in the next 12 months, and we cannot assure you that such agreements will be renewed. Our renewal rates may decline due to a variety of factors, including the services and prices offered by our competitors, consolidation in our customer base or if some of our customers cease their operations. If our renewal rates are low or decline for any reason, or if customers renew on less favorable terms, our revenue may decrease, which could adversely affect our stock price.

If we fail to respond to rapidly changing technology or evolving industry standards, our services may become obsolete or less competitive.

     The market for our services is characterized by rapid technological advances, changes in client requirements, changes in protocols and evolving industry standards. If we are unable to develop enhancements to and new features for our existing services or acceptable new services that keep pace with rapid technological developments, our services may become obsolete, less marketable and less competitive and our business will be harmed. The success of any enhancements, new features and services depends on several factors, including the timely completion, introduction and market acceptance of the feature or edition. Failure to produce acceptable new features and enhancements may significantly impair our revenue growth and reputation.

We may be liable to our customers and may lose customers if we provide poor service, if our services do not comply with our agreements or if there is a loss of data.

     The information in our databases may not be complete or may contain inaccuracies that our customers regard as significant. Our ability to collect and report data may be interrupted by a number of factors, including our inability to access the Internet or the failure of our network or software systems. In addition, computer viruses may harm our systems causing us to lose data, and the transmission of computer viruses could expose us to litigation. Our subscription agreements generally give our customers the right to terminate their agreements for cause if we fail to meet certain reliability standards stated in the agreements or if we otherwise materially breach our obligations. Any failures in the services that we supply or the loss of any of our customers’ data may give our customers the right to terminate their agreements with us and could subject us to liability. We may also be required to spend substantial amounts to defend lawsuits and pay any resulting damage awards. We may be liable to our customers for loss of business, loss of future revenue, breach of contract or even for the loss of goodwill to their business. In addition to potential liability, if we supply inaccurate information or experience interruptions in our ability to supply information, our reputation could be harmed and we could lose customers.

     Although we have errors and omissions insurance with coverage limits of up to $2 million, this coverage may be inadequate or may not be available in the future on acceptable terms, or at all. In addition, we cannot assure you that this policy will cover any claim against us for loss of data or other indirect or consequential damages and defending a suit, regardless of its merit, could be costly and divert management’s attention.

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If we cannot successfully integrate our business with that of Avivo, or if the benefits of the merger with Avivo does not meet the expectations of investors or financial or industry analysts, the market price of our common stock may decline.

We completed the acquisition of Avivo on May 4, 2005. The market price of our common stock may decline as a result of our acquisition of Avivo for a variety of reasons, including, among others, the following:

•	the integration of our business with that of Avivo is not completed in a timely and efficient manner;
•	the combined company does not achieve the benefits of the merger as rapidly as, or to the extent, anticipated by financial or industry analysts; and/or
•	significant numbers of stockholders of the combined company dispose of their shares after the merger.

     As a result, there can be no assurance that we will realize the anticipated benefits of the merger.

We may expand through acquisitions of, or investments in, other companies or through business relationships, all of which may divert our management’s attention, resulting in additional dilution to our stockholders and consumption of resources that are necessary to sustain our business.

     One of our business strategies is to acquire competing or complementary services, technologies or businesses. We also may enter into relationships with other businesses in order to expand our service offerings, which could involve preferred or exclusive licenses, additional channels of distribution or discount pricing or investments in other companies.

     An acquisition, investment or business relationship may result in unforeseen operating difficulties and expenditures. In particular, we may encounter difficulties assimilating or integrating the acquired businesses, technologies, products, personnel or operations of the acquired companies, particularly if the key personnel of the acquired company choose not to work for us, and we may have difficulty retaining the customers of any acquired business due to changes in management and ownership. Acquisitions may also disrupt our ongoing business, divert our resources and require significant management attention that would otherwise be available for ongoing development of our business. Moreover, we cannot assure you that the anticipated benefits of any acquisition, investment or business relationship would be realized or that we would not be exposed to unknown liabilities. In connection with one or more of those transactions, we may:

	•	issue additional equity securities that would dilute our stockholders;
	•	use cash that we may need in the future to operate our business;
	•	incur debt on terms unfavorable to us or that we are unable to repay;
	•	incur large charges or substantial liabilities;
	•	encounter difficulties retaining key employees of the acquired company or integrating diverse business cultures; and
	•	become subject to adverse tax consequences, substantial depreciation or deferred compensation charges.

     We periodically engage in preliminary discussions relating to acquisitions, but we are not currently a party to any acquisition agreement other than our agreement and plan of merger to acquire Avivo Corporation, which merger was recently completed.

Any efforts we may make in the future to expand our services beyond the web analytics market may not succeed.

     Although we have historically focused on the web analytics market, we plan to expand our service offerings to address the demand for other digital marketing services. Any efforts to expand our services beyond the web analytics market may not result in significant revenue growth for us. In addition, our efforts to expand may divert management resources from our existing operations and require us to commit significant resources to an unproven business, limiting the financial and other resources that we are able to devote to our existing business. For example, our acquisition of Avivo Corporation may divert management resources and financial and other resources from our existing business and may not result in the revenue growth we anticipate from the acquisition.

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Because we recognize revenue from subscriptions to our services over the term of the applicable agreement, the lack of subscription renewals or new subscription agreements may not be immediately reflected in our operating results.

     We recognize revenue from our customers monthly over the term of their agreements with us. The majority of our quarterly revenue usually represents deferred revenue from subscription agreements entered into during previous quarters. As a result, a decline in new or renewed subscription agreements in any one quarter will not necessarily be fully reflected in the revenue for the corresponding quarter but will negatively affect our revenue in future quarters. Additionally, the effect of significant downturns in sales and market acceptance of our services may not be fully reflected in our results of operations until future periods. Our business model would also make it difficult for us to reflect any rapid increase in our customer base and the effect of this increase in our revenue in any one period because revenue from new customers must be recognized over the applicable subscription agreement term.

Fluctuations in our operating results may make it difficult to predict our future performance and may result in volatility in the market price of our common stock.

     Due to our limited experience selling our services, our evolving business model and the unpredictability of our emerging industry, we may not be able to accurately forecast our rate of growth. In addition, we may experience significant fluctuations in our operating results for other reasons such as:

	•	our ability to retain and increase sales to existing customers, attract new customers and satisfy our customers’ requirements;
	•	the timing and success of new product introductions or upgrades by us or our competitors;
	•	changes in our pricing policies or payment terms or those of our competitors;
	•	concerns relating to the security of our network and systems;
	•	the rate of success of our domestic and international expansion;
	•	our ability to hire and retain key executives and technical and sales and marketing personnel;
	•	our ability to expand our operations and the amount and timing of expenditures related to this expansion;
	•	limitations in the bandwidth of our network and systems;
	•	costs related to the development or acquisition of technologies, products or businesses; and
	•	general economic, industry and market conditions.

     These factors tend to make the timing and amount of revenue unpredictable and may lead to greater period-to-period fluctuations in revenue than we have experienced historically.

     As a result of the factors described above, we believe that our quarterly revenue and results of operations are likely to vary significantly in the future and that period-to-period comparisons of our operating results may not be meaningful. You should not rely on the results of one quarter as an indication of future performance. If our quarterly revenue or results of operations fall below the expectations of investors, the price of our common stock could decline substantially.

We rely on a small number of third parties to support our network, any disruption of which could affect our ability to provide our services and could harm our reputation.

     Our network is susceptible to outages due to fires, floods, power loss, telecommunications failures, systems failures, break-ins and similar events. We have experienced some outages due to power loss, systems failure and telecommunications failure. In addition, our network infrastructure is located in San Diego, California, an area susceptible to earthquakes and rolling electricity black-outs. We do not have multiple operating sites for our services in the event of any such occurrence. Our servers are vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems. Frequent or persistent disruptions of our services could cause us to suffer losses that are impossible to quantify at this time such as claims by customers for indirect or consequential damages, loss of market share and damages to our reputation. Our business interruption insurance may not compensate us for every kind of loss resulting from disruptions of our services, and even if the type of loss is covered, the amount incurred may exceed the loss limitations in our insurance policies.

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     All of our customers’ data and our servers are located at a single, third party co-location facility located in San Diego, California, operated by Level 3 Communications, Inc. Our agreement with Level 3 expires on May 31, 2005. Level 3 has the right to discontinue our service if, within 30 days of providing written notice to us, we fail to cure any of the following: (a) our failure to pay any amounts past due within three business days of written notice; (b) our violation of any laws related to our service; (c) a material misrepresentation by us related to our service; (d) our filing for bankruptcy or reorganization, or our failure to discharge any involuntary petition for bankruptcy within 60 days; or (e) our use of the service that materially exceeds our credit limit, and our failure to give adequate security for payment of the additional use within one day of receipt of written notice from Level 3.

     We depend on access to the Internet through Internet service providers, or ISPs, to operate our business. If we lose the services of one or more of our ISPs for any reason, we could experience disruption in our service offerings. The loss of one of our ISPs as the result of consolidation in the ISP industry could delay us from retaining the services of a replacement ISP and increase the potential for disruption of our business. Any disruption to our business could damage our reputation and result in a decrease in our revenue from the loss of current or potential customers.

A rapid expansion of our network and systems could cause us to lose Internet user behavior measurement information or cause our network or systems to fail.

     In the future, we may need to expand our network and systems at a more rapid pace than we have in the past. We may suddenly require additional bandwidth for which we have not adequately planned. We may secure an extremely large customer or a group of customers with extraordinary volumes of information to collect and process that would require significant system resources, and our systems may be unable to process the information. Our network or systems may not be capable of meeting the demand for increased capacity, or we may incur additional unanticipated expenses to accommodate such capacity constraints. In addition, we may lose valuable Internet user data or our network may temporarily shut down if we fail to expand our network to meet future requirements. Any lapse in our ability to collect Internet user information will decrease the value of our existing data as well as prevent us from providing the complete data requested by our customers. Any disruption in our network processing or loss of Internet user data may damage our reputation and result in the loss of customers.

If our security measures are breached and unauthorized access is obtained, our services may be perceived as not being secure, and customers may hold us liable or reduce their use of our services.

     Our services involve the storage and transmission of proprietary information, and security breaches could expose us to a risk of loss of this information, litigation and possible liability. If our security measures are breached as a result of third-party action, employee error or otherwise, and as a result, someone obtains unauthorized access to our data or our customers’ data, we could incur liability and our reputation will be damaged. For example, hackers or individuals who attempt to breach our network security could, if successful, misappropriate proprietary information or cause interruptions in our services. If we experience any breaches of our network security or sabotage, we might be required to expend significant capital and resources to protect against or to alleviate problems. We may not be able to remedy any problems caused by hackers or saboteurs in a timely manner, or at all. Because techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. If an actual or perceived breach of our security occurs, the perception of the effectiveness of our security measures could be harmed and we could lose current and potential customers.

The success of our business depends in large part on our ability to protect and enforce our intellectual property rights.

     We regard the protection of our inventions, patent, copyrights, service marks, trademarks and trade secrets as important to our future success. We rely on a combination of patent, copyright, service mark, trademark, and trade secret laws and contractual restrictions to establish and protect our proprietary rights, all of which only offer limited protection. We endeavor to enter into agreements with our employees and contractors and agreements with parties with whom we do business in order to limit access to and disclosure of our proprietary information. Despite our efforts, the steps we have taken to protect our intellectual property may not prevent the misappropriation of proprietary rights or the reverse engineering of our technology. Moreover, others may independently develop technologies that are competitive to ours or infringe our intellectual property. The enforcement of our intellectual property rights also depends on our legal actions against such infringers being successful, but we cannot be sure such actions will be successful, even when our rights have been infringed.

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     Although we do have two U.S. patents, several registered service marks, and pending patent and service mark applications, we cannot assure you that any future patents or service mark registrations will be issued with respect to pending or future applications or that any issued patents or registered service marks will be enforceable or provide adequate protection of our proprietary rights.

     Because of the global nature of the Internet, our websites can be viewed worldwide, but we do not have intellectual property protection in every jurisdiction. Furthermore, effective patent, trademark, service mark, copyright and trade secret protection may not be available in every country in which our services are available over the Internet. In addition, the legal standards relating to the validity, enforceability and scope of protection of intellectual property rights in Internet-related industries are uncertain and still evolving.

If a third party asserts that we are infringing its intellectual property, whether successful or not, it could subject us to costly and time-consuming litigation or expensive licenses, and our business may be harmed.

     The software and Internet industries are characterized by the existence of a large number of patents, trademarks and copyrights and by frequent litigation based on allegations of infringement or other violations of intellectual property rights. Third parties may assert patent and other intellectual property infringement claims against us in the form of lawsuits, letters or other forms of communication. If a third party successfully asserts a claim that we are infringing their proprietary rights, royalty or licensing agreements might not be available on terms we find acceptable or at all. As currently pending patent applications are not publicly available, we cannot anticipate all such claims or know with certainty whether our technology infringes the intellectual property rights of third parties. We expect that the number of infringement claims in our market will increase as the number of services and competitors in our industry grows. These claims, whether or not successful, could:

	•	divert management’s attention;
	•	result in costly and time-consuming litigation;
	•	require us to enter into royalty or licensing agreements, which may not be available on acceptable terms, or at all; or
	•	require us to redesign our software and services to avoid infringement.

     As a result, any third-party intellectual property claims against us could increase our expenses and adversely affect our business. In addition, many of our subscription agreements require us to indemnify our customers for third-party intellectual property infringement claims, which would increase the cost to us resulting from an adverse ruling in any such claim. Even if we have not infringed any third parties’ intellectual property rights, we cannot be sure our legal defenses will be successful, and even if we are successful in defending against such claims, our legal defense could require significant financial resources and management’s time.

Any failure to adequately expand our direct sales force will impede our growth.

     We expect to be substantially dependent on our direct sales force to obtain new customers, particularly large enterprise customers, and to manage our customer relationships. We believe that there is significant competition for direct sales personnel with the advanced sales skills and technical knowledge we need. Our ability to achieve significant growth in revenue in the future will depend, in large part, on our success in recruiting, training and retaining sufficient direct sales personnel. New hires require significant training and may, in some cases, take more than a year before they achieve full productivity. Our recent hires and planned hires may not become as productive as we would like, and we may be unable to hire sufficient numbers of qualified individuals in the future in the markets where we do business. If we are unable to hire and develop sufficient numbers of productive sales personnel, sales of our service will suffer.

If we fail to develop our brand cost-effectively, our business may suffer.

     We believe that developing and maintaining awareness of the WebSideStory brand in a cost-effective manner is critical to achieving widespread acceptance of our current and future services and is an important element in attracting new customers. Furthermore, we believe that the importance of brand recognition will increase as competition in our market develops. Successful promotion of our brand will depend largely on the effectiveness of our marketing efforts and on our ability to provide reliable and useful services at competitive prices. Brand promotion activities may not yield increased revenue, and even if they do, any increased revenue may not offset the expenses we incur in building our brand. If we fail to successfully promote and maintain our brand, or incur substantial expenses in an unsuccessful attempt to promote and maintain our brand, we may fail to attract enough new customers

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or retain our existing customers to the extent necessary to realize a sufficient return on our brand-building efforts, and our business and results of operations could suffer.

We rely on a relatively new management team and need additional personnel to grow our business.

     Several of our executive officers are relatively new, and we intend to continue to hire key management personnel. Our success and future growth depends to a significant degree on the skills and continued services of Jeffrey W. Lunsford, our president, chief executive officer and chairman, who was hired in April 2003. We may experience difficulty assimilating our recently hired managers, and we may not be able to successfully locate, hire, assimilate and retain other qualified key management personnel.

     We have employment agreements with our executive officers; however, under these agreements, our employment relationships with our executive officers are “at-will” and they can terminate their employment relationship with us at any time. We do not maintain key person life insurance on any members of our management team.

     Our future success also depends on our ability to attract, retain and motivate highly skilled technical, managerial, marketing and customer service personnel. We plan to hire additional personnel in all areas of our business, in particular for our sales, marketing and technology development areas, both domestically and internationally. Competition for these types of personnel is intense, particularly in the Internet industry. As a result, we may be unable to successfully attract or retain qualified personnel. Our inability to retain and attract the necessary personnel could adversely affect our business.

We may encounter difficulties managing our growth, which could adversely affect our results of operations.

     We will need to expand and effectively manage our organization, operations and facilities in order to successfully sell our services and maintain our recent profitability. We increased the number of our full-time employees from 17 as of January 1, 1998 to 141 as of March 31, 2005, and we expect to continue to grow to meet our strategic objectives. If we continue to grow, it is possible that our management, systems and facilities currently in place may not be adequate. Our need to effectively manage our operations and growth requires that we continue to improve our operational, financial and management controls, reporting systems and procedures. We may not be able to successfully implement these tasks on a large scale and, accordingly, may not achieve our strategic objectives.

Our business strategy includes expanding our international operations; therefore, our business is susceptible to risks associated with international operations.

     We currently maintain a sales office in the Netherlands and currently have sales personnel or independent sales consultants in Australia, Canada, France, Germany, Singapore, Sweden and the United Kingdom. We have limited experience operating in these foreign jurisdictions and no experience operating in other foreign markets into which we may expand in the future. Conducting international operations subjects us to new risks that we have not generally faced in the United States. These include:

	•	political, social and economic instability abroad, including the conflicts in the Middle East, terrorist attacks and security concerns in general;
	•	localization of our service, including translation into foreign languages and associated expenses;
	•	fluctuations in currency exchange rates;
	•	unexpected changes in foreign regulatory requirements;
	•	longer accounts receivable payment cycles and difficulties in collecting accounts receivable;
	•	difficulties in managing and staffing international operations;
	•	potentially adverse tax consequences, including the complexities of foreign value added tax systems and restrictions on the repatriation of earnings;
	•	maintaining and servicing computer hardware in distant locations;
	•	the burdens of complying with a wide variety of foreign laws and different legal standards; and

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

     The occurrence of any one of these risks could negatively affect our international business and, consequently, our results of operations generally. In addition, the Internet may not be used as widely in international markets in which we expand our international operations and, as a result, we may not be successful in offering our services there.

     Some of our international subscription fees are currently denominated in U.S. dollars and paid in local currency. As a result, fluctuations in the value of the U.S. dollar and foreign currencies may make our services more expensive for international customers, which could harm our business.

Changes in financial accounting standards or practices or existing taxation rules or practices may cause adverse, unexpected financial reporting fluctuations and affect our reported results of operations.

     A change in accounting standards or practices or a change in existing taxation rules or practices can have a significant effect on our reported results and may even affect our reporting of transactions completed before the change is effective. New accounting pronouncements and taxation rules and varying interpretations of accounting pronouncements and taxation practice have occurred and may occur in the future. Changes to existing rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business. For example, in December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123R, Share-Based Payment (“SFAS No. 123R”). This statement is a revision of SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”). SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. Such stock option expensing will require us to change our accounting policy. We currently account for stock-based awards to employees in accordance with APB No. 25, Accounting for Stock Issued to Employees. Under our current accounting policy, we record stock-based compensation based on the difference between the exercise price of the stock option and the fair market value at the time of grant. To arrive at the fair value for each option grant, SFAS No. 123R requires the use of an option pricing model to evaluate our stock by factoring in additional variables such as expected life of the option, risk-free interest rate, expected volatility of the stock and expected dividend yield. Subsequently, in May 2005, the SEC approved the rule delaying the effective date of SFAS No. 123R to the annual period beginning after June 15, 2005. SFAS No. 123R will be effective for us for the quarter ended March 31, 2006. We are evaluating the effect this rule will have on our condensed consolidated financial statements and our future results.

Our net operating loss and tax credit carryforwards may expire unutilized, which could prevent us from offsetting future taxable income.

     We believe that a change of control occurred in connection with our October 2004 initial public offering and that will cause the limitation of Section 382 of the Internal Revenue Code of 1986, as amended. Furthermore, sales of our convertible redeemable preferred stock in 1999, 2000 and 2001 may be deemed a change of control that could cause the limitation of Section 382 to be applicable. This limitation would allow us to use only a portion of the net operating loss and tax credit carryforwards generated prior to the deemed Section 382 change of control to offset future taxable income, if any, for United States and state income tax purposes. However, based on the annual limitation available and projected taxable income, it is not expected that the change in ownership will impact our cash tax payments. As of December 31, 2004, we have federal net operating loss carryforwards of approximately $12.8 million and state net operating loss carryforwards of approximately $5.9 million. Federal net operating losses generally carry forward for 20 years from the year generated. The expiration dates for net operating losses vary among states. Most of our state net operating losses are in California, and these net operating losses will begin to expire in 2006. As of December 31, 2004, we have federal research and development tax credits of $166,000 and California research and development tax credits of $107,000. Federal research and development tax credits have a 20-year carry forward period and begin to expire in 2016. California research and development tax credits have no expiration.

Risks Related to Our Industry

Widespread blocking or erasing of cookies or limitations on our ability to use cookies may impede our ability to collect information with our technology and reduce the value of that data.

     Our technology currently uses cookies, which are small files of information placed on an Internet user’s computer, to collect information about the user’s visits to the websites of our customers. Third-party software and our own technology make it easy for users to block or delete our cookies. Several software programs, sometimes marketed as ad-ware or spyware detectors, block our

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cookies by default or prompt users to delete or block our cookies. If a large proportion, such as a majority, of users delete or block our cookies, this could significantly undermine the value of the data that we collect for our customers and could negatively impact our ability to deliver accurate reports to our customers, which would harm our business.

     Changes in web browsers may also encourage users to block our cookies. Microsoft, for example, frequently modifies its Internet Explorer web browser. Some modifications by Microsoft could substantially impair our ability to use cookies for data collection purposes. If that happens and we are unable to adapt our technology and practices adequately in response to changes in Microsoft’s technology, then the value of our services will be substantially impaired. Additionally, other technologies could be developed that impede the operation of our services. These developments could prevent us from providing our services to our customers or reduce the value of our services.

     In addition, laws regulating the use of cookies by us and our customers could also prevent us from providing our services to our customers or require us to employ alternative technology. A European Union Directive currently being implemented by member countries requires us to tell users about cookies placed on their computers, describe how we and our customers will use the information collected and offer users the right to refuse a cookie. Although no European country currently requires consent prior to delivery of a cookie, one or more European countries may do so in the future. If we were required to obtain consent before delivering a cookie or if the use or effectiveness of cookies is limited, we would be required to switch to alternative technologies to collect user profile information, which may not be done on a timely basis, at a reasonable cost, or at all.

     Currently, the only alternative to using cookies to identify a browser and its browsing session is the use of an Internet protocol, or IP, address. The IP address is an identifier that each computer or other device connected to the Internet has. However, for purposes of web analytics, IP addresses are not as reliable as cookies, because they are often re-assigned by Internet service providers. We do not believe that a better alternative to using cookies currently exists. Creating replacement technology for cookies could require us to expend significant time and resources. We may be unable to complete this alternative technology development in time to avoid negative consequences to our business, and the replacement methods we develop may not be commercially feasible. The replacement of cookies might also reduce our existing customer base by requiring current customers to take specific action to accommodate new technology.

Privacy concerns and laws or other domestic or foreign regulations may subject us to litigation or limit our ability to collect and use Internet user information, resulting in a decrease in the value of our services and an adverse impact on the sales of our services.

     We collect, use and distribute information derived from the activities of Internet users. Federal, state and foreign government bodies and agencies have adopted or are considering adopting laws regarding the collection, use and disclosure of personal information obtained from consumers. The costs of compliance with, and the other burdens imposed by, such laws may limit the adoption of our services. In addition, some companies have been the subject of class-action lawsuits and governmental investigations based on their collection, use and distribution of Internet user information without the consent of the Internet users. For example, the Federal Trade Commission, or FTC, investigates companies’ compliance with their own stated privacy policies. These investigations have covered such activities as the sale of personally identifiable information to third parties and the proposed merger of online anonymous profile information with personally identifiable information obtained from off-line sources. While we are not aware of any FTC investigation regarding any practices we currently employ, in the future, the FTC may investigate the practices we employ. Governmental entities and private persons or entities may assert that our methods of collecting, using and distributing Internet user information are illegal or improper. Any such legal action, even if unsuccessful, may distract our management’s attention, divert our resources, negatively affect our public image and harm our business.

     Both existing and proposed laws regulate and restrict the collection and use of information over the Internet that personally identifies the Internet user. These laws continue to change and vary among domestic and foreign jurisdictions, but certain information such as names, addresses, telephone numbers, credit card numbers and email addresses are widely considered personally identifying. The scope of information collected over the Internet that is considered personally identifying may become more expansive, and it is possible that current and future legislation may apply to information that we currently collect without the explicit consent of Internet users. If information that we collect and use without consent is considered to be personally identifying, our ability to collect and use this information will be restricted and we will have to change our methods.

     Recently, the legislatures of several states including Utah, California, Arizona, Virginia, and Arkansas enacted legislation designed to protect Internet users’ privacy by prohibiting certain kinds of downloadable software defined as “spyware.” Similar legislation has been proposed in several other states and in the U.S. House of Representatives. Such legislation, if it includes a broad definition of

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“spyware,” could restrict our information collection methods. Any restriction or change to our information collection methods would cause us to spend substantial money and time to make such changes and could decrease the amount and utility of the information that we collect.

     In addition, domestic and foreign governments are considering restricting the collection and use of Internet usage data. Some privacy advocates argue that even anonymous data, individually or when aggregated, may reveal too much information about Internet users. If governmental authorities were to follow privacy advocates’ recommendations and enact laws that limit our online profiling practices, we would likely have to obtain the express consent, or opt-in, of an Internet user before we could collect, share, or use any of that user’s information. It might not be possible to comply with all domestic and foreign governmental restrictions simultaneously. Any change to an opt-in system of profiling would damage our ability to aggregate and utilize the information we currently collect from Internet users and would reduce the amount and value of the information that we provide to customers. A reduction in the value of our information might cause some existing customers to discontinue their use of our services or discourage potential customers from subscribing to our services, which would reduce our revenue. We would also need to expend considerable effort and resources, both human and financial, to develop new information collection procedures to comply with an opt-in requirement. Even if we succeeded in developing new procedures, we might be unable to convince Internet users to agree to our collection and use of their information. This would negatively impact our revenue, growth and potential for expanding our business and could cause our stock price to decline.

The success of our business depends on the continued growth of the Internet as a business tool and the growth of the web analytics market.

     Expansion in the sales of our service depends on the continued acceptance of the Internet as a communications and commerce platform for enterprises. The use of the Internet as a business tool could be adversely impacted by delays in the development or adoption of new standards and protocols to handle increased demands of Internet activity, security, reliability, cost, ease-of-use, accessibility and quality-of-service. The performance of the Internet and its acceptance as a business tool has been harmed by viruses, worms, and similar malicious programs, and the Internet has experienced a variety of outages and other delays as a result of damage to portions of its infrastructure. If for any reason the Internet does not remain a widespread communications medium and commercial platform and business processes do not continue to move online, the demand for our service would be significantly reduced, which would harm our business.

     In addition, the market for Internet user measurement and analysis services is new and rapidly evolving. In particular, the market for outsourced, on-demand information services such as ours is relatively new and evolving. We will not be able to sell our services or grow our business if the market for Internet user measurement and analysis services does not grow or is not outsourced, or if on-demand services are not widely adopted.

Risks Related to the Securities Market and the Ownership of Our Common Stock

Our stock price may be volatile and you may not be able to sell your shares at an attractive price.

     Our common stock had not been publicly traded prior to our initial public offering, which was completed in October 2004, and an active trading market may be difficult to sustain. We have not paid cash dividends since our inception and do not intend to pay cash dividends in the foreseeable future. Therefore, investors will have to rely on appreciation in our stock price and a liquid trading market in order to achieve a gain on their investment. The market prices for securities of technology companies in general have been highly volatile and may continue to be highly volatile in the future. The trading price of our common stock may fluctuate substantially as a result of one or more of the following factors:

	•	variations in our operating results;
	•	announcements of technological innovations, new services or service enhancements or significant agreements by us or by our competitors;
	•	recruitment or departure of key personnel;
	•	changes in the estimates of our operating results or changes in recommendations by any securities analysts that elect to follow our common stock;

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	•	sales of our common stock, including sales by officers, directors and funds affiliated with them;
	•	fluctuations in stock market prices and trading volumes of similar companies or of the markets generally;
	•	market conditions in our industry, the industries of our customers and the economy as a whole; or
	•	economic and political factors, including wars, terrorism and political unrest.

We might require additional capital to support business growth, and this capital might not be available on acceptable terms, or at all.

     We intend to continue to make investments to support our business growth and may require additional funds to respond to business challenges, including the need to develop new services or enhance our existing service, enhance our operating infrastructure and acquire competing or complementary businesses and technologies. Accordingly, we may need to engage in equity or debt financings to secure additional funds. If we raise additional funds through further issuances of equity or convertible debt securities, our existing stockholders could suffer significant dilution, and any new equity securities we issue could have rights, preferences and privileges superior to those of holders of our common stock. Any debt financing secured by us in the future could involve restrictive covenants relating to our capital raising activities and other financial and operational matters, which may make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions. In addition, we may not be able to obtain additional financing on terms favorable to us, if at all. If we are unable to obtain adequate financing or financing on terms satisfactory to us, when we require it, our ability to continue to support our business growth and to respond to business challenges could be significantly limited.

There may be an adverse effect on the market price of our stock as a result of shares being available for sale in the future.

     Sales by our current stockholders of a substantial number of shares could significantly reduce the market price of our common stock. Moreover, the holders of a substantial number of shares of common stock will have rights, subject to some conditions, to require us to file registration statements covering their shares or to include their shares in registration statements that we may file ourselves or for other stockholders. We also registered the shares of our common stock that are subject to outstanding stock options or reserved for issuance under our stock option plans. These shares can be freely sold in the public market upon issuance.

     If any of our stockholders cause a large number of securities to be sold in the public market, the sales could reduce the trading price of our common stock. These sales also could impede our ability to raise future capital.

Our executive officers and directors have control over our affairs.

     As of March 31, 2005, our executive officers and directors and entities affiliated with them beneficially own, in the aggregate, approximately 52.1% of our common stock, including options or warrants that are exercisable within 60 days from March 31, 2005. As a group they will be able to control our business. These stockholders will have the ability to exert substantial influence over all matters requiring approval by our stockholders, including the election and removal of directors and any merger, consolidation or sale of all or substantially all of our assets. This concentration of ownership could have the effect of delaying, deferring or preventing a change of control or impeding a merger or consolidation, takeover or other business combination.

Provisions in our amended and restated certificate of incorporation and bylaws or under Delaware law might discourage, delay or prevent a change of control of our company or changes in our management and, therefore, depress the trading price of our common stock.

     Our amended and restated certificate of incorporation and bylaws contain provisions that could depress the trading price of our common stock by acting to discourage, delay or prevent a change of control of our company or changes in our management that the stockholders of our company may deem advantageous. These provisions:

	•	establish a classified board of directors so that not all members of our board are elected at one time;
	•	provide that directors may only be removed “for cause” and only with the approval of 66 2/3% of our stockholders;
	•	require super-majority voting to amend some provisions in our amended and restated certificate of incorporation and bylaws;

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	•	authorize the issuance of “blank check” preferred stock that our board of directors could issue to increase the number of outstanding shares to discourage a takeover attempt;
	•	prohibit stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of our stockholders;
	•	provide that the board of directors is expressly authorized to make, alter or repeal our bylaws; and
	•	establish advance notice requirements for nominations for elections to our board or for proposing matters that can be acted upon by stockholders at stockholder meetings.

     Additionally, we are subject to Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any “interested” stockholder for a period of three years following the date on which the stockholder became an “interested” stockholder and which may discourage, delay or prevent a change of control of our company.

We will incur increased costs as a result of being a public company.

     As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act of 2002, as well as new rules implemented by the Securities and Exchange Commission and the Nasdaq National Market, requires changes in corporate governance practices of public companies. We expect these new rules and regulations to significantly increase our legal and financial compliance costs and to make some activities more time-consuming and costly. We will also incur additional costs associated with our public company reporting requirements. We also expect these new rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified people to serve on our board of directors or as executive officers. We are currently evaluating and monitoring developments with respect to these new rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs..

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Foreign Currency Exchange Risk

     Our results of operations and cash flows are subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the Euro. We will analyze our exposure to currency fluctuations and may engage in financial hedging techniques in the future to reduce the effect of these potential fluctuations. We have not entered into any hedging contracts since exchange rate fluctuations have had little impact on our operating results and cash flows. The majority of our subscription agreements are denominated in U.S. dollars. To date, our foreign revenue have been primarily in Euros. Revenue from our customers domiciled outside the United States were approximately 19% and 16% of our total revenue in the year ended December 31, 2004 and in the three months ended March 31, 2005, respectively.

Interest Rate Sensitivity

     We had unrestricted cash, cash equivalents and short and long-term marketable securities totaling $30.7 million and $31.6 million at December 31, 2004 and March 31, 2005, respectively. These amounts were invested primarily in money market funds. The unrestricted cash, cash equivalents and short-term marketable securities are held for working capital purposes. We do not enter into investments for trading or speculative purposes. Due to the short-term nature of these investments, we believe that we do not have any material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates. Declines in interest rates, however, will reduce future investment income.

Item 4. Controls and Procedures

     We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including

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our chief executive officer and chief financial officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

     As required by Securities and Exchange Commission Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the quarter covered by this report. Based on the foregoing, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

     There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

     Section 404 of the Sarbanes-Oxley Act requires company management to assess and report on our internal controls. It also requires a company’s independent, outside auditors to issue an “attestation” to management’s assessment, as well as assess the proper design and function of internal controls. We anticipate being required to comply with this requirement for the first time as of December 31, 2005. We expect to comply with the reporting disclosure requirements of Section 404 by our year ending December 31, 2005.

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PART II — OTHER INFORMATION

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

Use of Proceeds

     Our initial public offering of common stock was effected through a Registration Statement on Form S-1 (File Nos. 333-119516 and 333-119322) that was declared effective by the Securities and Exchange Commission on September 27, 2004. On October 1, 2004, 5,000,000 shares of common stock were sold on our behalf at an initial public offering price of $8.50 per share for an aggregate offering price of $42.5 million. Friedman, Billings, Ramsey & Co., Inc., RBC Capital Markets Corporation, William Blair & Company, L.L.C. and Roth Capital Partners LLC managed the offering. On October 26, 2004, in connection with the full exercise of the underwriters’ over-allotment option, 750,000 additional shares of common stock were sold on behalf of certain of our stockholders at the initial public offering price of $8.50 per share for an aggregate offering price of approximately $6.4 million. We did not receive any proceeds from the sale of these additional shares. Following the sale of the 5,750,000 shares, the offering terminated.

     We paid to the underwriters underwriting discounts and commissions totaling approximately $3.0 million in connection with the offering. In addition, we estimate that we incurred additional expenses of approximately $1.4 million in connection with the offering, which when added to the underwriting discounts and commissions paid by us, amounts to total estimated expenses of approximately $4.4 million. Thus, the net offering proceeds to us, after deducting underwriting discounts and commissions and estimated offering expenses, were approximately 38.1 million. No offering expenses were paid directly or indirectly to any of our directors or officers (or their associates) or persons owning ten percent or more of any class of our equity securities or to any other affiliates.

     As of March 31, 2004, we had used $16.75 million of the net proceeds from our initial public offering to redeem all of the outstanding shares of our redeemable preferred stock.

     On May 4, 2005, pursuant to the Merger Agreement, entered into by us on February 8, 2005, Merger Sub merged with and into Avivo. As a result of the Merger, and pursuant to the terms of the Merger Agreement, Avivo is now a wholly-owned subsidiary of us and will be merged with and into another one of our wholly-owned subsidiaries within 30 days of the date of the Merger. Under the terms of the Merger Agreement, we issued 3,123,149 shares of common stock and options and paid $4,199,172 in cash, in exchange for the outstanding capital stock and options of Avivo. Avivo’s shareholders also have the right to receive an earn-out payment based on achievement of certain revenues by Avivo in the fifteen-month period following the closing, with such payment not to exceed $4.1 million. The cash used to fund the payment of the Merger cash consideration was paid from the net proceeds from our initial public offering.

     We expect to use the remainder of the proceeds from our initial public offering to fund other working capital and general corporate purposes, to expand our service offerings or technologies and for the possible acquisition of, and investment in, competing or complementary businesses, services or technologies. The complementary businesses, services and technologies that we may invest in or acquire include automated management of promotional campaigns on search engines, online marketing surveys, email marketing, website search tools, affiliate marketing networks, call center analytics, content management, and other web-based, on-demand services that our customers might want from us. We periodically engage in preliminary discussions relating to acquisitions, but we are not currently a party to any acquisition agreement other than our agreement and plan of merger to acquire Avivo as described above.

     We cannot specify with certainty all of the particular uses for the net proceeds from our initial public offering. The amounts we actually expend for these purposes may vary significantly and will depend on a number of factors including the growth of our revenue, the type of efforts we make to refine our core technology and enhance our services and competitive developments. Accordingly, our management will retain broad discretion in the allocation of the net proceeds. Pending their use, the net proceeds will be invested in short and long-term, interest-bearing, investment-grade securities.

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Item 6. Exhibits

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SIGNATURES

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

Dated: May 6, 2005

	/s/ Thomas D. Willardson
	Thomas D. Willardson
	Chief Financial Officer (Duly Authorized Officer and Principal Financial Officer)

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