**UNITED STATES SECURITIES ANDEXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

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

 

**For thequarterly period ended September 30, 2005**

 

**or**

 

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

 

**For thetransition period from                                    to**

 

**Commission file number: 1-14355**

 

**24/7 RealMedia, Inc.**

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITSCHARTER)

 
| **Delaware**                     | ** ** | **13-3995672**                     |
|----------------------------------|------------|------------------------------------|
| (STATE OR OTHER  JURISDICTION OF |       | (IRS EMPLOYER  IDENTIFICATION NO.) |
| INCORPORATION OR  ORGANIZATION)  |       |                               |

 

**132 West 31stStreet, New York, NY 10001**

(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

 

**(212) 231-7100**

(REGISTRANT’S TELEPHONE NUMBER, INCLUDINGAREA CODE)

 

Indicateby check mark whether the registrant: (1) has filed all reports requiredto be filed by Section 13 or 15 (d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. YES ý NO o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act). YES ý NO o

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). YES o NO ý

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date.

 
| **CLASS**                              | ** ** | **OUTSTANDING AT SEPTEMBER 30,  2005** |
|----------------------------------------|------------|---------------------------------------------|
| Common Stock, par value $.01 per share |       | 45,963,006 Shares                           |

 

 

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**24/7 RealMedia, Inc.**

**September 30,2005**

**FORM 10-Q**

**INDEX**

 
| Part I. Financial Information                                                                                       | 3      |
|--------------------------------------------------------------------------------------------------------------------------|--------|
| Item 1. Consolidated  Financial Statements                                                                               | 3      |
| Consolidated Balance  Sheets as of September 30, 2005 (unaudited) and December 31, 2004                        | 3      |
| Consolidated  Statements of Operations for the three and nine months ended September 30,  2005 and 2004 (unaudited) | 4      |
| Consolidated  Statements of Cash Flows for the nine months ended September 30, 2005  and 2004 (unaudited)           | 5      |
| Notes to  Unaudited Interim Consolidated Financial Statements                                                            | 6      |
| Item 2. Management’s  Discussion and Analysis of Financial Condition and Results of Operations                      | 22     |
| Item 3. Quantitative  and Qualitative Disclosures about Market Risk                                                      | 48     |
| Item 4. Controls  and Procedures                                                                                         | 49     |
|                                                                                                                     |   |
| Part II. Other  Information                                                                                         | 50     |
| Item 1. Legal  Proceedings                                                                                               | 50     |
| Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds                                                     | 50     |
| Item 3.  Defaults Upon Senior Securities                                                                                 | 50     |
| Item 4.  Submission of Matters to a Vote of Security Holders                                                             | 50     |
| Item 5. Other  Information                                                                                               | 50     |
| Item 6. Exhibits                                                                                                         | 50     |
| Signatures                                                                                                               | 51     |

 

Open AdStream® is a registered trademark of 24/7 Real Media, Inc.and Open AdSystemTM, Open AdvertiserTM, Insight XETM, Insight ACTTM andDecide DNATM are pending trademarks of 24/7 Real Media, Inc. All otherbrand names or trademarks appearing herein are the property of their respectiveholders.

 

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PART I. FINANCIAL INFORMATION

 

ITEM1. CONSOLIDATED FINANCIAL STATEMENTS

 

**24/7 REAL MEDIA, INC.**

**CONSOLIDATED BALANCE SHEETS**

**(in thousands, except share data)**

 
| ** **                                                                                                                                                                | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| ** **                                                                                                                                                                | ** ** | **(unaudited)**        | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                |       |                   |       |                  |       |
| Current assets:                                                                                                                                                           |       |                   |       |                  |       |
| Cash and cash equivalents                                                                                                                                                 |       | $                      | 34,903     |                  | $          | 27,690 |   |
| Short-term investments                                                                                                                                                    |       | 1,826                  |       | 3,876                 |       |
| Accounts receivable, less allowances of  $2,319 and $1,727, respectively                                                                                                  |       | 31,314                 |       | 28,224                |       |
| Prepaid expenses and other current assets                                                                                                                                 |       | 2,376                  |       | 2,710                 |       |
|                                                                                                                                                                      |       |                   |       |                  |       |
| Total current assets                                                                                                                                                      |       | 70,419                 |       | 62,500                |       |
|                                                                                                                                                                      |       |                   |       |                  |       |
| Property and equipment, net                                                                                                                                               |       | 6,629                  |       | 4,783                 |       |
| Goodwill                                                                                                                                                                  |       | 34,573                 |       | 34,573                |       |
| Intangible assets, net                                                                                                                                                    |       | 10,330                 |       | 12,676                |       |
| Other assets                                                                                                                                                              |       | 6,303                  |       | 6,866                 |       |
|                                                                                                                                                                      |       |                   |       |                  |       |
| Total assets                                                                                                                                                              |       | $                      | 128,254    |                  | $          | 121,398 |   |
|                                                                                                                                                                      |       |                   |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                             |       |                   |       |                  |       |
| Current liabilities:                                                                                                                                                      |       |                   |       |                  |       |
| Accounts payable                                                                                                                                                          |       | $                      | 15,076     |                  | $          | 16,425 |   |
| Accrued liabilities                                                                                                                                                  |       | 17,206                 |       | 11,808                |       |
| Deferred revenue                                                                                                                                                          |       | 2,793                  |       | 3,222                 |       |
| Subordinated convertible debentures, 2%,  due 2006                                                                                                                        |       | 14,389                 |       | 7,500                 |       |
|                                                                                                                                                                      |       |                   |       |                  |       |
| Total current liabilities                                                                                                                                                 |       | 49,464                 |       | 38,955                |       |
|                                                                                                                                                                      |       |                   |       |                  |       |
| Subordinated convertible debentures, 2%,  due 2006                                                                                                                        |       | —                 |       | 6,431                 |       |
| Warrant liability                                                                                                                                                         |       | 859                    |       | 516                   |       |
| Other long-term liabilities                                                                                                                                               |       | 495                    |       | 207                   |       |
|                                                                                                                                                                      |       |                   |       |                  |       |
| Total liabilities                                                                                                                                                         |       | 50,818                 |       | 46,109                |       |
|                                                                                                                                                                      |       |                   |       |                  |       |
| Commitments and contingencies                                                                                                                                             |       |                   |       |                  |       |
| Minority interests in consolidated  subsidiaries                                                                                                                          |       | 1,729                  |       | 21                    |       |
|                                                                                                                                                                      |       |                   |       |                  |       |
| Stockholders’ equity:                                                                                                                                                |       |                   |       |                  |       |
| Preferred stock; $.01 par value; 10,000,000  shares authorized, 78,000 shares issued and outstanding at December 31,  2004 (liquidation preference of $10 per share) |       | —                 |       | 1                     |       |
| Common stock; $.01 par value; 350,000,000  shares authorized; 45,963,006 and 44,797,067 shares issued and outstanding,  respectively                                      |       | 460                    |       | 448                   |       |
| Additional paid-in capital                                                                                                                                                |       | 1,175,959              |       | 1,173,765             |       |
| Deferred stock-based compensation                                                                                                                                         |       | —                 |       | (17                   | )          |
| Accumulated other comprehensive income                                                                                                                                    |       | 1,041                  |       | 1,463                 |       |
| Accumulated deficit                                                                                                                                                       |       | (1,101,753             | )          | (1,100,392            | )          |
| Total stockholders’ equity                                                                                                                                           |       | 75,707                 |       | 75,268                |       |
|                                                                                                                                                                      |       |                   |       |                  |       |
| Total liabilities and stockholders’ equity                                                                                                                           |       | $                      | 128,254    |                  | $          | 121,398 |   |

 

See accompanying notes tounaudited interim consolidated financial statements.

 

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**24/7 REALMEDIA, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(inthousands, expect share and per share data)**

 
| ** **                                                                                                | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                                | ** ** | **2005**                                  | ** ** | **2004**                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                | ** ** | **(unaudited)**                           | ** ** | **(unaudited)**                          | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** |
| Revenues:                                                                                                 |       |                                      |       |                                     |       |   |   |   |   |
| Media                                                                                                     |       | $                                         | 15,547     |                                     | $          | 12,070 |   | $ | 46,460 |   | $ | 34,451 |   |
| Search                                                                                                    |       | 13,731                                    |       | 4,109                                    |       | 35,063 |   | 9,658 |   |
| Technology                                                                                                |       | 5,839                                     |       | 4,628                                    |       | 16,550 |   | 13,676 |   |
| Total  revenues                                                                                           |       | 35,117                                    |       | 20,807                                   |       | 98,073 |   | 57,785 |   |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Cost of  revenues:                                                                                        |       |                                      |       |                                     |       |   |   |   |   |
| Media                                                                                                     |       | 10,516                                    |       | 9,180                                    |       | 31,470 |   | 24,986 |   |
| Search                                                                                                    |       | 10,026                                    |       | 2,241                                    |       | 24,405 |   | 6,363 |   |
| Technology                                                                                                |       | 998                                       |       | 827                                      |       | 3,167 |   | 2,528 |   |
| Total cost  of revenues                                                                                   |       | 21,540                                    |       | 12,248                                   |       | 59,042 |   | 33,877 |   |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Gross profit                                                                                              |       | 13,577                                    |       | 8,559                                    |       | 39,031 |   | 23,908 |   |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Operating  expenses:                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Sales and  marketing                                                                                      |       | 5,606                                     |       | 4,272                                    |       | 16,627 |   | 11,481 |   |
| General and  administrative                                                                               |       | 4,885                                     |       | 3,626                                    |       | 14,457 |   | 9,627 |   |
| Product  development                                                                                      |       | 1,563                                     |       | 1,115                                    |       | 4,171 |   | 3,261 |   |
| Amortization  of intangible assets and deferred financing costs                                           |       | 1,140                                     |       | 1,068                                    |       | 3,419 |   | 3,270 |   |
| Stock-based  compensation (a)                                                                        |       | 493                                       |       | 209                                      |       | 1,447 |   | 706 |   |
| Restructuring  costs                                                                                      |       | —                                    |       | —                                   |       | 973 |   | 501 |   |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Total  operating expenses                                                                                 |       | 13,687                                    |       | 10,290                                   |       | 41,094 |   | 28,846 |   |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Loss from  operations                                                                                     |       | (110                                      | )          | (1,731                                   | )          | (2,063 | ) | (4,938 | ) |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Interest  expense, net                                                                                    |       | (48                                       | )          | (93                                      | )          | (190 | ) | (371 | ) |
| Change in  fair value of warrant liability                                                                |       | (384                                      | )          | 266                                      |       | (344 | ) | 2,075 |   |
| Recovery of  investment                                                                                   |       | —                                    |       | —                                   |       | 2,100 |   | — |   |
| Impairment  of marketable securities                                                                      |       | —                                    |       | —                                   |       | (588 | ) | — |   |
| Loss on sale  of maketable securities                                                                     |       | (25                                       | )          | —                                   |       | (18 | ) | — |   |
| Gain on  legal settlement                                                                                 |       | —                                    |       | —                                   |       | — |   | 2,896 |   |
| Other income  (expense), net                                                                              |       | (55                                       | )          | 12                                       |       | (95 | ) | 123 |   |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Loss before  provision for income taxes and minority interest in operations of  consolidated subsidiaries |       | (622                                      | )          | (1,546                                   | )          | (1,198 | ) | (215 | ) |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Provision  for income taxes                                                                               |       | (164                                      | )          | (44                                      | )          | (184 | ) | (176 | ) |
| Minority  interest in operations of consolidated subsidiaries                                             |       | 21                                        |       | —                                   |       | 21 |   | — |   |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Net loss                                                                                                  |       | $                                         | (765       | )                                        | $          | (1,590 | ) | $ | (1,361 | ) | $ | (391 | ) |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Dividends on  preferred stock                                                                             |       | (3                                        | )          | (73                                      | )          | (25 | ) | (295 | ) |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Net loss  attributable to common stockholders                                                             |       | $                                         | (768       | )                                        | $          | (1,663 | ) | $ | (1,386 | ) | $ | (686 | ) |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Basic and  diluted net loss per share attributable to common stockholders                                 |       | $                                         | (0.02      | )                                        | $          | (0.04 | ) | $ | (0.03 | ) | $ | (0.02 | ) |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Weighted  average shares outstanding used in basic and diluted net loss per share                         |       | 45,478,444                                |       | 37,007,505                               |       | 45,097,696 |   | 32,244,122 |   |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
|                                                                                                           |
| (a) Stock-based compensation charges  are excluded from the following operating expense categories:  |
|                                                                                                      |       |                                      |       |                                     |       |   |   |   |   |
| Cost of  revenues                                                                                         |       | $                                         | 7          |                                     | $          | — |   | $ | 23 |   | $ | — |   |
| Sales and  marketing                                                                                      |       | 117                                       |       | 125                                      |       | 323 |   | 335 |   |
| General and  administrative                                                                               |       | 318                                       |       | 74                                       |       | 950 |   | 337 |   |
| Product  development                                                                                      |       | 51                                        |       | 10                                       |       | 151 |   | 34 |   |
|                                                                                                      |       | $                                         | 493        |                                     | $          | 209 |   | $ | 1,447 |   | $ | 706 |   |

 

See accompanying notes to unaudited interim consolidated financialstatements.

 

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**24/7 REALMEDIA, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(inthousands)**

 
| ** **                                                                                     | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                     | ** ** | **2005**                                 | ** ** | **2004** | ** ** |
| ** **                                                                                     | ** ** | **(unaudited)**                          | ** ** | **(unaudited)** | ** ** |
| Cash flows from operating activities:                                                          |       |                                     |       |   |   |
| Net loss                                                                                       |       | $                                        | (1,361     | ) | $ | (391 | ) |
| Adjustments to reconcile net loss to net  cash provided by (used in) operating activities:     |       |                                     |       |   |   |
| Depreciation and amortization                                                                  |       | 2,079                                    |       | 1,412 |   |
| Provision for doubtful accounts and sales  reserves                                            |       | 1,672                                    |       | 372 |   |
| Amortization of intangible assets and  deferred financing costs                                |       | 3,419                                    |       | 3,270 |   |
| Amortization of warrants                                                                       |       | 458                                      |       | 458 |   |
| Non-cash compensation                                                                          |       | 1,447                                    |       | 706 |   |
| Accrued interest on notes payable                                                              |       | 76                                       |       | 76 |   |
| Change in fair value of warrant liability                                                      |       | 344                                      |       | (2,075 | ) |
| Loss on sale of marketable securities                                                          |       | 18                                       |       | — |   |
| Impairment of marketable securities                                                            |       | 588                                      |       | — |   |
| Recovery of investment                                                                         |       | (2,100                                   | )          | — |   |
| Minority interest in losses of consolidated  subsidiaries                                      |       | (21                                      | )          | — |   |
| Gain on legal settlement                                                                       |       | —                                   |       | (2,896 | ) |
| Changes in  operating assets and liabilities, net of effect of acquisitions and  dispositions: |       |                                     |       |   |   |
| Accounts  receivable                                                                           |       | (4,762                                   | )          | (5,706 | ) |
| Prepaid  expenses and other current assets                                                     |       | 334                                      |       | (328 | ) |
| Other assets                                                                                   |       | (510                                     | )          | (4,340 | ) |
| Accounts  payable and accrued liabilities                                                      |       | 5,412                                    |       | 2,520 |   |
| Deferred  revenue                                                                              |       | (429                                     | )          | 366 |   |
|                                                                                           |       |                                     |       |   |   |
| Net cash  provided by (used in) operating activities                                           |       | 6,664                                    |       | (6,556 | ) |
|                                                                                           |       |                                     |       |   |   |
| Cash flows from investing activities:                                                          |       |                                     |       |   |   |
| Recovery of investment                                                                         |       | 2,100                                    |       | — |   |
| Proceeds from sale / maturities of  short-term investments                                     |       | 648                                      |       | — |   |
| Proceeds from sale of marketable securities                                                    |       | 856                                      |       | — |   |
| Capital expenditures, including capitalized  software                                          |       | (4,916                                   | )          | (1,550 | ) |
| Cash paid for investment                                                                       |       | —                                   |       | (422 | ) |
| Cash paid for acquisitions, net                                                                |       | —                                   |       | (17,244 | ) |
|                                                                                           |       |                                     |       |   |   |
| Net cash  used in investing activities                                                         |       | (1,312                                   | )          | (19,216 | ) |
|                                                                                           |       |                                     |       |   |   |
| Cash flows from financing activities:                                                          |       |                                     |       |   |   |
| Proceeds from minority investor of  consolidated subsidiaries                                  |       | 1,729                                    |       | — |   |
| Proceeds from exercise of stock options                                                        |       | 677                                      |       | 609 |   |
| Payment of capital lease obligations                                                           |       | (62                                      | )          | (40 | ) |
| Proceeds from issuance of common stock, net                                                    |       | —                                   |       | 37,240 |   |
|                                                                                           |       |                                     |       |   |   |
| Net cash  provided by financing activities                                                     |       | 2,344                                    |       | 37,809 |   |
|                                                                                           |       |                                     |       |   |   |
| Net change  in cash and cash equivalents                                                       |       | 7,696                                    |       | 12,037 |   |
| Effect of foreign currency on cash                                                             |       | (483                                     | )          | 440 |   |
| Cash and cash equivalents at beginning of  year                                                |       | 27,690                                   |       | 21,645 |   |
|                                                                                           |       |                                     |       |   |   |
| Cash and cash equivalents at end of period                                                     |       | $                                        | 34,903     |   | $ | 34,122 |   |

 

See accompanying notes to unaudited interim consolidated financialstatements.

 

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**NOTE 1 – ORGANIZATION AND NATURE OF OPERATIONS**

 

24/7 Real Media, Inc. (the “Company”) together with itssubsidiaries provides advertising services and software solutions for theonline advertising needs of Web publishers and advertisers, includingadvertising sales, search engine marketing services, online advertisementserving, analytics and audience management. As of September 30, 2005, theCompany principally operated in North America, Europe, South Korea andAustralia and provided the following products and services:

 

*Media*, collectivelymarketed as the 24/7 Web Alliance, a global alliance of Web sites representedby the Company, through which advertisers can place campaign orders directlywith the Company.

 

*Search*primarilyconsisting of full budget management services, including paid-inclusion serviceand pay-per-click bid management, optimization services and search engine andconsulting services, including natural search engine optimization servicesdesigned to help advertisers promote their Web sites in or in association withrelevant search results displayed by the Company’s partner search engines andto optimize their search marketing budgets.

 

*Technology*primarilyconsisting of Open AdStream and Open Advertiser advertisement delivery andmanagement software and services, the Insight XE web analytics and audiencemanagement software and services and the Insight ACT behavioral targetingservice. The Company licenses software products to customers that are hostedlocally and provides services from software hosted centrally on its servers asan application service provider.

 

**NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

#### (a) Basisof Presentation

####  

Theaccompanying consolidated financial statements include the accounts of theCompany and its majority-owned and controlled subsidiaries from theirrespective dates of acquisition. The interest of shareholders other thanthose of the Company is recorded as minority interest in the accompanyingconsolidated statements of operations and consolidated balance sheets. Whenlosses applicable to minority interest holders in a subsidiary exceed theminority interest in the equity capital of the subsidiary, these losses areincluded in the Company’s results, as the minority interest holder has noobligation to provide further financing to the subsidiary. All significantintercompany transactions and balances have been eliminated in consolidation.

 

Theaccompanying interim consolidated financial statements are unaudited. In theCompany’s opinion, the unaudited consolidated financial statements have beenprepared on the same basis as the annual consolidated financial statements andreflect all adjustments, which include only normal recurring adjustments,necessary to present fairly the financial position and the results of theoperations and cash flows of the Company for the interim periods presented. Thefinancial statements, financial data and other information disclosed in thenotes to the consolidated results are not necessarily indicative of the resultsexpected for the full fiscal year or any future period.

 

Theaccompanying consolidated financial statements should be read in conjunctionwith the audited consolidated financial statements for the year ended December 31,2004. Certain information and footnote disclosures normally included infinancial statements prepared in accordance with accounting principlesgenerally accepted in the United States of America have

 

6

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beencondensed or omitted pursuant to the rules and regulations of theSecurities and Exchange Commission (“SEC”).

 

###### (b) Useof Estimates

######  

The preparation ofconsolidated financial statements in accordance with accounting principlesgenerally accepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities andthe disclosure of contingent assets and liabilities at the date of theconsolidated financial statements and the reported amounts of revenues andexpenses during the reporting period. Actual results could differ from thoseestimates. On an ongoing basis, the Company evaluates its estimates, includingthose related to revenue recognition, accruals, allowance for doubtfulaccounts, fair value of acquired intangible assets and goodwill, useful livesof intangible assets and property and equipment, among others. The Companybases its estimates on historical experience and on various other assumptionsthat are believed to be reasonable, the results of which form the basis formaking judgments about the carrying values of assets and liabilities.

 

###### (c) Cashand Cash Equivalents

######  

The Company considers all highly liquid securities, with originalmaturities of three months or less from the balance sheet date, to be cashequivalents. Cash and cash equivalents consist principally of money marketaccounts.

 

The Company maintains letters of credit, secured by cash, related toits office leases. Letters of credit with maturities of one year or less fromthe balance sheet date are classified as other current assets and letters ofcredit with maturities greater than one year from the balance sheet date areclassified as other assets on the consolidated balance sheets.

 

(d) Investments

 

Investments consist of securities with statedmaturities of three months or more and marketable securities consisting ofregistered corporate equity securities. The Company classifies themarketable securities as available-for-sale in accordance with Statement ofFinancial Accounting Standards (“SFAS”) No. 115, *Accountingfor Certain Investments in Debt and Equity Securities*.Available-for-sale securities are carried at fair value, with the unrealizedgains or losses, net of tax, reported as a separate component of stockholders’equity. In determining realized gains and losses, the cost of securities soldis based upon specific identification. Realized gains and losses and declinesin value judged to be other-than-temporary, are included in the consolidatedstatements of operations.

 

Investments in non-marketable equity securities ofcompanies in which the Company owns less than 20% of a company’s stock and doesnot have the ability to exercise significant influence are accounted for on thecost basis. On an ongoing basis, the Company assesses the need to record impairmentlosses on investments and records such losses when the impairment is determinedto be other-than-temporary.

 

7

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(e) Accounts Receivable

 

Accounts receivable are recorded at the invoiced amount net ofallowance for doubtful accounts and sales allowance. The Company does notrequire collateral. The Company maintains an allowance for doubtful accounts toreserve for potentially uncollectible receivables and a sales allowance toreserve for potential credits issued to customers. The allowances are estimatescalculated based on an analysis of current business and economic risks,customer credit-worthiness, specific identifiable risks such as bankruptcies,terminations or discontinued customers, or other factors that may indicate apotential loss.

 

As a normal part of the business, the Company has receivables that areinvoiced in the month following the completion of the earnings process. Allunbilled receivables are billed within 30 days after each month-end.

 

(f) Concentration of Credit Risk

 

Financial instruments that potentially subject the Company toconcentrations of credit risk consist principally of cash equivalents, accountsreceivable and debentures. The fair value of cash equivalents and accounts receivableinstruments approximate their financial statement amount because of theshort-term maturity of these instruments. The fair value of the debenturesapproximates their financial statement carrying value based on interest ratesfor similar borrowing.

 

At times, cash may exceed the federally insured limits. In addition,the majority of the Company’s cash is managed by one financial institution.

 

(g) Significant Customers and Suppliers

 

No single customeraccounted for greater than 10% of net revenues for the three or nine monthperiods ended September 30, 2005 and 2004.

 

Substantially all Media revenue is generated from advertising inventoryprovided by partner Web sites. Search revenue is generated from relationshipswith search engine distribution partners, and substantially all Search revenueis derived from two such relationships. In each case, with the exceptionof Lycos, arrangements with the Company’s partners are often short-term orsubject to termination upon short notice. The Company may not be successful inrenewing any of these agreements, or if they are renewed, they may not be onterms as favorable as current agreements. The Company may not be successful inentering into agreements with new distribution partners on commerciallyacceptable terms.

 

On a geographic basis, the Company may also experience significantconcentration among our customers or partners. The Company examines thisconcentration on a country-by-country basis.

 

(h) Property and Equipment; Capitalized Software

 

Property and equipment are recorded at cost and are depreciated usingthe straight-line method over the shorter of the estimated useful lives of therelated assets, generally three to five years, or the lease term.

 

In accordance with Statement of Position (“SOP”) No. 98-1, *Accounting for the Costs of Computer SoftwareDeveloped or Obtained for Internal Use*, software development costsincurred during the application development stage are capitalized. Costsincurred during the preliminary project and post implementation stages of aninternal use software project are expensed as incurred. The capitalized cost ofinternal use software is charged over the estimated useful life of two to threeyears.

 

8

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As required by SFAS No. 86, *Accountingfor the Costs of Computer Software To Be Sold, Leased, or Otherwise Marketed*,the Company requires certain product development costs to be capitalized when aproduct’s technological feasibility has been established by completion of aworking model of the product and ending when a product is available for generalrelease to customers. Capitalized software is depreciated using the greater ofthe amount computed using (a) the ratio that current gross revenues for aproduct bears to the total of current and anticipated future gross revenue forthat product or (b) the straight-line method over the remaining estimatedeconomic life of the software, generally four years.

 

(i) Business Combinations

 

TheCompany’s acquisitions are accounted for as purchase business combinations inaccordance with SFAS No. 141, *BusinessCombinations*, and SFAS No. 142, *Goodwill and Other Intangible Assets*. The Companyallocates the purchase price to tangible and intangible assets and records asgoodwill the excess of the purchase price over the fair value of theidentifiable net assets acquired. Intangible assets include trademarks, customer relationships, acquiredtechnology and covenants not to compete. Such intangible assets are amortizedon a straight-line basis over their estimated useful lives, which are generallyfour to seven years.

 

(j) Impairment of Long-Lived Assets

 

Long-lived assets, including property and equipment, goodwill and otherintangible assets are reviewed for impairment whenever events or changes incircumstances indicate that the carrying amount may not be fully recoverable.Conditions that would necessitate an impairment assessment include asignificant decline in the observable market value of an asset, a significantchange in the extent or manner in which an asset is used, or a significantadverse change that would indicate that the carrying amount of an asset orgroup of assets is not recoverable. The Company assesses impairment inaccordance with the requirements of SFAS No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets*. The Company assesses the impairment of goodwilland intangible assets in accordance with the provisions of SFAS No. 142, *Goodwill and Other Intangible Assets*. TheCompany determines the recoverability of the assets by comparing the carryingamount of the assets to net future cash flows that the asset is expected togenerate. The impairment recognized is the amount by which the carrying amountexceeds the fair market value of the asset.

 

(k) Revenue Recognition; Cost of Revenues; DeferredRevenue

 

*Media*

 

Media revenues aregenerated by delivering advertising impressions for a fixed fee to third-partyWeb sites. Agreements are primarily short-term and revenues are recognized asservices are delivered provided that no significant Company obligations remainoutstanding and collection of the resulting receivable is probable. The Companybecomes obligated to make payments to third-party Web sites that havecontracted with the Company in the period the advertising impressions aredelivered. Such expenses are classified as cost of revenues in the accompanyingconsolidated statements of operations.

 

*Search*

 

Search revenues are derived from attracting clicks on clientadvertisers’ Web listings in search results. Agreements are primarilyshort-term and revenues are recognized as services are delivered provided thatno significant Company obligations remain outstanding and collection of theresulting receivable is probable. The Company becomes obligated to makepayments to search engine distribution partners that

 

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have contracted with the Company in the period in which the clicksoccur. Such expenses are classified as cost of revenues in the accompanyingconsolidated statements of operations.

 

In specific circumstances, when the Company provides search marketingservices as an agent for a fixed commission, or otherwise in transactionsin which it does not have principal risk and reward, the Company recognizesrevenue on a net basis.

 

*Technology*

 

Technology revenues are derived primarily from licensing of oursoftware, hosted advertisement serving and software maintenance and technicalsupport services. Revenue from software licensing agreements is recognized inaccordance with SOP No. 97-2, *SoftwareRevenue Recognition*, and Staff Accounting Bulletin (“SAB”) No. 104,*Revenue Recognition*, upondelivery of the software, which is generally when the software is madeavailable for download, there is persuasive evidence of an arrangement,collection is reasonably assured, the fee is fixed or determinable andvendor-specific objective evidence exists to allocate the total fees to allelements of the arrangement. Contracts that bundle the software license withmaintenance and technical support are recognized ratably over the contractterm. Revenue from hosted advertisement serving is recognized upon delivery.Revenue from software maintenance and technical support contracts is recognizedratably over the term of the agreement, which typically does not exceed oneyear.

 

Expenses from Technology revenues are primarily payroll costs incurredto deliver and support the software, hosting, bandwidth and license fees paidto third-party software vendors. These expenses are classified as cost of revenuesin the accompanying consolidated statements of operations.

 

*Deferred Revenue*

 

Revenues that are billed or collected in advance of services beingcompleted are deferred until the conclusion of the period of the service forwhich the advance billing or collection relates. Deferred revenues are includedon the consolidated balance sheets as a current liability until the service isperformed and then recognized in the period in which the service is completed.The Company’s deferred revenues primarily consist of billings in advance forsoftware license subscriptions and software maintenance and technical supportservices.

 

(l) Stock-Based Compensation

 

The Company accounts for stock-based employee compensation arrangementsin accordance with the provisions of Accounting Principles Board (“APB”)Opinion No. 25, “*Accounting for StockIssued to Employees*,” and Financial Accounting Standards Board (“FASB”)interpretation No. 44, “*Accounting for CertainTransactions Involving Stock Compensation—an interpretation of APB Opinion No. 25*,”and complies with the disclosure provisions of SFAS No. 123, “*Accounting for Stock-Based Compensation*” and SFAS No. 148,“*Accounting for Stock-Based Compensation—Transitionand Disclosure*.” Under APB No. 25, compensation cost is recognizedbased on the difference, if any, on the date of grant between the fair value ofthe Company’s common stock and the amount an employee must pay to acquire thecommon stock. SFAS No. 148 requires more prominent and more frequentdisclosures in both interim and annual financial statements about the method ofaccounting for stock-based compensation and the effect of the method used onreported results. The Company adopted the disclosure provisions of SFAS No. 148as of December 31, 2002 and continues to apply the measurement provisionsof APB No. 25.

 

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Had the Company determined compensation cost based on the fair value atthe grant date for its stock options under SFAS No. 123, the Company’s netloss would have been adjusted to the pro forma amounts indicated below:

 
| ** **                                                                                                                           | ** ** | **Three Months Ended  September 30,**    | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                                           | ** ** | **2005**                                      | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                                           | ** ** | **(in thousands, except per share  amounts)** | ** ** |
| Net loss  attributable to common stockholders:                                                                                       |       |                                          |       |                                      |       |   |   |   |   |
| As reported                                                                                                                          |       | $                                             | (768       | )                                         | $          | (1,663 | ) | $ | (1,386 | ) | $ | (686 | ) |
| Deduct:  Total stock-based employee compensation expense determined under  fair-value-based method for all awards, net of tax effect |       | (1,383                                        | )          | (1,123                                    | )          | (4,298 | ) | (4,291 | ) |
| Pro forma                                                                                                                            |       | $                                             | (2,151     | )                                         | $          | (2,786 | ) | $ | (5,684 | ) | $ | (4,977 | ) |
|                                                                                                                                 |       |                                          |       |                                      |       |   |   |   |   |
| Basic and  diluted net loss per share:                                                                                               |       |                                          |       |                                      |       |   |   |   |   |
| As reported                                                                                                                          |       | $                                             | (0.02      | )                                         | $          | (0.04 | ) | $ | (0.03 | ) | $ | (0.02 | ) |
| Pro forma                                                                                                                            |       | (0.05                                         | )          | (0.08                                     | )          | (0.13 | ) | (0.15 | ) |

 

The per share weighted-average fair value of stockoptions granted during the three and nine month periods ended September 30,2005 was $2.74 and $2.51, respectively, and was $3.76 and $4.76 for the threeand nine month periods ended September 30, 2004, respectively, on the dateof grant using the Black-Scholes method with the following weighted averageassumptions:

 
| ** **                | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
|---------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                | ** ** | **2005**               | ** ** | **2004**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|                      |       |                   |       |                   |       |   |   |   |   |
| Expected  dividend yield  |       | 0                      | %          | 0                      | %          | 0 | % | 0 | % |
| Risk-free  interest rate  |       | 4.22                   | %          | 3.07                   | %          | 3.09 | % | 2.38 | % |
| Expected  life (in years) |       | 3.0                    |       | 3.0                    |       | 2.5 |   | 2.6 |   |
| Volatility                |       | 99                     | %          | 132                    | %          | 103 | % | 132 | % |

 

In December 2004, the FASB issued the revisedSFAS No. 123, *Share-Based Payment*(“SFAS 123R”), which addresses the accounting for share-based paymenttransactions in which the Company obtains employee services in exchange for (a) equityinstruments of the Company or (b) liabilities that are based on the fairvalue of the Company’s equity instruments or that may be settled by theissuance of such equity instruments. Under SFAS 123R, the Company is requiredto report expensing of stock options and other equity awards issued toemployees and directors as of the first interim or annual reporting periodbeginning after June 15, 2005. However, the SEC amended the compliancedates to the next fiscal year after June 15, 2005 (January 1, 2006for the Company).

 

SFAS 123R applies to all awards granted or modifiedafter the effective date. In addition, compensation cost for the unvestedportion of previously granted awards that remain outstanding on the effectivedate shall be recognized on or after the effective date, as the relatedservices are rendered, based on the awards’ grant-date fair value as previouslycalculated for the pro-forma disclosure under SFAS 123.

 

The Company expects that upon the adoption of SFAS123R it will apply the modified prospective application transition method, aspermitted by the statement. Under such transition method, upon the

 

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adoption of SFAS 123R, the Company’s financial statementsfor periods prior to the effective date of the statement will not be restated.

 

(m) Restructuring Estimates

 

Restructuring activities are accounted for inaccordance with SFAS No. 146, *Accounting For CostsAssociated with Exit or Disposal Activities*. Restructuring-relatedliabilities include estimates for, among other things, involuntary terminationsof employees and disposition of lease obligations. Key variables in determiningsuch estimates include timing of sublease rentals, estimates of sublease rentalpayment amounts and tenant improvement costs, and estimates for brokerage andother related costs. The Company periodically evaluates and, if necessary,adjusts the estimates based on currently available information.

 

(n) Warrant Liability

 

Warrant liability is presented in accordance withEITF 00-19, *Accounting for DerivativeFinancial Instruments Indexed To, And Potentially Settled In, a Company’s OwnStock*. EITF 00-19 requires freestanding contracts that are settledin a Company’s own stock, including common stock warrants, to be designated asan equity instrument, asset or liability. Under the provisions of EITF 00-19, acontract designated as an asset or a liability must be carried at fair valueuntil exercised or expired, with any changes in fair value recorded in theresults of operations. A contract designated as an equity instrument must beincluded within equity, and no fair value adjustments are required. The Companyreviews the classification of its contracts at each balance sheet date.

 

(o) Basic and Diluted Net Loss Per Share

 

Netloss per share is presented in accordance with the provisions of SFAS No. 128,*Earnings Per Share* (“EPS”). BasicEPS excludes dilution for potentially dilutive securities and is computed bydividing income (loss) available to common shareholders by the weighted averagenumber of common shares outstanding for the period. Diluted EPS reflects thepotential dilution that could occur if securities or other contracts to issuecommon stock were exercised or converted into common stock and resulted in theissuance of common stock. Potential common shares consist of incremental commonshares issuable upon the exercise of stock options and warrants (using thetreasury stock method), the conversion of subordinated convertible debenturesand preferred stock (using the if-converted method) and the vesting ofrestricted stock.

 

Diluted EPS is equal tobasic EPS for the three and nine month periods ended September 30, 2005and 2004 since all potentially dilutive securities are antidilutive. Thecomputation of net loss per share for the three and nine month periods ended September 30,2005 and 2004 excludes outstanding options of 7.4 million and 4.7 million topurchase shares of common stock, respectively; 0.9 million and 11,000 shares ofunvested restricted stock, respectively; the effects of 0.6 million sharesissuable upon the exercise or conversion of common stock warrants in 2004 and2005, 0.6 million shares issuable upon the conversion of preferred stock in2004 and 1.7 million shares issuable upon the conversion of the subordinatedconvertible debentures in 2004 and 2005, since their inclusion would have ananti-dilutive effect.

 

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**NOTE 3 - ACQUISITIONS AND UNAUDITED PRO FORMA SUMMARY**

 

(a)          Acquisitionof Decide Holdings Pty Limited (“Decide”)

 

OnAugust 19, 2004, the Company completed its acquisition of Decide, aleading provider of search engine marketing in Australia and Europe. Pursuantto the acquisition agreements, the Company acquired all of the outstandingshares of Decide for $15.0 million in cash, approximately 4.5 million shares ofits common stock, valued at $12.6 million, and approximately $1.1 million intransaction fees. Additionally, the Company is required to pay up to anadditional $2.5 million in cash and issue $7.5 million in shares of commonstock (up to a maximum of 2.3 million shares) to the selling shareholders ofDecide if Decide achieves certain performance targets.

 

Thepurchase price in excess of fair value of net tangible liabilities assumed of$28.8 million has been allocated as follows: $20.0 million to goodwill and $8.8million to intangible assets.

 

Ofthe $8.8 million of intangible assets, $1.1 million was assigned to trademarksthat are not subject to amortization. The remaining $7.7 million of intangibleassets have a weighted-average useful life of approximately five years. Theintangible assets that make up that amount include acquired technology of $6.6million (five year weighted-average useful life), customer relationships of$1.0 million (five year weighted-average useful life) and non-competeagreements of $0.1 million (two year weighted-average useful life).

 

The$20.0 million of goodwill was assigned to the Search segment and, of that amount,none is deductible for tax purposes.

 

Thenet tangible liabilities assumed consist of the following:

 

| **Asset / Liability**     | ** ** | **Amount** | ** ** |
|---------------------------|------------|------------|------------|
| Cash and cash equivalents |       | $          | 305        |   |
| Other current assets      |       | 1,692      |       |
| Fixed assets              |       | 616        |       |
| Other assets              |       | 180        |       |
| Accrued liabilities       |       | (2,838     | )          |
| Long-term liabilities     |       | (21        | )          |
|                      |       | $          | (66        | ) |

 

(b)         Acquisitionof Real Media Korea (“RMK”)

 

On January 6, 2004, the Company completed its acquisition of RMK,a leader in interactive marketing in the Republic of South Korea, by acquiringthe approximately 90.4% of the outstanding shares of RMK that the Company didnot already own. The Company paid total consideration of $20.1 million inexchange for the RMK shares, which consisted of $5.0 million in cash,approximately 2.1 million shares of the Company’s common stock valued at$14.6 million and approximately $0.5 million in transaction costs.Approximately 0.9% of the outstanding shares of RMK are held in an employeestock union established under Korean law. The employee shareholders agreed totransfer their RMK shares to the Company upon vesting in accordance with theterms and conditions of the stock union and Korean law. For accountingpurposes, the effective date of the acquisition is January 1, 2004. Therewas no material activity between the effective date and the acquisition date.In 2005, the Company changed the name of RMK to 24/7 Real Media, Inc.

 

The purchase price in excess of fair value of net tangible assetsacquired of $16.1 million has been allocated as follows: $11.9 million togoodwill and $4.2 million to intangible assets.

 

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Ofthe $4.2 million of intangible assets, $0.7 million was assigned to trademarksthat are not subject to amortization. The remaining $3.5 million of intangibleassets have a weighted-average useful life of approximately six years. Theintangible assets that make up that amount include acquired technology of $0.5million (six year weighted-average useful life), customer relationships of $2.4million (seven year weighted-average useful life) and a non-compete agreementof $0.6 million (five year weighted-average useful life).

 

The$11.9 million of goodwill was assigned to the Media and Technology segments inthe amounts of $11.2 million and $0.7 million, respectively. Of that totalamount, none is deductible for tax purposes.

 

The net tangible assets acquired consist of the following:

 

| **Asset/ Liability**      | ** ** | **Amount** | ** ** |
|---------------------------|------------|------------|------------|
| Cash and cash equivalents |       | $          | 3,469      |   |
| Other current assets      |       | 5,151      |       |
| Fixed assets              |       | 170        |       |
| Non-current assets        |       | 384        |       |
| Accrued liabilities       |       | (5,159     | )          |
|                      |       | $          | 4,015      |   |

 

(c) Unaudited ProForma Summary

 

The results of operationsof Decide and RMK have been included in the Company’s consolidated statementsof operations since the completion of the acquisitions. The following unauditedpro forma information presents a summary of the results of operations of theCompany assuming the acquisitions of Decide and RMK at the beginning of eachperiod presented:

 
| ** **                                                                          | ** ** | **Three Months Ended**                    | ** ** | **Nine Months Ended**       | ** ** |
|-------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                          | ** ** | **September 30, 2004**               | ** ** | **September 30, 2004** | ** ** |
| ** **                                                                          | ** ** | **(in thousands except per share  data)** | ** ** |
| ** **                                                                          | ** ** | ** **                                | ** ** | ** **                  | ** ** |
| Total  revenue                                                                      |       | $                                         | 22,121     |                        | $          | 64,480 |   |
| Net loss  attributable to common stockholders                                       |       | (2,035                                    | )          | (1,055                      | )          |
| Basic and  diluted net loss attributable to common stockholders per share           |       | $                                         | (0.05      | )                           | $          | (0.03 | ) |
| Weighted  average common shares used in basic and diluted per share calculation (1) |       | 39,482,272                                |       | 36,086,959                  |       |

 

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(1) Theweighted average shares used to compute pro forma basic and diluted net lossper share for the three and nine month periods ended September 30, 2004include the 4.5 million and 2.1 million shares of common stock issued forDecide and RMK, respectively, as if the shares were issued at the beginning ofeach period presented.

 

The pro forma summary isnot necessarily indicative of the operating results that would have beenachieved had the transactions been in effect as of the beginning of the periodspresented and should not be construed as being representative of futureresults.

 

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**NOTE 4 – JOINT VENTURE**

 

(a)          K.K. 24/7 Search

 

On September 5, 2005, the Company signed a joint venture agreementwith Dentsu Inc. to deliver search engine marketing (“SEM”) services to theJapanese market. The partnership, K.K. 24/7 Search, in which Dentsu owns asignificant minority interest, simultaneously entered into an agreement to bethe exclusive provider of SEM services to Dentsu’s extensive client base. Underthe terms of the agreement, Dentsu will contribute its extensive Japanese marketingindustry knowledge and connections to the joint venture, and consign to thejoint venture all SEM services provided to its clients. The Company willlicense its Decide DNA technology to the joint venture, as well as provide SEMexpertise and operational management.

 

Upon inception, the Company made an initial investment of $1.9 million,representing a 51% ownership interest in the joint venture. The Companyincluded the results of operations and financial position of the joint venturein its consolidated financial statements with minority interest presentedseparately. As of September 30, 2005, the carrying value of the investmentwas approximately $1.7 million.

 

**NOTE 5 – BALANCE SHEET COMPONENTS**

 

(a) Short-termInvestments

 

Short-terminvestments as of September 30, 2005 and December 31, 2004 consistedof $1.4 million and $2.1 million, respectively, in certificate of deposits withoriginal maturities greater than three months from the balance sheet date, and$0.4 million and $1.8 million, respectively, in available-for-sale securities.Proceeds from the sale of marketable securities were $0.9 million for the ninemonth period ended September 30, 2005 and realized losses were immaterial.During 2005, the Company determined the decline in the market value of thesecurities to be other-than-temporary and recorded a loss of $0.6 million.  Subsequently, the price increased, resultingin an unrealized gain of $0.1 million at September 30, 2005, which isincluded in accumulated other comprehensive income on the consolidated balancesheet.

 

(b) Property and Equipment

 

As of September 30, 2005 and December 31,2004, property and equipment included capitalized software of $0.2 million and$0.4 million, respectively. Approximately $0.1 and $0.3 million was amortizedduring the three and nine month periods ended September 30, 2005,respectively.

 

(c) Goodwill

 

The$34.6 million in goodwill as of September 30, 2005 and December 31,2004 related $20.0 million to Decide, $12.0 million to RMK,$1.1 million to 24/7 Canada (formerly ClickThrough), $1.1 million toReal Media and $0.4 million to 24/7 Search (formerly Website Results).

 

(d) Intangible Assets, Net

 

The$10.3 million in intangible assets, net as of September 30, 2005 related$7.0 million to Decide, $3.2 million to RMK and $0.1 million to Real Media. The $12.7 million in intangible assets,net as of December 31, 2004 related $8.2 million to Decide,$3.7 million to RMK and $0.8 million to Real Media.

 

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**NOTE 6 – RESTRUCTURING**

 

Duringthe first quarter of 2005, the Company recorded a restructuring charge of $1.0 million relatingto its former New York headquarters.

 

Thefollowing sets forth the activities in the Company’s restructuring reserve forthe nine month period ended September 30, 2005, which is included inaccrued liabilities in the consolidated balance sheets (in thousands):

 
| ** **                    | ** ** | **Beginning  Balance** | ** ** | **Current Year  Provision** | ** ** | **Current Year  Utilization** | ** ** | **Ending Balance** | ** ** |
|-------------------------------|------------|------------------------|------------|-----------------------------|------------|-------------------------------|------------|--------------------|------------|
| Employee termination benefits |       | $                      | 369        |                        | $          | —                        |       | $                  | 369        |   | $ | — |   |
| Office closing costs          |       | 529                    |       | 973                         |       | 256                           |       | 1,246              |       |
|                          |       | $                      | 898        |                        | $          | 973                           |       | $                  | 625        |   | $ | 1,246 |   |

 

**NOTE 7 – 2% SUBORDINATED CONVERTIBLE DEBENTURES**

 

On September 26,2003, the Company completed the placement to an institutional accreditedinvestor of $15.0 million of subordinated convertible debentures due September 2006(“Debentures”). The Debentures are convertible into shares of the Company’scommon stock at $8.75 per share. Interest on the Debentures at the rate of 2%is due semi-annually starting in January 2004. The investor also acquireda five-year warrant (the “Warrants”) to purchase 0.4 million shares of theCompany’s common stock at $9.5685 per share.

 

The maturity date of theDebentures is subject to extension, and the conversion price is subject toadjustment, on the terms and conditions set forth in the Debentures. Inaddition, the Company may elect to pay the principal of and interest on theDebentures in shares of its common stock rather than cash. If the Companyelects to pay the principal amount due under the Debentures at maturity inshares of its common stock, rather than in cash, the maturity date conversionprice will be equal to 90% of the average of the daily volume-weighted averageprices of the Company’s common stock on the NASDAQ SmallCap Market (or suchother market in which the Debentures are then listed or quoted) for the fifteenconsecutive trading days immediately preceding the maturity date. If theCompany elects to make interest payments due under the Debentures in shares of itscommon stock, rather than in cash, the interest conversion price will be equalto 90% of the average of the daily volume-weighted average prices of theCompany’s common stock on the NASDAQ SmallCap Market (or such other market inwhich the Debentures are then listed or quoted) for the five consecutivetrading days immediately preceding the interest payment date. Interest expenseon the debentures amounted to approximately $0.2 million for each of thenine month periods ended September 30, 2005 and 2004.

 

Additionally, if thespecific conditions set forth in the Debentures are satisfied, the Company mayrequire the holder to convert the Debentures into shares of the Company’scommon stock at the conversion rate then in effect, or the Company may prepaythe Debentures prior to the maturity date, for an amount in cash equal to 150%of the amount prepaid. In addition, if at any time on or after the secondanniversary of the initial issuance date, the weighted average price of thecommon stock is less than $8.75 on any five consecutive trading days, theholder shall have the right, in its sole discretion, to require that theCompany redeem up to $7.5 million principal amount of the Debentures incash.  The redemption right constitutesan embedded derivative. The value of this embedded derivative at September 30,2005 is immaterial to the financial position of the Company. The Companyreviews the value of the derivative on a quarterly basis, in accordance withSFAS No. 149, *Amendment ofStatement 133 on Derivative Instruments and Hedging Activities*.

 

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The Company valued theWarrants at $1.8 million using a Black-Scholes pricing model with thefollowing factors: risk free interest rate of 1.48%, volatility of 143%,dividend yield of 0% and a life of 2.5 years. The aggregate fair marketvalue of the Warrants was reflected as a reduction of the face amount of theDebentures on the consolidated balance sheet and is being amortized over threeyears, the initial term of the Debentures, using the effective interest method.Accordingly, the carrying value of the Debentures will be increased over theinitial term. Pursuant to EITF Issue No. 00-19, since the effectiveregistration of the securities underlying the warrants was an event outside thecontrol of the Company, the Company recorded the fair value of the warrants aslong-term liabilities. In connection with the amendment to the registrationrights agreement entered into during 2004, the Company reclassified the value ofthe warrants (approximately $1.0 million) on the amendment date to additionalpaid in capital. Interest expense attributable to the amortization of thewarrants amounted to approximately $0.1 million and $0.4 million for eachof the three and nine month periods ended September 30, 2005 and 2004.

 

In connection with theissuance of the Debentures and Warrants, the Company incurred placement agentfees, legal fees and other expenses of approximately $1.2 million to bepaid in cash. In addition to the placement fees, the Company issued warrants tothe placement agent. The warrants to purchase 86,000 shares of common stock atan exercise price of $10.068 are in the same form and on the same terms andconditions as the Warrants issued to the investor. The Company included thevalue of the warrants, $0.4 million, using the factors above, and the cashplacement fees of $1.2 million in other assets on the consolidated balancesheet. Collectively, the debt issuance costs of $1.6 million are beingamortized over three years, the initial term of the Debentures. For each of thethree and nine month periods ended September 30, 2005 and 2004,approximately $0.2 million and $0.4 million of the deferred financing costs areincluded in amortization expense.

 

**NOTE 8 -****EQUITY INSTRUMENTS**

 

(a) Preferred Stock

 

In the nine month periodended September 30, 2005, 78,000 shares of Series C Preferred Stockwere converted into 0.6 million shares of the Company’s common stock. Allpreferred stock previously issued and outstanding have been converted as of September 30,2005.

 

The Company’s preferredstock accrue and cumulate dividends at a rate of 6% per year, compoundedmonthly, payable when, as and if declared by the Company’s Board of Directors.Accordingly, the accrued dividends are reflected as “Preferred stock dividends”on the consolidated statements of operations. Accrued dividends must be paidbefore any dividends may be declared or paid on the common stock, and shall bepaid as an increase in the liquidation preference of the preferred stockpayable upon a sale, merger, liquidation, dissolution or winding up of theCompany. Accrued but unpaid dividends are canceled upon conversion of thepreferred stock. As of September 30, 2005, all accrued but unpaiddividends have been canceled.

 

(b) Common Stock

 

*Additional Paid-in Capital*

 

*During the nine month period ended September 30, 2005,the Company’s additional paid-in capital increased by $2.2 million primarilydue to $1.5 million in stock-based compensation issued to employees and $0.7million from exercise of stock options.*

 

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**NOTE 9 - STOCK INCENTIVE PLANS**

 

*In January 2005, the Company entered into agreements togrant 1.7 million shares of restricted stock to certain employees, subsequentlyadjusted to 1.5 million shares for forfeitures. Approximately 0.9 million willbe granted and vested annually over a three year period contingent uponemployment with the Company on the date of vesting. Approximately 0.6 millionwill be granted and vested contingent upon the attainment of a performancemilestone of the Company’s stock, which is outside the control of theCompany. In accordance with APB 25, no expense related to these shares isrecorded until the Company’s stock price reaches the milestone. Ifthe Company’s stock price reaches the milestone, the Company would incurapproximately $5.9 million in stock-based compensation.*

* *

For the nine month period ended September 30, 2005, the Companygranted 4.1 million stock options under the 2002 Stock Incentive Plan toemployees at exercise prices based on the fair market value of the Company’scommon stock at the respective dates of grant.

 

On January 1, 2005, in accordance with the terms of the 2002 StockIncentive Plan, shares reserved for issuance under the Plan were increased by0.6 million.

 

**NOTE 10 – RECOVERY OF INVESTMENT**

 

In January 2005, the Company received $2.1 million as a return onan investment in Bidland. The return on investment was a result of thesettlement of pending litigation between Bidland and Telefonica S.A. and thesubsequent liquidation of Bidland. A portion of the settlement proceeds havebeen retained by Bidland until all tax issues are resolved, at which time anyremaining proceeds will be distributed. The Company does not expect futuredistributions, if any, to be material. In 2000, Bidland ceased operations and,accordingly, the Company recorded an impairment charge related to thecost-based investment.

 

**NOTE 11 -****SUPPLEMENTAL CASH FLOWINFORMATION**

 

Inthe nine month period ended September 30, 2005, the Company paid $1.1million for computer equipment capitalized at December 31, 2004.

 

Forthe nine month periods ended September 30, 2005 and 2004, the amount ofcash paid for interest was $0.3 million and $0.2 million, respectively.

 

**NOTE 12 – SEGMENTS**

 

TheCompany’s business is comprised of three reportable segments: Media, Search andTechnology. As a result of the Company’s acquisition of Decide in August 2004,the Company is reporting Search as a separate segment from Media. The Companymeasures segments based on segment income (loss) from operations. The Companyadjusted prior period segment disclosures to conform to the currentpresentation. The summarized segment information at and for the threeand nine month periods ended September 30, 2005 and 2004, is as follows:

 

18

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|                                                               |       | **Three Month Period Ended September 30, 2005** | ** ** | **Nine Month Period Ended September 30, 2005** | ** ** |
|--------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
|                                                               |       | **Media**                                            | ** ** | **Search**                                          | ** ** | **Technology** | ** ** | **Total** | ** ** | **Media** | ** ** | **Search** | ** ** | **Technology** | ** ** | **Total** | ** ** |
|                                                               |       | **(in thousands)**                                   | ** ** | **(in thousands)**                                  | ** ** |
|                                                               |       | ** **                                           | ** ** | ** **                                          |       |
| Revenues                                                           |       | $                                                    | 15,547     |                                                | $          | 13,731 |   | $ | 5,839 |   | $ | 35,117 |   | $ | 46,460 |   | $ | 35,063 |   | $ | 16,550 |   | $ | 98,073 |   |
| Depreciation                                                       |       | 81                                                   |       | 176                                                 |       | 504 |   | 761 |   | 323 |   | 516 |   | 1,240 |   | 2,079 |   |
| Amortization of intangible assets and deferred  financing costs    |       | 495                                                  |       | 395                                                 |       | 250 |   | 1,140 |   | 1,485 |   | 1,185 |   | 749 |   | 3,419 |   |
| Stock-based compensation                                           |       | 138                                                  |       | 151                                                 |       | 204 |   | 493 |   | 407 |   | 448 |   | 592 |   | 1,447 |   |
| Restructuring                                                      |       | —                                               |       | —                                              |       | — |   | — |   | 252 |   | 228 |   | 493 |   | 973 |   |
| Segment income (loss) from operations                              |       | 313                                                  |       | (838                                                | )          | 415 |   | (110 | ) | 892 |   | (2,513 | ) | (442 | ) | (2,063 | ) |
|                                                               |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                               |       | **Three Month Period Ended September 30, 2004** | ** ** | **Nine Month Period Ended September 30, 2004** |       |
|                                                               |       | **Media**                                            | ** ** | **Search**                                          | ** ** | **Technology** | ** ** | **Total** | ** ** | **Media** | ** ** | **Search** | ** ** | **Technology** | ** ** | **Total** |   |
|                                                               |       | **(in thousands)**                                   | ** ** | **(in thousands)**                                  |       |
|                                                               |       | ** **                                           | ** ** | ** **                                          |       |
| Revenues                                                           |       | $                                                    | 12,070     |                                                | $          | 4,109 |   | $ | 4,628 |   | $ | 20,807 |   | $ | 34,451 |   | $ | 9,658 |   | $ | 13,676 |   | $ | 57,785 |   |
| Depreciation                                                       |       | 138                                                  |       | 51                                                  |       | 278 |   | 467 |   | 495 |   | 146 |   | 771 |   | 1,412 |   |
| Amortization of intangible assets and deferred  financing costs    |       | 614                                                  |       | 125                                                 |       | 329 |   | 1,068 |   | 1,726 |   | 557 |   | 987 |   | 3,270 |   |
| Stock-based compensation                                           |       | 143                                                  |       | 56                                                  |       | 10 |   | 209 |   | 466 |   | 132 |   | 108 |   | 706 |   |
| Restructuring                                                      |       | —                                               |       | —                                              |       | — |   | — |   | 136 |   | 97 |   | 268 |   | 501 |   |
| Segment loss from operations                                       |       | (1,436                                               | )          | (159                                                | )          | (136 | ) | (1,731 | ) | (2,954 | ) | (1,574 | ) | (410 | ) | (4,938 | ) |
|                                                               |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Total assets:**                                                  |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| September 30, 2005                                            |       | $                                                    | 67,187     |                                                | $          | 47,261 |   | $ | 13,806 |   | 128,254 |   |   |   |   |   |   |   |   |   |
| December 31, 2004                                             |       | 72,910                                               |       | 36,849                                              |       | 11,639 |   | 121,398 |   |   |   |   |   |   |   |   |   |
|                                                               |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| ** **                                                         | ** ** | **United**                                           | ** ** | **United**                                          | ** ** | **South** | ** ** | **Other -** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                         | ** ** | **States**                                           | ** ** | **Kingdom**                                         | ** ** | **Korea** | ** ** | **International** | ** ** | **Total** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                         | ** ** | **(in thousands)**                                   | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                                               |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenues for the three month period ended September 30,  2005 |       | $                                                    | 15,343     |                                                | $          | 7,141 |   | $ | 3,489 |   | $ | 9,144 |   | $ | 35,117 |   |   |   |   |   |   |   |
| Revenues for the nine month period ended September 30,  2005  |       | 44,575                                               |       | 20,450                                              |       | 9,349 |   | 23,699 |   | 98,073 |   |   |   |   |   |   |   |
| Long-lived assets as of September 30, 2005                    |       | 11,814                                               |       | 834                                                 |       | 15,979 |   | 29,208 |   | 57,835 |   |   |   |   |   |   |   |
|                                                               |       |                                                 |       |                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenues for the three month period ended September 30,  2004 |       | $                                                    | 11,067     |                                                | $          | 3,386 |   | $ | 2,729 |   | $ | 3,625 |   | $ | 20,807 |   |   |   |   |   |   |   |
| Revenues for the nine month period ended September 30,  2004  |       | 29,437                                               |       | 9,578                                               |       | 9,246 |   | 9,524 |   | 57,785 |   |   |   |   |   |   |   |
| Long-lived assets as of December 31, 2004                     |       | 11,603                                               |       | 351                                                 |       | 16,512 |   | 30,432 |   | 58,898 |   |   |   |   |   |   |   |

 

**NOTE 13 - COMMITMENTS AND CONTINGENCIES**

 

(a) Commitments

 

*Lycos, Inc. Services Agreements*

 

On February 11, 2004, the Company entered into a five-yeararrangement with Lycos, Inc. (“Lycos”), including an advertising servicesagreement to provide media sales, a technology services agreement to provideadvertisement serving and analytics technology services to Lycos’ U.S. Webproperties, and a transition services agreement to transition personnel and otherservices to the Company. The Company and Lycos amended the advertising servicesagreement and the technology services agreement on December 7, 2004 and,as amended, Lycos effectively may terminate the media services agreementon January 1, 2007.

 

The amended media services agreement provides that Lycos will have theexclusive right to sell advertising, and for the billing and collection of alladvertising, on Wired.com and Quote.com, on July 1, 2005 and January 1,2006, respectively.  On or prior to therespective transition dates, the Company will identify twenty advertisingaccounts (“24/7 Accounts”) to which it has sold advertising on Wired.Com andQuote.com.

 

19

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Theagreement provides that Lycos will pay the Company transition commissions basedon advertising sales revenue minus bad debt (“net advertising sales revenue”)as follows:

 

•                  35%of net advertising sales revenue generated from the 24/7 Accounts on Wired.comfor each of July and August 2005, payable on or prior to October 15,2005, provided that the transition commission is capped at 35% of the averagemonthly gross revenues generated from the 24/7 Accounts during the period from January 1,2005 to June 30, 2005;

 

•                  17.5%of net advertising sales revenue generated from the 24/7 Accounts on Wired.comfor each of September and October 2005, payable on or prior to December 15,2005, provided that the transition commission is capped at 17.5% of the averagemonthly gross revenues generated from the 24/7 Accounts during the period from January 1,2005 to June 30, 2005;

 

•                  35%of net advertising sales revenue generated from the 24/7 Accounts on Quote.comfor each of January and February 2006, payable on or prior to April 15,2006, provided that the transition commission is capped at 35% of the averagemonthly gross revenues generated from the 24/7 Accounts during the period from July 1,2005 to December 31, 2005; and

 

•                  17.5%of net advertising sales revenue generated from the 24/7 Accounts on Quote.comfor each of March and April 2006, payable on or prior to June 15,2006, provided that the transition commission is capped at 17.5% of the averagemonthly gross revenues generated from the 24/7 Accounts during the period from July 1,2005 to December 31, 2005.

 

Theamended media services agreement reconciled past royalty payments and requiresthe Company to pay quarterly royalties for advertising inventory made availableby Lycos as follows:

 

•                  Inceptionthrough December 31, 2004: $6.2 million, which was paid ininstallments of $5.7 million in 2004 and $0.5 million in February 2005.

 

•                  January 1,2005 through March 31, 2005: 65% of net advertising sales revenue;

 

•                  April 1,2005 through June 30, 2005: 65% of the greater of (i) of netadvertising sales revenue generated during the period and (ii) the minimumcost-per-thousand (“CPM”) revenue for such period;

 

•                  July 1,2005 through December 31, 2005: 62.5% of the greater of (i) of netadvertising sales revenue generated during the period and (ii) the minimumCPM revenue for such period;

 

•                  January 1,2006 through the expiration or termination of the media services agreement:62.5% of net advertising sales revenue.

 

Pursuant to the mediaservices agreement minimum CPM revenue is determined on a quarterly basis bymultiplying Lycos’ projected advertisement impression level for that quarter byspecific CPM prices for advertising inventory in specific category and unittypes.

 

In addition to the royalties, the Company paid Lycosa $4.5 million transition fee, which the Company recorded as an otherasset and is amortizing the fee over the term of the agreement of five years.Amortization related to the transition fee was $0.2 million and $0.7 millionfor each of the three and nine month periods ended September 30, 2005 and2004, respectively. In accordance with SFAS 144, the Company periodicallyevaluates the recoverability of this asset.

 

20

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*Acquisition Earn-Out Payments*

 

The Company has contingent obligations related toits acquisition of Decide. Decide stockholders may receive up to an additional$10.0 million, consisting of up to $2.5 million in cash and up to $7.5million in common stock, subject to achievement of earn-out targets relating toDecide’s operating performance in 2005.

 

*Indemnifications*

 

Whilethe Company has various indemnification obligations included in contracts inthe normal course of business, these indemnities do not represent significantcommitments or contingent liabilities of the indebtedness of others.Accordingly, the Company has not recorded a liability related toindemnification provisions.

 

(b) Litigation

 

The Company is involved in various claims and legal actions arising inthe ordinary course of business. In the opinion of management, the ultimatedisposition of these matters will not have a material effect on the Company’sfinancial position, results of operations or liquidity.

 

*Litigation with Brian Anderson*

 

On July 15, 2001, Brian Anderson, former Chief Executive Officerof our AwardTrack, Inc. subsidiary, served the Company with notice of alawsuit filed in Superior Court for the State of California in and for theCounty of Santa Cruz, alleging breach of contract, fraud, intentionalinfliction of emotional distress and breach of fiduciary duty, in connectionwith the acquisition of AwardTrack and subsequent events. The Company removedthe lawsuit to federal court in California and moved to dismiss the complaintin its entirety. The motion was granted in part, with leave to amend, and deniedin part. The plaintiff subsequently refiled the complaint and the Company fileda counterclaim. In June 2005, the Company settled with Mr. Andersonfor the release of all claims and termination of all litigation matters.

 

21

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ITEM2.  MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

This Quarterly Reportincludes forward-looking statements within the meaning of the PrivateSecurities Litigation Reform Act of 1995. This Act provides a “safe harbor” forforward-looking statements to encourage companies to provide prospectiveinformation about themselves so long as they identify these statements asforward looking and provide meaningful cautionary statements identifying importantfactors that could cause actual results to differ from the projected results.All statements other than statements of historical fact, including statementsregarding industry prospects and future results of operations or financialposition, made in this Quarterly Report are forward-looking. We use words suchas “anticipates,” “believes,” “expects,” “future” and “intends” and similarexpressions to identify forward-looking statements. Forward-looking statementsreflect management’s current expectations, plans or projections and areinherently uncertain. Our actual results may differ significantly frommanagement’s expectations, plans or projections. Readers are cautioned not toplace undue reliance on these forward-looking statements, which speak only asof the date hereof. Certain risks and uncertainties that could cause our actualresults to differ significantly from management’s expectations are described inthe section entitled “Factors that Could Affect Future Results” andelsewhere in this Quarterly Report. We undertake no obligation to publiclyrelease any revisions to these forward-looking statements to reflect events orcircumstances after the date hereof or to reflect the occurrence ofunanticipated events. Readers are urged, however, to review the risk factorsset forth in reports that we file from time to time with the Securities andExchange Commission (“SEC”). Unless the context requires otherwise in thisQuarterly Report the terms “24/7 Real Media,” the “Company,” “we,” “us” and “our”refer to 24/7 Real Media, Inc. and its consolidated subsidiaries, andreferences to “24/7 Search” refer to 24/7 Search, Inc., formerly 24/7Website Results, Inc., and Decide Holdings Pty Limited (“Decide”), each awholly owned subsidiary of 24/7 Real Media, Inc.

 

### **GENERAL**

###  

24/7 Real Media is apioneer in the Internet industry, providing online advertising and searchmarketing strategies since 1995. We have three distinct lines ofbusiness, Media, Search and Technology, and operate in over a dozen countries. OurMedia business helps advertisers increase their reach through sophisticatedtargeting and a network of more than 1,562 Web sites. Our Search businessenables marketers to maximize their search engine marketing spending andachieve optimum returns on their investments. Our Technology business developsand licenses our powerful technology, which serves as the underlying engine foreverything we do.

 

*Media*

 

We sell advertising space for Web publishers through the 24/7 WebAlliance, a network of Web sites with brand names, quality content and globalreach. Web publishers join the 24/7 Web Alliance to increase advertisingrevenues from the available advertising space on their Web sites. We solicitadvertisers seeking online strategies to target audiences, build their brandsand generate customer response. Advertisers purchase space through the 24/7 WebAlliance to make one purchase across several Web sites and to increase thereturn on their advertising spending. We also use targeting technology to bestselect advertising space made available through the 24/7 Web Alliance foradvertisers and to improve the performance of under-utilized advertising spacefor Web publishers.

 

We generate Media revenue from fees paid by client advertisers foradvertising space. We typically sell advertising space on acost-per-thousand-impressions (“CPM”) basis, enabling a client advertiser topay a fee based on the number of times its advertisement is displayed. Wetypically count an advertising

 

22

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impression each time a user’s Web browser requests that our computerservers transmit the advertisement. We may charge higher CPMs toadvertisers that purchase our advanced targeting solutions, such as ourbehavioral targeting solution, in comparison to those that purchase advertisingspace that requires less specific targeting.

 

We pay Web publishers included in the 24/7 Web Alliance a royalty fortheir advertising space. The royalty generally does not exceed 65% of the grossadvertising revenue we generate from a Web publisher’s advertising space, butmay be more, for example, if the advertising space is viewed by a larger orbetter quality audience.

 

On a very limited basis, we have generated revenue from e-mailadvertisements and marketing.

 

*Search*

 

We provide search marketing services that connect advertisers withconsumers using search engines to find information, products and services. Weleverage our relationships with search engines and our understanding of searchengine algorithms to help advertisers optimize their Web pages and achievebetter placement in algorithmic search engines. We also create Web sitelistings for advertisers and submit their listings into the databases ofpay-for-placement (“P4P”) and paid-inclusion (“PI”) search engine platforms. Wehelp advertisers determine the keywords most relevant to their products andservices and use advanced technology to manage keyword bidding simultaneouslyacross P4P search platforms. Our technology shows advertisers which keywords leadusers from search engines to their Web sites and helps them optimize theiradvertising spending to convert click-throughs (users who click on theiradvertisement and are directed to their Web site) into sales.

 

Our Search revenue is primarily based on cost-per-click(“CPC”) fees paid by client advertisers. CPC fees are generated each timesearch engine users click Web site listings submitted by us into search enginedatabases and are directed to our client advertisers’ Web sites. To a lesserextent, we also generate revenue from fees paid by advertisers for consultingservices and search engine optimization services, and from fees paid by searchengines that employ us to optimize the relevancy of Web site listings andreport on advertising campaigns for their advertisers. We develop directrelationships with P4P and algorithmic search engines in order to enhance theservices we provide to our client advertisers. We refer to search engines wework with as search engine distribution partners.

 

*Technology*

 

We provide online advertisement serving and analytics software tocustomers from software hosted locally on the customers’ servers or fromsoftware hosted centrally on our servers. Our technology products and servicesare all based on our proprietary Open AdSystem platform. We generate Technologyrevenue in the following ways:

 

*Open AdStream Central Service.*We charge service fees to Web publishers for operating our Open AdStream (“OAS”)online advertisement serving software centrally from our servers. We typicallycharge a service fee determined by multiplying an agreed CPM by the number ofadvertising impressions served using OAS. The service fee may vary based on theforecasted number of advertising impressions a Web publisher will serve usingour software and the service term, among other factors. We typically billservice fees monthly.

 

*Open AdStream Local Software.* Wecharge fees to Web publishers for operating our OAS software locally from theirown servers. Our license agreements typically provide for a license fee, asoftware maintenance and technical support services fee and a training fee. Weoften base license fees on the

 

23

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forecasted number of advertising impressions a Webpublisher will serve using our software, the use of advanced software modulesand the license term.

 

*Open Advertiser Service.* Wecharge service fees to advertisers and agencies for operating our OpenAdvertiser (“OAD”) advertisement serving software centrally from our servers.We determine our service fee by multiplying the CPM by the number ofadvertising impressions delivered. We typically bill service fees monthly. Theservice fee may vary based on the forecasted number of advertising impressionsa Web publisher will serve using our software and the service term, among otherfactors. In the fourth quarter of 2004, we made the strategic decision tointegrate OAD functionalities into OAS. As a result, OAD service revenue maydecline.

 

*Insight XE Software and Service.*  OurInsight XE solution offers Web publishers active campaign reporting andmarketing intelligence and helps advertisers measure, analyze and manage onlineaudiences. We charge service fees to Web publishers for operating our XEsoftware centrally on our servers. We determine the service fees by multiplyingan agreed CPM by the number of page views measured by our Insight XEsoftware.

 

*Insight ACT Software.* Our Insight ACT software, whichrequires our OAS and Insight XE software solutions, enables Web publishers toidentify and target segments of their audiences based on user activity. Wegenerate revenue from Insight ACT on the same basis as the associated OAS andInsight XE arrangements. As of September 30, 2005, we have not generatedsignificant revenue from Insight ACT.

 

To a lesser extent, we generate revenue by providingprofessional services charged at an hourly rate and from fees paid by Webpublishers for trafficking their advertisements. Trafficking advertisementsrefers to entering advertisement creative material and campaign specificationsinto our OAS software.

 

**RECENTDEVELOPMENTS**

 

On September 5, 2005, we signed a joint venture agreement withDentsu Inc. (“Dentsu”) to deliver search engine marketing (“SEM”) services tothe Japanese market. The partnership, K.K. 24/7 Search, in which Dentsu owns asignificant minority interest, simultaneously entered into an agreement to bethe exclusive provider of SEM services to Dentsu’s extensive client base. Underthe terms of the agreement, Dentsu will contribute its extensive Japanesemarketing industry knowledge and connections to the joint venture, and consignto the joint venture all SEM services provided to its clients. We will licenseour Decide DNA technology to the joint venture, as well as provide SEMexpertise and operational management.

 

# **RESULTS OF OPERATIONS**

#  

### Thefollowing table compares the results of operations for the three and nine monthperiods ended September 30, 2005 to the results of operations for thethree and nine month periods ended September 30, 2004 (in thousands):

 

24

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| ** **                                                                                               | ** ** | **Three Months Ended September 30,** | ** ** | ** **      | ** ** | **Nine Months Ended September 30,** | ** ** | ** **      | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|-----------------|------------|------------------------------------------|------------|-----------------|------------|
| ** **                                                                                               | ** ** | **2005**                                  | ** ** | **2004**        | ** ** | **$ Var**                           | ** ** | **2005**        | ** ** | **2004** | ** ** | **$ Var** | ** ** |
| ** **                                                                                               | ** ** | **(unaudited)**                           | ** ** | **(unaudited)** | ** ** | ** **                               | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** | ** ** | ** ** |
| Revenues:                                                                                                |       |                                      |       |            |       |                                     |       |            |       |   |   |   |   |
| Media                                                                                                    |       | $                                         | 15,547     |            | $          | 12,070                                   |       | $               | 3,477      |   | $ | 46,460 |   | $ | 34,451 |   | $ | 12,009 |   |
| Search                                                                                                   |       | 13,731                                    |       | 4,109           |       | 9,622                                    |       | 35,063          |       | 9,658 |   | 25,405 |   |
| Technology                                                                                               |       | 5,839                                     |       | 4,628           |       | 1,211                                    |       | 16,550          |       | 13,676 |   | 2,874 |   |
| Total revenues                                                                                           |       | 35,117                                    |       | 20,807          |       | 14,310                                   |       | 98,073          |       | 57,785 |   | 40,288 |   |
|                                                                                                     |       |                                      |       |            |       |                                     |       |            |       |   |   |   |   |
| Cost of revenues:                                                                                        |       |                                      |       |            |       |                                     |       |            |       |   |   |   |   |
| Media                                                                                                    |       | 10,516                                    |       | 9,180           |       | 1,336                                    |       | 31,470          |       | 24,986 |   | 6,484 |   |
| Search                                                                                                   |       | 10,026                                    |       | 2,241           |       | 7,785                                    |       | 24,405          |       | 6,363 |   | 18,042 |   |
| Technology                                                                                               |       | 998                                       |       | 827             |       | 171                                      |       | 3,167           |       | 2,528 |   | 639 |   |
| Total cost of revenues                                                                                   |       | 21,540                                    |       | 12,248          |       | 9,292                                    |       | 59,042          |       | 33,877 |   | 25,165 |   |
|                                                                                                     |       |                                      |       |            |       |                                     |       |            |       |   |   |   |   |
| Gross profit                                                                                             |       | 13,577                                    |       | 8,559           |       | 5,018                                    |       | 39,031          |       | 23,908 |   | 15,123 |   |
|                                                                                                     |       |                                      |       |            |       |                                     |       |            |       |   |   |   |   |
| Operating expenses:                                                                                      |       |                                      |       |            |       |                                     |       |            |       |   |   |   |   |
| Sales and marketing                                                                                      |       | 5,606                                     |       | 4,272           |       | 1,334                                    |       | 16,627          |       | 11,481 |   | 5,146 |   |
| General and administrative                                                                               |       | 4,885                                     |       | 3,626           |       | 1,259                                    |       | 14,457          |       | 9,627 |   | 4,830 |   |
| Product development                                                                                      |       | 1,563                                     |       | 1,115           |       | 448                                      |       | 4,171           |       | 3,261 |   | 910 |   |
| Amortization of intangible assets and deferred financing  costs                                          |       | 1,140                                     |       | 1,068           |       | 72                                       |       | 3,419           |       | 3,270 |   | 149 |   |
| Stock-based compensation                                                                                 |       | 493                                       |       | 209             |       | 284                                      |       | 1,447           |       | 706 |   | 741 |   |
| Restructuring costs                                                                                      |       | —                                    |       | —          |       | —                                   |       | 973             |       | 501 |   | 472 |   |
|                                                                                                     |       |                                      |       |            |       |                                     |       |            |       |   |   |   |   |
| Total operating expenses                                                                                 |       | 13,687                                    |       | 10,290          |       | 3,397                                    |       | 41,094          |       | 28,846 |   | 12,248 |   |
|                                                                                                     |       |                                      |       |            |       |                                     |       |            |       |   |   |   |   |
| Loss from operations                                                                                     |       | (110                                      | )          | (1,731          | )          | 1,621                                    |       | (2,063          | )          | (4,938 | ) | 2,875 |   |
|                                                                                                     |       |                                      |       |            |       |                                     |       |            |       |   |   |   |   |
| Interest expense, net                                                                                    |       | (48                                       | )          | (93             | )          | 45                                       |       | (190            | )          | (371 | ) | 181 |   |
| Change in fair value of warrant liability                                                                |       | (384                                      | )          | 266             |       | (650                                     | )          | (344            | )          | 2,075 |   | (2,419 | ) |
| Recovery of investment                                                                                   |       | —                                    |       | —          |       | —                                   |       | 2,100           |       | — |   | 2,100 |   |
| Impairment of marketable securities                                                                      |       | —                                    |       | —          |       | —                                   |       | (588            | )          | — |   | (588 | ) |
| Loss on sale of maketable securities                                                                     |       | (25                                       | )          | —          |       | (25                                      | )          | (18             | )          | — |   | (18 | ) |
| Gain on legal settlement                                                                                 |       | —                                    |       | —          |       | —                                   |       | —          |       | 2,896 |   | (2,896 | ) |
| Other income (expense), net                                                                              |       | (55                                       | )          | 12              |       | (67                                      | )          | (95             | )          | 123 |   | (218 | ) |
|                                                                                                     |       |                                      |       |            |       |                                     |       |            |       |   |   |   |   |
| Loss before provision for income taxes and minority  interest in operations of consolidated subsidiaries |       | (622                                      | )          | (1,546          | )          | 924                                      |       | (1,198          | )          | (215 | ) | (983 | ) |
|                                                                                                     |       |                                      |       |            |       |                                     |       |            |       |   |   |   |   |
| Provision for income taxes                                                                               |       | (164                                      | )          | (44             | )          | (120                                     | )          | (184            | )          | (176 | ) | (8 | ) |
| Minority interest in operations of consolidated  subsidiaries                                            |       | 21                                        |       | —          |       | 21                                       |       | 21              |       | — |   | 21 |   |
|                                                                                                     |       |                                      |       |            |       |                                     |       |            |       |   |   |   |   |
| Net loss                                                                                                 |       | $                                         | (765       | )               | $          | (1,590                                   | )          | $               | 825        |   | $ | (1,361 | ) | $ | (391 | ) | $ | (970 | ) |

 

**Revenues; Cost of Revenues and Gross Profit**

 

*Media*

 

*Revenue*. We generateMedia revenue primarily from our 24/7 Web Alliance. Media revenue was $15.6million and $46.5 million for the three and nine month periods ended September 30,2005, respectively, as compared to $12.1 million and $34.4 million for thethree and nine month periods ended September 30, 2004, respectively, anincrease of 28.8% and 34.9%, respectively. The increase is primarily related toan increase in advertising impressions sold. The number of advertisingimpressions delivered increased from approximately 13.7 billion in the thirdquarter of 2004 to 23.3 billion in third quarter of 2005.

 

*Cost of Revenues*.****Mediacost of revenues consisted primarily of fees paid to Web publishers in our 24/7Web Alliance. Cost of revenues also included advertisement serving costs, whichare intercompany charges from our Technology segment based on a fixed CPM.

 

*Gross Profit*. Gross profit margins for Media were 32.4%and 32.3% for the three and nine month periods ended September 30, 2005,respectively, and 23.9% and 27.5% for the three and nine month periods ended September 30,2004, respectively. The increase is a result of the increase in the number anddiversity of Web publishers in the 24/7 Network which decreased the averageroyalty percentage that we paid to Web publishers, and an increase in thenumber of network campaigns we delivered. Advertisement serving costs were $0.5million and $1.3 million for the three and nine month periods

 

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ended September 30, 2005,respectively. Advertisement serving costs were $0.3 million and $0.9 millionfor the three and nine month periods ended September 30, 2004, respectively.

 

*Search*

 

*Revenue*. Search revenue was $13.7 million and $35.1 million for the three andnine month periods ended September 30, 2005, respectively, as compared to $4.1million and $9.7 million for the three and nine month periods ended September30, 2004, respectively, an increase of 234.2% and 263.0%, respectively.  The increase is due to the addition of newadvertiser accounts, the use of the Decide DNA technology acquired in August2004 across all of our accounts, and the additional advertiser accounts that wegained as a result of the Decide acquisition. In addition, growth in the Searchmarketplace has led to growth in the businesses of our search enginedistribution partners, which when combined with our sales efforts and improvedoperational controls, we believe has contributed to an increase in the averagerevenue per account.

 

*Cost of Revenues*. Search cost of revenues consisted primarily of fees paid to oursearch engine distribution partners, which are calculated as a percentage ofrevenues for algorithmic search engines and a fixed CPC for pay-for-placementsearch engines. Search cost of revenues also included hosting and bandwidthcharges associated with the infrastructure.

 

*Gross Profit*. Grossprofit margins for Search were 27.0% and 30.4% for the three and nine monthperiods ended September 30, 2005, respectively, and 45.5% and 34.1% for thethree and nine month periods ended September 30, 2004, respectively. Thedecrease was due to faster growth and a decreasing margin in our lower marginfull service offering. Full service margins are decreasing due to the additionof higher quality, high volume accounts which usually command a better price,as well as competition in the marketplace.

 

*Technology*

 

*Revenue*.****Technology revenue was$5.8 million and $16.6 million for the three and nine month periods endedSeptember 30, 2005, respectively, as compared to $4.6 million and $13.7 millionfor the three and nine month periods ended September 30, 2004, respectively,representing an increase of 26.2% and 21.0%, respectively. The increaseprimarily reflects expanded usage by existing customers of Open AdStreamCentral and usage by new customers. In particular, Open AdStream Centraldelivered 50.7 billion impressions in the third quarter of 2005, up from 24.0billion in the comparable period in 2004.

 

*Cost of Revenues*.Technology cost of revenues consisted of costs for hosting, bandwidth,third-party license and support fees and support and maintenance of theinfrastructure, including salaries and benefits of related technical personnel.The cost of revenues is offset by intercompany fees charged to our Mediasegment for advertisement serving.

 

*Gross Profit*. Grossprofit margins for Technology were approximately 82.9% and 80.9% for the threeand nine month periods ended September 30, 2005, respectively, and 82.1% and81.5% for the three and nine month periods ended September 30, 2004,respectively.

 

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**Sales andMarketing Expenses**

 

Sales and marketing expensesconsisted primarily of compensation and personnel related expenses for sales,account management, business development, affiliate relations andmarketing, and marketing costs such as advertising, trade shows and public andinvestor relations firms.

 

Sales and marketing expenses were $5.6million and $16.6 million for the three and nine month periods ended September30, 2005, respectively, and $4.3 million and $11.5 million for the three andnine month periods ended September 30, 2004, respectively. The increase wasprimarily due to additional personnel-related costs and an increase in marketingactivities. Sales andmarketing expenses decreased as a percentage of revenue from 20.5% to 16.0% forthe three month periods ended September 30, 2004 and 2005, respectively, andfrom 19.9% to 17.0% for the nine month periods ended September 30, 2004 and2005, respectively, as we were able to gain operating leverage. The number ofemployees included in sales and marketing increased from 188 at September 30,2004 to 207 at September 30, 2005.

 

**General andAdministrative Expenses**

 

General and administrative expenses consistedprimarily of compensation and related expenses for executive and administrativepersonnel, costs related to leasing, maintaining and operating our facilitiesand systems, insurance, bad debts, fees for professional services, feesassociated with the reporting and other obligations of a public company,depreciation and other general and administrative costs. Fees for professional servicesincluded payments to external lawyers, accountants and other professionals inconnection with operating our business, compliance and evaluating and pursuingnew opportunities.

 

General and administrative expenses were $4.9million and $14.5 million for the three and nine month periods ended September30, 2005, respectively, and $3.6 million and $9.6 million for the three andnine month periods ended September 30, 2004, respectively. The increase was dueprimarily to an increase in employee headcount from 56 at September 30, 2004 to60 at September 30, 2005 and increased compliance costs. As a percentage ofrevenue, the expenses decreased from 17.4% to 13.9% for the three month periodsended September 30, 2004 and 2005, respectively, and from 16.7% to 14.7% forthe nine month periods ended September 30, 2004 and 2005, respectively, showingincreased leverage of these expenses over a larger revenue base.

 

**ProductDevelopment Expenses**

 

Product development expensesconsisted primarily of compensation and related expenses for personnelresponsible for the development and maintenance of features, enhancements andfunctionality and qualityassurance for our software and services and development of new products.

 

Product development expenses were $1.6million and $4.2 million for the three and nine month periods ended September30, 2005, respectively, and $1.1 million and $3.3 million for the three andnine month periods ended September 30, 2004, respectively.  The increasereflects our continued investment in the development and enhancement of ourproducts and services. The number of employees included in product developmentdecreased from 53 at September 30, 2004 to 50 at September 30, 2005 as weconsolidated our efforts after the acquisition of Decide and the outsourcing ofsome of our development efforts.

 

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**Amortizationof Intangible Assets and Deferred Financing Costs**

 

Amortization expense relatedto intangible assets acquired with 24/7 Search in August 2000, Real Media inOctober 2001, Insight First in January 2003, Real Media Korea in January 2004and Decide in August 2004; deferred financing costs associated with thesubordinated convertible debenture offering in September 2003; and thetransition payment to Lycos, Inc. in February 2004.

 

For the nine month period ended September 30,2005, amortization expense related $1.7 million to acquired technology, $0.6million to other intangible assets, $0.4 million to deferred financing costsand $0.7 million to the transition payment to Lycos. For the nine month periodended September 30, 2004, amortization expense was attributed as follows: $1.5million to acquired technology, $0.8 million to other intangible assets, $0.4million to deferred financing costs and $0.6 million to the transition paymentto Lycos.

 

**Stock-BasedCompensation**

 

Stock-based compensation was $1.4 million and$0.7 million for the nine month periods ended September 30, 2005 and 2004,respectively. Stock-based compensation in 2005 related primarily to theamortization of deferred compensation for restricted shares to be issued tocertain employees. Stock-based compensation in 2004 consisted of $0.5 millionaccrued for potential performance incentives and $0.2 million in amortizationof deferred compensation for restricted shares issued to certainemployees.

 

**RestructuringCosts**

 

During the nine month period ended September30, 2005, we recorded a restructuringcharge of $1.0 million relating to our former New York headquarters.

 

During the nine month period ended September30, 2004, the Company took additional steps to align its sales, development andadministrative organization and reduce corporate overhead to position itselffor profitable growth in the future. This involved the involuntary terminationof approximately seven employees, as well as charges for excess real estatespace, primarily at our German office. The Company recorded a restructuringcharge in connection with these activities of approximately $0.5 million.

 

**InterestExpense, Net**

 

Interest expense, net related to ourlong-term debt and capital lease obligations offset by interest income relatedto our cash and cash equivalents. Interest expense for the three and nine monthperiods ended September 30, 2004 and September 30, 2005 primarily related tothe $15.0 million of subordinated convertible debentures due September 2006 (“debentures”)we issued on September 26, 2003, of which a portion of the interest incurredrelates to a cash payment due and a portion related to the amortization ofwarrants issued with the debentures. Interest expense in these periods in 2004and 2005 was offset by interest income from cash in overnight deposits andmoney market accounts.

 

**Change inFair Value of Warrant Liability**

 

Our liability relates to warrants outstandingfrom our preferred stock and subordinated convertible debenture offerings, andis adjusted to fair value at the end of each reporting period. The expense forthe nine month period ended September 30, 2005 is due to an increase in thefair value of the warrants outstanding, which increased the correspondingliability. The increase in the fair value was primarily due to the higher fairmarket value of our stock compared to the fair value of our common stock atDecember 31, 2004.

 

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**Recoveryof Investment**

 

In January 2005, we received$2.1 million as a return on an investment in Bidland. The return was a resultof the settlement of pending litigation between Bidland and Telefonica S.A andthe subsequent liquidation of Bidland. A portion of the settlement proceedshave been retained by Bidland until all tax issues are resolved at which timeany remaining proceeds will be distributed. We do not expect futuredistributions, if any, to be material. In 2000, Bidland ceased operations and,accordingly, we recorded an impairment charge related to the cost-basedinvestment.

 

**Impairmentof Marketable Securities**

 

During the first quarter of2005, we wrote down our available-for-sale investment in chinadotcom andrecognized an impairment charge of approximately $0.6 million forother-than-temporary declines in the value of the investment.

 

**Loss onSale of Marketable Securities**

 

During the nine month periodended September 30, 2005, the Company sold 278,700 shares of its chinadotcomcommon stock, which resulted in proceeds of approximately $0.9 million and a realizedloss of approximately $18,000.

 

**MinorityInterest in Operations of Consolidated Subsidiaries**

 

Minority interest in operations of consolidatedsubsidiaries represents the minority holders’ percentage share of losses fromsuch subsidiaries in which we hold a majority ownership interest, but less than100 percent, and consolidate the subsidiaries’ results in our consolidatedfinancial statements.

 

**Gain onLegal Settlement**

 

We recorded a $2.9 million gain for the nine monthperiod ended September 30, 2004 related to our legal settlement withchinadotcom corporation, which we received in the form of 0.4 million shares ofchinadotcom common stock, valued at the market price on the date of settlement.

 

**OtherIncome (Expense), Net**

 

Other income (expense), net in 2005 consistedof legal fees associated with a former subsidiary that we shut down, a legalsettlement and realized foreign currency losses offset by earn-out paymentsreceived in excess of amounts recorded.

 

Other income (expense), net in 2004 consistedprimarily of legal fees associated with a former subsidiary that we shut down.

 

**Dividendson Preferred Stock**

 

Our preferred stock accrue andaccumulate dividends at a rate of 6% per year, compounded monthly, payablewhen, as and if declared by our Board of Directors. All accrued dividends mustbe paid before any dividends may be declared or paid on the common stock, andshall be paid as an increase in the liquidation preference of the preferredstock payable upon a sale, merger, liquidation, dissolution or winding up ofthe Company. Accrued but unpaid dividends cancel upon conversion of thepreferred stock.

 

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**LIQUIDITYAND CAPITAL RESOURCES**

 

Cash flow for the nine month periods endedSeptember 30, 2005 and 2004 were as follows (in thousands):

 

| ** **                                           | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                           | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| Net cash  provided by (used in) operating activities |       | $                                   | 6,664      |   | $ | (6,556 | ) |
| Net cash  used in investing activities               |       | $                                   | (1,312     | ) | $ | (19,216 | ) |
| Net cash  provided by financing activities           |       | $                                   | 2,344      |   | $ | 37,809 |   |

 

Since our inception we have financed ouroperations through equity financings and long-term debt. Net cash provided byoperating activities was $6.7 million during the nine month period endedSeptember 30, 2005. We used approximately $6.6 million of cash in operatingactivities during the nine month period ended September 30, 2004. Cash providedby (used in) operating activities is generally a result of our net operatinglosses, adjusted for certain non-cash items included in our operating resultsas well as changes in various components of working capital, particularly accounts receivable. Wegenerally pay our search engine distribution partners and some of ourWeb site publishers in advance of receiving payments from our customers.

 

Net cash used in investing activities wasapproximately $1.3 million during the nine month period ended September 30,2005. Investing activities in the nine month period ended September 30, 2005consisted of $0.6 million of proceeds from maturities of short-terminvestments, $0.9 million of proceeds from the sale of marketable securitiesand $2.1 million from the recovery of an investment offset by $4.9 million incapital expenditures for operational purposes. Net cash used in investing activitieswas approximately $19.2 million during the nine month period ended September30, 2004. Investing activities during the nine month period ended September 30,2004 related $2.0 million to the acquisition of RMK, $15.3 million to theacquisition of Decide, $1.5 million to capital expenditures for generaloperational purposes and $0.4 million in short-term investments.

 

Financing activities provided $2.3 millionand $37.8 million in the nine month periods ended September 30, 2005 and 2004,respectively. Financing activities during the nine month period ended September30, 2005 were attributed as follows: $1.7 million from proceeds received fromDentsu, the minority investor of our consolidated subsidiary, K.K. 24/7 Search,and $0.7 million from the exercise of common stock options offset by $0.1million in payment of capital lease obligations. Financing activities duringthe nine month period ended September 30, 2004 were attributed as follows:$37.2 million from net proceeds from our secondary offering of common stock and$0.6 million from the exercise of common stock options.

 

On September 26, 2003, wecompleted the placement to an institutional accredited investor of oursubordinated convertible debentures. If at any time on or after September 26,2005, the second anniversary of the initial issuance date, the weighted averageprice of our common stock is less than $8.75 on any five consecutive tradingdays, the holder has the right, in its sole discretion, to require that weredeem up to $7.5 million in principal amount of the debentures in cash.Management believes the holder may exercise its right to require redemption.Management believes existing cash and investments will be sufficient to meetthe obligation to redeem should the holder exercise its right.

 

The Company maintains cashbalances at the subsidiary level to meet short-term capital requirementsand to satisfy local statutory liquidity requirements. These requirements,as well as local tax implications, may limit the amount of capital that can berepatriated from certain subsidiaries. These funds are freely

 

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available to the subsidiariesfor operational purposes. Specifically, K.K. 24/7 Search has $3.4 millionin cash as of September 30, 2005 that must be kept in Japan for operationalpurposes.

 

We continue to increase capital expendituresand operating lease commitments, which is consistent with our increasedstaffing and operational expansion, and we anticipate this will continue in thefuture as business conditions merit. Additionally, we will continue toevaluate possible acquisitions of, or investments in businesses, products andtechnologies that are complementary to our business, which may require the useof cash. Management believes existing cash and investments will be sufficientto meet operating requirements for at least the next twelve months; however, wemay sell additional equity or debt securities or obtain credit facilities tofurther enhance our liquidity position. The sale of additional securities couldresult in further dilution to our stockholders.

 

**OFF-BALANCESHEET ARRANGEMENTS**

 

We did not have anyrelationships with unconsolidated entities or financial partnerships, such asentities often referred to as structured finance or special purpose entities,which would have been established for the purpose of facilitating off-balancesheet financial arrangements or other contractually narrow or limited purposesat September 30, 2005. Accordingly, we are not materially exposed to anyfinancing, liquidity, market or credit risk that could arise if we had engagedin such relationships.

 

**CRITICALACCOUNTING POLICIES**

 

Our consolidated financialstatements are prepared in conformity with accounting principles generallyaccepted in the United States of America. As such, we are required to makecertain estimates, judgments and assumptions that management believes arereasonable based upon the information available. These estimates, judgments andassumptions affect the reported amounts of assets and liabilities and thedisclosure of contingent assets and liabilities at the dates of theconsolidated financial statements and the reported amounts of revenues andexpenses during the reporting periods.

 

The significant accounting policies which webelieve are the most critical to aid in fully understanding and evaluating thereported consolidated financial results include the following:

 

**RevenueRecognition; Cost of Revenues**

 

*Media*

 

Our Media revenues aregenerated from fees paid by client advertisers for advertising impressions. Wetypically offer advertisers a pricing model based on CPM, which enables clientadvertisers to pay a fee based on the number of times its advertisement isdisplayed. Agreements are primarily short-term and revenues are recognized asservices are delivered provided that no significant obligations remainoutstanding and collection of the resulting receivable is probable. We becomeobligated to make royalty payments to Web sites that have contracted with us,in the period the advertising impressions are delivered. Such expenses areclassified as cost of revenues in the consolidated statements of operations.

 

*Search*

 

Our revenue from our Searchsegment is primarily based on CPC fees paid by client advertisers. CPC fees aregenerated each time users click Web site listings that we submitted into searchengine databases and are directed to our client advertisers’ Web sites. To alesser extent, we also generate revenue from fees

 

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paid by search engines thatemploy us to optimize the submission of Web site listings and report onadvertising campaigns for their advertisers. Agreements are primarilyshort-term and revenues are recognized as services are delivered provided thatno significant obligations remain outstanding and collection of the resultingreceivable is probable. We become obligated to make payments to search enginedistribution partners, which have contracted us, in the period in which theclicks occur. Such expenses are classified as cost of revenues in theconsolidated statements of operations. In specific circumstances, when weprovide search marketing services as an agent for a fixed commission orotherwise in transactions in which we do not have principal risk and reward, werecognize revenue on a net basis.

 

*Technology*

 

Our Technology revenues arederived primarily from licensing our software, hosted advertisement serving andsoftware maintenance and technical support services. Revenue from softwarelicensing agreements is recognized in accordance with Statements of Position (“SOP”)No. 97-2, *Software Revenue Recognition*,and Staff Accounting Bulletin (“SAB”) No. 104, *RevenueRecognition*, upon delivery of the software, which is generally whenthe software is made available for download, there is persuasive evidence of anarrangement, collection is reasonably assured, the fee is fixed or determinableand vendor-specific objective evidence exists to allocate the total fees to allelements of the arrangement. Contracts that bundle the software license withsoftware maintenance and technical support are recognized ratably over thecontract term. Revenue from hosted advertisement serving is recognized upondelivery. Revenue from software maintenance and technical support contracts isrecognized ratably over the life of the agreement, which typically does notexceed one year.

 

Expenses related to ourTechnology revenues are primarily payroll costs incurred to deliver and supportthe software, hosting, bandwidth and license fees paid to third-party softwarevendors. These expenses are classified as cost of revenues in the consolidatedstatements of operations.

 

*Deferred Revenue*

 

Revenues that are billed orcollected in advance of services being completed are deferred until the conclusionof the period of the service for which the advance billing or collectionrelates. Deferred revenues are included on the consolidated balance sheets as acurrent liability until the service is performed and then recognized in theperiod in which the service is completed. Our deferred revenues primarilyconsist of billings in advance for software license subscriptions and softwaremaintenance and technical support services.

 

**Allowancefor Doubtful Accounts; Sales Allowance**

 

We maintain an allowance fordoubtful accounts to reserve for potentially uncollectible receivables and asales allowance to reserve for potential credits issued to customers. Theallowances are estimates calculated based on an analysis of current businessand economic risks, customer credit-worthiness, specific identifiable riskssuch as bankruptcies, terminations or discontinued customers, or other factorsthat may indicate a potential loss.

 

**Valuationof Goodwill, Intangible Assets and Long-Lived Assets**

 

Effective January 1, 2002,we adopted Statement of Financial Accounting Standards (“SFAS”) No. 142, *Goodwill and Other Intangible Assets* andSFAS No. 144, *Accounting for theImpairment or Disposal of Long-Lived Assets*. SFAS 142eliminates the amortization of goodwill and indefinite-lived intangible assets,addresses the amortization of intangible assets with finite lives and addressesimpairment testing

 

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and recognition for goodwilland intangible assets. SFAS No. 144 establishes a single model for theimpairment of long-lived assets.

 

Goodwill and intangible assetsare reviewed for impairment whenever events or changes in circumstancesindicate that the carrying amount may not be fully recoverable. Conditions thatwould necessitate an impairment assessment include a significant decline in theobservable market value of an asset, a significant change in the extent ormanner in which an asset is used or a significant adverse change that wouldindicate that the carrying amount of an asset or group of assets is notrecoverable. For long-lived assets to be held and used, the Company recognizesan impairment loss only if its carrying amount is not recoverable through itsundiscounted cash flows and measures the impairment loss based on thedifference between the carrying amount and fair value. Long-lived assets heldfor sale are reported at the lower of cost or fair value less costs to sell.

 

**BusinessCombinations**

 

Our acquisitions are accounted for aspurchase business combinations in accordance with SFAS No. 141, *Business Combinations*, and SFAS No. 142, *Goodwill and Other Intangible Assets*.We allocate the purchase price of tangible and intangible assets, and record asgoodwill, the excess of purchase price over the fair value of the identifiablenet assets acquired. Intangible assets include trademarks, customerrelationships, acquired technology and covenants not to compete. Suchintangible assets are amortized on a straight-line basis over their estimateduseful lives, which are generally four to seven years.

 

**Contingenciesand Litigation**

 

We evaluate contingentliabilities including threatened or pending litigation in accordance with SFASNo. 5, *Accounting for Contingencies*,and record accruals when the outcome of these matters is deemed probable andthe liability is reasonably estimable. We make these assessments based on thefacts and circumstances, and in some instances based in part on the advice ofoutside legal counsel.

 

**RestructuringActivities**

 

Restructuring activities areaccounted for in accordance with SFAS No. 146, *Accountingfor Costs Associated with Exit or Disposal Activities*.Restructuring-related liabilities include estimates for, among other things,involuntary terminations of employees and disposition of lease obligations. Keyvariables in determining such estimates include timing of sublease rentals,estimates of sublease rental payment amounts and tenant improvement costs, andestimates for brokerage and other related costs. We periodically evaluate and,if necessary, adjust the estimates based on currently available information.

 

**Short-TermInvestments**

 

SFAS 115, *Accountingfor Certain Investments in Debt and Equity Securities*, and SEC StaffAccounting Bulletin (“SAB”) 59, *Accountingfor Non-current Marketable**Equity Securities*, provide guidance on determining when aninvestment is other-than-temporarily impaired. Investments are reviewedquarterly for indicators of other-than-temporary impairment. This determinationrequires significant judgment. In making this judgment, we evaluate, amongother factors, the duration and extent to which the fair value of an investmentis less than its cost, the financial health of the investee, and our intent andability to hold the investment. Investments with an indicator are further evaluatedto determine the likelihood of a significant adverse effect on the fair valueand amount of the impairment as necessary. If market, industry and/or investeeconditions deteriorate, we may incur future impairments.

 

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**MARKET FORCOMPANY’S COMMON EQUITY**

 

We have not declared or paid any dividends on ourcapital stock since our inception and do not anticipate paying dividends in theforeseeable future. Our current policy is to retain earnings, if any, tofinance the expansion of our business. In addition, our debentures restrict ourability to pay cash dividends on our capital stock. The future payment ofdividends will depend on the results of operations, financial condition,capital expenditure plans and other factors that we deem relevant and will beat the sole discretion of our Board of Directors.

 

Since our initial public offering on August 13, 1998until June 2002, our common stock traded on the NASDAQ National Market underthe symbol “TFSM.”  In June 2002, wetransferred our common stock to the NASDAQ SmallCap Market, where it was tradedunder that same symbol. On November 3, 2005, our common stock was re-listed onthe NASDAQ National Market, where it continues to trade under “TFSM.”

 

**FACTORSTHAT COULD AFFECT FUTURE RESULTS**

 

Because of the following factors, as well asother variables affecting our operating results, past financial performance maynot be a reliable indicator of future performance, and historical trends shouldnot be used to anticipate results or trends in future periods.

 

**RISKS RELATED TO 24/7 REAL MEDIA, INC.**

 

WE HAVE A HISTORY OFLOSSES AND MAY NEVER ACHIEVE PROFITABILITY.

 

We have not achievedprofitability in accordance with generally accepted accounting principles, orGAAP, in any reporting period in our history, except as the result ofnon-recurring gains, and we may not be able to achieve or sustain profitabilityin the future. We incurred net losses of $0.8 million and $1.4 million for thethree and nine month periods ended September 30, 2005, respectively. We mayincur net losses for the foreseeable future. Even if we do achieveprofitability, we may not sustain profitability on a consistent basis, if atall, in the future.

 

OUR ABILITY TO GENERATESUFFICIENT CASH FLOW TO REPAY OUR INDEBTEDNESS DEPENDS ON MANY FACTORS, SOME OFWHICH ARE BEYOND OUR CONTROL.

 

On September 26, 2003, weissued to a single holder $15.0 million in principle amount of our 2%subordinated convertible debentures due 2006.  On January 1, 2004, we began makingsemi-annual interest payments, which, thus far, we have elected to pay withcash flow from operations.  The entireprincipal amount of the debentures matures on September 26, 2006. We needto ensure that we will have sufficient cash on hand to pay the balance atmaturity, or in the event that the holder’s repurchase right under thedebentures is triggered.  Our ability togenerate cash flow is, to a certain extent, subject to economic, financial,competitive, regulatory and other factors beyond our control.  If we are unable to generate sufficient cashflow to meet our debt service obligations, we may need to, among other things,seek additional financing, refinance or restructure our debt or reduce or issuea lot of common stock that would be very dilutive or delay plannedexpenditures.

 

Our ability to arrangefinancing and the cost of this financing will depend upon many factors,including: general economic and capital market conditions generally, and inparticular the non-investment grade debt market; credit availability from banksor other lenders; investor confidence in our industry generally and our companyspecifically; and provisions of tax and securities law that are conducive toraising capital.

 

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Taking these measures still maynot enable us to service our debt, and any financing might not be available oneconomically favorable terms, if at all. Any inability to generate sufficient cash or to raise capital onfavorable terms could put us in breach under the terms of the debentures andcould have a material adverse effect on our financial condition and operations.

 

THE AMOUNT AND TERMS OF OURINDEBTEDNESS MAY LIMIT OUR ABILITY TO OBTAIN ADDITIONAL FINANCING AND MAY LIMITOUR FLEXIBILITY TO REACT TO INDUSTRY OR ECONOMIC CONDITIONS.

 

We have $15.0 million of ourdebentures outstanding, and may incur additional debt in the future. The amountand terms of our debt could have negative consequences on our flexibility andour business, including:

 

•                  impairing ourability to obtain additional financing for working capital, capitalexpenditures, acquisitions or general corporate purposes;

 

•                  requiring us todedicate a substantial portion of any operating cash flow that we generate topaying principal and interest on indebtedness, thereby reducing the fundsavailable for operations;

 

•                  limiting ourability to grow and make capital expenditures due to the covenants contained inour debt arrangements;

 

•                  impairing ourability to adjust rapidly to changing market conditions, invest in new ordeveloping technologies, or take advantage of significant businessopportunities that may arise;

 

•                  placing us at acompetitive disadvantage compared to our competitors that have less debt orbetter access to capital resources; and

 

•                  making us morevulnerable if there is an economic downturn, an increase in competitivepressures or if our business or industry experiences difficulties.

 

If we cannot generatesufficient additional cash flow, we may not be able to meet our debt serviceobligations, repay our debt when due, or comply with other covenants in thesubordinated convertible debentures. If we breach the debentures, the investorcould require repayment of all amounts owed, and we may not have sufficientcash reserves to repay such amounts.

 

THE TERMS OF THE DEBENTURESHAVE ANTI-DILUTION PROVISIONS FAVORING THE HOLDER, WHICH DISCOURAGE US FROMENGAGING IN TRANSACTIONS IN WHICH THE ISSUANCE OF COMMON STOCK MIGHT BEREQUIRED AND WHICH OTHERWISE MIGHT BE BENEFICIAL TO OUR BUSINESS.

 

The terms of the debenturesprovide that, subject to certain exceptions, if, for financing purposes, weissue or sell any shares of our common stock at a price less than theconversion price of the debentures, which is $8.75 per share of our commonstock, the conversion price of the debentures will be reduced to the price atwhich we issue new shares.  This device,which is anti-dilutive for the debenture holder, may discourage us fromengaging in a transaction that might otherwise be beneficial to our securityholders, if we would be required to issue common stock at a price below $8.75per share.

 

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THE ISSUANCE OF STOCK UPONCONVERSION OR REDEMPTION OF OUR DEBENTURES MAY SUBSTANTIALLY DILUTE THEINTERESTS OF OTHER SECURITY HOLDERS.

 

If the holder of our debentureschooses to exercise its right to convert the debentures into shares of ourcommon stock, or if we elect to pay the principal amount of the debentures inshares of our common stock, such action will dilute the ownership interests ofour existing stockholders.  Any sales inthe public market of the common stock the debenture holder receives couldadversely affect prevailing market prices of our common stock.

 

WE MAY ISSUE SHARES OF COMMON STOCKTO RAISE ADDITIONAL FUNDS TO CONTINUE OPERATIONS.  ANY SUCH ISSUANCE MAY BE HIGHLY DILUTIVE TOOUR STOCKHOLDERS.

 

An unforeseen reduction in ourrevenues, an unexpected impairment of our receivables, or an unbudgetedincrease in expenses or capital expenditures may require us to raise additionalfunds to continue operations. To the extent we encounter further opportunitiesto raise cash, we may sell additional equity or debt securities, which wouldresult in further dilution for our current stockholders. Stockholders mayexperience extreme dilution if our stock price remains at its current levelsand we need a substantial amount of financing, and these securities may haverights senior to those of holders of our common stock. Access to the capital marketshas been unpredictable in the past. The amount of capital that a company suchas ours is able to raise often depends on variables that are beyond ourcontrol, such as the market price of our common stock and its trading volume.As a result, efforts to secure financing on terms attractive to us may not besuccessful, and we may not be able to secure additional financing on any terms.

 

OUR ACQUISITIONS, WHICH HAVEBEEN CRITICAL TO OUR GROWTH, MAY NOT BE SUCCESSFUL AND COULD ADVERSELY AFFECTOUR ABILITY TO PROJECT RESULTS.

 

We were formed inFebruary 1998 to consolidate three Internet advertising companies and havesince acquired or entered into joint ventures with many other companies. Mostrecently, in September 2005, we formed a joint venture with the advertisingcompany Dentsu to provide our search engine marketing services in Japan. We maycontinue pursuing selective acquisitions of businesses, technologies andproduct lines and additional joint ventures as a key component of our growthstrategy. If we acquire additional companies or expand our business linesthrough joint ventures, we will continue to face risks of integrating andimproving our financial and management controls, advertisement servingtechnology, reporting systems, infrastructure and procedures, and expanding,training and managing our work force. This process of integration may take asignificant period of time and may require the dedication of global resources,personnel and members of management, on a short or long-term basis, which maydistract management’s attention from our other operations. Any futureacquisition, investment or joint venture may result in the use of significantamounts of cash, potentially dilutive issuances of equity securities, theincurrence of debt and amortization expenses related to intangible assets. Inaddition, acquisitions involve numerous risks, including:

 

•                  the difficultiesin the integration and assimilation of the operations, technologies, productsand personnel of an acquired business;

 

•                  the diversion ofmanagement’s attention from other business concerns;

 

•                  the availabilityof favorable acquisition financing for future acquisitions; and

 

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•                  the potentialloss of key senior managers or employees of any acquired business.

 

Our inability to successfullyintegrate any acquired company, or failure to achieve any expected synergies ofan acquisition or joint venture, could adversely affect our business.

 

OUR FUTURE REVENUES AND RESULTSOF OPERATIONS MAY BE DIFFICULT TO FORECAST AND RESULTS IN PRIOR PERIODS MAY NOTBE INDICATIVE OF FUTURE RESULTS.

 

At times in the past and incertain segments, our revenues have grown significantly and have decreasedsignificantly. Accurate predictions of future revenues are difficult because ofthe rapid changes in our markets.

 

Our results of operations havefluctuated and may continue to fluctuate significantly in the future as aresult of a variety of factors, many of which are beyond our control. Thesefactors include:

 

•                  the addition ofnew clients or the loss of existing clients;

 

•                  changes in feespaid by advertisers or other clients;

 

•                  changes in theamount of royalties payable by us to owners of Web sites or the imposition ofnew charges or fees by Web site owners;

 

•                  the demand byadvertisers and Web publishers for our advertising solutions;

 

•                  the introductionof new Internet marketing services by us or our competitors;

 

•                  variations inthe levels of capital or operating expenditures and other costs relating to themaintenance or expansion of our operations, including personnel costs;

 

•                  seasonality,which generally results in lower revenue for the Company in the first and thirdquarter of each year;

 

•                  changes inresults of operations brought about by newly acquired businesses or new jointventures, which may be exceedingly difficult to predict due to management’slack of history with such businesses or joint ventures;

 

•                  changes ingovernmental regulation of the Internet; and

 

•                  general economicconditions.

 

Our future revenues and resultsof operations may be difficult to forecast due to the above factors and thetime we may need to adequately respond to any changes in them. For example,certain of the search engines that we partner with in the management of search enginemarketing may impose additional charges for using their technology interfacesto assist our clients. Our profit margins may suffer if we are unable to passsome of the costs on to our customers. In addition, our expense levels arebased in large part on our investment plans and estimates of future revenues.Any increased expenses may precede or may not be followed by increasedrevenues, as we may be unable to, or may elect not to, adjust spending in atimely manner to compensate for any unexpected revenue shortfall. As a result,we believe that period-to-period comparisons of our results of operations maynot be meaningful.

 

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OUR TECHNOLOGY PRODUCTS ANDSERVICES ARE BASED ON OUR PROPRIETARY OPEN ADSYSTEM PLATFORM, AND OUR BUSINESSWOULD SUFFER IF OPEN ADSYSTEM WAS DISRUPTED.

 

Open AdSystem is ourproprietary advertisement serving technology and serves as our soleadvertisement serving solution. We have developed a variety of products to workon or with this platform, and our Media Solutions business also utilizes OpenAdSystem technology. We must, among other things, ensure that the technologywill continue to function efficiently at high volumes, interact properly withour database, offer the functionality demanded by our customers and assimilateour sales and reporting functions. We must also ensure that Open AdSystem’sperformance levels remain steady when and if we combine it with other softwareproducts, such as Insight XE and Decide DNA. Customers may become dissatisfiedby any system failure that interrupts our ability to provide our services tothem, including failures affecting our ability to deliver advertisements orreport on advertisement delivery without significant delay. Sustained or repeatedsystem failures would reduce the attractiveness of our solutions toadvertisers, advertising agencies and Web publishers and result in contractterminations, fee rebates and make-goods, thereby reducing our revenue.  Slower response time or system failures mayalso result from straining the capacity of our deployed software or hardwaredue to an increase in the volume of advertising delivered through our servers.To the extent that we do not effectively address any capacity constraints orsystem failures, our business, results of operations and financial conditioncould be materially and adversely affected.

 

OUR REVENUE COULD DECLINE IF WEFAIL TO EFFECTIVELY MANAGE ADVERTISING INVENTORY MADE AVAILABLE TO US AND OURGROWTH COULD BE IMPEDED IF WE FAIL TO ACQUIRE ACCESS TO NEW ADVERTISINGINVENTORY.

 

Our success depends in part onour ability to effectively manage advertising inventory made available to us.The Web publishers that list their unsold advertising inventory with us are notbound by long-term contracts. In addition, Web publishers can change the amountof inventory they make available to us at any time. If a Web publisher decidesnot to make advertising space from its Web sites available to us, we may not beable to replace this advertising space with advertising space from other Websites that have comparable traffic patterns and user demographics quicklyenough to fulfill our advertisers’ requests. This would result in lost revenue.We expect that our customers’ requirements will become more sophisticated asthe Web matures as an advertising medium. If we fail to manage our existingadvertising space effectively to anticipate or meet our customers’ changingrequirements, our revenue could decline. Our growth also depends on our abilityto expand our advertising inventory. To attract new advertisers, we mustmaintain a consistent supply of attractive advertising space. We intend toexpand our advertising inventory by selectively adding to our network new Webpublishers that offer attractive demographics, innovative and quality contentand large audiences. Our ability to attract new Web publishers to our networkand to retain Web publishers currently in our network will depend on variousfactors, some of which are beyond our control. These factors include ourability to introduce new and innovative product lines and services, our abilityto efficiently manage our existing advertising inventory, our pricing policiesand the cost-efficiency to Web publishers of outsourcing all or part of theiradvertising sales. In addition, the number of competing intermediaries thatpurchase advertising inventory from Web publishers continues to increase. Thesize of our inventory may not increase or even remain constant in the future,which could cause our advertising revenue to decline significantly.

 

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WE COULD LOSE CUSTOMERS ORADVERTISING INVENTORY IF WE FAIL TO MEASURE IMPRESSIONS, CLICKS AND ACTIONS ONADVERTISEMENTS IN A MANNER THAT IS ACCEPTABLE TO OUR ADVERTISERS AND WEBPUBLISHERS.

 

We earn advertising revenue andmake payments to Web publishers based on the number of impressions, clicks andactions from advertisements delivered on our network. Advertisers’ and Webpublishers’ willingness to use our services and join our network will depend onthe extent to which they perceive our delivery of advertisements and ourmeasurements of clicks to be accurate and reliable. Advertisers and Webpublishers often maintain their own technologies and methodologies for countingclicks, and from time to time we have had to resolve differences between ourmeasurements and theirs or regarding over-delivery of advertising impressions.Further, search advertisers are paying closer attention to allegations of clickfraud in the industry generally and have become more willing to inquire aboutor challenge click counts related to search marketing services.  Any significant dispute over the propermeasurement of clicks or other user responses to advertisements could cause usto lose customers or advertising inventory or both.

 

WE DISCLOSE PRO FORMAINFORMATION, WHICH MAY EXCLUDE ITEMS THAT ARE IMPORTANT TO AN INVESTOR’SUNDERSTANDING OF OUR RESULTS OF OPERATIONS.

 

We prepare and releasequarterly unaudited financial statements prepared in accordance with GAAP. Wealso disclose and discuss certain pro forma and other non-GAAP information inthe related earnings releases and investor conference calls. This pro formafinancial information excludes or may exclude certain special charges and othercosts. We believe the disclosure of the pro forma financial information helpsinvestors more meaningfully evaluate the results of our ongoing operations.However, we urge investors to carefully review the GAAP financial informationincluded as part of our Quarterly Reports on Form 10-Q, our Annual Reportson Form 10-K, and our quarterly earnings releases, and to compare the GAAPfinancial information with the pro forma financial results disclosed in ourquarterly earnings releases and investor calls.

 

OUR NET OPERATING LOSSCARRYFORWARDS MAY BE LIMITED.

 

Due to the “change in ownership”provisions of the Internal Revenue Code, the availability of our net operatingloss and credit carryforwards may be subject to an annual limitation againsttaxable income in future periods, which could substantially limit the eventualutilization of these carryforwards.

 

WE COULD BE ADVERSELY AFFECTEDBY AN IMPAIRMENT OF A SIGNIFICANT AMOUNT OF GOODWILL AND/OR INTANGIBLE ASSETSON OUR BALANCE SHEET.

 

In the course of our operatinghistory, we have acquired and disposed of numerous assets and businesses. Someof our acquisitions have resulted in the recording of a significant amount ofgoodwill and/or intangible assets on our financial statements. The goodwilland/or intangible assets were recorded because the fair value of the net assetsacquired was less than the purchase price. We may not realize the full value ofthe goodwill and/or intangible assets. As such, we evaluate on at least anannual basis whether events and circumstances indicate that all or some of thecarrying value of goodwill and/or intangible assets are no longer recoverable,in which case we would write off the unrecoverable portion as a charge to ourearnings.

 

To improve our operatingperformance, we may determine to acquire other assets or businessescomplementary to our business and, as a result, we may record additionalgoodwill and/or intangible assets in the future. The possible write-off of thegoodwill and/or intangible assets could negatively impact our future earnings.We will also be required to allocate a portion of the purchase price of anyacquisition to the value of any intangible assets that meet the criteriaspecified in the Statement of Financial Accounting Standards No. 141, “*Business Combinations*,” such as marketing,customer or contract-based intangibles. The amount allocated to theseintangible assets could be amortized over a

 

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fairly short period. As aresult, our earnings and the market price of our common stock could benegatively affected.

 

THE SUCCESS OF OUR 24/7 SEARCHOPERATIONS DEPENDS ON A FEW SEARCH ENGINE DISTRIBUTION PARTNERS, AND THE LOSSOF ONE OF THEM COULD RESULT IN A SUBSTANTIAL DECREASE IN OUR 24/7 SEARCHREVENUE.

 

We have generated the majorityof our global Search revenue from clicks originating on Google and Overture,which is a subsidiary of Yahoo!, through relationships in many countries inwhich we operate. We expect that these search engines will continue to generatea majority or more of our 24/7 Search revenue for the foreseeable future. Theinterruption or loss of our relationship with Google or Overture would cause asignificant decrease in search revenue. As a result of consolidation amongsearch engines, and other search marketing companies, we could lose one or moreof our clients or face increased competition from clients that internallydevelop or acquire capabilities similar to our service. In addition, as oursearch engine clients’ operations continue to evolve, we may be required toadjust our business strategy to maintain relationships with our clients. Theloss of, or a change in, one or more of these relationships could have amaterial adverse effect on our Search revenue.

 

OUR MAJOR BUSINESS PARTNERS MAYEXPERIENCE ADVERSE BUSINESS CONDITIONS THAT COULD ADVERSELY AFFECT OURBUSINESS.

 

We have entered into astrategic business relationship with Lycos, we have major search enginedistribution partners, such as Google and Overture, and we may enter into similarrelationships with other companies. A substantial portion of our revenue is,directly or indirectly, attributable to these major relationships.  If one or more of these companies experiencesadverse business conditions that may render them unable to meet ourexpectations for the strategic business relationship or to fulfill theircontractual obligations to us, such an event could have a material adverseimpact on our business, financial condition and results of operations.

 

IF WE LOSE ANY KEY PERSONNEL,OUR BUSINESS WILL BE ADVERSELY AFFECTED.

 

Our success depends, to asignificant extent, upon our senior management and key sales and technicalpersonnel, particularly our Chief Executive Officer, our Chief FinancialOfficer and our Chief Exective Officer of Europe.  The loss of the services of one or more ofthese persons, other similarly positioned members of management or other keypersonnel could materially and adversely affect our ability to develop ourbusiness.

 

IN ORDER TO CONTINUE TO OPERATEEFFICIENTLY AND TO GROW OUR BUSINESS, WE WILL NEED TO ATTRACT AND RETAINQUALIFIED PERSONNEL AND MANAGE OUR COSTS, WHICH WE MAY BE UNABLE TO DO.

 

Our success depends on ourability to attract and retain qualified technical, sales and marketing,customer support, financial and accounting, and managerial personnel.  We may expand our total workforce and willneed to continue to attract qualified personnel in order to grow our businesssuccessfully.  Additionally, as ourbusiness has escalated, we have increased our reliance on contractors andoutside firms for development.  We maynot be able to attract, integrate and retain the numbers and types ofcandidates that we desire, and we may not be able to retain our contractors andoutside firms and may not be able to replace them.  Even if we are successful in attracting newstaff, we may not be able to increase revenue quickly enough to offset thecosts of the additional personnel.  Any ofthese contingencies could cause our business to suffer.

 

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We have experienced in thepast, and may continue to experience in the future, particular difficulty inhiring and retaining qualified staff in the area of search engine marketing (“SEM”).Competition for SEM staff is very high, and training is difficult because therequired skill set is complex and there is no industry standard.  Search is currently one of our fastestgrowing areas.  If we are unable toattract, train and retain qualified search staff, we may not remain competitivein SEM and could lose business and our customers, which could have an adverseeffect on revenue.

 

OUR OPERATIONS ARE VULNERABLETO NATURAL DISASTERS AND OTHER EVENTS, INCLUDING TERRORIST ATTACKS, BECAUSE WEHAVE LIMITED BACKUP SYSTEMS.

 

We have limited backup systemsand have experienced system failures and electrical outages from time to timein the past, which have disrupted our operations. We have a limited disasterrecovery plan in the event of damage from fire, floods, typhoons, earthquakes,power loss, telecommunications failures, break-ins and similar events. Ouroperations are dependent on our ability to protect our computer systems againstthese unexpected adverse events.

 

If any of the foregoing occurs,we may experience a complete system shutdown. Any business interruptioninsurance that we carry is unlikely to be sufficient to compensate us for lossof business in the event of a significant catastrophe.

 

In addition, interruptions inour services could result from the failure of our telecommunications providersto provide the necessary data communications capacity in the time frame werequire. Our Open AdSystem technology resides on computer systems located inour data centers housed by Savvis in the United States and Level 3 Communicationsin Europe. These systems’ continuing and uninterrupted performance is criticalto our success, as a substantial portion of the revenue depend on thecontinuing availability of these systems. Despite precautions that we havetaken, unanticipated problems affecting our systems have from time to time inthe past caused, and in the future could cause, interruptions in the deliveryof our solutions. Our business, results of operations and financial conditioncould be materially and adversely affected by any damage or failure thatinterrupts or delays our operations. To improve the performance and to preventdisruption of our services, we may have to make substantial investments todeploy additional servers or one or more copies of our Web sites to mirror our onlineresources. Although we believe we carry property insurance with adequatecoverage limits, our coverage may not be adequate to compensate us for alllosses, particularly with respect to loss of business and reputation that mayoccur.

 

In addition, terrorist acts oracts of war may cause damage to our employees, facilities, clients, our clients’customers and vendors, which could significantly impact our revenues, costs andexpenses and financial position. The potential for future terrorist attacks,the national and international responses to terrorist attacks or perceivedthreats to national security, and other acts of war or hostility have createdmany economic and political uncertainties that could adversely affect ourbusiness and results of operations in ways that cannot be presently predicted.We are predominantly uninsured for losses and interruptions caused by terroristacts and acts of war.

 

OUR NETWORK OPERATIONS MAY BEVULNERABLE TO HACKING, VIRUSES AND OTHER DISRUPTIONS, WHICH MAY MAKE OUR PRODUCTSAND SERVICES LESS ATTRACTIVE AND RELIABLE.

 

Internet usagecould decline if any well-publicized compromise of security occurs. “Hacking”involves efforts to gain unauthorized access to information or systems or tocause intentional malfunctions or loss or corruption of data, software,hardware or other computer equipment. Hackers have made many attempts to breach the security of our networkoperations, with minimal disruption to date. If hackers are successful in thefuture, they could misappropriate proprietary information or cause substantial

 

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disruptions inour service. We may be required to expend capital and other resources toprotect our Web site against hackers. Any measures we may take may not beeffective. In addition, the inadvertent transmission of computer viruses couldexpose us to a material risk of loss or litigation and possible liability, aswell as materially damage our reputation and decrease our user traffic.

 

WE DEPEND ON PROPRIETARYRIGHTS, AND WE FACE THE RISK OF INFRINGEMENT.

 

Our success and ability tocompete are substantially dependent on our internally developed technologiesand trademarks, which we protect through a combination of patent, copyright,trade secret and trademark law. We have received two patents in the UnitedStates, and have filed and intend to file additional patent applications in theUnited States. In addition, we apply to register our trademarks in the UnitedStates and internationally. Our patent applications and trademark applicationsmay not be approved. Even if they are approved, such patents or trademarks maybe successfully challenged by others or invalidated. If our trademarkregistrations are not approved because third parties own such trademarks, ouruse of such trademarks will be restricted unless we enter into arrangementswith such third parties that may be unavailable on commercially reasonableterms.

 

We generally enter intoconfidentiality or license agreements with our employees, consultants andcorporate partners, and generally control access to and distribution of ourtechnologies, documentation and other proprietary information. Despite ourefforts to protect our proprietary rights from unauthorized use or disclosure,parties may attempt to disclose, obtain or use our solutions or technologies.The steps we have taken may not prevent misappropriation of our solutions ortechnologies, particularly in many foreign countries in which we operate, wherelaws or law enforcement practices may not protect our proprietary rights asfully as in the United States.

 

We have from time to timelicensed, and we may license in the future, elements of our trademarks, tradedress and similar proprietary rights to third parties. While we attempt toensure that the quality of our brand is maintained by these business partners,such partners may take actions that could materially and adversely affect thevalue of our proprietary rights or our reputation. The value of our proprietaryrights could decline in the future since the validity, enforceability and scopeof protection of certain proprietary rights in Internet-related industries isuncertain and still evolving.

 

We have, from time to time,been, and may in the future be, subject to claims of alleged infringement ofthe trademarks and other intellectual property rights of third parties by us orby Web publishers with Web sites in our 24/7 Web Alliance, or by customers whoemploy our Technology solutions.  We maybe required, or may elect, to indemnify these parties against such claims. Suchclaims and any resultant litigation could subject us to significant liabilityfor damages and could result in the invalidation of our proprietary rights. Inaddition, even if we prevail, such litigation could be time-consuming andexpensive to defend, and could result in the diversion of our time andattention, any of which could materially and adversely affect our business,results of operations and financial condition. Any claims or litigation fromthird parties may also result in limitations on our ability to use thetrademarks and other intellectual property subject to such claims or litigationunless we enter into arrangements with the third parties responsible for suchclaims or litigation, which may be unavailable on commercially reasonableterms, if at all.

 

From time to time, we mayselectively pursue claims of infringement of our patents and other intellectualproperty rights by third parties. Such claims and any resultant litigationpresent the risk that a court could determine, either preliminarily or finally,that some of our patents or other intellectual property rights are not valid,which may make it difficult to sell our technology solutions and may lead to aloss of and an inability to generate licensing revenue from our patents. Inaddition, even if we prevail, such litigation could be time-consuming andexpensive to pursue, and could result in the diversion of our time and

 

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attention, any of which couldmaterially and adversely affect our business, results of operations andfinancial condition.

 

OUR INTERNATIONAL OPERATIONSFACE LEGAL AND CULTURAL CHALLENGES AND SUBJECT US TO ADDITIONAL RISKS.

 

We have operations in a numberof international markets, including Australia, Canada, Europe and South Korea,and we currently derive more than half our revenue from non-U.S. markets. Todate, we have limited experience in marketing, selling and distributing oursolutions internationally. Our international operations are subject to otherrisks, including:

 

•                  changes inregulatory requirements;

 

•                  reducedprotection for intellectual property rights in some countries;

 

•                  potentiallyadverse tax consequences and restrictions on cash flow resulting from, amongother things:

 

•                  local statutoryliquidity requirements for businesses operating in certain foreign countries;

 

•                  the need tomaintain cash balances to meet short term capital requirements;

 

•                  operations inforeign countries with higher tax rates than the United States;

 

•                  the inability toutilize certain foreign tax credits; and

 

•                  the inability toutilize some or all of losses generated in one or more foreign countries;

 

•                  generalimport/export restrictions relating to encryption technology and/or privacymatters;

 

•                  difficulties andcosts of staffing and managing foreign operations;

 

•                  political andeconomic instability;

 

•                  fluctuations incurrency exchange rates; and

 

•                  seasonalreductions in business activity during the summer months in Europe and certainother parts of the world.

 

OUR SEARCH BUSINESS ISCURRENTLY OUR FASTEST GROWING BUSINESS SEGMENT, AND WE MAY HAVE INEFFICIENCIESIN OUR BUSINESS MODEL OR MAY BE UNABLE TO CAPITALIZE ON CURRENT OR FUTURESEARCH TRENDS.

 

As companies recognize thevalue of targeting advertisements to particular consumers during the searchprocess, search marketing services have become increasingly in demand.  As a result, our Search segment has beengrowing faster than our other business segments.  The search industry is still relatively new,competition is high and there are no set parameters among service providers asto how to run campaigns, track data or include more complex features, such asbehavioral targeting.  We are working todevelop set

 

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standards as our Searchbusiness grows, but we do not have a long-term business model in place and donot know which, if any, of our current strategies will be successful in thelong-run.  As a result, it is difficultto predict how our Search segment will perform in the future.  For example, revenue in the segment hasincreased significantly in recent periods, while margins have decreased as ourlower gross margin search engine marketing managed services business performedbetter than other search areas.  Further,as we work to develop a long-term business model for Search we may encounterinefficiencies, such as the under or over-delivery of campaigns due toprogramming difficulties, or set-backs, such as outdated methodologies andtools that must be reconfigured or replaced. There is no guarantee that our current or future Search software andtechniques will meet our clients’ needs, successfully manage increasinglycomplex campaigns or be profitable for our business.

 

WE ARE UNDERTAKING SEVERALGLOBAL INITIATIVES IN ORDER TO BETTER LEVERAGE OUR BUSINESS, AND OUR EFFORTSMAY NOT BE SUCCESSFUL OR MAY NOT BE BENEFICIAL TO EACH OF THE OFFICES IN WHICHWE OPERATE.

 

In order to realign and betterleverage our business we have commenced several global initiatives, includingharmonizing our global product lines across the offices in which we operate andcreating global standards for product management, development and marketing,which we will continue during the course of 2006.  In order to synchronize our various officesand create a uniform worldwide business model we will need to, among otherthings, set up uniform processes, formalize and build out training courses, setup global information sharing and communication processes, identify and trackproductivity and cost measurements and identify areas of inefficiency anddevelop global recovery plans.  While weanticipate that the global realignment will have cost and efficiency savingsfor our business, there is no guarantee that our global efforts will besuccessful over the long run. Additionally, the global business model that we implement for each ofour business segments may not be the ideal standard for each of our offices,and may result in increased costs and decreased savings for particular officesand lines of business throughout our organization.

 

**RISKS RELATED TO THE MARKET FOR OUR COMMON STOCK.**

 

WE HAVE A VERY SUBSTANTIAL OVERHANG OF COMMONSTOCK AND FUTURE SALES OF OUR COMMON STOCK WILL CAUSE SUBSTANTIAL DILUTION ANDMAY NEGATIVELY AFFECT THE MARKET PRICE OF OUR COMMON STOCK.

 

As of September 30, 2005, therewere approximately 46.0 million shares of our common stock outstanding. As ofthat date, we also had an aggregate of approximately 10.6 million sharesof common stock that may be sold into the market in the future, includingapproximately 7.4 million shares of our common stock issuable uponexercise of options, 0.1 million shares of our common stock issuable uponthe exercise of the warrants related to our preferred stock, approximately 0.9million shares of our common stock issuable upon vesting of restricted shares,and 2.2 million shares of our common stock issuable upon conversion of thedebentures and exercise of the related warrants. In addition, if we undertakean additional acquisition or financing involving securities convertible intoshares of our common stock, the aggregate number of shares into which thosesecurities are convertible will further increase our overhang.

 

We cannot predict the effect,if any, that future sales of shares of our common stock into the market, or theavailability of shares of common stock for future sale, will have on the marketprice of our common stock. Sales of substantial amounts of common stock(including shares issued upon the exercise of stock options or conversion ofshares of preferred stock), or the perception that such sales could occur, maymaterially and adversely affect prevailing market prices for our common stock.

 

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OUR SHARE PRICE MAY BE VOLATILEAND COULD DECLINE SUBSTANTIALLY.

 

The market price of our commonstock has fluctuated significantly in the past and may continue to be volatile.In addition, the stock market has experienced extreme price and volumefluctuations, and the market prices of the securities of Internet-relatedcompanies have been especially volatile. As a result of any of these factors, investors may be unable to recoupany or all the value of their investment shares of our common stock. In thepast, following periods of volatility in the market price of a particularcompany’s securities, securities class action litigation has often been broughtagainst that company. Many companies in our industry have been subject to thistype of litigation in the past. We may also become involved in this type oflitigation. Litigation is often expensive and diverts management’s attentionand resources, which could materially and adversely affect our business,financial condition and results of operations.

 

THE POWER OF OUR BOARD OF DIRECTORSTO DESIGNATE AND ISSUE SHARES OF STOCK COULD HAVE AN ADVERSE EFFECT ON HOLDERSOF OUR COMMON STOCK.

 

Our Board of Directors isauthorized to issue up to 350,000,000 shares of common stock for suchconsideration as they may consider sufficient, without seeking stockholderapproval. The issuance of additional shares of common stock in the future wouldreduce the proportionate ownership and voting power of current stockholders.Our Amended and Restated Certificate of Incorporation also authorizes our Boardof Directors to issue up to 10,000,000 shares of preferred stock, the rightsand preferences of which our Board of Directors may designate withoutstockholder approval. The designation and issuance of preferred stock in thefuture could create additional securities with dividend and liquidationpreferences prior in right of payment to the outstanding shares of commonstock.

 

EFFECTS OF ANTI-TAKEOVERPROVISIONS COULD INHIBIT THE ACQUISITION OF OUR COMPANY.

 

Some of the provisions of ourAmended and Restated Certificate of Incorporation, our By-laws and Delaware lawcould, among other things, together or separately:

 

•                  discourage,delay or prevent potential acquisition proposals;

 

•                  discourage,delay or prevent transactions involving an actual or threatened change incontrol;

 

•                  impede theability of our stockholders to change the composition of our board of directorsin any one year; and

 

•                  limit the pricethat investors might be willing to pay for shares of our common stock.

 

These provisions may apply evenif the action that is limited or prevented might be in the best interest of ourshareholders.

 

WE DO NOT INTEND TO PAY FUTURECASH DIVIDENDS.

 

We currently do not anticipatepaying cash dividends on our common stock at any time in the near future. We maynever pay cash dividends or distributions on our common stock. In addition, theterms of our debentures restrict our ability to pay cash dividends on ourcommon stock. Whether we pay cash dividends in the future will be at thediscretion of our Board of Directors and will be dependent upon our

 

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financial condition, results ofoperations, capital requirements, contractual restrictions and any otherfactors that the Board of Directors decides is relevant.

 

**RISKS RELATED TO OUR INDUSTRY**

 

OUR FAILURE TO COMPETESUCCESSFULLY MAY HINDER OUR GROWTH.

 

The markets for Internetadvertising and related products and services are intensely competitive andsuch competition is expected to increase. Our failure to compete successfullymay hinder our growth. We believe that our ability to compete depends upon manyfactors both within and beyond our control, including:

 

•                  the developmentof new online advertising media and methods;

 

•                  the timing andmarket acceptance of new products and enhancements of existing servicesdeveloped by us and our competitors;

 

•                  the ability toattract and retain qualified personnel;

 

•                  changing demandsregarding customer service and support;

 

•                  shifts in salesand marketing efforts by us and our competitors; and

 

•                  the ease of use,performance, price and reliability of our services and products.

 

Some of our competitors havelonger operating histories, greater name recognition, larger customer bases andsignificantly greater financial, technical and marketing resources than ours.In addition, current and potential competitors have established or mayestablish cooperative relationships among themselves or with third parties toincrease the ability of their products or services to address the needs of ourprospective clients.  In addition, mostonline advertising companies are seeking to broaden their business models, sothat companies that do not currently compete directly with us may decide tocompete more directly with us in the future. We may be unable to competesuccessfully against current or future competitors.

 

CHANGES IN GOVERNMENTREGULATION COULD DECREASE OUR REVENUES AND INCREASE OUR COSTS.

 

Laws and regulations directlyapplicable to Internet communications, commerce and advertising are becomingmore prevalent, and new laws and regulations are under consideration by theUnited States Congress and state legislatures. Any legislation enacted orrestrictions arising from current or future government investigations or policycould dampen the growth in use of the Internet generally and decrease theacceptance of the Internet as a communications, commercial and advertisingmedium. State governments or governments of foreign countries might attempt toregulate our transmissions or levy sales or other taxes relating to ouractivities. The laws governing the Internet, however, remain largely unsettled,even in areas where there has been some legislative action. It may take yearsto determine whether and how existing laws such as those governing intellectualproperty, privacy, libel and taxation apply to the Internet and Internetadvertising. In addition, the growth and development of Internet commerce mayprompt calls for more stringent consumer protection laws, both in the UnitedStates and abroad, which may impose additional burdens on companies conductingbusiness over the Internet. Our

 

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business, results of operationsand financial condition could be materially and adversely affected by the adoptionor modification of laws or regulations relating to the Internet.

 

CHANGES IN LAWS AND STANDARDSRELATING TO DATA COLLECTION AND USE PRACTICES AND THE PRIVACY OF INTERNETUSERS, OR RELATED LITIGATION, COULD HARM OUR BUSINESS.

 

The U.S. federal and variousstate governments have recently proposed limitations on the collection and useof information regarding Internet users. In 2004 and 2005, the U.S. Congressproposed several new pieces of legislation that would limit the use oftechnologies deemed to be “spyware”, which some bills have defined to includecookies, Web beacons and javascript, which are required by our products andservices. The effectiveness of our Open AdSystem products and services could besignificantly limited by federal and state regulations limiting the collectionor use of information regarding Internet users. Since many of the proposedfederal and state laws or regulations are being developed, we cannot yetdetermine the impact these regulations may have on our business. In addition,growing public concern about privacy and the collection, distribution and useof personal information has led to self-regulation of these practices by theInternet advertising and direct marketing industry, and to increased federaland state regulation.  Lastly, a numberof civil actions have been brought by federal and state authorities againstcompanies alleged to have distributed “spyware” without the proper consent ofusers. The Network Advertising Initiative, of which we are a member, hasdeveloped self-regulatory principles for online preference marketing. We arealso subject to various federal and state regulations concerning thecollection, distribution and use of personal information. These laws includethe Children’s Online Privacy Protection Act and state laws that limit orpreclude the use of voter registration and drivers license information, as wellas other laws that govern the collection and use of consumer creditinformation. While we monitor legislative initiatives, in the event that more onerousfederal or state laws or regulations are enacted or applied to us or to ourclients, our business, financial condition and results of operations could bematerially and adversely affected.

 

PRIVACY CONCERNS MAY PREVENT USFROM COLLECTING USER DATA.

 

Growing concerns about the useof cookies and data collection may limit our ability to develop user profiles.Web sites typically place small files of information, commonly known as “cookies,”on a user’s hard drive, generally without the user’s knowledge or consent.Cookie information is passed to the Web site through the Internet user’sbrowser software. Open AdSystem technology enables the use of cookies and othernon-personally-identifying information to deliver targeted advertising and tolimit the frequency with which an advertisement is shown to a user. Mostcurrently available Internet browsers allow users to modify their browsersettings to prevent cookies from being stored on their hard drive, andMicrosoft Corporation changed the design and instrumentation of its Web browserto give users the option to accept or reject third-party cookies.  A small minority of users are currentlychoosing to prevent certain cookies. Users can also delete cookies from their harddrive or modify them at any time. Some Internet commentators and privacyadvocates have suggested limiting or eliminating the use of cookies. Anyreduction or limitation in the use of cookies or increase in the number ofusers blocking cookies could limit the effectiveness of our sales and marketingefforts and impair our profiling and targeting capabilities. Such changes alsocould adversely affect our ability to determine the reach of advertisingcampaigns sold and delivered by us and the frequency with which users of sitesin the 24/7 Web Alliance see the same advertisement.

 

If the use or effectiveness ofcookies is limited, we would likely have to switch to other technology thatwould allow us to gather demographic and behavioral information. While suchtechnology currently exists, it is substantially less effective than cookies.Replacement of cookies could require significant

 

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engineering time and resources,might not be completed in time to avoid negative consequences to our business,financial condition or results of operations, and might not be commerciallyfeasible.

 

WE FACE RISKS ASSOCIATED WITHTECHNOLOGICAL CHANGE.

 

The Internet and Internetadvertising markets are characterized by rapidly changing technologies,evolving industry standards, frequent new product and service introductions andchanging customer demands. Our future success will depend on our ability toadapt to rapidly changing technologies and to enhance existing solutions anddevelop and introduce a variety of new solutions to address our customers’changing demands. We may experience difficulties that could delay or preventthe successful design, development, introduction or marketing of our solutions.In addition, our new solutions or enhancements must meet the requirements ofour current and prospective customers and must achieve significant marketacceptance. Material delays in introducing new solutions and enhancements maycause customers to forego purchases of our solutions and purchase those of ourcompetitors.

 

In addition, the development ofcommercial software and technology that blocks, eliminates or otherwise screensout Internet advertising may reduce the value of advertising inventory on our24/7 Web Alliance and the benefits of our technology solutions to ourcustomers.  We cannot guarantee that anew commercial software or technology, for end-users or enterprises, will notbe capable of eliminating a portion or all of the advertisement formats,including banners, pop-ups, pop-unders and other formats, that we utilizethrough our 24/7 Web Alliance or that we currently deliver through ourtechnology solutions.  To the extent thatour customers refuse to pay for advertisements that are blocked, or if the useof blocking software exceeds our expectations, our business, results ofoperations and financial condition may be materially and adversely affected.

 

ITEM 3.  QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

**INTERESTRATE RISK**

 

The primary objective of ourinvestment activities is to preserve capital. Cash and cash equivalents areinvestments with original maturities of three months or less. Therefore,changes in the market’s interest rates do not affect the value of theinvestments as recorded by 24/7 Real Media. The following table presents theamounts of our financial instruments that are subject to interest rate risk byexpected maturity and average interest rates as of September 30, 2005 (inthousands):

 
| ** **                 | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| Cash and  cash equivalents |       | $        | 34,903     |     | $          | —   |       | $              | —     |      | $          | — |   | $ | 34,903 |   |
| Average  interest rate     |       | 3.39     | %          |     |       |     |       |           |       | 3.39      | %          |
|                       |       |     |       |     |       |     |       |           |       |      |       |
| Loan payable               |       | $        | 7,500      |     | $          | 7,500    |       | $              | —     |      | $          | — |   | $ | 15,000 |   |
| Loan payable               |       | 2.00     | %          | 2.00     | %          |     |       |           |       | 2.00      | %          |

 

The terms of our debenturescontain a provision that gives the holder the ability to call a portion of thenote upon the satisfaction of a trading price condition. This conditionconstitutes an embedded derivative. The value of this embedded derivative atSeptember 30, 2005 is immaterial to our financial position. We review the valueof the derivative on a quarterly basis, in accordance with SFAS No. 149, *Amendment of Statement 133 on Derivative Instrumentsand Hedging Activities*. At September 30, 2005, we did not hold anyother derivative financial instruments.

 

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**FOREIGNCURRENCY RISK**

 

We transact business in avariety of foreign countries and are thus subject to exposure from adversemovements in foreign currency exchange rates. This exposure is primarilyrelated to revenue and operating expenses. The effect of foreign exchange ratefluctuations for the three and nine month periods ended September 30, 2005 and2004 were not material. We do not use derivative financial instruments to limitour foreign currency risk exposure. At September 30, 2005, we had$12.5 million in cash and cash equivalents denominated in foreigncurrencies.

 

ITEM 4. CONTROLSAND PROCEDURES

 

*Evaluation of Controls and Procedures*

 

As of the end of the period covered by this Quarterly Report on Form10-Q, an evaluation of the effectiveness of the design and operation of ourdisclosure controls and procedures was carried out by us under the supervisionand with the participation of our management, including our Chief ExecutiveOfficer and Chief Financial Officer. Based on that conclusion, our ChiefExecutive Officer and Chief Financial Officer concluded that our disclosurecontrols and procedures have been designed and are being operated in a mannerthat provides reasonable assurance that the information required to bedisclosed in our Exchange Act reports is recorded, processed, summarized andreported within the time periods specified in the SEC’s rules and forms, andthat such information is accumulated and communicated to our management,including our Chief Executive Officer and Chief Financial Officer, asappropriate, to allow timely decisions regarding required disclosure. Indesigning and evaluating the disclosure controls and procedures, our managementrecognizes that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives, and our management necessarily is required to apply itsjudgment in evaluating the cost-benefit relationship of possible controls andprocedures.

 

In 2004, as a complement to our existing overall program of internalcontrol, we initiated a company-wide review of our internal control overfinancial reporting as part of the process for compliance with Section 404of the Sarbanes-Oxley Act of 2002. As a result of the review, we have madeimprovements to the design and effectiveness of our internal control throughthe nine month period ended September 30, 2005.  We anticipate thatimprovements will continue to be made.

 

*Changes in Internal Control*

 

There has beenno change in our internal control over financial reporting during our mostrecent fiscal quarter that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

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PART II.  OTHER INFORMATION

 

ITEM 1.  LEGAL PROCEEDINGS

 

We are involved in various claims and legal actions arising in theordinary course of business.  In theopinion of management, the ultimate disposition of these matters will not havea material effect on our financial position, results of operations orliquidity.

 

ITEM2.  UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS

 

None.

 

ITEM3.  DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS

 

None.

 

ITEM 5.  OTHER INFORMATION

 

None.

 

ITEM 6.  EXHIBITS

 

**Exhibits**

 
| Exhibit 31.1 |   | Certification of Chief Executive Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                     |
|--------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |   |                                                                                                                                                          |
| Exhibit 31.2 |   | Certification of Chief Financial Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                     |
|         |   |                                                                                                                                                          |
| Exhibit 32.1 |   | Certification of Chief Executive Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.* |
|         |   |                                                                                                                                                          |
| Exhibit 32.2 |   | Certification of Chief Financial Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.* |

 

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(*)           Thiscertification accompanies this Quarterly Report on Form 10-Q, but is not deemedfiled with the SEC and is not to be incorporated by reference into any filingof the Company under the Securities Act of 1933, as amended, or the SecuritiesExchange Act of 1934, as amended (whether made before, on or after the date ofthis Quarterly Report on Form 10-Q), irrespective of any general incorporationlanguage contained in such filing.

 

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Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.

 
|                    | 24/7 REAL  MEDIA, INC. |
|-------------------------|------------------------|
|                    | *(Registrant)*         |
|                    |                   |
|                    |                   |
| Date:  November 9, 2005 |                   | By: |   /s/  DAVID J. MOORE |   |
|                    |                   | David J.  Moore |
| * *                | * *               | *Chairman and Chief  Executive Officer  (Principal Executive Officer)* |

 

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