**UNITED STATES SECURITIES ANDEXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark one)**

 

**ý****QUARTERLY REPORT PURSUANTTO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**For thequarterly period ended June 30, 2004**

** **

**or**

** **

**o****TRANSITIONAL REPORTPURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**For thetransition periodfrom                              to                              **

** **

**Commission file number 1-14355**

** **

**24/7 Real Media, Inc.**

(Exactname of registrant as specified in its charter)

 
| **DELAWARE**                                                     | ** ** | **13-3995672**                      |
|------------------------------------------------------------------|------------|-------------------------------------|
| (STATE  OR OTHER JURISDICTION OF  INCORPORATION OR ORGANIZATION) |       | (IRS  EMPLOYER  IDENTIFICATION NO.) |
|                                                             |       |                                |
| **1250 BROADWAY, NEW YORK, NY**                                  | ** ** | **10001**                           |
| (ADDRESS  OF PRINCIPAL EXECUTIVE OFFICES)                        |       | (ZIP  CODE)                         |

 

**(212) 231-7100**

(REGISTRANT’STELEPHONE NUMBER, INCLUDING AREA CODE)

 

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

 

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

 

Indicate the number of shares outstanding ofeach of the issuer’s classes of common stock, as of the latest practicabledate.

 
| **CLASS**                               | ** ** | **OUTSTANDING AT August 5, 2004** |
|-----------------------------------------|------------|-----------------------------------|
| Common  Stock, par value $.01 per share |       | 34,175,937  Shares                |

 

 

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**24/7 Real Media, Inc.**

**June 30, 2004**

**FORM 10-Q**

**INDEX**

 
| Part I. Financial  Information                                                                                |   |
|---------------------------------------------------------------------------------------------------------------|--------|
| Item 1.  Consolidated Financial Statements                                                                    |   |
| Consolidated Balance Sheets  as of June 30, 2004 (unaudited) and December 31, 2003                            |   |
| Consolidated  Statements of Operations for the three and six months ended June 30, 2004 and  2003 (unaudited) |   |
| Consolidated  Statements of Cash Flows for the six months ended June 30, 2004 and 2003  (unaudited)           |   |
| Notes to Unaudited Interim  Consolidated Financial Statements                                                 |   |
| Item  2. Management’s Discussion and Analysis of Financial Condition and Results of  Operations          |   |
| Item 3. Quantitative  and Qualitative Disclosure about Market Risk                                            |   |
| Item 4. Controls and  Procedures                                                                              |   |
|                                                                                                          |   |
| Part II. Other Information                                                                                    |   |
| Item 1. Legal  Proceedings                                                                                    |   |
| Item 2. Changes in  Securities and Use of Proceeds                                                            |   |
| Item 3.  Defaults Upon Senior Securities                                                                      |   |
| Item  4. Submission of Matters to a Vote of Security Holders                                                  |   |
| Item 5. Other Information                                                                                     |   |
| Item 6.  Exhibits and Reports on Form 8-K                                                                     |   |
| Signatures                                                                                                    |   |

 

Open AdStream®, Open AdSystemTM, OpenAdvertiserTM, Insight XETM, Insight ACTTM and Insight SETM are trademarks of 24/7Real Media, Inc.  All other brand namesor trademarks appearing herein are the properties of their respective holders.

 

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PART I. FINANCIALINFORMATION

 

ITEM 1. CONSOLIDATEDFINANCIAL STATEMENTS

 

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

**CONSOLIDATEDBALANCE SHEETS**

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

** **
| ** **                                                                                                                                                                            | ** ** | **June 30,  2004**  | ** ** | **December 31,  2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                            | ** ** | **(unaudited****)** | ** ** | ** **             | ** ** |
| **ASSETS**                                                                                                                                                                            |       |                |       |                   |       |
| Current assets:                                                                                                                                                                       |       |                |       |                   |       |
| Cash and cash equivalents                                                                                                                                                             |       | $                   | 52,511     |                   | $          | 21,645 |   |
| Marketable securities                                                                                                                                                                 |       | 2,896               |       | —                 |       |
| Accounts receivable, less allowances of $1,146 and $971,  respectively                                                                                                           |       | 19,888              |       | 11,603                 |       |
| Prepaid expenses and other current assets                                                                                                                                             |       | 1,824               |       | 1,669                  |       |
|                                                                                                                                                                                  |       |                |       |                   |       |
| Total current assets                                                                                                                                                                  |       | 77,119              |       | 34,917                 |       |
|                                                                                                                                                                                  |       |                |       |                   |       |
| Property and equipment, net                                                                                                                                                           |       | 2,907               |       | 2,862                  |       |
| Goodwill                                                                                                                                                                              |       | 14,530              |       | 2,621                  |       |
| Intangible assets, net                                                                                                                                                                |       | 5,960               |       | 3,352                  |       |
| Other assets                                                                                                                                                                          |       | 6,602               |       | 2,428                  |       |
|                                                                                                                                                                                  |       |                |       |                   |       |
| Total assets                                                                                                                                                                          |       | $                   | 107,118    |                   | $          | 46,180 |   |
|                                                                                                                                                                                  |       |                |       |                   |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                        |       |                |       |                   |       |
| Current liabilities:                                                                                                                                                                  |       |                |       |                   |       |
| Accounts payable                                                                                                                                                                      |       | $                   | 11,015     |                   | $          | 6,266 |   |
| Accrued liabilities                                                                                                                                                                   |       | 12,775              |       | 10,086                 |       |
| Deferred revenue                                                                                                                                                                      |       | 2,837               |       | 2,544                  |       |
|                                                                                                                                                                                  |       |                |       |                   |       |
| Total current liabilities                                                                                                                                                             |       | 26,627              |       | 18,896                 |       |
|                                                                                                                                                                                  |       |                |       |                   |       |
| Subordinated convertible debentures, 2%, due 2006                                                                                                                                     |       | 13,625              |       | 13,320                 |       |
| Warrant liability                                                                                                                                                                     |       | 747                 |       | 3,595                  |       |
| Other long-term liabilities                                                                                                                                                           |       | 312                 |       | 332                    |       |
|                                                                                                                                                                                  |       |                |       |                   |       |
| Total liabilities                                                                                                                                                                     |       | 41,311              |       | 36,143                 |       |
|                                                                                                                                                                                  |       |                |       |                   |       |
| Commitments and contingencies                                                                                                                                                         |       |                |       |                   |       |
|                                                                                                                                                                                  |       |                |       |                   |       |
| Stockholders’ equity:                                                                                                                                                            |       |                |       |                   |       |
| Preferred stock; $.01 par value; 10,000,000 shares authorized,  689,351 and 828,250 shares issued and  outstanding, respectively (liquidation  preference of $10 per share) |       | 7                   |       | 8                      |       |
| Common stock; $.01 par value; 350,000,000 shares authorized;  34,161,742 and 23,367,421 shares issued and  outstanding, respectively                                        |       | 342                 |       | 234                    |       |
| Additional paid-in capital                                                                                                                                                            |       | 1,160,815           |       | 1,106,984              |       |
| Deferred stock compensation                                                                                                                                                           |       | (107                | )          | (257                   | )          |
| Accumulated other comprehensive income                                                                                                                                                |       | 788                 |       | 305                    |       |
| Accumulated deficit                                                                                                                                                                   |       | (1,096,038          | )          | (1,097,237             | )          |
| Total stockholders’ equity                                                                                                                                                       |       | 65,807              |       | 10,037                 |       |
|                                                                                                                                                                                  |       |                |       |                   |       |
| Total liabilities and stockholders’ equity                                                                                                                                       |       | $                   | 107,118    |                   | $          | 46,180 |   |

 

See accompanying notes to unaudited interim consolidated financialstatements.

 

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

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(in thousands, expect share and per share data)**

** **
| ** **                                                                                                                         | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                                                                                                         | ** ** | **2004**                        | ** ** | **2003**                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                                         | ** ** | **(unaudited)**                 | ** ** | **(unaudited)**               | ** ** |
|                                                                                                                               |       |                            |       |                          |       |   |   |   |   |
| Revenues:                                                                                                                          |       |                            |       |                          |       |   |   |   |   |
| Integrated media solutions                                                                                                         |       | $                               | 14,891     |                          | $          | 8,362 |   | $ | 27,930 |   | $ | 16,705 |   |
| Technology solutions                                                                                                               |       | 4,706                           |       | 3,788                         |       | 9,048 |   | 7,269 |   |
| Total revenues                                                                                                                     |       | 19,597                          |       | 12,150                        |       | 36,978 |   | 23,974 |   |
|                                                                                                                               |       |                            |       |                          |       |   |   |   |   |
| Cost of revenues:                                                                                                                  |       |                            |       |                          |       |   |   |   |   |
| Integrated media solutions                                                                                                         |       | 10,487                          |       | 5,084                         |       | 19,928 |   | 10,594 |   |
| Technology solutions (exclusive of $0, $10,  $0 and $10, respectively, reported below as  stock-based compensation)           |       | 879                             |       | 1,062                         |       | 1,701 |   | 2,227 |   |
| Total cost of revenues                                                                                                             |       | 11,366                          |       | 6,146                         |       | 21,629 |   | 12,821 |   |
|                                                                                                                               |       |                            |       |                          |       |   |   |   |   |
| Gross profit                                                                                                                       |       | 8,231                           |       | 6,004                         |       | 15,349 |   | 11,153 |   |
|                                                                                                                               |       |                            |       |                          |       |   |   |   |   |
| Operating expenses:                                                                                                                |       |                            |       |                          |       |   |   |   |   |
| Sales and marketing (exclusive of $186,  $33, $210 and $41, respectively, reported below as stock-based  compensation)        |       | 3,893                           |       | 3,227                         |       | 7,209 |   | 6,371 |   |
| General and administrative (exclusive of  $92, $67, $263 and $105, respectively, reported below as  stock-based compensation) |       | 3,019                           |       | 2,776                         |       | 6,001 |   | 5,698 |   |
| Product development (exclusive of $20, $36,  $24 and $38, respectively, reported below as  stock-based compensation)          |       | 1,095                           |       | 755                           |       | 2,146 |   | 1,342 |   |
| Amortization of intangible assets and  deferred financing costs                                                                    |       | 1,414                           |       | 661                           |       | 2,202 |   | 1,308 |   |
| Stock-based compensation                                                                                                           |       | 298                             |       | 146                           |       | 497 |   | 194 |   |
| Restructuring costs                                                                                                                |       | 501                             |       | —                        |       | 501 |   | — |   |
|                                                                                                                               |       |                            |       |                          |       |   |   |   |   |
| Total operating expenses                                                                                                           |       | 10,220                          |       | 7,565                         |       | 18,556 |   | 14,913 |   |
|                                                                                                                               |       |                            |       |                          |       |   |   |   |   |
| Loss from operations                                                                                                               |       | (1,989                          | )          | (1,561                        | )          | (3,207 | ) | (3,760 | ) |
|                                                                                                                               |       |                            |       |                          |       |   |   |   |   |
| Interest expense, net                                                                                                              |       | (96                             | )          | (56                           | )          | (278 | ) | (147 | ) |
| Change in fair value of warrant liability                                                                                          |       | 881                             |       | —                        |       | 1,809 |   | — |   |
| Gain on legal settlement                                                                                                           |       | 2,896                           |       | —                        |       | 2,896 |   | — |   |
| Other income (expense), net                                                                                                        |       | (69                             | )          | (834                          | )          | 111 |   | (834 | ) |
|                                                                                                                               |       |                            |       |                          |       |   |   |   |   |
| Income (loss) before provision for income  taxes                                                                                   |       | 1,623                           |       | (2,451                        | )          | 1,331 |   | (4,741 | ) |
|                                                                                                                               |       |                            |       |                          |       |   |   |   |   |
| Provision for income taxes                                                                                                         |       | 32                              |       | 33                            |       | 132 |   | 40 |   |
|                                                                                                                               |       |                            |       |                          |       |   |   |   |   |
| Net income (loss)                                                                                                                  |       | 1,591                           |       | (2,484                        | )          | 1,199 |   | (4,781 | ) |
|                                                                                                                               |       |                            |       |                          |       |   |   |   |   |
| Dividends on preferred stock                                                                                                       |       | (104                            | )          | (158                          | )          | (222 | ) | (287 | ) |
| Preferred stock conversion discount                                                                                                |       | —                          |       | (1,780                        | )          | — |   | (1,780 | ) |
| Net income (loss) attributable to common  stockholders                                                                             |       | $                               | 1,487      |                          | $          | (4,422 | ) | $ | 977 |   | $ | (6,848 | ) |
|                                                                                                                               |       |                            |       |                          |       |   |   |   |   |
| Basic net income (loss) per share  attributable to common stockholders                                                             |       | $                               | 0.04       |                          | $          | (0.31 | ) | $ | 0.03 |   | $ | (0.50 | ) |
|                                                                                                                               |       |                            |       |                          |       |   |   |   |   |
| Weighted average shares used in basic net  income (loss) per share                                                                 |       | 34,054,489                      |       | 14,475,512                    |       | 29,836,259 |   | 13,689,656 |   |
|                                                                                                                               |       |                            |       |                          |       |   |   |   |   |
| Diluted net income (loss) per share  attributable to common stockholders                                                           |       | $                               | 0.04       |                          | $          | (0.31 | ) | $ | 0.03 |   | $ | (0.50 | ) |
|                                                                                                                               |       |                            |       |                          |       |   |   |   |   |
| Weighted average shares used in diluted net  income (loss) per share                                                               |       | 43,886,508                      |       | 14,475,512                    |       | 39,845,899 |   | 13,689,656 |   |

 

See accompanying notes to unaudited interimconsolidated financial statements.

 

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands)**

** **
| ** **                                                                                     | ** ** | **Six months ended June 30,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                                     | ** ** | **2004**                      | ** ** | **2003** | ** ** |
| ** **                                                                                     | ** ** | **(unaudited)**               | ** ** |
| Cash flows from operating activities:                                                          |       |                          |       |   |   |
| Net income (loss)                                                                              |       | $                             | 1,199      |   | $ | (4,781 | ) |
| Adjustments to reconcile net income (loss)  to net cash used in operating activities:          |       |                          |       |   |   |
| Depreciation and amortization                                                                  |       | 945                           |       | 1,238 |   |
| Provision for doubtful accounts and sales  reserves                                            |       | 349                           |       | 293 |   |
| Amortization of intangible assets and  deferred financing costs                                |       | 2,202                         |       | 1,308 |   |
| Amortization of warrants                                                                       |       | 306                           |       | — |   |
| Non-cash compensation                                                                          |       | 497                           |       | 194 |   |
| Accrued interest on notes payable                                                              |       | 149                           |       | 166 |   |
| Non-cash gain from legal settlement                                                            |       | (2,896                        | )          | — |   |
| Change in fair value of warrant liability                                                      |       | (1,809                        | )          | — |   |
| Changes in operating assets and  liabilities, net of effects of acquisitions and dispositions: |       |                          |       |   |   |
| Accounts receivable                                                                            |       | (3,563                        | )          | (1,933 | ) |
| Prepaid assets and other current assets                                                        |       | (126                          | )          | 642 |   |
| Other assets                                                                                   |       | (4,433                        | )          | 43 |   |
| Accounts payable and accrued liabilities                                                       |       | 2,131                         |       | (1,405 | ) |
| Deferred revenue                                                                               |       | 282                           |       | 671 |   |
|                                                                                           |       |                          |       |   |   |
| Net cash used in operating activities                                                          |       | (4,767                        | )          | (3,564 | ) |
|                                                                                           |       |                          |       |   |   |
| Cash flows from investing activities:                                                          |       |                          |       |   |   |
| Cash paid for acquisitions, net                                                                |       | (1,958                        | )          | (150 | ) |
| Capital expenditures, including capitalized  software                                          |       | (819                          | )          | (506 | ) |
| Cash paid for investment                                                                       |       | —                        |       | (50 | ) |
|                                                                                           |       |                          |       |   |   |
| Net cash used in investing activities                                                          |       | (2,777                        | )          | (706 | ) |
|                                                                                           |       |                          |       |   |   |
| Cash flows from financing activities:                                                          |       |                          |       |   |   |
| Proceeds from issuance of common stock, net                                                    |       | 37,364                        |       | — |   |
| Proceeds from exercise of stock options and  conversion of warrants                            |       | 587                           |       | 486 |   |
| Payment of capital lease obligations                                                           |       | (24                           | )          | (24 | ) |
| Proceeds from issuance of preferred stock,  net                                                |       | —                        |       | 6,792 |   |
| Retirement of debt                                                                             |       | —                        |       | (1,500 | ) |
|                                                                                           |       |                          |       |   |   |
| Net cash provided by financing activities                                                      |       | 37,927                        |       | 5,754 |   |
|                                                                                           |       |                          |       |   |   |
| Net change in cash and cash equivalents                                                        |       | 30,383                        |       | 1,484 |   |
| Effect of foreign currency on cash                                                             |       | 483                           |       | (38 | ) |
| Cash and cash equivalents at beginning of  year                                                |       | 21,645                        |       | 7,674 |   |
|                                                                                           |       |                          |       |   |   |
| Cash and cash equivalents at end of period                                                     |       | $                             | 52,511     |   | $ | 9,120 |   |

 

See accompanying notes to unaudited interim consolidated financialstatements.

 

5

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**(1)  NATURE OF OPERATIONS AND SIGNIFICANTACCOUNTING POLICIES**

 

# **Nature of Operations**

#  

24/7 Real Media, Inc. (the “Company”) togetherwith its subsidiaries offers a suite of media and technology products for theonline advertising needs of Web publishers and advertisers, including Webrepresentation, advertisement serving, analytics and search marketing services.

 

The Company has organized its business in twoprincipal segments: Integrated Media Solutions and Technology Solutions.

 

Integrated Media Solutions consist of the 24/7 WebAlliance, a global alliance of Web sites represented by the Company throughwhich advertisers can place campaign orders directly with the Company, and 24/7Search, an Internet search marketing service designed to connect advertiserswith consumers using search engines to find product information.

 

Technology Solutions are primarily based onthe Company’s patent-protected Open AdSystem technology platform for Internetadvertisement delivery, management and analytics, and consist of: Open AdStreamLocal, which the Company licenses to Web publishers to run on their proprietary,local servers; Open AdStream Central, which the Company provides to Webpublishers from software hosted centrally on the Company’s servers; OpenAdvertiser, which the Company provides to advertisers and advertising agenciesfrom software hosted centrally on the Company’s servers; and the Company’sInsight software solutions, which integrate with Open AdStream to offer Webpublishers active campaign reporting and marketing intelligence and helpadvertisers measure, analyze, manage and monetize audiences.

 

# **Organization and Basis ofPresentation**

#  

#### *(a)  Principles of Consolidation*

####  

The accompanying consolidated financialstatements include the accounts of the Company and its majority-owned andcontrolled subsidiaries from their respective dates of acquisition.  All significant intercompany transactions andbalances have been eliminated.

 

The accompanying interim consolidatedfinancial statements are unaudited.  Inthe Company’s opinion, the unaudited consolidated financial statements havebeen prepared on the same basis as the annual consolidated financial statementsand reflect 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 periodspresented.  The financial statements,financial data and other information disclosed in these notes to theconsolidated results are not necessarily indicative of the results expected forthe full fiscal year or any future period.

 

The accompanying consolidated financialstatements should be read in conjunction with the audited consolidatedfinancial statements for the year ended December 31, 2003.  Certain information and footnote disclosuresnormally included in financial statements prepared in accordance withaccounting principles generally accepted in the United States of America havebeen condensed or omitted pursuant to the Securities and Exchange Commission’srules and regulations.

 

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###### *(b)  Use of Estimates*

######  

###### The preparation of consolidated financial statementsin accordance with accounting principles generally accepted in the UnitedStates of America requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities and the disclosure ofcontingent assets and liabilities at the date of the consolidated financialstatements and the reported amounts of revenues and expenses during thereporting period.  Actual results coulddiffer from those estimates.

######  

On an ongoing basis, theCompany evaluates its estimates, including those related to revenuerecognition, accruals, allowance for doubtful accounts, fair value of acquiredintangible assets and goodwill, useful lives of intangible assets and propertyand 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)  Cash and Cash Equivalents and MarketableSecurities*

######  

The Company considers all highly liquidsecurities, with original maturities of three months or less, to be cashequivalents.  Cash and cash equivalentsconsisted principally of money market accounts.

 

Marketable securities consist of corporateequity securities.  The Company has classified its marketablesecurities as available-for-sale. Accordingly, these investments are carried at fair value, withunrealized gains and losses, net of related taxes, as a separate component ofstockholders’ equity.  The Companyrecognizes gains and losses when these securities are sold.  The Company has not recognized any gains orlosses from the sale of its marketable securities.

 

*(d)  Concentration of Credit Risk and SignificantCustomers*

 

Financial instruments that potentially subject theCompany to concentrations of credit risk consist principally of cashequivalents and accounts receivable. Cash equivalents consist of money market funds, which, at times, exceedfederally insured limits.  Accountsreceivable are typically unsecured and are derived from revenues earned fromcustomers primarily located in the United States, Europe and Korea.  Many of those customers are in the Internetindustry.  To appropriately manage creditrisk, the Company performs ongoing evaluations of customer credit and limitsthe amount of credit extended, but generally no collateral is required.  The Company maintains reserves for estimatedcredit losses and these losses have generally been within management’sexpectations.

 

No single customer accounted for greater than 10% ofnet revenues for the three and six month periods ended June 30, 2004 and 2003.

 

###### *(e)  Accounts Receivable*

######  

Accounts receivable are recorded at the invoicedamount and are non-interest bearing.  TheCompany maintains an allowance for doubtful accounts to reserve for potentiallyuncollectible receivables.  Managementreviews the accounts receivable by aging category to identify specificcustomers with known disputes or collectibility issues.  In determining the amount of the reserve,management makes judgments about the creditworthiness of significant customersbased on ongoing credit evaluations.  TheCompany also maintains a sales allowance to reserve for

 

7

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potential credits issued to customers.  The amount of the reserve is determined basedon historical credits issued.

 

###### *(f)  Unbilled Receivables*

######  

AtJune 30, 2004 and December 31, 2003, accounts receivable included approximately$3.5 million and $4.4 million, respectively, of earned but unbilledreceivables, which are a normal part of the Company’s business, as receivablesare usually invoiced in the month following the completion of the earningprocess.  All unbilled receivables have been subsequentlybilled.

 

*(g)*  *Capitalized Software; Product Development Costs*

 

In accordance with Statement of Financial AccountingStandards (“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.  Generally, thecompletion of the working model coincides with general release.  The Company capitalized approximately$1.2 million in connection with the development of its Open Advertiseradvertisement serving software product, which is included in property andequipment, net on the consolidated balance sheet.  The product was released in June 2003and is being amortized using the straight-line method over the estimated usefullife of the software, or four years. Amortization for the three and six month periods ended June 30, 2004 was$0.1 million and $0.2 million, respectively, and accumulated amortization as ofJune 30, 2004 was $0.3 million.

 

*(h)  Revenue Recognition; Cost of Revenues*

 

*Integrated Media Solutions*

 

24/7 Web Alliance revenues are generated bydelivering advertising impressions for a fixed fee to third-party Websites.  24/7 Search revenues are derivedfrom driving valid visitors to client Web sites. E-mail related revenues arederived from delivering advertisements to e-mail lists for advertisers and Websites.  Agreements are primarily shortterm and revenues are recognized as services are delivered provided that nosignificant Company obligations remain outstanding and collection of theresulting receivable is probable.

 

The Company becomes obligated to make payments tothird-party Web sites, search engine distribution partners and e-mail listswhich have contracted with the Company, in the period the advertisingimpressions, valid visitors or e-mails are delivered. Such expenses areclassified as cost of revenues in the accompanying consolidated statements ofoperations.

 

*Technology Solutions*

 

Technology Solutionsrevenues are derived primarily from licensing of our software, hostedadvertisement serving, and software maintenance and technical supportservices.  Revenue from softwarelicensing agreements is recognized in accordance with Statements of Position(“SOP”) No. 97-2, *Software RevenueRecognition*, and Staff Accounting Board (“SAB”) No. 104, *Revenue Recognition*, upon delivery of thesoftware, which is generally when the software is made available for download,there is persuasive evidence of an arrangement, collection is reasonablyassured, the fee is fixed or determinable, and vendor-specific objective evidenceexists to allocate the total fees to all elements of the arrangement.  Contracts that bundle the software licensewith

 

8

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maintenance and technicalsupport are recognized ratably over the contract term.  Revenue from advertisement serving isrecognized upon delivery.  Revenue fromsoftware maintenance and technical support contracts is recognized ratably overthe life of the agreement, which typically does not exceed one year.

 

Expenses from the Company’s licensing, softwaremaintenance, technical support and advertisement serving revenues are primarilypayroll costs incurred to deliver and support the software.  These expenses are classified as cost ofrevenues in the accompanying consolidated statements of operations.

 

*Deferred Revenue*

 

Revenues that are billed or collected in advance of services being completed are deferred until the conclusion of the period of the service for which the advance billing or collection relates.  Deferred revenues are included on the consolidated balance sheets as a current liability until the service is performed and then recognized in the period in which the service is completed.  The Company’s deferred revenues primarily consist of billings in advance for software license subscriptions and software maintenance and technical support services.

 

###### *(i)  Warrant Liability*

######  

In September 2000, the EmergingIssues Task Force (“EITF”) issued EITF Issue No. 00-19 (“EITF 00-19”), *Accounting for Derivative Financial Instruments Indexedto, and Potentially Settled in, a Company’s Own Stock*, whichrequires freestanding contracts that are settled in a Company’s own stock,including common stock warrants, to be designated as an equity instrument,asset or liability.  Under the provisionsof EITF 00-19, a contract designated as an asset or a liability must be carriedat fair value until exercised or expired, with any changes in fair valuerecorded on the consolidated statement of operations.  A contract designated as an equity instrumentmust be included within equity, and no fair value adjustments arerequired.  The classification of acontract should be reviewed at each balance sheet date.

 

Inconnection with the placement of the Company’s preferred stock and subordinatedconvertible debentures, the Company issued warrants to investors to purchaseshares of the Company’s common stock. The Company agreed to register the shares issuable upon exercise of thewarrants and to pay penalties for a delayed filing or a failure to file aregistration statement prior to the agreed deadline.  The Company also agreed to pay penalties ifthe registration statement becomes temporarily or permanently unavailable foruse by the warrant holders.  Accordingly,pursuant to EITF 00-19, the Company reflected the value of the warrants as awarrant liability on the consolidated balance sheet and the liability will bereclassified to equity upon exercise or conversion.  The fair value of the outstanding warrants isevaluated at each reporting period with any resulting change in the fair valuebeing reflected in the consolidated statement of operations.  As a result of such evaluation, the Companydecreased the warrant liability at June 30, 2004 by $1.8 million on theconsolidated balance sheet and recorded a change in fair value of warrantliability on the consolidated statement of operations.

 

InJune 2004, the Company amended the registration rights agreement related to thesubordinated convertible debentures.  Theamendment provided that the Company is no longer obligated to pay any filing ormaintenance penalties pursuant to the registration rights agreement withrespect to the warrants issued to the holders of the debentures.  Accordingly, the Company reclassified thewarrant liability related to the debentures to additional paid in capital.

 

9

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###### *(j)  Stock-Based Compensation*

######  

TheCompany accounts for stock-based employee compensation arrangements inaccordance with the provisions of Accounting Principles Board Opinion (“APB”)No. 25, *Accounting for Stock Issued toEmployees*, and Financial Accounting Standards Board (“FASB”)interpretation No. 44, *Accounting forCertain Transactions Involving Stock Compensation – an interpretation of APBOpinion No. 25*, and complies with the disclosure provisions of SFASNo. 123, *Accounting for Stock-BasedCompensation*, and SFAS No. 148, *Accountingfor Stock-Based Compensation – Transition and Disclosure*.  Under APB No. 25, compensation cost isrecognized based on the difference, if any, on the date of grant between thefair value of the Company’s common stock and the amount an employee must pay toacquire the common stock.  SFAS No. 148requires more prominent and more frequent disclosures in both interim andannual financial statements about the method of accounting for stock-basedcompensation and the effect of the method used on reported results.  We adopted the disclosure provisions of SFASNo. 148 as of December 31, 2002 and continue to apply the measurementprovisions of APB No. 25.

 

Had the Company determinedcompensation cost based on the fair value at the grant date for its stockoptions under SFAS No. 123, the Company’s net income (loss) would have beenadjusted to the pro forma amounts indicated below:

 
| ** **                                                                                                                           | ** ** | **Three Months Ended  June 30,**             | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                           | ** ** | **2004**                                     | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                                           | ** ** | **(in thousands, except per share amounts)** | ** ** |
| Net income (loss) attributable to common  stockholders:                                                                              |       |                                         |       |                           |       |   |   |   |   |
| As reported                                                                                                                          |       | $                                            | 1,487      |                           | $          | (4,422 | ) | $ | 977 |   | $ | (6,848 | ) |
| Deduct: Total stock-based employee  compensation expense determined under fair-value-based method for all awards,  net of tax effect |       | 1,400                                        |       | 1,204                          |       | 3,168 |   | 3,414 |   |
| Pro forma                                                                                                                            |       | $                                            | 87         |                           | $          | (5,626 | ) | $ | (2,191 | ) | $ | (10,262 | ) |
| Basic net income (loss) attributable to  common stockholders per share:                                                              |       |                                         |       |                           |       |   |   |   |   |
| As reported                                                                                                                          |       | $                                            | 0.04       |                           | $          | (0.31 | ) | $ | 0.03 |   | $ | (0.50 | ) |
| Pro forma                                                                                                                            |       | 0.00                                         |       | (0.39                          | )          | (0.07 | ) | (0.75 | ) |
| Diluted net income (loss) attributable to  common stockholders per share:                                                            |       |                                         |       |                           |       |   |   |   |   |
| As reported                                                                                                                          |       | $                                            | 0.04       |                           | $          | (0.31 | ) | $ | 0.03 |   | $ | (0.50 | ) |
| Pro forma                                                                                                                            |       | 0.01                                         |       | (0.39                          | )          | (0.05 | ) | (0.75 | ) |

 

The per shareweighted-average fair value of stock options granted for the three and sixmonth periods ended June 30, 2004 was $5.77 and $4.83, respectively, and was$0.50 and $0.80 for the three and six month period ended June 30, 2003,respectively, on the date of grant using the Black-Scholes method with thefollowing weighted-average assumptions:

 

10

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| ** **               | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **               | ** ** | **2004**                         | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| Expected dividend yield  |       | 0                                | %          | 0                              | %          | 0 | % | 0 | % |
| Risk-free interest rate  |       | 2.59                             | %          | 1.13                           | %          | 2.30 | % | 1.42 | % |
| Expected life (in years) |       | 3.0                              |       | 1.5                            |       | 2.6 |   | 2.4 |   |
| Volatility               |       | 136                              | %          | 94                             | %          | 132 | % | 132 | % |

 

TheCompany accounts for non-employee stock-based awards in which goods or servicesare the consideration received for the equity instruments issued based on thefair value of the equity instruments issued in accordance with the EITF No.96-18, *Accounting For Equity InstrumentsThat Are Issued To Other Than Employees For Acquiring, or in Conjunction WithSelling Goods or Services*.

 

###### *(k)  Preferred Stock*

######  

| ** ** | ** ** | ** **             | ** ** | ** **           | ** ** | ** **           | ** ** | **Shares Ouststanding at** | ** ** |
|------------|------------|------------------------|------------|----------------------|------------|----------------------|------------|----------------------------|------------|
| **Series** | ** ** | **Shares  Authorized** | ** ** | **Price Per  Share** | ** ** | **Conversion  Rate** | ** ** | **June 30,  2004**         | ** ** | **December 31,  2003** | ** ** |
| A          |       | 800,000                |       | $                    | 10.00      |                 | $          | 1.02675                    |       | 611,351 |   | 750,000 |   |
| C          |       | 718,250                |       | 10.00                |       | 1.20790              |       | 78,000                     |       | 78,250 |   |
|       |       |                   |       |                 |       |                 |       | 689,351                    |       | 828,250 |   |
|            |            |                        |            |                      |            |                      |            |                            |            |  |  |  |  |

 

Duringthe six month period ended June 30, 2004, 138,649 shares of Series A and 250shares of Series C Preferred Stock were converted into 1,350,364 and 2,070shares of common stock, respectively. The preferred stock accrues and cumulates dividends at a rate of 6% peryear, compounded monthly, payable when, as and if declared by the Company’sBoard of Directors.  All accrueddividends must be paid before any dividends may be declared or paid on thecommon stock, and shall be paid as an increase in the liquidation preferencepayable upon the sale, merger, liquidation, dissolution or winding up of theCompany.  Accrued but unpaid dividendsare cancelled upon conversion.  At June30, 2004, there are approximately $0.7 million of accrued but unpaid dividends.

 

Inthe event of a liquidation, dissolution or winding up of the Company, theholders of the preferred stock are entitled to a liquidation preference paymentper share equal to the purchase price, plus any dividends accrued butunpaid as of such date before any payment to holders of common stock.  After payment of the foregoing preference,the holders of each share of preferred stock would then participate *pro rata* with theholders of the common stock, on an as converted basis, in the distribution ofthe proceeds fromsuch a liquidation event to the holders of the common stock until such time asthe holders of preferred stock shall have received an amount equal to threetimes the purchase price (inclusive of their liquidation preference).  A merger, consolidation or sale of theCompany will be treated as a liquidation event unless such transaction has beenapproved by the holders of a majority of the outstanding preferred stock.

 

###### *(l)  Comprehensive Income (Loss)*

######  

Totalcomprehensive income (loss) for the six month periods ended June 30, 2004 and2003 was $1.7 million and $(4.8) million, respectively.  Comprehensive income (loss) resulted from netincome (losses) of $1.2 million and $(4.8) million, and in 2004 foreigncurrency translation adjustment of $0.5 million.

 

11

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### *(m) Basic and Diluted Net Income(Loss) Per Share*

###  

Netincome (loss) per share is presented in accordance with the provisions of SFASNo. 128, *Earnings Per Share*(“EPS”).  Basic EPS excludes dilution forpotentially dilutive securities and is computed by dividing income (loss)available to common shareholders by the weighted average number of commonshares outstanding for the period. Diluted EPS reflects the potential dilution that could occur ifsecurities or other contracts to issue common stock were exercised or convertedinto common stock and resulted in the issuance of common stock.  Potential common shares consist ofincremental common shares issuable upon the exercise of stock options andwarrants (using the treasury stock method), the conversion of subordinatedconvertible debentures and preferred stock (using the if-converted method) andthe vesting of restricted stock.

 

The computation ofdiluted net income (loss) per share for the three month period ended June 30,2004 excludes outstanding options of approximately 2.2 million to purchaseshares of common stock and the effects of 0.5 million shares issuable upon theexercise or conversion of common stock warrants, since their inclusion wouldhave an antidilutive effect.  Similarly,for the six month period ended June 30, 2004, the computation excludesoutstanding options of approximately 0.3 million to purchase shares of commonstock and the effects of 0.5 million shares issuable upon the exercise orconversion of common stock warrants.

 

The computation of net income (loss) pershare for the three and six month period ended June 30, 2003 excludesoutstanding options of 3.5 million to purchase shares of common stock and theeffects of 1.9 million shares issuable upon the exercise or conversion ofcommon stock warrants and 13.7 million shares issuable upon the conversion ofpreferred stock, since their inclusion would have an antidilutive effect.

 

### *(n)  Reclassifications*

###  

Certain reclassifications have been made toprior year consolidated financial statements to conform to current year’spresentation.

 

*(o)  Recent Accounting Pronouncements*

 

In April 2004, the EITF issued EITF Issue No.03-06 (“EITF 03-06”), *Participating Securitiesand the Two-Class Method Under FASB Statement No. 128, Earnings Per Share,*which addresses a number of questions regarding the computation of earnings pershare by companies that have issued securities other than common stock thatcontractually entitle the holder to participate in dividends and earnings ofthe company when, and if, it declares dividends on its common stock.  Theissue also provides further guidance in applying the two-class method ofcalculating earnings per share, clarifying what constitutes a participatingsecurity and how to apply the two-class method of computing earnings per shareonce it is determined that a security is participating, including how toallocate undistributed earnings to such a security.  EITF 03-06 iseffective for fiscal periods beginning after March 31, 2004.  TheCompany is currently evaluating the effect of adopting EITF 03-06 on itsfinancial statements.

 

**(2)  ACQUISITIONS AND UNAUDITED PRO FORMA SUMMARY**

 

*(a)  Acquisition of Real Media Korea Co., Ltd(“RMK”)*

 

On January 6, 2004, the Company completed theacquisition of Real Media Korea Co., Ltd., by acquiring the approximately90.4% of the outstanding shares of RMK that the Company did not

 

12

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already own. The Company paid total consideration of $20.1 million in exchangefor the RMK shares, which consisted of $5.0 million in cash, approximately2.1 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 accounting purposes, the effective dateof the acquisition is January 1, 2004.

 

Thepurchase price in excess of fair value of net tangible assets and liabilitiesacquired of $16.1 million has been preliminarily allocated as follows: $11.9million to goodwill; $2.3 million to agency relationships; $0.7 million totrade name; $0.5 million to acquired technology; and $0.7 million to otherintangible assets.  The purchase priceallocation is subject to revision pending final external valuation.  The acquisition was accounted for as apurchase business combination in accordance with SFAS No. 141, *Business Combinations*, and SFAS No. 142, *Goodwill and Other Intangible Assets*.

 

The net tangible assets acquired consist ofthe following:

 

| **Asset/  Liability**     | ** ** | **Amount** | ** ** |
|---------------------------|------------|------------|------------|
|                      |       |       |       |
| Cash and cash equivalents |       | $          | 3,469      |   |
| Other current assets      |       | 5,151      |       |
| Fixed assets              |       | 170        |       |
| Non-current assets        |       | 385        |       |
| Accrued liabilities       |       | (5,119     | )          |
|                      |       | $          | 4,056      |   |

 

*(b)  Acquisition of Insight First, Inc.*

 

OnJanuary 21, 2003, the Company acquired certain assets of Insight First, Inc.,including specific contracts, intangible assets, and employee relationships,related to the Insight First’s Web analytics solutions, including theintellectual property relating to specific products, in exchange forapproximately 0.7 million shares of the Company’s common stock valued atapproximately $1.1 million, plus $150,000 in cash.  In addition, the Company has a contingentobligation to pay additional earn-out consideration of up to $1.0 million, ineither cash or common stock, at the Company’s discretion, subject toachievement of earn-out targets relating to revenue generated by the acquiredbusiness in fiscal year 2004.

 

The purchase price in excess of fair value ofnet tangible assets and liabilities acquired of $1.3 million has been allocatedto acquired technology.  The acquiredtechnology is being amortized over the expected benefit period of fouryears.  The acquisition was accounted foras a purchase business combination in accordance with SFAS No. 141, *Business Combinations* and SFAS No. 142, *Goodwill and Other Intangible Assets*.

 

The net tangible assets acquired consist ofthe following:

 

13

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| **Asset/  Liability** | ** ** | **Amount** | ** ** |
|-----------------------|------------|------------|------------|
|                  |       |       |       |
| Fixed assets          |       | $          | 44         |   |
| Accrued liabilities   |       | (41        | )          |
|                  |       | $          | 3          |   |

 

*(c)  Unaudited Pro Forma Summary*

 

The following pro forma consolidated amountsgive effect to the Company’s RMK and Insight First acquisition accounted for bythe purchase method of accounting as if they had occurred at the beginning ofthe period by consolidating the results of operations of the acquired entitiesfor the three and six month periods ended June 30, 2004 and 2003.

 

The pro forma consolidated statements ofoperations are not necessarily indicative of the operating results that wouldhave been achieved had the transactions been in effect as of the beginning ofthe periods presented and should not be construed as being representative offuture operating results.

 
| ** **                                                               | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                               | ** ** | **2004**                         | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                     |       |                             |       |                           |       |   |   |   |   |
| Total revenues                                                           |       | $                                | 19,597     |                           | $          | 15,089 |   | $ | 36,978 |   | $ | 29,874 |   |
| Net income (loss) attributable to common  stockholders                   |       | 1,487                            |       | (4,509                         | )          | 977 |   | (7,065 | ) |
|                                                                     |       |                             |       |                           |       |   |   |   |   |
| Basic net income (loss) attributable to  common stockholders per share   |       | $                                | 0.04       |                           | $          | (0.27 | ) | $ | 0.03 |   | $ | (0.44 | ) |
| Weighted average shares used in basic per  share calculation (1)         |       | 34,054,489                       |       | 16,601,933                     |       | 29,906,361 |   | 15,897,898 |   |
|                                                                     |       |                             |       |                           |       |   |   |   |   |
| Diluted net income (loss) atrributable to  common stockholders per share |       | $                                | 0.04       |                           | $          | (0.27 | ) | $ | 0.03 |   | $ | (0.44 | ) |
| Weighted average shares used in diluted per  share calculation (1)       |       | 43,886,508                       |       | 16,601,933                     |       | 39,916,001 |   | 15,897,898 |   |

 

----

(1) The weighted average shares used tocompute pro forma basic and diluted net income (loss) per share for the threeand six month periods ended June 30, 2004 and 2003 includes the 2.1 million and0.7 million shares of common stock issued for RMK and Insight First,respectively, as if the shares were issued on January 1, 2003.

 

**(3)  DISPOSAL OF NON-CORE ASSETS**

 

*Sale ofiPromotions, Inc.*

 

OnJanuary 31, 2003, the Company entered into an Asset Purchase Agreement withiPromotions, Inc., a corporation formed by private investors including some ofthe Company’s former employees.  Pursuantto the terms of the Asset Purchase Agreement, the Company sold to theinvestors, specific contracts, equipment, intangible assets, and employeerelationships related to the Company’s iPromotions business, including theintellectual property relating to specific products.  The Company also invested $50,000 in cash inexchange for shares of preferred stock

 

14

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representinga 19.9% interest in iPromotions, Inc. on a converted basis.  Accordingly, the Company effectively sold amajority stake in its iPromotions business. Prior to the sale, the carrying value of iPromotions was $0, therefore,there was no gain or loss on the transaction. The cash payment was recorded as an investment.  The Company wrote-off the investment in thesecond quarter of 2004.

 

**(4)  GOODWILL AND INTANGIBLE ASSETS, NET**

 

Pursuant to SFAS No. 141, *Business Combinations*, and SFAS No. 142, *Goodwill and Other Intangible Assets*, theCompany recorded goodwill and intangible assets when the fair value of the nettangible assets acquired was less than the purchase price of the asset orbusiness acquired.  Effective January 1,2002, the Company adopted SFAS No. 142, *Goodwilland Other Intangible Assets*, and SFAS No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets*.  SFAS No.142 eliminates the amortization of goodwill and indefinite-lived intangibleassets, addresses the amortization of goodwill and intangible assets withfinite lives and addresses the impairment testing and recognition for goodwilland intangible assets.  SFAS No. 144establishes a single model for the impairment of long-lived assets.

 

On an ongoing basis, management reviews thatvalue and period of amortization of goodwill and intangible assets.  No event occurred or circumstanceschanged during the six month period ended June 30, 2004 that would have, morelikely than not, reduced the fair value of goodwill and intangible assets belowthe amounts reflected in the consolidated balance sheet and accordingly, noimpairment charge was recorded for the three and six month periods ended June30, 2004.

 

*(a)  Goodwill*

 

The $14.5 million in goodwill at June 30,2004 relates $11.9 million to RMK, $1.1 million to 24/7 Canada, $1.1 million toReal Media and $0.4 million to 24/7 Search. The $2.6 million in goodwill at December 31, 2003 relates $1.1 millionto 24/7 Canada, $1.1 million to Real Media and $0.4 million to 24/7 Search.

 

*(b)  Intangible Assets, Net*

 

The $6.0 million in intangible assets, net atJune 30, 2004 relates $3.7 million to RMK, $1.4 million to Real Media, $0.8million to Insight First and $0.1 million to 24/7 Search.  The $3.4 million in intangible assets, net atDecember 31, 2003 relates $1.8 million to Real Media, $1.0 million to InsightFirst and $0.6 million to 24/7 Search.

 

15

----

 
| ** **                    | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** | **Estimated  Useful Lives** | ** ** |
|-------------------------------|------------|--------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                    | ** ** | **(in thousands)** | ** ** | ** **             | ** ** |
|                          |       |               |       |                   |       |                        |       |
| Goodwill (1)                  |       | $                  | 14,530     |                   | $          | 2,621                       |       |   |   |
|                          |       |               |       |                   |       |                        |       |
| Technology (2)                |       | $                  | 7,813      |                   | $          | 7,263                       |       | 4 |   |
| Less accumulated amortization |       | (5,237             | )          | (4,142                 | )          |                        |       |
| Net Technology                |       | 2,576              |       | 3,121                  |       |                        |       |
|                          |       |               |       |                   |       |                        |       |
| Other Intangible assets (3)   |       | 4,160              |       | 500                    |       | 4 - 5                       |       |
| Less accumulated amortization |       | (776               | )          | (269                   | )          |                        |       |
| Net Other intangible assets   |       | 3,384              |       | 231                    |       |                        |       |
|                          |       |               |       |                   |       |                        |       |
| Gross Intangible assets       |       | 11,973             |       | 7,763                  |       |                        |       |
| Less accumulated amortization |       | (6,013             | )          | (4,411                 | )          |                        |       |
| Net Intangible assets         |       | $                  | 5,960      |                   | $          | 3,352                       |       |   |   |

 

----

(1) Goodwill increased $11.9 million due tothe acquisition of RMK.

(2) Acquired technologyincreased $0.5 million due to the acquisition of RMK.

(3) Other intangible assets include tradenames, agency relationships and non-compete agreements and increased $3.7million due to the acquisition of RMK.

 

**(5)  RESTRUCTURING**

 

Restructuring-related liabilities include estimatesfor, among other things, involuntary terminations of employees and dispositionof lease obligations.  Key variables indetermining such estimates include timing of sublease rentals, estimates ofsublease rental payment amounts and tenant improvement costs, and estimates forbrokerage and other related costs.  TheCompany periodically evaluates and, if necessary, adjusts the estimates basedon currently-available information.

 

Thefollowing sets forth the activities in the Company’s restructuring reserve forthe six month period ended June 30, 2004, which is included in accruedliabilities in the consolidated balance sheet (in thousands):

 
| ** **                    | ** ** | **Beginning  Balance** | ** ** | **Current year  provision** | ** ** | **Current Year  Utilization** | ** ** | **Ending Balance** | ** ** |
|-------------------------------|------------|------------------------|------------|-----------------------------|------------|-------------------------------|------------|--------------------|------------|
| Employee termination benefits |       | $                      | 470        |                        | $          | 335                           |       | $                  | (513       | ) | $ | 292 |   |
| Office closing costs          |       | 1,165                  |       | 166                         |       | (453                          | )          | 878                |       |
| Other exit costs              |       | 28                     |       | —                      |       | (28                           | )          | —             |       |
|                          |       | $                      | 1,663      |                        | $          | 501                           |       | $                  | (994       | ) | $ | 1,170 |   |

 

16

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**(6)** **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 dueSeptember 2006 (“Debentures”).  TheDebentures are convertible into shares of the Company’s common stock at $8.75per share.  Interest on the Debentures atthe rate of 2% is due semi-annually starting in January 2004.  The investor also acquired a five-yearwarrant (the “Warrants”) to purchase 0.4 million shares of the Company’s commonstock 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.  In addition, the Company may elect to pay theprincipal of and interest on the Debentures in shares of its common stockrather than cash.  If the Company electsto pay the principal amount due under the Debentures at maturity in shares ofits common stock, rather than in cash, the maturity date conversion price willbe equal to 90% of the average of the daily volume-weighted average prices ofthe Company’s common stock on the Nasdaq SmallCap Market for the fifteenconsecutive trading days immediately preceding the maturity date.  If the Company elects to make interestpayments due under the Debentures in shares of its common stock, rather than incash, the interest conversion price will be equal to 90% of the average of thedaily volume-weighted average prices of the Company’s common stock on theNasdaq SmallCap Market for the five consecutive trading days immediatelypreceding the interest payment date.

 

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, ifat any time on or after the second anniversary of the initial issuance date,the weighted average price of the common stock is less than $8.75 on any fiveconsecutive trading days after such second anniversary, the holder shall havethe right, in its sole discretion, to require that the Company redeem up to$7.5 million principal amount of these Debentures.  The redemption right constitutes an embeddedderivative.  The value of the embeddedderivative at June 30, 2004 is immaterial to the financial position of theCompany.  The Company will continue toreview the value of the derivative on a quarterly basis, in accordance withSFAS No. 149, *Amendment ofStatement 133 on Derivative Instruments and Hedging Activities*.

 

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 market value of theWarrants was reflected as a reduction of the face amount of the Debentures onthe consolidated balance sheet and is being amortized over three years, theinitial term of the Debentures, using the effective interest method.  Accordingly, the carrying value of theDebentures will be increased over the initial term.

 

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 theplacement fees, the Company issued warrants to the placement agent.  The warrants to purchase 86,000 shares ofcommon stock at an exercise price of $10.068 are in the same form and on thesame terms and conditions as the Warrants issued to the investor.  The Company included the value of thewarrants, $0.4 million, using the factors above, and the cash placementfees of $1.2 million in other assets on the consolidated balance sheet.  Collectively, the debt issuance costs of $1.6million are being amortized over three years, the initial term of theDebentures.  For the three and six monthperiods ended June 30, 2004, approximately $0.1

 

17

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million and $0.3 millionof the deferred costs are included in amortization expense and at June 30,2004, the unamortized portion of the debt issuance costs is $1.2 million.

 

**(7) ****EQUITY INSTRUMENTS**

 

PREFERRED STOCK

 

During the six monthperiod ended June 30, 2004, 138,649 shares of Series A and 250 shares of SeriesC Preferred Stock were converted into 1,350,364 and 2,070 shares of commonstock, respectively.

 

COMMON STOCK

 

*(a)  Secondary Stock Offering*

 

On March 30, 2004, theCompany completed a secondary stock offering in which a total of 8.0 millionshares of common stock were sold at $6.00 per share.  Of the shares sold, the Company sold 6.0million shares and selling stockholders sold 2.0 million shares.  The Company and the selling stockholdersreceived proceeds net of underwriting discounts and commission, and beforeother offering expenses, of $33.8 million and $11.3 million, respectively.  In connection with the offering, the Companyand selling stockholders granted to the underwriters an option to purchase upto an additional 1.2 million shares of common stock at $6.00 per share lessunderwriter discounts and commissions for the purpose of coveringover-allotments.  Of the additionalshares offered, approximately 0.8 million shares and 0.4 million shares wereoffered by the Company and by the selling stockholders, respectively. Theunderwriters exercised the over-allotment option in April 2004.  The Company and selling stockholders receivedadditional proceeds of $4.3 million and $2.3 million, respectively, net ofunderwriting discounts and commissions and before other offering expenses.  The Company estimates $1.0 million of otheroffering expenses of which approximately $0.7 million has been paid as of June30, 2004.

 

*(b)  Reverse Stock Split*

 

On February 27,2004, the Company completed a one-for-five reverse split of its common stock.As a result of the reverse split, every five shares of the Company’s commonstock were combined into one share of common stock. The reverse split does notaffect the number of shares of preferred stock and warrants outstanding,however, the conversion ratio is adjusted. All figures relating to common stock, preferred stock, stock options,warrants and other equity-linked instruments have been adjusted in this Form10-Q to reflect the reverse stock split.

 

*(c)  Other Issuances*

 

On January 6, 2004, theCompany issued approximately 2.1 million shares, valued at $14.6 million, inconnection with the acquisition of RMK.

 

*(d)  Additional Paid-in Capital*

 

*During the six month period endedJune 30, 2004, the Company’s additional paid-in capital increased by $53.8million primarily due to $37.0 million in connection with the Company’ssecondary offering of common stock, $14.6 million in connection with theacquisition of RMK, $1.0 million in connection with the amendment of theregistration rights agreement related to the*

 

18

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*debentures, $0.6 million in otherstock-based compensation issued to employees and $0.6 million from exercise ofstock options and warrants.*

* *

**(8)  STOCK INCENTIVE PLANS**

 

For the six month period endedJune 30, 2004, the Company granted 1.9 million stock options under the 2002Stock Incentive Plan to employees at exercise prices based on the fair marketvalue of the Company’s common stock at the respective dates of grant.

 

On January 1, 2004, inaccordance with the terms of the 2002 Stock Incentive Plan, shares reserved forissuance under the Plan were increased by 0.6 million.

 

**(9)  SUPPLEMENTAL CASH FLOW INFORMATION**

 

*Cash Paidfor Interest*

 

For the six months ended June 30, 2004 and2003, the amount of cash paid for interest was $82,000 and $5,000,respectively.

 

**(10)  SEGMENTS**

 

The Company’s business is comprised of tworeportable segments:  Integrated MediaSolutions and Technology Solutions.  TheIntegrated Media Solutions segment generates the majority of its revenues bydelivering advertisements and promotions to affiliated Web sites and searchengine traffic delivery and marketing services. The Technology Solutions segment generates revenue by providingthird-party advertisement serving and other technology services.  The Company’s management periodically reviewscorporate assets and overhead expenses for each segment.  The summarized segment information asof and for the three and six month periods ended June 30, 2004 and 2003, is asfollows:

 

19

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| ** **                                                      | ** ** | **Three months ended June 30, 2004** | ** ** | **Six months ended June 30, 2004** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                      | ** ** | **Integrated  Media  Solutions**     | ** ** | **Technology  Solutions**          | ** ** | **Corporate** | ** ** | **Total** | ** ** | **Integrated  Media  Solutions** | ** ** | **Technology  Solutions** | ** ** | **Corporate** | ** ** | **Total** | ** ** |
| ** **                                                      | ** ** | **(in thousands)**                   | ** ** | **(in thousands)**                 | ** ** |
|                                                            |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenues                                                        |       | $                                    | 14,891     |                               | $          | 4,706 |   | $ | — |   | $ | 19,597 |   | $ | 27,930 |   | $ | 9,048 |   | $ | — |   | $ | 36,978 |   |
| Depreciation                                                    |       | 191                                  |       | 255                                |       | 11 |   | 457 |   | 439 |   | 478 |   | 28 |   | 945 |   |
| Amortization of intangible assets and  deferred financing costs |       | 953                                  |       | 329                                |       | 132 |   | 1,414 |   | 1,280 |   | 658 |   | 264 |   | 2,202 |   |
| Stock-based compensation                                        |       | 131                                  |       | 20                                 |       | 147 |   | 298 |   | 159 |   | 20 |   | 318 |   | 497 |   |
| Segment income (loss) from operations                           |       | (728                                 | )          | 840                                |       | (2,101 | ) | (1,989 | ) | (893 | ) | 1,579 |   | (3,893 | ) | (3,207 | ) |
| Interest income (expense), net                                  |       | 27                                   |       | —                             |       | (123 | ) | (96 | ) | 50 |   | — |   | (328 | ) | (278 | ) |
| Change in fair value of warrant liability                       |       | —                               |       | —                             |       | 881 |   | 881 |   | — |   | — |   | 1,809 |   | 1,809 |   |
| Gain on legal settlement                                        |       | —                               |       | —                             |       | 2,896 |   | 2,896 |   | — |   | — |   | 2,896 |   | 2,896 |   |
| Other income (expense), net                                     |       | 47                                   |       | —                             |       | (116 | ) | (69 | ) | 38 |   | — |   | 73 |   | 111 |   |
| Income tax expense                                              |       | (32                                  | )          | —                             |       | — |   | (32 | ) | (132 | ) | — |   | — |   | (132 | ) |
| Segment income (loss)                                           |       | (686                                 | )          | 840                                |       | 1,437 |   | 1,591 |   | (937 | ) | 1,579 |   | 557 |   | 1,199 |   |
|                                                                 |            |                                      |            |                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                            | ** ** | **Three months ended June 30, 2003** | ** ** | **Six months ended June 30, 2003** | ** ** |
|---------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                            | ** ** | **Integrated  Media  Solutions**     | ** ** | **Technology  Solutions**          | ** ** | **Corporate** | ** ** | **Total** | ** ** | **Integrated  Media  Solutions** | ** ** | **Technology  Solutions** | ** ** | **Corporate** | ** ** | **Total** | ** ** |
| ** **                            | ** ** | **(in thousands)**                   | ** ** | **(in thousands)**                 | ** ** |
|                                  |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenues                              |       | $                                    | 8,362      |                               | $          | 3,788 |   | $ | — |   | $ | 12,150 |   | $ | 16,705 |   | $ | 7,269 |   | $ | — |   | $ | 23,974 |   |
| Depreciation                          |       | 370                                  |       | 187                                |       | 24 |   | 581 |   | 804 |   | 380 |   | 54 |   | 1,238 |   |
| Amortization of intangible assets and |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| deferred financing costs              |       | 333                                  |       | 328                                |       | — |   | 661 |   | 666 |   | 642 |   | — |   | 1,308 |   |
| Stock-based compensation              |       | 75                                   |       | 15                                 |       | 56 |   | 146 |   | 95 |   | 15 |   | 84 |   | 194 |   |
| Segment income (loss) from operations |       | 106                                  |       | 21                                 |       | (1,688 | ) | (1,561 | ) | (386 | ) | (21 | ) | (3,353 | ) | (3,760 | ) |
| Interest income (expense), net        |       | 8                                    |       | —                             |       | (64 | ) | (56 | ) | 10 |   | — |   | (157 | ) | (147 | ) |
| Other income (expense)                |       | 4                                    |       | —                             |       | (838 | ) | (834 | ) | 4 |   | — |   | (838 | ) | (834 | ) |
| Income tax expense                    |       | (33                                  | )          | —                             |       | — |   | (33 | ) | (40 | ) | — |   | — |   | (40 | ) |
| Segment income (loss)                 |       | 85                                   |       | 21                                 |       | (2,590 | ) | (2,484 | ) | (412 | ) | (21 | ) | (4,348 | ) | (4,781 | ) |
|                                  |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total assets:                         |       |                                 |       |                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| June 30, 2004                         |       | 36,885                               |       | 10,853                             |       | 59,380 |   | 107,118 |   |   |   |   |   |   |   |   |   |
| December 31, 2003                     |       | 10,381                               |       | 11,173                             |       | 24,626 |   | 46,180 |   |   |   |   |   |   |   |   |   |
|                                       |            |                                      |            |                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                             | ** ** | **United States**  | ** ** | **United  Kingdom** | ** ** | **South Korea** | ** ** | **Other -  International** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|--------------------|------------|---------------------|------------|-----------------|------------|----------------------------|------------|-----------|------------|
| ** **                             | ** ** | **(in thousands)** | ** ** |
| **Period ended June 30, 2004**         |       |               |       |                |       |            |       |                       |       |      |       |
| Revenues for the three months ended    |       | $                  | 9,947      |                | $          | 2,912           |       | $                          | 3,365      |      | $          | 3,373 |   | $ | 19,597 |   |
| Revenues for the six months ended      |       | 18,370             |       | 6,192               |       | 6,517           |       | 5,899                      |       | 36,978    |       |
| Long-lived assets                      |       | 11,964             |       | 309                 |       | 16,213          |       | 1,513                      |       | 29,999    |       |
|                                   |       |               |       |                |       |            |       |                       |       |      |       |
| **Period ended June 30, 2003**         |       |               |       |                |       |            |       |                       |       |      |       |
| Revenues for the three months ended    |       | $                  | 7,203      |                | $          | 2,181           |       | $                          | —     |      | $          | 2,766 |   | $ | 12,150 |   |
| Revenues for the six months ended      |       | 14,644             |       | 4,301               |       | —          |       | 5,029                      |       | 23,974    |       |
| Long-lived assets at December 31, 2003 |       | 9,549              |       | 146                 |       | —          |       | 1,568                      |       | 11,263    |       |

 

**(11)  COMMITMENTS AND CONTINGENCIES**

 

**COMMITMENTS**

 

***Lycos, Inc.Services Agreements***

 

On February 11, 2004, the Company entered into a five-yeararrangement with Lycos, Inc. (“Lycos”) to provide media sales,advertisement serving and analytics technology services to Lycos’ U.S. Webproperties and to transition personnel and other services from Lycos to theCompany.

 

The agreement requires the Company to pay Lycos the greater of 65% ofall net advertising sales revenue generated by the Company in respect of Lycos’U.S. Web properties, or specified minimum required annual payments.  For 2004, the minimum annual payment is $10.0million and is payable $2.5 million 45 days after each quarter end.  To the extent that Lycos’ 65% revenue shareexceeds the quarterly amount of the minimum annual payment,

 

20

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the Company may credit such excess against the next succeedingquarterly payment of the minimum annual payment.  Management believes that the minimums will bemet, resulting in no additional expense for the quarter.

 

The Company also will pay Lycos a transition payment of$4.5 million in equal installments at each quarter end in 2004.  The amount was recorded as an other long-termasset and a current liability.  The assetwill be amortized over the term of the agreement of five years.

 

***Indemnifications***

 

While the Company has various indemnificationobligations included in contracts in the normal course of business, theseindemnities do not represent significant commitments or contingent liabilitiesof the indebtedness of others. Accordingly, the Company has not recorded a liability related toindemnification provisions.

 

**LITIGATION**

 

*aQuantive*

 

In March 2004, the Federal Circuit Court of Appealshas affirmed, without opinion, a July 2003 decision of the U.S. FederalCourt for the Western District of Washington that granted summary judgment toaQuantive, Inc. in a lawsuit that alleged that aQuantive infringed theCompany’s U.S. patent number 6,026,368.  The lower court’s ruling heldthat aQuantive’s Atlas DMT advertisement serving system does not infringe the‘368 patent.  The Company filed a requestfor rehearing before the Federal Circuit Court of Appeals that was denied.

 

*Brian Anderson*

 

On July 5, 2001, Brian Anderson, former Chief Executive of ourAwardTrack, Inc. subsidiary, served the Company with notice of a lawsuitfiled in Superior Court for the State of California in and for the County ofSanta Cruz, alleging breach of contract, fraud, intentional infliction ofemotional distress and breach of fiduciary duty, in connection with theacquisition of AwardTrack and subsequent events.  The Company removed the lawsuit to federal courtin California and moved to dismiss the complaint in its entirety.  The motion was granted in part, with leave toamend, and denied in part.  The plaintiffhas subsequently refiled the complaint and the Company filed acounterclaim.  Discovery has concluded,and the Company has moved for summary judgment to dismiss the complaint in itsentirety.

 

*chinadotcom Corporation*

 

OnJune 1, 2004, the Company and David J. Moore, its Chief Executive Officer,reached a settlement with chinadotcom Corporation (“chinadotcom”) involving therelease of all claims and the termination of all litigation matters involvingthe two companies and their affiliates. As part of the settlement, chinadotcom agreed to issue to 24/7 RealMedia 400,000 Class A common shares of chinadotcom.  The shares, valued at $2.9 million based on market price on the date of settlement, isincluded on the consolidated statement of operations as a gain on legalsettlement.

 

21

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*General*

 

The Company is involved in various claims and legal actions arising inthe ordinary course of business.  In theopinion of management, the ultimate disposition of these matters will not havea material effect on the Company’s financial position, results of operations orliquidity.

 

22

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

 

This report includesforward-looking statements within the meaning of the Private Securities LitigationReform Act of 1995. This Act provides a “safe harbor” for forward-lookingstatements to encourage companies to provide prospective information aboutthemselves so long as they identify these statements as forward looking andprovide meaningful cautionary statements identifying important factors thatcould cause actual results to differ from the projected results. All statementsother than statements of historical fact, including statements regardingindustry prospects and future results of operations or financial position, madein this Quarterly Report are forward looking. We use words such as“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 “Risk Factors” and elsewhere in this Quarterly Report. Weundertake no obligation to publicly release any revisions to theseforward-looking statements that may be made to reflect events or circumstancesafter the date hereof or to reflect the occurrence of unanticipated events.Readers are urged, however, to review the risk factors set forth in reportsthat we file from time to time with the Securities and Exchange Commission.Unless the context requires otherwise in this Quarterly Report the terms “24/7Real Media,” the “Company,” “we,” “us” and “our” refer to 24/7 RealMedia, Inc. and its subsidiaries, and references to “24/7 Search” refer to24/7 Search, Inc., formerly 24/7 Website Results, Inc., a whollyowned subsidiary of 24/7 Real Media, Inc.

 

### **GENERAL**

###  

We offer a comprehensive suite of media andtechnology products for the online advertising needs of Web publishers andadvertisers, including Web representation, advertisement serving, analytics andsearch services. Our 24/7 Web Alliance of over 800 affiliated Web sitesaggregates advertising inventory online and targets audience segments toattract advertisers worldwide. Through 24/7 Search, we connect advertisers withconsumers who use search engines to find information about products andservices.  Our Open AdSystem technologyhelps Web publishers and advertisers target, convert and retain onlinecustomers and maintain audience relationships.

 

We generate revenue intwo business segments:  Integrated MediaSolutions and Technology Solutions.

 

*IntegratedMedia Solutions*

 

**24/7 Web Alliance**

 

We generate revenue through the 24/7 Web Allianceprimarily from fees paid by client advertisers for advertisingimpressions.  We typically count anadvertising impression each time a request is made to our servers to display anadvertiser’s advertisement to an end user. We typically offer advertisers a pricing model based oncost-per-thousand-impressions (“CPM”) enabling a client advertiser to pay a feebased on the number of times its advertisement is viewed.

 

23

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We share advertising revenue generated through the24/7 Web Alliance with Web publishers included in the 24/7 Web Alliance.  Our 24/7 Web Alliance consists of our 24/7Network, a network of hundreds of Web sites offering a variety of content primarilyin the U.S., and the 24/7 Portfolio, a select global portfolio of brand nameWeb sites.  We generally retain between40% and 50% of advertising revenues generated from 24/7 Network Web sites andbetween 20% and 40% of advertising revenue generated from 24/7 Portfolio Websites.  Our revenue share may varydepending on, among other things, audience size, the number of unique visitors,impressions and page views; geography and the prominence of the Web publisher’sbrand name.

 

The following table showsby quarter the number of paid impressions and the average CPM sinceJanuary 1, 2002. Metrics prior to 2002 are not comparable due to theacquisition of Real Media.

 

| ** ** | ** ** | **Number of Paid  Impressions (in  billions)** | ** ** | **Average CPM** | ** ** |
|------------|------------|------------------------------------------------|------------|-----------------|------------|
| Q2 2004    |       | 14.3                                           |       |            | 0.86       |   |   |
| Q1 2004    |       | 9.6                                            |       |            | 1.03       |   |   |
| Q4 2003    |       | 6.6                                            |       |            | 0.90       |   |   |
| Q3 2003    |       | 5.9                                            |       |            | 0.95       |   |   |
| Q2 2003    |       | 6.2                                            |       |            | 0.88       |   |   |
| Q1 2003    |       | 6.1                                            |       |            | 0.79       |   |   |
| Q4 2002    |       | 4.8                                            |       |            | 0.99       |   |   |
| Q3 2002    |       | 3.0                                            |       |            | 1.23       |   |   |
| Q2 2002    |       | 3.3                                            |       |            | 1.19       |   |   |
| Q1 2002    |       | 4.2                                            |       |            | 1.01       |   |   |

 

**24/7Search**

 

24/7 Search provides servicesfor the inclusion of an advertiser’s Web site into both pay-for-placement andalgorithmic search engines.  Theseservices are commonly referred to as bidded services and paid inclusion,respectively.  Our 24/7 Search contentbuilders review advertiser Web site content for relevancy to satisfy bothadvertiser conversion metrics and search engine editorial standards. Our 24/7Search optimization team produces a content feed for insertion into thedatabases of our search distribution partners and helps our advertisers selectthe most relevant Web site landing page for visitors.  Through relationships with our search enginedistribution partners, we submit advertiser Web site content via automated datafeeds.  Our services only provide thatour client advertisers’ Web site content will be included in the database ofour search engine distribution partners. We do not guarantee our client advertisers any particular ranking withinsearch results listings displayed by our search engine distribution partners tousers.

 

We generate revenue through 24/7 Search primarilyfrom performance-based fees paid by our client advertisers for valid visitortraffic to their Web sites.  Our clientadvertisers pay a predetermined cost-per-click, or CPC, for each valid visitordelivered to their Web sites.  For ourbidded service, which constitutes a larger portion of our 24/7 Search revenue,we agree on a CPC price with our client advertisers and then we place CPC bidsfor various keywords and phrases with our search engine distributionpartners.  We pay the CPC bid price toour distribution partner when a valid visitor links to one of our clientadvertisers’ Web sites by clicking a link displayed in the search results forsuch keywords or phrases.  We generallykeep the spread between the CPC price charged to our client advertiser and theCPC bid price paid to our distribution partner. For our paid inclusion service, we share the revenue generated by our24/7 Search services with our

 

24

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search engine distribution partners that include ourclient advertisers’ Web site content in their databases.  We generally retain between 30% and 45% ofthe revenue depending on the size of our distribution partner, the number ofvalid visitors, the number of searches conducted and the prominence of ourdistribution partner’s brand name, among other factors.  We also provide search agency services toclient advertisers that involves placing and managing CPC keyword bids for themwith our distribution partners.  For thisservice, we charge our client advertiser the amount of the CPC bid plus a fixedcommission for each valid visitor delivered and only recognize the fixedcommission as revenue.

 

The following table shows by quarter the number ofvalid visitors and the average CPC for our performance-based 24/7 Searchservices since January 1, 2002.

 

| ** ** | ** ** | **Number of Valid  Visitors (in  millions)** | ** ** | **Average CPC** | ** ** |
|------------|------------|----------------------------------------------|------------|-----------------|------------|
| Q2 2004    |       | 11.7                                         |       |            | 0.20       |   |
| Q1 2004    |       | 13.2                                         |       |            | 0.23       |   |
| Q4 2003    |       | 12.6                                         |       |            | 0.21       |   |
| Q3 2003    |       | 9.0                                          |       |            | 0.24       |   |
| Q2 2003    |       | 11.0                                         |       |            | 0.21       |   |
| Q1 2003    |       | 16.5                                         |       |            | 0.19       |   |
| Q4 2002    |       | 12.5                                         |       |            | 0.18       |   |
| Q3 2002    |       | 9.6                                          |       |            | 0.21       |   |
| Q2 2002    |       | 10.7                                         |       |            | 0.22       |   |
| Q1 2002    |       | 8.4                                          |       |            | 0.20       |   |

 

Our other media services primarily relate to e-maillist rental. We derive revenue from this service by delivering advertisementsto e-mail lists for advertisers, who pay based on a CPM basis. Our revenueshare with list providers generally ranges between 25% and 35%.

 

*Technology Solutions*

 

Our Technology Solutions are primarily based on ourpatent-protected Open AdSystem technology platform for Internet advertisementdelivery, management and analytics. We provide these solutions to our customersfrom software hosted on our servers or from software hosted on a customer’sserver that is administrated by us.  Ourtechnology Solutions consist of:

 

•      Open AdStream Local, whichwe license to Web publishers to run on their proprietary, local servers;

 

•      Open AdStream Central, whichwe provide to Web publishers from software hosted centrally on our servers;

 

•      Open Advertiser, which weprovide to advertisers and advertising agencies from software hosted centrallyon our servers;

 

•      Insight XE, which offers Web publishers active campaignreporting and marketing intelligence and help advertisers measure, analyze andmanage online audiences;

 

•      Insight ACT, which, in combination with Insight XE and Open AdStream,enables Web publishers to identify and target segments of their audiences basedon user activity; and

 

25

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•      Insight SE, which we designed to allow an advertiser to create targetedcampaigns using keywords and phrases, and generate performance metrics thattrack visitors from specific search engines throughout the entire sales cycle,from prospecting by new customers to the final sale.

 

We generate revenue from licensing our Open AdStreamLocal software to Web publishers. Our license agreements typically provide foran upfront license fee and a software maintenance and service fee. We negotiatelicense fees based on, among other things, the forecasted number of impressionsa Web publisher will deliver using our software.

 

We generate revenue from our Open AdStream Centraland Open Advertiser services from fees paid by Web publishers and advertisersand agencies, respectively. We typically offer Web publishers or advertisers aCPM-based pricing model allowing the Web publisher or advertiser to pay usbased on advertising impressions. Our service revenue is determined bymultiplying the CPM rate by the number of impressions delivered and istypically billed on a monthly basis.

 

We generate revenue from our Insight XE solutionfrom fees paid by Web publishers. We typically offer Web publishers page-viewpricing enabling them to pay us based on how many page views are measured. Ourrevenue is calculated by multiplying the CPM rate by the number of page viewsdelivered.

 

The following table shows by quarter certain metricsfor our Technology Solutions since 2002. We believe that metrics for periodsprior to 2002 are not comparable because our Technology Solutions then includeda different product mix.

 
| ** ** | ** ** | **OAS Local**                               | ** ** | **OAS Central and OAD**                     | ** ** | **Insight XE**                                 | ** ** | ** **                                  | ** ** |
|------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|------------------------------------------------|------------|---------------------------------------------|------------|
| ** ** | ** ** | **Number of  Active Client  Contracts (1)** | ** ** | **Number of  Active Client  Contracts (1)** | ** ** | **Number of Paid  Impressions  (in billions)** | ** ** | **Number of  Active Client  Contracts (1)** | ** ** | **Number of Paid  Pageviews  (in billions)** | ** ** | **Annual  Revenue per  Contract** | ** ** |
| Q2 2004    |       | 210                                         |       | 161                                         |       | 19.5                                           |       |                                        | 42         |   | 3.4 |   | 45,579 |   |
| Q1 2004    |       | 201                                         |       | 138                                         |       | 18.6                                           |       |                                        | 32         |   | 1.1 |   | 46,814 |   |
| Q4 2003    |       | 199                                         |       | 133                                         |       | 11.9                                           |       |                                        | 17         |   | 3.0 |   | 45,009 |   |
| Q3 2003    |       | 219                                         |       | 146                                         |       | 10.6                                           |       |                                        | 16         |   | 2.7 |   | 42,845 |   |
| Q2 2003    |       | 221                                         |       | 142                                         |       | 9.6                                            |       |                                        | 14         |   | 2.3 |   | 40,191 |   |
| Q1 2003    |       | 235                                         |       | 151                                         |       | 8.8                                            |       |                                        | 13         |   | 1.8 |   | 34,897 |   |
| Q4 2002    |       | 258                                         |       | 162                                         |       | 7.5                                            |       |                                        | —     |   | — |   | 37,457 |   |
| Q3 2002    |       | 273                                         |       | 159                                         |       | 6.4                                            |       |                                        | —     |   | — |   | 30,926 |   |
| Q2 2002    |       | 271                                         |       | 153                                         |       | 5.1                                            |       |                                        | —     |   | — |   | 30,660 |   |
| Q1 2002    |       | 274                                         |       | 152                                         |       | 4.9                                            |       |                                        | —     |   | — |   | 30,376 |   |

 

----

(1) A client contract may represent multiple clientsand Web Sites utilizing Open AdStream products and services.

 

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 Open AdStream software engine.

 

26

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# **RESULTS OF OPERATIONS**

#  

# **FACTORS AFFECTING COMPARABILITY OF2004 TO 2003**

#  

In January 2004, we acquired Real Media KoreaCo., Ltd. (“RMK”), a leader in interactive marketing in Seoul, SouthKorea.  Revenue contributed by RMK forthe three and six month periods ended June 30, 2004 was approximately $3.3million and $6.5 million, respectively.

 

### The following table compares the results ofoperations for the three and six month periods ended June 30, 2004 to the resultsof operations for the three and six month periods ended June 30, 2003 (inthousands):

 
| ** **                                                      | ** ** | **Three months ended June 30,** | ** ** | **Dollar  Variance** | ** ** | **Six months ended June 30,** | ** ** | **Dollar  Variance** | ** ** |
|-----------------------------------------------------------------|------------|---------------------------------|------------|----------------------|------------|-------------------------------|------------|----------------------|------------|
| **2004**                                                        | ** ** | **2003**                        | **2004**   | ** **           | **2003**   |
| ** **                                                      | ** ** | **(in thousands)**              | ** ** | **(in thousands)**   | ** ** |
| ** **                                                      | ** ** | **(unaudited)**                 | ** ** | ** **           | ** ** | **(unaudited)**               | ** ** | ** **           | ** ** |
| Revenues:                                                       |       |                            |       |                 |       |                          |       |                 |       |   |   |   |   |
| Integrated media solutions                                      |       | $                               | 14,891     |                 | $          | 8,362                         |       | $                    | 6,529      |   | $ | 27,930 |   | $ | 16,705 |   | $ | 11,225 |   |
| Technology solutions                                            |       | 4,706                           |       | 3,788                |       | 918                           |       | 9,048                |       | 7,269 |   | 1,779 |   |
| Total revenues                                                  |       | 19,597                          |       | 12,150               |       | 7,447                         |       | 36,978               |       | 23,974 |   | 13,004 |   |
|                                                            |       |                            |       |                 |       |                          |       |                 |       |   |   |   |   |
| Cost of revenues:                                               |       |                            |       |                 |       |                          |       |                 |       |   |   |   |   |
| Integrated media solutions                                      |       | 10,487                          |       | 5,084                |       | 5,403                         |       | 19,928               |       | 10,594 |   | 9,334 |   |
| Technology solutions                                            |       | 879                             |       | 1,062                |       | (183                          | )          | 1,701                |       | 2,227 |   | (526 | ) |
| Total cost of revenues                                          |       | 11,366                          |       | 6,146                |       | 5,220                         |       | 21,629               |       | 12,821 |   | 8,808 |   |
|                                                            |       |                            |       |                 |       |                          |       |                 |       |   |   |   |   |
| Gross profit                                                    |       | 8,231                           |       | 6,004                |       | 2,227                         |       | 15,349               |       | 11,153 |   | 4,196 |   |
|                                                            |       |                            |       |                 |       |                          |       |                 |       |   |   |   |   |
| Operating expenses:                                             |       |                            |       |                 |       |                          |       |                 |       |   |   |   |   |
| Sales and marketing                                             |       | 3,893                           |       | 3,227                |       | 666                           |       | 7,209                |       | 6,371 |   | 838 |   |
| General and administrative                                      |       | 3,019                           |       | 2,776                |       | 243                           |       | 6,001                |       | 5,698 |   | 303 |   |
| Product development                                             |       | 1,095                           |       | 755                  |       | 340                           |       | 2,146                |       | 1,342 |   | 804 |   |
| Amortization of intangible assets and  deferred financing costs |       | 1,414                           |       | 661                  |       | 753                           |       | 2,202                |       | 1,308 |   | 894 |   |
| Stock-based compensation                                        |       | 298                             |       | 146                  |       | 152                           |       | 497                  |       | 194 |   | 303 |   |
| Restructuring costs                                             |       | 501                             |       | —               |       | 501                           |       | 501                  |       | — |   | 501 |   |
|                                                            |       |                            |       |                 |       |                          |       |                 |       |   |   |   |   |
| Total operating expenses                                        |       | 10,220                          |       | 7,565                |       | 2,655                         |       | 18,556               |       | 14,913 |   | 3,643 |   |
|                                                            |       |                            |       |                 |       |                          |       |                 |       |   |   |   |   |
| Loss from operations                                            |       | (1,989                          | )          | (1,561               | )          | (428                          | )          | (3,207               | )          | (3,760 | ) | 553 |   |
|                                                            |       |                            |       |                 |       |                          |       |                 |       |   |   |   |   |
| Interest expense, net                                           |       | (96                             | )          | (56                  | )          | (40                           | )          | (278                 | )          | (147 | ) | (131 | ) |
| Change in fair value of warrant liability                       |       | 881                             |       | —               |       | 881                           |       | 1,809                |       | — |   | 1,809 |   |
| Gain on legal settlement                                        |       | 2,896                           |       | —               |       | 2,896                         |       | 2,896                |       | — |   | 2,896 |   |
| Other income (expense), net                                     |       | (69                             | )          | (834                 | )          | 765                           |       | 111                  |       | (834 | ) | 945 |   |
|                                                            |       |                            |       |                 |       |                          |       |                 |       |   |   |   |   |
| Income (loss) before provision for income  taxes                |       | 1,623                           |       | (2,451               | )          | 4,074                         |       | 1,331                |       | (4,741 | ) | 6,072 |   |
|                                                            |       |                            |       |                 |       |                          |       |                 |       |   |   |   |   |
| Provision for income taxes                                      |       | 32                              |       | 33                   |       | (1                            | )          | 132                  |       | 40 |   | 92 |   |
|                                                            |       |                            |       |                 |       |                          |       |                 |       |   |   |   |   |
| Net income (loss)                                               |       | $                               | 1,591      |                 | $          | (2,484                        | )          | $                    | 4,075      |   | $ | 1,199 |   | $ | (4,781 | ) | $ | 5,980 |   |

 

27

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### **REVENUES**

###  

**INTEGRATEDMEDIA SOLUTIONS.**Revenueis derived from three sources: 24/7 Web Alliance, 24/7 Search and Other MediaServices.  24/7 Web Alliance revenue was$12.1 million and $21.8 million for the three and six month periods ended June30, 2004, respectively, as compared to $5.5 million and $10.2 million for thethree and six month periods ended June 30, 2003, respectively, an increase of120.2% and 114.3%, respectively.  Theincrease is primarily related to revenue contributed by RMK and sales ofadditional advertising inventory provided by Lycos, Inc. Web sites, whichincreased the number of paid impressions delivered through our 24/7 Networkfrom 6.2 billion in 2003 to 14.3 billion in 2004.  RMK contributed revenue of $3.1 million and$6.1 million for the three and six month periods ended June 30, 2004,respectively.

 

24/7Search revenue was $2.5 million and $5.5 million for the three and six monthperiods ended June 30, 2004, respectively, as compared to $2.3 million and $5.4million for the three and six month periods ended June 30, 2003, respectively,an increase of 8.3% and 2.3%, respectively. During the first six months of 2003, we generated a significant portionof our 24/7 Search revenue from Inktomi, which accounted for approximately15.8% and 38.9% of our 24/7 Search revenue for the three and six month periodsended June 30, 2003, respectively.  Ourcontract with Inktomi expired in May 2003. The loss of revenue related to Inktomi was partially offset by revenue fromincreased traffic generated through expanded relationships with our otherdistribution partners and new search relationships.

 

*Other Media Services revenue in2004 is generated from e-mail and revenue in 2003 was generated from e-mail andiPromotions, which was sold in January 2003. iPromotions revenue was $0.1 million and $0.2 million for the three andsix month periods ended June 30, 2003, respectively.  E-mail revenue decreased $0.2 million or41.3% from $0.5 million to $0.3 million for the three month periods ended June30, 2003 and 2004, respectively, and decreased $0.4 million or 36.2% from $1.0million to $0.6 million for the six month periods ended June 30, 2003 and 2004,respectively.  The decrease was due toless emphasis placed on e-mail as we focus on our core businesses.*

* *

**TECHNOLOGYSOLUTIONS.**OurTechnology Solutions revenue was $4.7 million and $9.0 million for the threeand six month periods ended June 30, 2004, respectively, as compared to $3.8million and $7.3 million for the three and six month periods ended June 30,2003, respectively, representing an increase of 24.2% and 24.5%,respectively.  The increase reflectsincreased usage by customers of our Open AdStream Central and our Insight XEservices, new customer wins globally, and, to a lesser extent, revenuecontributed by RMK.  In particular, theCompany’s hosted solutions delivered 22.9 billion paid impressions and pageviews in the period, up from 11.9 billion in the second quarter of 2003.  RMK contributed revenue of $0.3 million and$0.4 million for the three and six month period ended June 30, 2004, respectively.

 

**COST OFREVENUE AND GROSS PROFIT**

 

**INTEGRATEDMEDIA SOLUTIONS COST OF REVENUES AND GROSS PROFIT.**Our cost of revenues consists primarily offees paid to affiliates, whether it is a Web site (24/7 Web Alliance), a searchengine distribution partner (for 24/7 Search) or a list provider (for e-mail),which is usually calculated as a percentage of revenues. Cost of revenues alsoincludes advertisement serving costs, which is an intercompany charge from theTechnology Solutions segment based on a fixed CPM.

 

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Gross profit margins were 29.6% and 28.7% forthe three and six month periods ended June 30, 2004, respectively, and 39.2%and 36.6% for the three and six month period ended June 30, 2003, respectively.  This decrease reflects the addition of RMK,which has a lower gross profit margin than our other business units, andincreased upward pressure on the cost of traffic, particularly CPC bid prices,for 24/7 Search.  In addition, 24/7Search generated a greater portion of its revenue from bid-for-placement whichgenerally has a lower gross margin than paid inclusion.

 

**TECHNOLOGYSOLUTIONS COST OF REVENUES AND GROSS PROFIT.**Our cost of technology revenues consists ofthe costs of operating equipment and broadband bandwidth capacity for ourcentrally hosted technology solutions and payroll costs to deliver and supportsoftware offset by the portion charged to Integrated Media Solutions foradvertisement serving.  Gross profitmargins were 81.3% and 81.2% for the three and six month periods ended June 30,2004, respectively, and 72.0% and 69.4% for the three and six month periodended June 30, 2003, respectively.  Theincrease in gross profit margins is due to declining hosting and bandwidthcosts and leveraging the existing support infrastructure over a higher revenuebase.

 

**SALES ANDMARKETING EXPENSES.**Sales and marketing expenses consist primarily of sales force salaries andcommissions, advertising expenditures and cost of trade shows, conventions and marketingmaterials.  Sales and marketing expenseswere $3.9 million and $7.2 million for the three and six month periods endedJune 30, 2004, respectively, $3.2 million and $6.4 million for the three andsix month periods ended June 30, 2003, respectively.  Sales and marketing expenses decreased as apercentage of revenue from 26.6% to 19.9% for the three month periods endedJune 30, 2003 and 2004, respectively, and from 26.6% to 19.5% for the six monthperiods ended June 30, 2003 and 2004, respectively, as we were able to gainoperating leverage off the existing cost structure.  The number of employees included in sales andmarketing increased from 122 at June 30, 2003 to 141 at June 30, 2004,primarily due to the addition of 32 employees from RMK.

 

**GENERAL ANDADMINISTRATIVE EXPENSES**.General and administrative expenses consist primarily of compensation,facilities expenses and other overhead expenses incurred to support thebusiness.  General and administrativeexpenses were $3.0 million and $6.0 million for the three and six month periodsended June 30, 2004, respectively, and $2.8 million and $5.7 million for thethree and six months ended June 30, 2003, respectively.  As a percentage of revenue, the expensesdecreased from 22.8% to 15.4% for the three month periods ended June 30, 2003and 2004, respectively, and from 23.8% to 16.2% for the six month periods endedJune 30, 2003 and 2004, respectively. General and administrative costs increased slightly to support thegrowth of the business; however it decreased as a percentage of revenue.  The number of general and administrativeemployees at June 30, 2004 and 2003 was 47 and 44, respectively.

 

**PRODUCTDEVELOPMENT EXPENSES.**Product development expenses consist primarily of compensation and relatedoperating expenses incurred to perform research and development, furtherenhance and maintain our existing products and provide quality assurance.  Product development expenses were $1.1million and $2.2 million for the three and six month periods ended June 30, 2004,respectively, as compared to $0.8 million and $1.3 million for the three andsix month periods ended June 30, 2003, respectively.  We capitalized approximately $0.4 million ofOpen Advertiser development costs for the six month period ended June 30, 2003.  The Company ceased capitalization of thecosts when Open Advertiser was commercially released in June 2003.  The remaining increase is related to thedevelopment of our Insight SE and Insight ACT products and further enhancementsto our Insight XE and Open AdStream products. The number of employees included in product development increased from32 at June 30, 2003 to 40 at June 30, 2004.

 

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**AMORTIZATIONOF INTANGIBLE ASSETS AND DEFERRED FINANCING COSTS.** Amortization expense relates to intangibleassets acquired with 24/7 Search in August 2000, Real Media in October 2001,Now Marketing in September 2002, Insight First in January 2003, and RMK inJanuary 2004; deferred financing costs associated with the subordinatedconvertible debenture offering in September 2003; and the transition payment toLycos in February 2004.  Amortizationexpense was $1.4 million and $2.2 million for the three and six month periodsended June 30, 2004, respectively, and $0.7 million and $1.3 million for thethree and six month periods ended June 30, 2003, respectively.  For the six month period ended June 30, 2004,amortization expense related $1.1 million to acquired technology, $0.5 millionto other intangible assets, $0.3 million to deferred financing costs and $0.3million to the transition payment to Lycos. Amortization expense for the six month period ended June 30, 2003related to acquired technology.  In thefourth quarter of 2003, the Company made the strategic decision to no longersupport the 24/7 Messenger product that was acquired with Now Marketing.  The related acquired technology was amortizeduntil December 31, 2003 and the remaining balance of $1.3 million wasconsidered impaired.

 

**STOCK-BASEDCOMPENSATION**. Stock-basedcompensation was $0.3 million and $0.5 million for the three and six monthperiods ended June 30, 2004, respectively, and $0.1 million and $0.2 millionfor the three and six month periods ended June 30, 2003, respectively.  The expense for the six month period endedJune 30, 2004 consists of $0.3 million accrued for potential performanceincentives and $0.2 million in amortization of deferred compensation forrestricted shares issued to certain employees. The expense for the six month period ended June 30, 2003 consists of$0.1 million in amortization of deferred compensation for restricted sharesissued to certain employees and $0.1 million in other compensation given toemployees.

 

**RESTRUCTURINGCOSTS**.  During the second quarter of 2004, the Companytook additional steps to align its sales, development and administrativeorganization and reduce corporate overhead to position itself for profitablegrowth in the future growth consistent with the Company’s long-term goals.  This involved the involuntary termination ofapproximately seven employees, as well as charges for excess real estate space,primarily at our German office.  TheCompany recorded a restructuring charge of approximately $0.5 million.

 

**INTERESTEXPENSE, NET**.Interest expense, net relates to our long-term debt and capital leaseobligations offset by interest income related to our cash and cashequivalents.  Interest expense, net was$0.1 million and $0.3 million for the three and six month periods ended June30, 2004, respectively, and $0.1 million and $0.2 million for the three and sixmonth periods ended June 30, 2003, respectively.  Interest expense in 2004 primarily relates tosubordinated convertible debentures issued in the third quarter of 2003 ofwhich a portion is cash and amortization of warrants issued with thedebentures.  Interest in 2003 primarilyrelated to the PubliGroupe debt that was settled in the second quarter of2003.  Interest expense in both periodswas offset by interest income from cash in overnight deposits and money marketaccounts.

 

**CHANGE INFAIR VALUE OF WARRANT LIABILITY**. Each quarter the liability related to warrants outstanding from ourpreferred stock and subordinated convertible debenture offerings will beadjusted to fair value.  The $0.9 millionand $1.8 million gain for the three and six month periods ended June 30, 2004,respectively, is due to a decrease in the fair value of the warrantsoutstanding which reduced the corresponding liability.  The decrease in the fair value is primarilydue to a lower stock price at the end of the second quarter compared to whenthe warrants were issued.

 

30

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**GAIN ONLEGAL SETTEMENT. **The $2.9 million for the six month periodended June 30, 2004 related to our legal settlement with chinadotcomCorporation (“chinadotcom”) 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 of $0.1 million for the six month period ended June 30, 2004consists of $0.2 million in amounts recovered from a former subsidiary offsetby $0.1 million of legal fees and other expenses related to previous patentlitigation.  Other expense of $0.8million for the six month period ended June 30, 2003 consists of $1.2 millionin legal fees and other expenses related to patent litigation offset by $0.4million in income related to the settlement of liabilities of disposedbusinesses on favorable terms.

 

**PROVISIONFOR INCOME TAXES**. Theprovision for income taxes recorded for the three and six month periods endedJune 30, 2004 consist primarily of income taxes on earnings of our foreignsubsidiaries.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

Cash flows for the six month periods endedJune 30, 2004 and 2003 were as follows (in thousands):

 
| ** **                                | ** ** | **Six month period ended** | ** ** | ** **         | ** ** |
|-------------------------------------------|------------|----------------------------|------------|--------------------|------------|
| ** **                                | ** ** | **June 30,  2004**         | ** ** | **June 30,  2003** | ** ** | **Year-over-Year  Change** | ** ** |
| ** **                                | ** ** | ** **                 | ** ** | ** **         | ** ** | **($)** | ** ** |
|                                      |       |                       |       |               |       |   |   |
| Net cash used in operating activities     |       | $                          | (4,767     | )                  | $          | (3,564 | ) | $ | 1,203 |   |
| Net cash used in investing activities     |       | $                          | (2,777     | )                  | $          | (706 | ) | $ | 2,071 |   |
| Net cash provided by financing activities |       | $                          | 37,927     |               | $          | 5,754 |   | $ | 32,173 |   |

 

***Operating Activities***

 

Since our inception we have financed ouroperations through equity financings and long-term debt.  We used approximately $4.8 million and $3.6million of cash in operating activities during the six month periods ended June30, 2004 and 2003, respectively, generally as a result of our net operatingincome (loss), adjusted for certain non-cash items included in our operatingresults as well as changes in various components of working capital.

 

***Investing Activities***

 

Net cash used in investing activities wasapproximately $2.8 million and $0.7 million during the six month periods endedJune 30, 2004 and 2003, respectively. Investing activities during the six month period of 2004 relate $2.0million to the acquisition of RMK and $0.8 million to capital expenditures forgeneral operational purposes.  During2003, we paid $0.2 million as part of the acquisition of certain assets ofInsight First, Inc. and as an investment in iPromotions, Inc. and $0.5 millionfor capital expenditures, including capitalized software.

 

***Financing Activities***

 

Financing activities provided $37.9 millionand $5.8 million for the six month periods ended June 30, 2004 and 2003,respectively.  Financing activities in2004 related $37.4 million to net

 

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proceeds from our secondary offering ofcommon stock and $0.6 million to the exercise of stock options.  Financing activities in 2003 related $6.8million to net proceeds from the issuance of our preferred stock and $0.5million to the exercise of stock options offset by $1.5 million from theretirement of the PubliGroupe promissory notes.

 

***CERTAINCOMMITMENTS AND CONTRACTUAL OBLIGATIONS***

* *

***SubordinatedConvertible Debentures***.  The $15.0 million principal amount of oursubordinated convertible debentures is due September 2006.  Semi-annual interest payments at 2% began inJanuary 2004.  Both the principal andinterest may be paid in common stock.

* *

***ServicesAgreement with Lycos, Inc***.  Pursuant to our agreement with Lycos, Inc.,we have a remaining liability of $2.3 million related to the transition paymentdue in equal installments at each quarter end in 2004 and specified minimumannual payments due 45 days after each quarter end.  For 2004, the minimal annual payment is $10.0million and is payable $2.5 million 45 days after each quarter end.

* *

***OperatingLeases***.  The operating lease agreements relate to ouroffices throughout the United States and internationally with original leaseperiods expiring between 2004 and 2008.

* *

***OtherCommitments and Contingencies***

* *

*The Company has various employmentagreements with employees, the majority of which are for one year with anautomatic renewal.  The potentialobligation under these contracts is approximately $4.1 million for 2004 includingsalary and performance based target bonuses. The Company pays bonuses to executive employees based on the achievementof revenue goals and other financial measures including earnings beforeinterest, taxes, amortization and stock-based compensation. These contractsalso require severance payments in the event of involuntary termination whichgenerally range in amount from three months to one year’s salary.  All non-U.S. employees have employmentcontracts as required by local law.  Themajority of these contracts allow for resignation or termination by eitherparty at any time, according to the notice period provisions contained in theemployment contracts, or according to the minimum notice period as mandated bylocal law.  The contracts or, if noexpressed provision is included in the contract, local law also requireseverance for involuntary terminations ranging from one to six months.  As of June 30, 2004, there were approximately66 employees in Europe whose annualized base salaries are approximately $4.9million.*

* *

We maintain director and officer insurance,which may cover certain liabilities arising from our obligation to indemnifyour directors, and officers and former directors, officers and employees ofacquired companies, in certain circumstances.  The indemnification providedby us to our officers and directors does not have a stipulated maximum,therefore we are not able to develop a reasonable estimate of the maximumliabilities.  To date, we have not incurred material costs as a result ofsuch obligations and have not accrued any liabilities related to suchindemnification obligations in our financial statements.

 

In connection with our commercial agreements,we provide indemnifications of varying scope and terms to customers, businesspartners and other parties with respect to certain matters, including, but notlimited to, losses arising out of our breach of such agreements and out ofintellectual property infringement claims made by third parties.

 

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As of June 30, 2004, we had approximately$1.2 million remaining of cash outlay obligations relating to restructuring andexit costs consisting of severance and rent. We expect to pay approximately $0.5 in the remainder of 2004, $0.2 millionin each year from 2005 to 2007 and $0.1 million in 2008.

 

We continue to increase capital expendituresand operating lease commitments, which is consistent with our increasedstaffing and operational expansion, and we anticipate that this will continuein the future as business conditions merit.  Additionally, we willcontinue to evaluate possible acquisitions of, or investments in businesses,products, and technologies that are complementary to our business, which mayrequire the use of cash. Management believes existing cash and investments willbe sufficient to meet operating requirements for at least the next twelvemonths; however, we may sell additional equity or debt securities or obtaincredit facilities to further enhance our liquidity position beyond June 30,2005. The sale of additional securities could result in further dilution to ourstockholders.

 

**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 June 30, 2004. Accordingly, we are not materially exposed to any financing,liquidity, market or credit risk that could arise if we had engaged in suchrelationships.

 

# **CRITICAL ACCOUNTING POLICIES ANDESTIMATES**

#  

We continue to invest resourcesto the process of comprehensively documenting and analyzing our system ofinternal controls. We have identified areas of our internal controls requiringimprovement, and we are in the process of designing enhanced processes andcontrols to address any issues identified through this review. Areas forimprovement include streamlining our domestic and international billingprocesses, further limiting internal access to certain data systems andcontinuing to improve coordination across business functions. Although webelieve that our efforts have strengthened our internal controls, we are continuingto work to improve our internal controls, including in the areas of access andsecurity. Accordingly, we plan to continue to invest the resources necessary toensure the effectiveness of our internal controls and procedures, including inthe areas of access and security.

 

###### ***General***

######  

Our consolidated financial statements areprepared in conformity with accounting principles generally accepted in theUnited States of America.  As such, weare required to make certain estimates, judgments and assumptions thatmanagement believes are reasonable based upon the information available.  These estimates and assumptions affect thereported amounts of assets and liabilities and the disclosure of contingentassets and liabilities at the dates of the consolidated financial statementsand the reported amounts of revenues and expenses 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:

 

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***Revenue Recognition***

*** ***

*Integrated Media Solutions*

 

24/7 Web Alliance revenues are generated bydelivering advertising impressions for a fixed fee to third-party Web sites. 24/7Search revenues are derived from driving valid visitors to a client’s Web site.E-mail related revenues are derived from delivering advertisements to e-maillists for advertisers and Web sites. Our agreements are primarily short-termand we recognize revenues as services are delivered provided that nosignificant obligations of ours remain outstanding and collection of theresulting receivable is probable.

 

We are obligated to make payments to third-party Websites, search engine distribution partners and e-mail lists which havecontracted with us to be part of our Network, in the period the advertisingimpressions, valid visitors or e-mails are delivered.  Such expenses are classified as cost ofrevenues in the accompanying consolidated statements of operations.

 

*Technology Solutions*

 

Technology Solutionsrevenues are derived primarily from licensing of our software, hostedadvertisement serving, and software maintenance and technical supportservices.  Revenue from softwarelicensing agreements is recognized in accordance with Statements of Position(“SOP”) No. 97-2, *Software RevenueRecognition*, and Staff Accounting Board (“SAB”) No. 104, *Revenue Recognition*, upon delivery of thesoftware, which is generally when the software is made available for download,there is persuasive evidence of an arrangement, collection is reasonablyassured, the fee is fixed or determinable, and vendor-specific objectiveevidence exists to allocate the total fees to all elements of the arrangement.  Contracts that bundle the software licensewith maintenance and technical support are recognized ratably over the contractterm.  Revenue from advertisement servingis recognized upon delivery.  Revenuefrom software maintenance and technical support contracts is recognized ratablyover the life of the agreement, which typically do not exceed one year.

 

Expenses from the Company’s licensing, maintenanceand technical support revenues are primarily payroll costs incurred to deliverand support the software.  These expensesare classified as cost of revenues in the accompanying consolidated statementsof operations.

 

*Deferred Revenue*

 

Revenues that are billed or collected in advance of services being completed are deferred until the conclusion of the period of the service for which the advance billing or collection relates.  Deferred revenues are included on the consolidated balance sheets as a current liability until the service is performed and then recognized in the period in which the service is completed.  The Company’s deferred revenues primarily consist of billings in advance for software license subscriptions and software maintenance and technical support services.

 

***AccountsReceivable***

 

We perform ongoing credit evaluations of ourcustomers and adjust credit limits based upon payment history and thecustomer’s current credit worthiness, as determined by a review of theircurrent credit information. We regularly monitor collections and payments fromour customers and maintain a provision for estimated credit losses based upon historicalexperience and any specific customer collection issues that have beenidentified. While such credit losses have

 

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historically been within our expectations and theprovisions established, we cannot guarantee that we will continue to experiencethe same credit loss rates that have been experienced in the past.

 

***Valuation ofgoodwill and intangible assets***

 

Effective January 1, 2002, we adopted SFASNo. 142, *Goodwill and Other IntangibleAssets* and SFAS No. 144, *Accountingfor the Impairment 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 and recognition for goodwill and intangible assets. SFASNo. 144 establishes a single model for the impairment of long-livedassets.

 

We assess goodwill for impairment annually unlessevents occur that require more frequent reviews. Long-lived assets, includingamortizable intangibles, are tested for impairment whenever events or changesin circumstances indicate that the carrying amount of an asset may not berecoverable. Discounted cash flow analyses are used to assess nonamortizableintangible impairment while undiscounted cash flow analyses are used to assesslong-lived asset impairment. If an assessment indicates impairment, theimpaired asset is written down to its fair market value based on the bestinformation available. Estimated fair market value is generally measured withdiscounted estimated future cash flows. Considerable management judgment isnecessary to estimate undiscounted and discounted future cash flows.Assumptions used for these cash flows are consistent with internal forecasts.

 

On an on-going basis, management reviews the valueand period of amortization or depreciation of long-lived assets, includinggoodwill and other intangible assets. During this review, we re-evaluate thesignificant assumptions used in determining the original cost of long-livedassets. Although the assumptions may vary from transaction to transaction, theygenerally include revenue growth, operating results, cash flows and otherindicators of value. Management then determines whether there has been an impairmentof the value of long-lived assets based upon events or circumstances that haveoccurred since acquisition. The impairment policy is consistently applied inevaluating impairment for each of our wholly owned subsidiaries andinvestments.

 

# ***Contingencies andLitigation***

#  

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.

 

**MARKET FORCOMPANY’S COMMON EQUITY**

 

We have notdeclared or paid any dividends on our capital stock since our inception and donot anticipate paying dividends in the foreseeable future. Our current policyis to retain earnings, if any, to finance the expansion of our business. Inaddition, our subordinated convertible debentures restrict our ability to paycash dividends on our capital stock. The future payment of dividends willdepend on the results of operations, financial condition, capital expenditureplans and other factors that we deem relevant and will be at the solediscretion of our Board of Directors.

 

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Since our initialpublic offering on August 13, 1998 until June 2002, our common stock traded onthe Nasdaq National Market under the symbol “TFSM.”  In June 2002, we transferred our common stockto the Nasdaq SmallCap Market, where it currently trades under that samesymbol.

 

**RISKFACTORS**

** **

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

 

WE MAY NOT BE ABLE TO SUSTAIN OUR PROFITABILITY.

 

We achieved profitability inaccordance with generally accepted accounting principles, or GAAP, for thethree and six month periods ended June 30, 2004 but we may not be able tosustain profitability in the future. We incurred net losses of$2.5 million and $4.8 million for the three and six month periods endedJune 30, 2003, respectively.  Each of ourpredecessors had net losses in every year of their operation.  We may incur operating losses in the currentperiod and for the foreseeable future. Even if we do maintain GAAPprofitability, we may not be able to sustain or increase our current level ofprofitability on a quarterly or annual basis in the future.

 

WE HAVE A LIMITED OPERATINGHISTORY ON WHICH AN INVESTOR CAN EVALUATE OUR BUSINESS.

 

We have a limited operatinghistory. You must consider the risks, expenses and difficulties typicallyencountered by companies with limited operating histories, particularlycompanies in new and rapidly expanding markets such as Internet advertising.These risks include our ability to:

 

•      develop new relationshipsand maintain existing relationships with our Web sites, advertisers, searchengine providers and other third parties;

 

•      continue to develop andupgrade our technology;

 

•      respond to competitivedevelopments;

 

•      implement and improveoperational, financial and management information systems;

 

•      adapt to industryconsolidation; and

 

•      attract, retain and motivatequalified employees.

 

Our limited operating historymakes it difficult to predict future revenues and operating expenses.

 

OUR BUSINESS MAY SUFFER IF WEARE UNABLE TO SUCCESSFULLY IMPLEMENT OUR BUSINESS MODEL.

 

A significant part of ourbusiness model is to generate revenue by providing interactive marketingsolutions to advertisers, advertising agencies and Web publishers. The profitpotential for this business model is unproven. To be successful, both Internetadvertising and our solutions will need to achieve broad market acceptance byadvertisers, advertising agencies and Web

 

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publishers. Our ability togenerate significant revenue from advertisers will depend, in part, on ourability to contract with Web publishers that have Web sites with adequateavailable advertisement space inventory. Further, these Web sites must generatesufficient user traffic with demographic characteristics attractive to ouradvertisers. The intense competition among Internet advertising sellers has ledto the creation of a number of pricing alternatives for Internet advertising.These alternatives make it difficult for us to project future levels ofadvertising revenue and applicable gross margin that can be sustained by us orthe Internet advertising industry in general.

 

Intensive marketing and salesefforts may be necessary to educate prospective advertisers regarding the usesand benefits of, and to generate demand for, our products and services,including our newer products and services such as 24/7 Search, Open Advertiserand Insight. Enterprises may be reluctant or slow to adopt a new approach thatmay replace, limit or compete with their existing direct marketing systems. Inaddition, since online direct marketing is emerging as a new and distinctbusiness apart from online advertising, potential adopters of online directmarketing services will increasingly demand functionality tailored to theirspecific requirements. We may be unable to meet the demands of these clients.Acceptance of our new solutions will depend on the continued emergence ofInternet commerce, communication and advertising. Demand for our new solutionsmay not emerge or become sustainable.

 

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 also have decreasedduring certain periods and in certain segments. Accurate predictions of futurerevenues are difficult because of the rapid changes in our markets and ourpossible need to sell assets to fund operations. We have also acquired or disposedof various subsidiaries and product lines over the last several years.Accordingly, investors should not rely on past revenue growth rates as anindicator of future revenue growth.

 

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 of new or lossof existing clients;

 

•      changes in fees paid byadvertisers or other clients;

 

•      changes in service feespayable by us to owners of Web sites, or advertisement serving fees payable byus to third parties;

 

•      the demand by advertisersand Web publishers for our advertising solutions;

 

•      the introduction of newInternet marketing services by us or our competitors;

 

•      variations in the levels ofcapital or operating expenditures and other costs relating to the maintenanceor expansion of our operations, including personnel costs;

 

•      changes in governmentalregulation of the Internet; and

 

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•      general economic conditions.

 

Our future revenues and resultsof operations may be difficult to forecast due to the above factors. Inaddition, our expense levels are based in large part on our investment plansand estimates of future revenues. Any increased expenses may precede or may notbe followed by increased revenues, as we may be unable to, or may elect not to,adjust spending in a timely manner to compensate for any unexpected revenueshortfall. As a result, we believe that period-to-period comparisons of ourresults of operations may not be meaningful.

 

You should not rely on pastperiods as indicators of future performance. In future periods, our results ofoperations may fall below the expectations of securities analysts andinvestors, which could adversely affect the trading price of our common stock.

 

OUR REVENUES ARE SUBJECT TOFLUCTUATIONS BY SEASON AND DUE TO GENERAL ECONOMIC CONDITIONS.

 

We believe that our revenuesare subject to seasonal fluctuations because advertisers generally place feweradvertisements during the first and third calendar quarters of each year.Furthermore, Internet user traffic typically drops during the summer months,which reduces the number of advertisements to sell and deliver. Expenditures byadvertisers tend to vary in cycles that reflect overall economic conditions aswell as budgeting and buying patterns. Our revenue could be materially reducedby a decline in the economic prospects of advertisers or the economy in general,which could alter current or prospective advertisers’ spending priorities orbudget cycles or extend our sales cycle. Due to such risks, you should not relyon quarter-to-quarter comparisons of our results of operations as an indicatorof our future results.

 

OUR REVENUE COULD DECLINE IF WEFAIL TO EFFECTIVELY MANAGE OUR EXISTING ADVERTISING INVENTORY AND OUR GROWTHCOULD BE IMPEDED IF WE FAIL TO ACQUIRE ACCESS TO NEW ADVERTISING INVENTORY.

 

Our success depends in part onour ability to effectively manage our existing advertising inventory. The Webpublishers that list their unsold advertising inventory with us are not boundby long-term contracts. In addition, Web publishers can change the amount ofinventory they make available to us at any time. If a Web publisher decides notto 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 quickly enoughto fulfill our advertisers’ requests. This would result in lost revenue. Weexpect that our customers’ requirements will become more sophisticated as theWeb matures as an advertising medium. If we fail to manage our existingadvertising space effectively to meet our customers’ changing requirements, ourrevenue could decline. Our growth also depends on our ability to expand ouradvertising inventory. To attract new advertisers, we must maintain aconsistent supply of attractive advertising space. We intend to expand ouradvertising inventory by selectively adding to our network new Web publishersthat offer attractive demographics, innovative and quality content and largeaudiences. Our ability to attract new Web publishers to our network and toretain Web publishers currently in our network will depend on various factors,some of which are beyond our control. These factors include our ability tointroduce new and innovative product lines and services, our ability toefficiently manage our existing advertising inventory, our pricing policies andthe 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.

 

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OUR TECHNOLOGY SOLUTIONS MAYNOT BE SUCCESSFUL AND MAY CAUSE BUSINESS DISRUPTION.

 

Open AdSystem is our proprietaryadvertisement serving technology that is intended to serve as our soleadvertisement serving solution. We have developed a variety of products to workon or with this platform. Some of these products, such as our Open Advertiser,Insight ACT and Insight SE products, are not yet available or are onlyavailable in beta version to some or all of our customers. We must, among otherthings, ensure that the technology will function efficiently at high volumes,interact properly with our database, offer the functionality demanded by ourcustomers and assimilate our sales and reporting functions. We must furthercomplete development of our beta products. This development effort could failtechnologically or could take more time than expected. Customers may becomedissatisfied by any system failure that interrupts our ability to provide ourservices to them, including failures affecting our ability to deliveradvertisements without significant delay to the viewer. 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. Slowerresponse time or system failures may also result from straining the capacity ofour deployed software or hardware due to an increase in the volume ofadvertising delivered through our servers. To the extent that we do noteffectively address any capacity constraints or system failures, our business,results of operations and financial condition could be materially and adverselyaffected.

 

WE HAVE SUBSTANTIAL DEBT, ANDWE MAY NOT GENERATE SUFFICIENT CASH FLOW TO MEET OUR DEBT SERVICE OBLIGATIONS.

 

In September 2003, weissued to a single holder a 2% subordinated convertible debenture in theprincipal amount of $15.0 million that matures in September 2006. Theamount of our debt could have important consequences, including:

 

•      impairing our ability toobtain additional financing for working capital, capital expenditures,acquisitions or general corporate purposes;

 

•      requiring us to dedicate asubstantial portion of any operating cash flow that we generate to payingprincipal and interest on indebtedness, thereby reducing the funds availablefor operations;

 

•      limiting our ability to growand make capital expenditures due to the covenants contained in our debtarrangements;

 

•      impairing our ability toadjust rapidly to changing market conditions, invest in new or developingtechnologies, or take advantage of significant business opportunities that mayarise;

 

•      placing us at a competitivedisadvantage compared to our competitors that have less debt; and

 

•      making us more vulnerable ifthere is an economic downturn or if our business experiences difficulties.

 

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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.

 

WE MAY BE UNABLE TO RAISE THEFUNDS NECESSARY TO REPAY OR REFINANCE OUR INDEBTEDNESS. THE ISSUANCE OF STOCKUPON REDEMPTION OF OUR SUBORDINATED CONVERTIBLE DEBENTURES MAY SUBSTANTIALLYDILUTE THE INTERESTS OF OTHER SECURITY HOLDERS.

 

Stockholders could experiencesubstantial dilution resulting from our election to pay the semi-annual accruedinterest due in common stock or repay the principal amount in common stock. Weare obligated to make semi-annual interest payments on January 1 andJuly 1 of each year and the entire principal face amount of the debenturesis due and payable on September 26, 2006. We may elect to pay interest incash, in shares of our common stock or in additional debentures. In addition,if, after September 26, 2005, the price of our common stock does notexceed the conversion price of the debentures for a period of five consecutivetrading days we may be required to repurchase $7.5 million in principalamount of the debentures on September 26, 2005. We may elect to repay theprincipal amount of the debentures in cash or in shares of our common stock. Ifwe so elect, payment in shares shall be based upon ninety percent of theaverage of the volume weighted average price of our common stock on theprincipal market as reported by Bloomberg Financial L.P. during the fivetrading days immediately prior to the interest payment date, in the case of aninterest payment, or during the 15 trading days immediately prior to thematurity date, in the case of the repayment of the principal amount of thedebentures.

 

If we decide to repay theprincipal in cash we will need additional capital to fund this obligation. Ourability to arrange financing and the cost of this financing will depend uponmany factors, including: general economic and capital market conditionsgenerally, and in particular the non-investment grade debt market; creditavailability from banks or other lenders; investor confidence in our industrygenerally and our company specifically; and provisions of tax and securitieslaw that are conducive to raising capital.

 

If we need additional funds andare unable to raise them, our inability to raise them will have an adverseeffect on our operations. If we decide to raise additional funds by incurringdebt, we may become subject to additional or more restrictive financialcovenants and ratios. If we fail to make the mandatory redemptions in cash andif our stock price significantly declines, we could potentially be obligated toissue a larger number of shares of our common stock in redemption of thedebentures.

 

WE MAY NEED TO RAISE ADDITIONALFUNDS TO CONTINUE OPERATIONS.

 

A significant acquisition, anunforeseen reduction in our revenues, an impairment of our receivables, or anincrease in expenses or capital expenditures may require us to raise additionalfunds to continue operations. To the extent we encounter additionalopportunities to raise cash, we may sell additional equity or debt securities,which would result in further dilution of our stockholders. Stockholders mayexperience extreme dilution due to our current stock price and the amount offinancing we may need to raise and these securities may have rights senior tothose of holders of our common stock. Our subordinated convertible debentureslimit our ability to incur additional debt, and any future indebtedness that wemay incur could contain covenants that restrict our operating flexibility.

 

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We have limited access to thecapital markets to raise capital. The capital markets have been unpredictablein the past, especially for unprofitable companies such as ours. In addition,it is difficult to raise capital in the current market conditions. The amountof capital that a company such as ours is able to raise often depends onvariables that are beyond our control, such as the share price of our stock andits trading volume. As a result, efforts to secure financing on termsattractive to us may not be successful, and we may not be able to secureadditional financing on any terms.

 

Due to our operating losses, itmay be difficult to obtain debt financing. If we are able to consummate a financingarrangement, the amount raised may not be sufficient to meet our future needs.If adequate funds are not available on acceptable terms, or at all, ourbusiness, results of operation, financial condition and continued viabilitywill be materially and adversely affected.

 

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 release and investor conference call. 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 ACQUISITIONS MAY NOT BESUCCESSFUL.

 

We were formed inFebruary 1998 to consolidate three Internet advertising companies and havesince acquired other companies. We may continue pursuing selective acquisitionsof businesses, technologies and product lines as a key component of our growthstrategy. If we acquire additional companies, we will continue to face risks ofintegrating and improving our financial and management controls, advertisementserving technology, reporting systems and procedures, and expanding, training andmanaging our work force. This process of integration may take a significantperiod of time and will require the dedication of management and otherresources, which may distract management’s attention from our other operations.Any future acquisition or investment may result in the use of significantamounts of cash, potentially dilutive issuances of equity securities,incurrence of debt and amortization expenses related to intangible assets. Inaddition, acquisitions involve numerous risks, including:

 

•      the difficulties in theintegration and assimilation of the operations, technologies, products andpersonnel of an acquired business;

 

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

 

•      the availability offavorable acquisition financing for future acquisitions; and

 

**•**      the potential loss of keyemployees of any acquired business.

 

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

 

WE MAY NOT BE ABLE TOSUCCESSFULLY INTEGRATE REAL MEDIA KOREA CO., LTD. INTO OUR COMPANY.

 

In January 2004, wecompleted our acquisition of Real Media Korea Co., Ltd. We may not realizethe anticipated financial and strategic goals of this acquisition, and thisacquisition may not be successful. The success of this acquisition will dependin part on our ability to expand the business of Real Media Korea into newgeographical markets in the region. We may have difficulty integrating thebusiness and operations of Real Media Korea or retaining their key personnel aswell as implementing and maintaining standards, controls, procedures andpolicies that are consistent with ours. Additionally, our ongoing business andmanagement’s attention may be disrupted or diverted by transition orintegration issues and the complexity of managing geographically and culturallydiverse locations. These factors could have a material adverse effect on ourbusiness, results of operations and financial condition or cash flows.

 

OUR NET OPERATING LOSSCARRYFORWARDS MAY BE LIMITED.

 

Due to the “change inownership” provisions of the Internal Revenue Code, the availability of our netoperating loss and credit carryforwards may be subject to an annual limitationagainst taxable income in future periods, which could substantially limit theeventual utilization 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-basedintangibles. The amount allocated to these intangible assets could be amortizedover a fairly short period. As a result, our earnings and the market price ofour common stock could be negatively affected.

 

THE SUCCESS OF OUR 24/7 SEARCHOPERATIONS DEPENDS ON A SMALL NUMBER OF SEARCH ENGINE CLIENTS, AND THE LOSS OFA SINGLE SEARCH ENGINE CLIENT COULD RESULT IN A SUBSTANTIAL DECREASE IN OUR24/7 SEARCH REVENUE.

 

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We have generated a significantportion of our 24/7 Search revenue from relationships with a small number ofsearch engines, including Alta Vista, Ask Jeeves, Google, MyGeek and Overture.We expect that a small number of search engine distribution partners willcontinue to generate a majority or more of our 24/7 Search revenue for theforeseeable future. The interruption or loss of any of our primary searchengine relationships could cause a significant decrease in 24/7 Search revenue.As a result of consolidation among search engines, and other search marketingcompanies, we could lose one of more of our distribution partners or faceincreased competition from search engines (including our current search enginedistribution partners) that internally develop or acquire capabilities similarto our service. In addition, as the operations and strategies of our searchengine distribution partners continue to evolve, we may be required to adjustour business strategy to maintain relationships with our clients, which couldhave a material adverse effect on our 24/7 Search revenue.

 

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

 

As a result of unfavorableconditions in the capital markets, some of our customers may have difficultyraising sufficient capital to support their long-term operations. As a result,these customers have reduced their spending on Internet advertising, which hasmaterially and adversely affected our business, financial condition and resultsof operations. In addition, we have entered into a strategic businessrelationship with Lycos, and may enter into similar relationships with othercompanies. These companies may experience similar adverse business conditionsthat may render them unable to meet our expectations for the strategic businessrelationship or to fulfill their contractual obligations to us. Such an eventcould have a material adverse impact on our business, financial condition andresults of operations.

 

WE HAVE SIGNIFICANT OBLIGATIONSUNDER OUR AGREEMENT WITH LYCOS AND WE EXPECT LYCOS TO REPRESENT A SIGNIFICANTPORTION OF OUR REVENUES.

 

We recently entered into anagreement with Lycos, Inc. to provide media sales, advertisement servingand analytics technology services to Lycos’ U.S. Web properties.  We expect that Lycos will generate asignificant portion of our revenues.  Aspart of our agreement with Lycos, we must hire additional personnel andimplement additional controls and procedures to provide advertising sales,billing and other important services related to the Lycos Web properties.  To the extent that we cannot hire additionalpersonnel or adequately implement additional controls and procedures, ourrelationship with Lycos may suffer and our obligations under this agreement maymaterially and adversely affect our business, results of operations andfinancial condition.

 

Our agreement with Lycosrequires us to make a minimum annual payment of $10 million in 2004, alongwith an initial payment of $4.5 million to be paid to Lycos over thecourse of 2004. We are also required to make minimum annual payments in eachsubsequent year during the term of the agreement. Our minimum annual paymentsunder this agreement could increase during the term of the agreement. To theextent that we fail to sell adequate advertising space on Lycos’ Webproperties, or if prices for advertising space fall below our expectations, ourobligations under this agreement may materially and adversely affect ourbusiness, results of operations and financial condition.

 

Lycos may have the right toterminate our agreement if Lycos or we are acquired.  Terra Lycos, the parent company of Lycos,recently engaged an investment banker to consider and advise on a

 

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possible sale of the Lycosproperty.  If our agreement with Lycos isterminated, although we would not have to make minimum annual payments, wewould lose a significant portion of our revenues which could materially andadversely affect our business, results of operations and financial condition.

 

IF WE LOSE OUR CEO OR OTHERSENIOR MANAGERS, OUR BUSINESS WILL BE ADVERSELY AFFECTED.

 

Our success depends, to a significant extent, upon our seniormanagement and key sales and technical personnel, particularly David J. Moore,our Chief Executive Officer, Jonathan K. Hsu, our Chief Financial Officer,Christopher J. Wagner, our Chief Executive Officer - Europe, Jae Woo Chung, ourChief Executive Officer - Korea, David Hills, our President, Media Solutions,and Tony Schmitz, our Chief Technology Officer and President, TechnologySolutions. The loss of the services of one or more of these persons couldmaterially and adversely affect our ability to develop our business. Oursuccess also depends on our ability to attract and retain qualified technical,sales and marketing, customer support, financial and accounting, and managerialpersonnel. We may be unable to retain our key personnel or attract, integrateor retain other highly qualified personnel in the future. We have experiencedin the past, and may continue to experience in the future, difficulty in hiringand retaining candidates with appropriate qualifications, especially in salesand marketing positions.

 

WE MIGHT EXPERIENCE SIGNIFICANTDEFECTS IN OUR PRODUCTS.

 

Software products frequentlycontain errors or failures, especially when first introduced or when newversions are released. We might experience significant errors or failures inour products, or they might not work with other hardware or software asexpected, which could delay the enhancement of our products, or which couldadversely affect market acceptance of our products. Any significant producterrors or design flaws would slow the adoption of our products and cause damageto our reputation, which would seriously harm our business. If customers weredissatisfied with product functionality or performance, we could lose revenueor be subject to liability for service or warranty costs and claims, and ourbusiness, operating results and financial condition could be adverselyaffected.

 

SOME OF OUR SOFTWARE ISLICENSED FROM THIRD PARTIES.

 

Some of our products, includingone or more modules for our Open AdSystem platform, contain software licensedfrom third parties. Some of these licenses may not be available to us in thefuture or on terms that are acceptable or allow our products to remaincompetitive. Our inability to use any of this third party software could resultin shipment delays, delays in the development of future products orenhancements of existing products, or other disruptions in our business, whichcould materially and adversely affect our business, financial condition andoperating results.

 

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.

 

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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 Cable & Wireless in the United States andLevel3 Communications in Europe. These systems’ continuing and uninterruptedperformance is critical to our success. Despite precautions that we have taken,unanticipated problems affecting our systems have from time to time in the pastcaused, and in the future could cause, interruptions in the delivery of oursolutions. Our business, results of operations and financial condition could bematerially and adversely affected by any damage or failure that interrupts ordelays our operations. To improve the performance and to prevent disruption ofour services, we may have to make substantial investments to deploy additionalservers or one or more copies of our Web sites to mirror our online resources.Although we believe we carry property insurance with adequate coverage limits,our coverage may not be adequate to compensate us for all losses, particularly withrespect to loss of business and reputation, that may occur.

 

In addition, terrorist acts oracts of war may cause damage to our employees, facilities, clients, ourclients’ customers and vendors, which could significantly impact our revenues,costs and expenses and financial position. The potential for future terroristattacks, the national and international responses to terrorist attacks orperceived threats to national security, and other acts of war or hostility havecreated many economic and political uncertainties that could adversely affectour business and results of operations in ways that cannot be presentlypredicted. We are predominantly uninsured for losses and interruptions causedby terrorist acts and acts of war.

 

OUR INTERNATIONAL OPERATIONSFACE LEGAL AND CULTURAL CHALLENGES.

 

We have operations in a numberof international markets, including Asia, Canada and Europe. To date, we havelimited experience in marketing, selling and distributing our solutionsinternationally. International operations are subject to other risks,including:

 

•      changes in regulatoryrequirements;

 

•      reduced protection forintellectual property rights in some countries;

 

•      potentially adverse taxconsequences;

 

•      general import/exportrestrictions relating to encryption technology and/or privacy;

 

•      difficulties and costs ofstaffing and managing foreign operations;

 

•      political and economicinstability;

 

•      fluctuations in currencyexchange rates; and

 

•      seasonal reductions inbusiness activity during the summer months in Europe and certain other parts ofthe world.

 

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WE MAY BE UNABLE TO PROMOTE ANDMAINTAIN OUR BRANDS.

 

We believe that establishingand maintaining the brand identities of our products and services is a criticalaspect of attracting and expanding a large client base. Promotion andenhancement of our brands will depend largely on our success in continuing toprovide high quality service. If businesses do not perceive our existingservices to be of high quality, or if we introduce new services or enter intonew business ventures that are not favorably received by businesses, we willrisk diluting our brand identities and decreasing their attractiveness toexisting and potential customers.

 

In order to attract and retaincustomers and to promote and maintain brands in response to competitivepressures, we may also have to increase substantially our financial commitmentto creating and maintaining a distinct brand loyalty among our customers. If weincur significant expenses in an attempt to improve our services or to promoteand maintain our brands, our business, prospects, financial condition andresults of operations could be materially adversely affected. Moreover, anybrand identities we establish may be diluted as a result of any inability toprotect our trademarks and service marks or domain names, which could have amaterial adverse effect on our business, prospects, financial condition andresults of operations.

 

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

 

WE HAVE A VERY SUBSTANTIALOVERHANG OF COMMON STOCK AND FUTURE SALES OF OUR COMMON STOCK WILL CAUSESUBSTANTIAL DILUTION AND MAY NEGATIVELY AFFECT THE MARKET PRICE OF OUR COMMONSTOCK.

 

As of June 30, 2004, there wereapproximately 34.2 million shares of our common stock outstanding. As ofthat date, we also had an aggregate of approximately 13.8 million sharesof common stock that may be sold into the market in the future, includingapproximately 4.9 million shares of our common stock issuable uponexercise of options, 6.7 million shares of our common stock issuable uponconversion of our outstanding preferred stock and exercise of the relatedwarrants and 2.2 million shares of our common stock issuable uponconversion of the debentures and exercise of the related warrants. In addition,if we undertake an additional 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.

 

OUR SHARE PRICE MAY BE VOLATILEAND COULD DECLINE SUBSTANTIALLY.

 

The market price of our commonstock has fluctuated in the past and may continue to be volatile. In addition,the stock market has experienced extreme price and volume fluctuations. Themarket prices of the securities of Internet-related companies have beenespecially volatile. Investors may be unable to resell their shares of ourcommon stock at or above the purchase price. In the past, following periods ofvolatility in the market price of a particular company’s securities, securitiesclass action litigation has often been brought against that company. Manycompanies in our industry have been subject to this type of litigation in thepast. We may also become involved in

 

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this type of litigation.Litigation is often expensive and diverts management’s attention and resources,which could materially and adversely affect our business, financial conditionand results of operations.

 

THE POWER OF OUR BOARD OFDIRECTORS TO DESIGNATE AND ISSUE SHARES OF STOCK COULD HAVE AN ADVERSE EFFECTON HOLDERS OF OUR COMMON STOCK.

 

We are authorized to issue upto 350,000,000 shares of common stock, which may be issued by our board ofdirectors for such consideration as they may consider sufficient withoutseeking stockholder approval. The issuance of additional shares of common stockin the future will reduce the proportionate ownership and voting power ofcurrent stockholders. Our Certificate of Incorporation also authorizes us toissue up to 10,000,000 shares of preferred stock, the rights and preferences ofwhich may be designated by our board of directors. These designations may bemade without stockholder approval. The designation and issuance of preferredstock in the future could create additional securities that would have dividendand liquidation preferences prior in right to the outstanding shares of commonstock. These provisions could also impede a change in control.

 

SUNRA CAPITAL HOLDINGS, LTD.AND PUBLIGROUPE USA HOLDING, INC. COLLECTIVELY CONTROL A SUBSTANTIAL PORTION OFOUR TOTAL OUTSTANDING VOTING POWER AND WILL LIKELY BE ABLE TO INFLUENCE CERTAINAPPROVAL MATTERS.

 

Sunra Capital Holdings Ltd. and affiliatedparties are currently the beneficial owners of a significant percentageof our common stock, including shares of our Series A Preferred Stockwhich benefit from protective provisions regarding specific corporatematters.  PubliGroupe USA Holdings alsoowns a significant percentage of our common stock, and has agreed to voteon all corporate matters in accordance with the recommendations of our Boardof Directors.

 

Basedon their voting power, Sunra and PubliGroupe may be able to influence theoutcome of matters requiring stockholder approval, including the electionof directors, amendment of our charter and approval ofsignificant corporate transactions. Sunra and PubliGroupe also could deter a change in control of 24/7Real Media, despite the approval of other stockholders, if, for example, athird party required their consent as a condition to closing a transaction withus.

 

OUR PREFERRED STOCK HASLIQUIDATION PREFERENCE AND PARTICIPATION RIGHTS THAT COULD REDUCE OR ELIMINATEANY PROCEEDS AVAILABLE TO OUR COMMON STOCKHOLDERS UPON A SALE OF OUR COMPANY.

 

Under certain circumstances,upon our sale, liquidation or dissolution, our Series A and Series Cpreferred stockholders may be entitled to receive an aggregate liquidationpreference of $6.9 million plus accrued dividends, before our commonstockholders receive any payment. After receipt of this payment, the preferredstockholders may also have the right to participate in receiving proceedspayable to the common stockholders on an as-converted basis. As a result, inthe event of our sale, liquidation or dissolution, including one in which thetotal proceeds represent a premium to the then prevailing price per share ofour common stock, our common stockholders may experience substantial dilutionin the amount payable to them, and if total proceeds are less than or equal tothe liquidation preference, then our common stockholders will not receive anyproceeds.

 

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

 

Some of the provisions of ourCertificate of Incorporation, our Bylaws and Delaware law could, together orseparately:

 

•      discourage potentialacquisition proposals;

 

•      delay or prevent a change incontrol;

 

•      impede the ability of ourstockholders to change the composition of our board of directors in any oneyear; and

 

•      limit the price thatinvestors might be willing to pay in the future for shares of our common stock.

 

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. Wemay never pay cash dividends or distributions on our common stock. In addition,our subordinated convertible debentures restrict our ability to pay cashdividends on our common stock. Whether we pay cash dividends in the future willbe at the discretion of our Board of Directors and will be dependent upon ourfinancial condition, results of operations, capital requirements, contractualrestrictions and any other factors that the Board of Directors decides isrelevant.

 

***RISKS RELATED TO OUR INDUSTRY.***

 

OUR BUSINESS MAY NOT GROW IFTHE INTERNET ADVERTISING MARKET DOES NOT CONTINUE TO DEVELOP.

 

The Internet as a marketingmedium has not been in existence for a sufficient period of time to demonstrateits effectiveness. Our business would be adversely affected if the Internetadvertising market fails to develop in the near future. There are currently nowidely accepted standards to measure the effectiveness of Internet advertisingother than clickthrough rates, which generally have been declining. Suchstandards may not develop to sufficiently support the Internet as a significantadvertising medium. Actual or perceived ineffectiveness of online advertisingin general, or inaccurate measurements or database information in particular,could limit the long-term growth of online advertising and cause our revenuelevels to decline.

 

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 timing and marketacceptance of new products and enhancements of existing services developed byus and our competitors;

 

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•      changing demands regardingcustomer service and support;

 

•      shifts in sales and marketingefforts 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. We may be unable to compete successfully against currentor future competitors. In addition, the Internet must compete for a share ofadvertisers’ total budgets with traditional advertising media, such astelevision, radio, cable and print, as well as content aggregation companiesand other companies that facilitate Internet advertising. To the extent thatthe Internet is perceived to be a limited or ineffective advertising medium,advertisers may be reluctant to devote a significant portion of theiradvertising budgets to Internet advertising, which could limit the growth ofInternet advertising.

 

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, that may impose additional burdens on companies conductingbusiness over the Internet. Our business, results of operations and financialcondition could be materially and adversely affected by the adoption ormodification of laws or regulations relating to the Internet.

 

CHANGES IN LAWS AND STANDARDSRELATING TO DATA COLLECTION AND USE PRACTICES AND THE PRIVACY OF INTERNET USERSAND OTHER INDIVIDUALS 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 October 1998, the EuropeanUnion adopted a directive that may limit our collection and use of informationregarding Internet users in Europe. The effectiveness of our Open AdSystemtechnology could be limited by any regulation limiting the collection or use ofinformation regarding Internet users. Since many of the proposed laws orregulations are just being developed, we cannot yet determine the impact theseregulations may have on its business. In addition, growing public concern aboutprivacy and the collection, distribution and use of personal information hasled to self-regulation of these practices by the Internet advertising anddirect marketing industry and to increased federal and state regulation. TheNetwork Advertising Initiative, or NAI, of which we are an associate

 

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member along with otherInternet advertising companies, has developed self-regulatory principles foronline preference marketing. We are also subject to various federal and stateregulations concerning the collection, distribution and use of personalinformation. These laws include the Children’s Online Privacy Protection Act,and state laws that limit or preclude the use of voter registration and driverslicense information, as well as other laws that govern the collection and useof consumer credit information. While we monitor legislative initiatives, inthe event that more onerous federal or state laws or regulations are enacted orapplied to us or our clients, our business, financial condition and results ofoperations could be materially 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,offer our behavioral targeting and otherwise provide Internet advertisementservices and technology. Web sites typically place small files of information,commonly known as “cookies”, on a user’s hard drive, generally without theuser’s knowledge or consent. Cookie information is passed to the Web sitethrough the Internet user’s browser software. Our Open AdSystem technologytargets advertising to users through the use of cookies and othernon-personally-identifying information. Open AdSystem enables the use ofcookies to deliver targeted advertising and to limit the frequency with whichan advertisement is shown to a user. Most currently available Internet browsersallow users to modify their browser settings to prevent cookies from beingstored on their hard drive, and a small minority of users are currentlychoosing to do so. Users can also delete cookies from their hard drive ormodify them at any time. Some Internet commentators and privacy advocates havesuggested limiting or eliminating the use of cookies. Any reduction orlimitation in the use of cookies could limit the effectiveness of our sales andmarketing efforts and impair our targeting capabilities. Microsoft Corporationhas changed the design and instrumentation of its Web browser in such a way asto give users the option to accept or reject third party cookies. Giving usersthe option to decline such cookies could result in a reduction of the number ofInternet users that we can profile anonymously. Such changes also couldadversely affect our ability to determine the reach of advertising campaignssold and delivered by us and the frequency with which users of sites in the24/7 Network 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 engineering time andresources, might not be completed in time to avoid negative consequences to ourbusiness, financial condition or results of operations, and might not becommercially feasible.

 

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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 or 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 foreign countries where laws or law enforcementpractices may not protect our proprietary rights as fully as in the UnitedStates.

 

We have licensed, and we maylicense in the future, elements of our trademarks, trade dress and similarproprietary rights to third parties. While we attempt to ensure that thequality of our brand is maintained by these business partners, such partnersmay take actions that could materially and adversely affect the value of ourproprietary rights or our reputation. The value of our proprietary rights coulddecline in the future since the validity, enforceability and scope ofprotection of certain proprietary rights in Internet-related industries isuncertain and still evolving.

 

We may be subject to claims ofalleged infringement of the trademarks and other intellectual property rightsof third parties by us or the Web publishers with Web sites in the 24/7Network. Such claims and any resultant litigation could subject us to significantliability for damages and could result in the invalidation of our proprietaryrights. In addition, even if we prevail, such litigation could betime-consuming and expensive to defend, and could result in the diversion ofour time and attention, any of which could materially and adversely affect ourbusiness, results of operations and financial condition. Any claims orlitigation from third parties may also result in limitations on our ability touse the trademarks and other intellectual property subject to such claims orlitigation unless we enter into arrangements with the third parties responsiblefor such claims or litigation, which may be unavailable on commerciallyreasonable terms.

 

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 litigation,such as our ongoing litigation with aQuantive, Inc., present the risk thata court could determine, either preliminarily or finally, that some of ourpatents or other intellectual property rights are not valid, which may make itdifficult to sell our technology solutions and may lead to a loss of and aninability to generate licensing revenue from our patents. In addition, even ifwe prevail, such litigation could be time-consuming and expensive to pursue,and could result in the diversion of our time and attention, any of which couldmaterially and adversely affect our business, results of operations andfinancial condition.

 

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WE MAY BE SUBJECT TOINTELLECTUAL PROPERTY LIABILITY.

 

We may be liable for contentavailable or posted on the Web sites of our publishers. We may be liable tothird parties for content in the advertising we serve if the music, artwork,text or other content involved violates the copyright, trademark or otherintellectual property rights of such third parties or if the content isdefamatory. Any claims or counterclaims could be time consuming, result incostly litigation or divert management’s attention.

 

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.

 

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

 

Internet usage could decline ifany well-publicized compromise of security occurs. “Hacking” involves effortsto gain unauthorized access to information or systems or to cause intentionalmalfunctions or loss or corruption of data, software, hardware or othercomputer equipment. Hackers, if successful, could misappropriate proprietaryinformation or cause disruptions in our service. We may be required to expendcapital and other resources to protect our Web site against hackers. Anymeasures we may take may not be effective. In addition, the inadvertent transmissionof computer viruses could expose us to a material risk of loss or litigationand possible liability, as well as materially damage our reputation anddecrease our user traffic.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

INTEREST RATE RISK

 

The primary objective of ourinvestment activities is to preserve capital. Cash and cash equivalents are investments with original maturities ofthree months or less.  Therefore, changesin the market’s interest rates do not affect the value of the investments asrecorded by 24/7 Real

 

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Media.  The following table presents the amounts ofour financial instruments that are subject to interest rate risk by expectedmaturity and average interest rates as of June 30, 2004 (in thousands):

 
| ** **                | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** | **Thereafter** | ** ** | **TOTAL** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| Cash and cash equivalents |       | $        | 52,511     |     | $          | —   |       | $              | —     |      | $          | — |   | $ | 52,511 |   |
| Average interest rate     |       | 0.90     | %          |     |       |     |       |           |       | 0.90      | %          |
| Marketable securities     |       | $        | 2,896      |     |       |     |       |           |       |      | $          | 2,896 |   |
|                      |       |     |       |     |       |     |       |           |       |      |       |
| Loan payable              |       | $        | —     |     | $          | —   |       | $              | 15,000     |      | $          | — |   | $ | 15,000 |   |
| Loan payable              |       |     |       |     |       | 2.00     | %          |           |       | 2.00      | %          |

 

The 2% subordinated convertibledebentures due 2006 contain a provision that gives the holder the ability tocall a portion of the note upon the satisfaction of a trading price condition.This condition constitutes an embedded derivative. The value of this embeddedderivative at June 30, 2004 is immaterial to our financial position. We willreview the value of the derivative on a quarterly basis in the future, inaccordance with SFAS No. 149, *Amendmentof Statement 133 on Derivative Instruments and Hedging Activities*.  As of June 30, 2004, we did not hold anyother derivative financial instruments.

 

FOREIGN CURRENCY RISK

 

We transact business in a variety of foreign countries and are thussubject to exposure from adverse movements in foreign currency exchangerates.  This exposure is primarilyrelated to revenue and operating expenses denominated in European and Koreancurrencies.  The effect of foreign exchangerate fluctuations for the three and six month periods ended June 30, 2004 and2003 were not material.  We do not usederivative financial instruments to limit our foreign currency risk exposure.  As of June 30, 2004, we had $5.8 million incash and cash equivalents denominated in foreign currencies.

 

ITEM 4. CONTROLS AND PROCEDURES

 

***Evaluation of Controls and Procedures***

 

As of the end of the period covered by this Form 10-Q, an evaluation ofthe effectiveness of the design and operation of our disclosure controls andprocedures was carried out by us under the supervision and with theparticipation of our management, including our Chief Executive Officer andChief Financial Officer.  Based on thatconclusion, our Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures have been designed and are beingoperated in a manner that provides reasonable assurance that the informationrequired to be disclosed in our Exchange Act reports is recorded, processed, summarizedand reported within the time periods specified in the SEC’s rules and forms,and that 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

 

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necessarily is required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures.

 

In 2003, 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 of preparing for compliance withSection 404 of the Sarbanes-Oxley Act of 2002. As a result of the review,we have made numerous improvements to the design and effectiveness of ourinternal control through the six month period ended June 30, 2004.  Weanticipate that improvements will continue to be made.

 

***Changes in Internal Control***

 

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

 

OnJanuary 12, 2004, our former Chief Financial Officer, Norman Blashka, left theCompany to pursue other interests. Jonathan K. Hsu was promoted to the role of Chief Financial Officer onJanuary 12, 2004.

 

Inaddition, during the first quarter of 2004, we acquired Real Media Korea Co.,Ltd.  As part of our ongoing integration activities, we are continuing toincorporate our controls and procedures into RMK.

 

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**PARTII.  OTHER INFORMATION**

 

**Item 1****.  LegalProceedings**

 

*aQuantive, Inc. (formerly Avenue A, Inc.)*

 

InMarch 2004, the Federal Circuit Court of Appeals has affirmed, without opinion,a July 2003 decision of the U.S. Federal Court for the Western District ofWashington that granted summary judgment to aQuantive, Inc. in a lawsuit thatalleged that aQuantive infringed on our U.S. patent number6,026,368.  The lower court’s ruling held that aQuantive’s Atlas DMTadvertisement serving system does not infringe the ‘368 patent.  We filed a request for rehearing before theFederal Circuit Court of Appeals that was denied.

 

*Brian Anderson*

 

On July 5, 2001, Brian Anderson, former Chief Executive of ourAwardTrack, Inc. subsidiary, served us with notice of a lawsuit filed inSuperior Court for the State of California in and for the County of Santa Cruz,alleging breach of contract, fraud, intentional infliction of emotionaldistress and breach of fiduciary duty, in connection with the acquisition ofAwardTrack and subsequent events. We removed the lawsuit to federal court inCalifornia and moved to dismiss the complaint in its entirety. This motion wasgranted in part, with leave to amend, and denied in part. The plaintiff hassubsequently refiled the complaint and we have filed a counterclaim. Discoveryis concluded, and we have moved for summary judgment to dismiss the complaintin its entirety.

 

*chinadotcom Corporation*

 

OnJune 1, 2004, we and David J. Moore, our Chief Exective Officer, reached asettlement with chinadotcom involving the release of all claims and thetermination of all litigation matters involving the two companies and theiraffiliates. As part of the settlement, chinadotcom agreed to issue to us400,000 Class A common shares of chinadotcom. The shares, valued at $2.9 million based on market price on the date of settlement, isincluded on the consolidated statement of operations as a gain on legalsettlement.

 

*General*

 

We are involved in variousclaims and legal actions arising in the ordinary course of business. In theopinion of management, the ultimate disposition of these matters will not havea material effect on our financial position, results of operation or liquidity.

 

**Item 2****.  Changes inSecurities and Use of Proceeds**

 

*Registered SecondaryStock Offering - Exercise of Over-Allotment Option*

 

Inconnection with the registered secondary stock offering by the Company in March2004, the Company and selling stockholders granted to the underwriters anoption to purchase up to an additional 1.2 million shares of common stock at$6.00 per share less underwriter discounts and commissions for the purpose ofcovering over-allotments.  Of theadditional shares offered, approximately 0.8 million shares and 0.4 millionshares were offered by the Company and by the

 

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sellingstockholders, respectively. The underwriters exercised the over-allotmentoption in April 2004.

 

*SeniorSubordinated Debentures - Amendment to Registration Rights Agreement*

 

InJune 2004, the Company amended the registration rights agreement related the subordinatedconvertible debentures.  The amendmentprovided that the Company is no longer obligated to pay any filing ormaintenance penalties pursuant to the registration rights agreement withrespect to the warrants issued to the holders of the debentures.

 

**Item3.  Defaults Upon Senior Securities**

 

None.

 

**Item4.  Submission of Matters to a Vote ofSecurities Holders**

 

None.

 

**Item 5.  OtherInformation**

 

None.

 

**Item6.  Exhibits and Reports on Form 8-K**

 

(a)           Exhibits.

 
| Exhibit 31.1 |   | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                 |
|--------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------|
|         |   |                                                                                                                                                |
| Exhibit 31.2 |   | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                 |
|         |   |                                                                                                                                                |
| Exhibit 32.1 |   | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2003.* |
|         |   |                                                                                                                                                |
| Exhibit 32.2 |   | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2003.* |

 

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(*)           Thiscertification accompanies this Quarterly Report on Form 10-Q, 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 or after the date of thisQuarterly Report on Form 10-Q), irrespective of any general incorporationlanguage contained in such filing.

 

(b)           Reports on Form 8-K.

 

None.

 

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Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized, in the city of New York, State of New York on August 9, 2004.

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

 

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