**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark one)**

 

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

 

**For the quarterly period ended September 30, 2003**

 

**or**

 

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

 

**For the transition periodfrom                                  to                                  **

 

**Commission file number 1-14355****24/7 Real Media, Inc.**

(Exact name of registrant as specified in its charter)

 

| **DELAWARE**                                                    |   | **13-3995672**                     |
|-----------------------------------------------------------------|--------|------------------------------------|
| (STATE OR OTHER JURISDICTION OF  INCORPORATION OR ORGANIZATION) |   | (IRS EMPLOYER  IDENTIFICATION NO.) |
|                                                            |   |                               |
| **7319**                                                        |
| (STANDARD INDUSTRIAL  CLASSIFICATION CODE)                      |
|                                                            |   |                               |
| **1250 BROADWAY, NEW YORK, NY**                                 |   | **10001**                          |
| (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                        |   | (ZIP CODE)                         |
|                                                            |   |                               |
| **(212) 231-7100**                                              |
| (REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)       |

 

Indicateby check mark whether the registrant has filed all reports required to be filedby Section 13 or 15 (d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. YES ý NO o

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

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

 
| **CLASS**                              |   | **OUTSTANDING  AT November 11, 2003** |
|----------------------------------------|--------|---------------------------------------|
| Common Stock, par value $.01 per share |   | 114,420,438 Shares                    |

 

 

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

**SEPTEMBER 30, 2003**

**FORM 10-Q**

**INDEX**

 
| Part I.   Financial Information                                                                                       |   |
|----------------------------------------------------------------------------------------------------------------------------|--------|
| Item 1.   Consolidated Financial Statements                                                                           |   |
| Consolidated Balance Sheets  as of September 30, 2003 (unaudited) and December 31, 2002                                    |   |
| Consolidated  Statements of Operations for the three and nine month periods ended September  30, 2003 and 2002 (unaudited) |   |
| Consolidated  Statements of Cash Flows for the nine month periods ended September 30, 2003  and 2002 (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                                                                             |   |
| Item 7.  Signatures                                                                                                   |   |

 

2

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PART I. FINANCIAL INFORMATION

 

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

 

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

**CONSOLIDATED BALANCE SHEETS**

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

 
|                                                                                                                                                                       |   | **September  30,****2003** |   | **December  31,****2002** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------|--------|---------------------------|--------|
|                                                                                                                                                                       |   | **(unaudited)**            |   |                      |   |
| **ASSETS**                                                                                                                                                                 |   |                       |   |                      |   |
| Current assets:                                                                                                                                                            |   |                       |   |                      |   |
| Cash and cash equivalents                                                                                                                                                  |   | $                          | 11,779 |                      | $      | 7,674 |   |
| Restricted cash                                                                                                                                                            |   | 12,000                     |   | —                    |   |
| Accounts receivable, less allowances of  $1,453 and $1,369, respectively                                                                                              |   | 10,150                     |   | 9,799                     |   |
| Notes and amounts receivable from disposition                                                                                                                              |   | 240                        |   | 720                       |   |
| Prepaid expenses and other current assets                                                                                                                                  |   | 973                        |   | 1,565                     |   |
|                                                                                                                                                                       |   |                       |   |                      |   |
| Total current assets                                                                                                                                                       |   | 35,142                     |   | 19,758                    |   |
|                                                                                                                                                                       |   |                       |   |                      |   |
| Property and equipment, net                                                                                                                                                |   | 3,160                      |   | 3,988                     |   |
| Goodwill                                                                                                                                                                   |   | 2,621                      |   | 2,621                     |   |
| Intangible assets, net                                                                                                                                                     |   | 5,295                      |   | 6,007                     |   |
| Notes and amounts receivable from disposition                                                                                                                              |   | 1,359                      |   | 1,045                     |   |
| Other assets                                                                                                                                                               |   | 1,978                      |   | 548                       |   |
|                                                                                                                                                                       |   |                       |   |                      |   |
| Total assets                                                                                                                                                               |   | $                          | 49,555 |                      | $      | 33,967 |   |
|                                                                                                                                                                       |   |                       |   |                      |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                             |   |                       |   |                      |   |
| Current liabilities:                                                                                                                                                       |   |                       |   |                      |   |
| Accounts payable                                                                                                                                                           |   | $                          | 5,471  |                      | $      | 4,039 |   |
| Accrued liabilities                                                                                                                                                        |   | 8,663                      |   | 12,015                    |   |
| Current installments of obligations under capital leases                                                                                                                   |   | 55                         |   | 47                        |   |
| Deferred revenue                                                                                                                                                           |   | 2,750                      |   | 2,748                     |   |
|                                                                                                                                                                       |   |                       |   |                      |   |
| Total current liabilities                                                                                                                                                  |   | 16,939                     |   | 18,849                    |   |
|                                                                                                                                                                       |   |                       |   |                      |   |
| Obligations under capital leases, excluding current installments                                                                                                           |   | 23                         |   | 66                        |   |
| Subordinated convertible debentures, 2%, due 2006                                                                                                                          |   | 13,167                     |   | —                    |   |
| Loan payable - related party                                                                                                                                               |   | —                     |   | 7,876                     |   |
| Other long term liabilities                                                                                                                                                |   | 332                        |   | 292                       |   |
|                                                                                                                                                                       |   |                       |   |                      |   |
| Total liabilities                                                                                                                                                          |   | 30,461                     |   | 27,083                    |   |
|                                                                                                                                                                       |   |                       |   |                      |   |
| Commitments and contingencies                                                                                                                                              |   |                       |   |                      |   |
|                                                                                                                                                                       |   |                       |   |                      |   |
| Stockholders’ equity:                                                                                                                                                 |   |                       |   |                      |   |
| Preferred stock; $.01 par value; 10,000,000 shares authorized, 995,250  and 925,000 shares issued and outstanding, respectively (liquidation  preference of $10 per share) |   | 10                         |   | 9                         |   |
| Common stock; $.01 par value; 350,000,000 shares authorized;  108,040,264 and 59,219,844 shares issued and outstanding, respectively                                       |   | 1,080                      |   | 592                       |   |
| Additional paid-in capital                                                                                                                                                 |   | 1,109,426                  |   | 1,089,575                 |   |
| Deferred stock compensation                                                                                                                                                |   | (359                       | )      | (209                      | )      |
| Accumulated other comprehensive income                                                                                                                                     |   | 376                        |   | 358                       |   |
| Accumulated deficit                                                                                                                                                        |   | (1,091,439                 | )      | (1,083,441                | )      |
| Total stockholders’ equity                                                                                                                                            |   | 19,094                     |   | 6,884                     |   |
|                                                                                                                                                                       |   |                       |   |                      |   |
| Total liabilities and stockholders’ equity                                                                                                                            |   | $                          | 49,555 |                      | $      | 33,967 |   |

 

See accompanying notes to unaudited interim consolidated financialstatements.

 

3

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

**CONSOLIDATED STATEMENTS OF OPERATIONS**

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

 
|                                                                                                                              |   | **Three  months ended September 30,** |   | **Nine months  ended September 30,** |   |
|-----------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|                                                                                                                              |   | **2003**                              |   | **2002**                             |   | **2003** |   | **2002** |   |
|                                                                                                                              |   | **(unaudited)**                       |   | **(unaudited)**                      |   |
| Revenues:                                                                                                                         |   |                                  |   |                                 |   |   |   |   |   |
| Integrated media solutions                                                                                                        |   | $                                     | 7,953  |                                 | $      | 6,379 |   | $ | 24,657 |   | $ | 21,224 |   |
| Technology solutions                                                                                                              |   | 4,081                                 |   | 3,340                                |   | 11,351 |   | 9,825 |   |
| Total revenues                                                                                                                    |   | 12,034                                |   | 9,719                                |   | 36,008 |   | 31,049 |   |
|                                                                                                                              |   |                                  |   |                                 |   |   |   |   |   |
| Cost of revenues:                                                                                                                 |   |                                  |   |                                 |   |   |   |   |   |
| Integrated media solutions                                                                                                        |   | 4,762                                 |   | 4,334                                |   | 15,357 |   | 14,435 |   |
| Technology solutions (exclusive of $10, $0, $20 and $7, respectively,  reported below as stock-based compensation                 |   | 957                                   |   | 847                                  |   | 3,183 |   | 2,586 |   |
| Total cost of revenues                                                                                                            |   | 5,719                                 |   | 5,181                                |   | 18,540 |   | 17,021 |   |
|                                                                                                                              |   |                                  |   |                                 |   |   |   |   |   |
| Gross profit                                                                                                                      |   | 6,315                                 |   | 4,538                                |   | 17,468 |   | 14,028 |   |
|                                                                                                                              |   |                                  |   |                                 |   |   |   |   |   |
| Operating expenses:                                                                                                               |   |                                  |   |                                 |   |   |   |   |   |
| Sales and marketing (exclusive of $144, $13, $176 and $68,  respectively, reported below as stock-based compensation)             |   | 3,116                                 |   | 3,178                                |   | 9,487 |   | 9,456 |   |
| General and administrative (exclusive of $86, $2,169, $200 and $2,484,  respectively, reported below as stock-based compensation) |   | 2,787                                 |   | 3,509                                |   | 8,485 |   | 10,954 |   |
| Product development (exclusive of $55, $8, $93 and $50, respectively,  reported below as stock-based compensation)                |   | 870                                   |   | 807                                  |   | 2,213 |   | 3,251 |   |
| Amortization of intangible assets                                                                                                 |   | 661                                   |   | 466                                  |   | 1,970 |   | 1,475 |   |
| Stock-based compensation                                                                                                          |   | 295                                   |   | 2,190                                |   | 489 |   | 2,609 |   |
| Loss on sale of assets, net                                                                                                       |   | —                                |   | 856                                  |   | — |   | 550 |   |
|                                                                                                                              |   |                                  |   |                                 |   |   |   |   |   |
| Total operating expenses                                                                                                          |   | 7,729                                 |   | 11,006                               |   | 22,644 |   | 28,295 |   |
|                                                                                                                              |   |                                  |   |                                 |   |   |   |   |   |
| Loss from operations                                                                                                              |   | (1,414                                | )      | (6,468                               | )      | (5,176 | ) | (14,267 | ) |
|                                                                                                                              |   |                                  |   |                                 |   |   |   |   |   |
| Interest income (expense), net                                                                                                    |   | 6                                     |   | (85                                  | )      | (141 | ) | (193 | ) |
| Other expense                                                                                                                     |   | (17                                   | )      | —                               |   | (849 | ) | — |   |
|                                                                                                                              |   |                                  |   |                                 |   |   |   |   |   |
| Loss before provision for income taxes                                                                                            |   | (1,425                                | )      | (6,553                               | )      | (6,166 | ) | (14,460 | ) |
|                                                                                                                              |   |                                  |   |                                 |   |   |   |   |   |
| Provision for income taxes                                                                                                        |   | 12                                    |   | —                               |   | 52 |   | — |   |
|                                                                                                                              |   |                                  |   |                                 |   |   |   |   |   |
| Net loss                                                                                                                          |   | (1,437                                | )      | (6,553                               | )      | (6,218 | ) | (14,460 | ) |
|                                                                                                                              |   |                                  |   |                                 |   |   |   |   |   |
| Dividends on preferred stock                                                                                                      |   | (200                                  | )      | (50                                  | )      | (488 | ) | (50 | ) |
| Preferred stock conversion discount                                                                                               |   | —                                |   | (6,628                               | )      | (1,780 | ) | (6,628 | ) |
| Net loss attributable to common stockholders                                                                                      |   | $                                     | (1,637 | )                                    | $      | (13,231 | ) | $ | (8,486 | ) | $ | (21,138 | ) |
|                                                                                                                              |   |                                  |   |                                 |   |   |   |   |   |
| Loss per common share - basic and diluted                                                                                         |   |                                  |   |                                 |   |   |   |   |   |
| Net Loss                                                                                                                          |   | $                                     | (0.02  | )                                    | $      | (0.12 | ) | $ | (0.08 | ) | $ | (0.28 | ) |
| Preferred stock dividends and conversion discount                                                                                 |   | (0.00                                 | )      | (0.13                                | )      | (0.03 | ) | (0.13 | ) |
| Net loss attributable to common stockholders                                                                                      |   | $                                     | (0.02  | )                                    | $      | (0.25 | ) | $ | (0.11 | ) | $ | (0.41 | ) |
|                                                                                                                              |   |                                  |   |                                 |   |   |   |   |   |
| Weighted average shares outstanding                                                                                               |   | 85,086,656                            |   | 52,540,206                           |   | 74,055,588 |   | 51,051,525 |   |

 

See accompanying notes to unaudited interim consolidated financialstatements.

 

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands)**

** **
|                                                                                          |   | **Nine Months Ended September 30,** |   |
|-----------------------------------------------------------------------------------------------|--------|-------------------------------------|--------|
|                                                                                          |   | **2003**                            |   | **2002** |   |
|                                                                                          |   | **(unaudited)**                     |   | **(unaudited)** |   |
| Cash flows from operating activities:                                                         |   |                                |   |   |   |
| Net loss                                                                                      |   | $                                   | (6,218 | ) | $ | (14,460 | ) |
| Adjustments to reconcile net loss to net cash used in operating  activities:                  |   |                                |   |   |   |
| Depreciation and amortization                                                                 |   | 1,840                               |   | 2,881 |   |
| Provision for doubtful accounts and sales reserves                                            |   | 251                                 |   | (162 | ) |
| Amortization of intangible assets                                                             |   | 1,970                               |   | 1,475 |   |
| Non-cash compensation                                                                         |   | 489                                 |   | 2,609 |   |
| Loss on sale of non-core assets, net                                                          |   | —                              |   | 550 |   |
| Accrued interest on note payable                                                              |   | 166                                 |   | 246 |   |
| Common stock issued for services                                                              |   | —                              |   | 47 |   |
| Changes in operating assets and liabilities, net of effect of  acquisitions and dispositions: |   |                                |   |   |   |
| Accounts receivable                                                                           |   | (602                                | )      | 3,066 |   |
| Notes and amounts receivable from disposition                                                 |   | 166                                 |   | 35 |   |
| Prepaid assets and other current assets                                                       |   | 593                                 |   | 748 |   |
| Other assets                                                                                  |   | 65                                  |   | 690 |   |
| Accounts payable and accrued liabilities                                                      |   | (2,674                              | )      | (8,151 | ) |
| Deferred revenue                                                                              |   | (40                                 | )      | 549 |   |
|                                                                                          |   |                                |   |   |   |
| Net cash used in operating activities                                                         |   | (3,994                              | )      | (9,877 | ) |
|                                                                                          |   |                                |   |   |   |
| Cash flows from investing activities:                                                         |   |                                |   |   |   |
| Increase in restricted cash                                                                   |   | (12,000                             | )      | — |   |
| Capital expenditures, including capitalized software                                          |   | (968                                | )      | (587 | ) |
| Cash (paid for) acquired from acquisition                                                     |   | (150                                | )      | 1,190 |   |
| Cash paid for investment                                                                      |   | (50                                 | )      | — |   |
| Proceeds from sale of non-core assets, net of expenses                                        |   | —                              |   | 2,381 |   |
|                                                                                          |   |                                |   |   |   |
| Net cash (used in) provided by investing activities                                           |   | (13,168                             | )      | 2,984 |   |
|                                                                                          |   |                                |   |   |   |
| Cash flows from financing activities:                                                         |   |                                |   |   |   |
| Proceeds from convertible debentures                                                          |   | 15,000                              |   | — |   |
| Payment of debt issuance costs                                                                |   | (40                                 | )      | — |   |
| Proceeds from issuance of preferred stock, net                                                |   | 6,797                               |   | 7,355 |   |
| Proceeds from exercise of stock options and warrants                                          |   | 1,027                               |   | 73 |   |
| Payment of capital lease obligations                                                          |   | (35                                 | )      | (30 | ) |
| Retirement of debt                                                                            |   | (1,500                              | )      | — |   |
| Proceeds from issuance of note payable - related party                                        |   | —                              |   | 3,000 |   |
|                                                                                          |   |                                |   |   |   |
| Net cash provided by financing activities                                                     |   | 21,249                              |   | 10,398 |   |
|                                                                                          |   |                                |   |   |   |
| Net change in cash and cash equivalents                                                       |   | 4,087                               |   | 3,505 |   |
| Effect of foreign currency on cash                                                            |   | 18                                  |   | 146 |   |
| Cash and cash equivalents at beginning of period                                              |   | 7,674                               |   | 6,974 |   |
|                                                                                          |   |                                |   |   |   |
| Cash and cash equivalents at end of period                                                    |   | $                                   | 11,779 |   | $ | 10,625 |   |

 

See accompanying notes to unaudited interim consolidated financialstatements.

 

5

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**(1)  Summary ofOperations and Significant Accounting Policies**

 

# **Summary ofOperations**

 

24/7Real Media, Inc. (the “Company”), together with its subsidiaries, develops andprovides solutions for interactive marketing. The Company is organized into two principal lines of business:Integrated Media Solutions and Technology Solutions.

 

IntegratedMedia Solutions connects advertisers to audiences through the followingsources:

 

•                  24/7 Web Alliance – a global alliance of Websites where advertisers can run site-specific ad campaigns on brand name sites,campaigns targeted to users in one or more of our content channels or global adcampaigns across our entire network of participating Web sites.

 

•                  24/7 Search (formerly 24/7 Website Results) –performance-based paid inclusion and search engine optimization services.

 

•                  Other services including an interactivedesktop information and messaging tool, known as 24/7 Messenger, and brokerageservices for online promotions and e-mail.

 

TechnologySolutions provides advertising delivery and management technology and servicesto Web sites, ad agencies and advertisers. The Company’s primary software product, Open AdStream ®, is based onpatented technology and available to customers in enterprise and centrallydistributed solutions.  The Company alsoprovides an ad serving product for ad agencies, advertisers and directmarketers, known as Open Advertiser, as well as a suite of web analyticssolutions under the “Insight” brand.

 

TheCompany’s business is characterized by rapid technological change, new productdevelopment and evolving industry standards. The Company’s success may depend, among other factors, upon thecontinued expansion of the Internet as a communications medium, prospectiveproduct development efforts and the continued acceptance of the Company’s solutionsby the marketplace.

 

**Factors Affecting Comparability of 2003 and 2002**

 

InMay 2002, the Company completed the sale of certain assets related to the USe-mail management product which had approximately $1.6 million in revenue forthe nine month period ended September 30, 2002.

 

InJanuary 2003, the Company sold a majority stake in iPromotions, Inc.  iPromotions revenue was approximately $0.3million and $0.9 million for the three and nine month periods ended September30, 2002, respectively, and $0.1 million for the nine month period endedSeptember 30, 2003 (see note 3).

 

InJanuary 2003, the Company acquired Insight First, Inc., a web analyticscompany.  The impact on the three andnine month periods ended September 30, 2003 was not significant (see note 2).

 

Dueto restructuring initiatives adopted in the fourth quarter of 2002, we reducedour headcount by approximately 26 employees during 2003. The number offull-time employees has decreased by 63 from 272 at September 30, 2002 to 209at September 30, 2003.

 

6

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**Organizationand Basis of Presentation**

 

*Principles of Consolidation*

 

Theaccompanying consolidated financial statements include the accounts of theCompany and its majority-owned and controlled subsidiaries from theirrespective dates of acquisition.  Allsignificant intercompany transactions and balances have been eliminated.

 

Theaccompanying interim consolidated financial statements are unaudited.  In the Company’s opinion, the unauditedconsolidated financial statements have been prepared on the same basis as theannual consolidated financial statements and reflect all adjustments, whichinclude only normal recurring adjustments, necessary to present fairly thefinancial position and the results of the Company’s operations and cash flowsfor the interim periods presented.  Thefinancial statements, financial data and other information disclosed in thesenotes to the consolidated results are not necessarily indicative of the resultsexpected for the full fiscal year or any future period.

 

Theaccompanying consolidated financial statements should be read in conjunctionwith the audited consolidated financial statements for the year ended December31, 2002.  Certain information andfootnote disclosures normally included in audited financial statements preparedin accordance with accounting principles generally accepted in the UnitedStates of America have been condensed or omitted pursuant to the Securities andExchange Commission’s rules and regulations.

 

###### *Use ofEstimates*

 

Thepreparation of consolidated financial statements in accordance with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect that reported amountsof assets and liabilities and the disclosure of contingent assets andliabilities at the date of the consolidated financial statements and thereported amounts of revenue and expenses during the reporting period.  These estimates and assumptions related toestimates of collectibility of accounts receivable, the realization of goodwilland other intangible assets, accruals and other factors.  Actual results could differ from thoseestimates.

 

###### *Cash andCash Equivalents*

 

TheCompany considers all highly liquid securities, with original maturities ofthree months or less, to be cash equivalents. Cash and cash equivalents consisted principally of money marketaccounts.

 

*Concentration of Credit Risk*

 

TheCompany maintains cash in bank deposit accounts which, at times, exceed thefederally insured limits.  The Companyhas not experienced any losses in these accounts.

 

###### *UnbilledReceivables*

######  

AtSeptember 30, 2003 and December 31, 2002, accounts receivable includedapproximately $4.8 million and $5.1 million, respectively, of earned butunbilled receivables, which are a normal part of the Company’s business.  Advertising contracts are typically invoicedmonthly, in the period

 

7

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subsequentto when the revenue has been earned. All unbilled receivables as of September 30, 2003 have subsequently beenbilled.

 

*Capitalized Software*

 

Inaccordance with Statement of Financial Accounting Standards No. 86, Accountingfor the Costs of Computer Software To Be Sold, Leased, or Otherwise Marketed(“SFAS No. 86”), the Company requires certain product development costs to becapitalized commencing when a product’s technological feasibility has beenestablished by completion of a working model of the product and ending when aproduct is available for general release to customers.  The Company capitalized approximately $1.2million in connection with the development of our Open Advertiser ad servingsoftware product in the twelve months prior to its release, which is includedin property and equipment, net on the consolidated balance sheet.  The product was released in June 2003 and isbeing amortized using the straight-line method over the estimated usefullife of the software, or 4 years. Amortization for the three month period ended September 30, 2003 is $0.1million and accumulated amortization as of September 30, 2003 is $0.1 million.

 

*Revenue and ExpenseRecognition*

 

Integrated Media Solutions

 

24/7 Web Alliance revenues are generated by delivering advertisingimpressions for a fixed fee to third-party Web sites.  24/7 Search revenues are derived from driving valid visitors toclient Web sites.  E-mail relatedrevenues are derived from delivering advertisements to e-mail lists foradvertisers and Web sites.  Agreementsin each of our media businesses are primarily short term and revenues arerecognized as services are delivered provided that no significant Companyobligations remain outstanding and collection of the resulting receivable isprobable.

 

Technology Solutions

 

Technology Solutions revenues are derived primarily from licensing theCompany’s software and from our ad serving and software maintenance andtechnical support contracts.  Revenuefrom software licensing agreements is recognized in accordance with Statementsof Position (“SOP”) 97-2, “Software Revenue Recognition,” and Staff AccountingBulletin No. 101, “Revenue Recognition in Financial Statements.” Generally, the Company begins to recognize revenue from software licensearrangements upon delivery of the software, and there is pervasiveevidence of an arrangement, collection is reasonably assured, the fee is fixedor determinable, and vendor-specific objective evidence exists to allocate thetotal fees to all elements of the arrangement.

 

The Company recently refined its OAS Local strategy to offer customersthe flexibility to adapt to rapidly changing enterprise requirements whilereducing the risks and costs associated with traditional software licensingmodels.  The Company has also adjusted its software arrangements, whichbundle a software license with maintenance and technical supportservices.  As a result, effective January 1, 2003, the Company changed therevenue recognition method for OAS Local sales, resulting in the deferralof a portion of OAS local revenue to future periods.  Using this method, the Company recognizes as revenue the totalvalue of its software arrangements ratably over the term of the softwarelicense.  This change will have theeffect of modestly reducing license fee revenue in 2003 and deferring a portionof revenue to future periods.  The Company will recapture thereduction in upfront license fee revenue in subsequent years as it recognizesdeferred revenue on its software arrangements. Under the prior arrangements, the Company typically recognizedsoftware license revenue immediately upon delivery of the

 

8

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software and recognized revenue related to software maintenance andtechnical support services ratably as earned.

 

Revenue from ad serving is recognized upon delivery.  The contracts are usually for a one-yearperiod and are billed on a monthly basis.

 

Expenses from the Company’s licensing, maintenance and technicalsupport revenues are primarily payroll costs incurred to deliver and supportthe software.  These expenses areclassified as cost of revenues in the accompanying consolidated statements ofoperations.

 

###### *Stock-BasedCompensation*

 

The Company accounts for stock-based employee compensation arrangementsin accordance with provisions of APB No. 25, “Accounting for Stock Issued toEmployees,” and FASB interpretation No. 44, “Accounting for CertainTransactions Involving Stock Compensation – an interpretation of APB OpinionNo. 25,” and complies with the disclosure provisions of SFAS No. 123,“Accounting for Stock-Based Compensation” and SFAS No. 148, “Accounting forStock-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 determined compensation cost based on the fair value atthe grant date for its stock options under SFAS No. 123, the Company’s net lossand net loss per share would have been increased to the pro forma amountsindicated below:

 
|                                                                                                                                 |   | **Three  Months Ended  September 30,**        |   | **Nine Months  Ended  September 30,** |   |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------|--------|---------------------------------------|--------|
|                                                                                                                                 |   | **2003**                                      |   | **2002**                              |   | **2003** |   | **2002** |   |
|                                                                                                                                 |   | **(in  thousands, except per share amounts)** |   |
| Net loss:                                                                                                                            |   |                                          |   |                                  |   |   |   |   |   |
| As reported                                                                                                                          |   | $                                             | (1,437 | )                                     | $      | (6,553 | ) | $ | (6,218 | ) | $ | (14,460 | ) |
| Deduct: Total stock-based  employee compensation expense determined under fair-value-based method for  all awards, net of tax effect |   | 327                                           |   | 3,501                                 |   | 3,742 |   | 11,921 |   |
| Pro forma                                                                                                                            |   | $                                             | (1,764 | )                                     | $      | (10,054 | ) | $ | (9,960 | ) | $ | (26,381 | ) |
| Net loss attributable to  common stockholders per share:                                                                             |   |                                          |   |                                  |   |   |   |   |   |
| As reported                                                                                                                          |   | $                                             | (0.02  | )                                     | $      | (0.25 | ) | $ | (0.11 | ) | $ | (0.41 | ) |
| Pro forma                                                                                                                            |   | (0.02                                         | )      | (0.32                                 | )      | (0.17 | ) | (0.65 | ) |

 

The per share weighted-average fair value of stock options granted forthe three and nine month periods ended September 30, 2003 is $1.19 and $0.20respectively, and the per share weighted average fair value of stock optionsgranted for the three and nine month periods ended September 30, 2002 is $0.17and $0.16, respectively, on the grant date with the following weighted averageassumptions:

 

9

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|                     |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|--------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                     |   | **2003**                               |   | **2002**                              |   | **2003** |   | **2002** |   |
|                     |   |                                   |   |                                  |   |   |   |   |   |
| Expected dividend yield  |   | 0                                      | %      | 0                                     | %      | 0 | % | 0 | % |
| Risk-free interest rate  |   | 2.05                                   | %      | 1.18                                  | %      | 1.44 | % | 1.08 | % |
| Expected life (in years) |   | 3.0                                    |   | 3.0                                   |   | 2.4 |   | 2.3 |   |
| Volatility               |   | 143                                    | %      | 97                                    | %      | 133 | % | 140 | % |

 

The Company accounts for non-employee stock-based awards in which goodsor services are the consideration received for the equity instruments issuedbased on the fair value of the equity instruments issued in accordance with theEITF 96-18, Accounting For Equity Instruments That Are Issued To Other ThanEmployees For Acquiring, or in Conjunction With Selling Goods or Services.

 

###### *PreferredStock*

 
|       |   | **Shares**     |   | **Price Per** |   | **Conversion** |   | **Ouststanding  at**    |   |
|------------|--------|----------------|--------|---------------|--------|----------------|--------|-------------------------|--------|
| **Series** |   | **Authorized** |   | **Share**     |   | **Rate**       |   | **September  30, 2003** |   | **December  31, 2002** |   |
| A          |   | 800,000        |   | $             | 10.00  |           | $      | 0.20535                 |   | 775,000 |   | 800,000 |   |
| B          |   | 125,000        |   | 10.00         |   | 0.20660        |   | —                  |   | 125,000 |   |
| C          |   | 718,250        |   | 10.00         |   | 0.24158        |   | 220,250                 |   | — |   |
|       |   |           |   |          |   |           |   | 995,250                 |   | 925,000 |   |
|            |        |                |        |               |        |                |        |                         |        |  |  |  |  |

 

During 2003, 25,000 shares of Series A, 125,000 shares of Series B and498,000 shares of Series C Preferred Stock were converted into 1,217,434,6,050,339 and 20,614,280 shares of common stock, respectively.

 

In June 2003, the Company sold 718,250 shares of Series C PreferredStock to several investment funds and individual accredited investors,including members of management and Board of Directors.

 

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.  As ofSeptember 30, 2003, there are approximately $0.6 million of accrued but unpaiddividends.

 

In the event of a liquidation, dissolution or winding up of the Company,the holders of the Preferred Stock are entitled to a liquidation preferencepayment per share equal to the purchase price, plus any dividendsaccrued but unpaid as of such date, before any payment to holders of CommonStock.  After payment of the foregoingpreference, the holders of each share of Preferred Stock would then participate*pro rata* with the holders of theCommon Stock, on an as converted basis, in the distribution of the proceedsfrom such a liquidation event to the holders of the Common Stock until suchtime as the holders of Preferred Stock shall have received an amount equal tothree times the purchase price (inclusive of their liquidationpreference).  A merger, consolidation orsale of the Company will be treated as a liquidation event unless suchtransaction has been approved by the holders of a majority of the outstandingPreferred Stock.

 

10

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###### *ComprehensiveLoss*

 

Totalcomprehensive loss attributable to common stockholders for the nine monthperiods ended September 30, 2003 and 2002 was $8.5 million and $21.0 million,respectively.  Comprehensive lossesresulted primarily from net losses of $8.5 million and $21.1 million,respectively, as well as foreign currency translation adjustments of $0.1million in 2002.

 

### *Loss PerShare*

 

Lossper share is presented in accordance with the provisions of SFAS No. 128,“Earnings Per Share” (“EPS”).  Basic EPSexcludes dilution for potentially dilutive securities and is computed bydividing losses available to common shareholders by the weighted average numberof common shares 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.  Diluted net loss per share is equal to basicnet loss per share since all potentially dilutive securities are anti-dilutivefor each of the periods presented. Diluted net loss per common share for the nine month periods endedSeptember 30, 2003 and 2002 does not include the effects of options to purchase17.4 million and 12.6 million shares of common stock, respectively; 3.9 millionand 8.3 million common stock warrants, respectively; 0.3 million and 32,000shares of unvested restricted stock, respectively; 46.9 and 45.0 million sharesof Preferred Stock, respectively, and 8.6 million shares of common stock in2003 related to the subordinated convertible debentures, on an “as if”converted basis, as the effect of their inclusion is anti-dilutive during eachperiod.

 

### *Reclassifications*

 

Certainreclassifications have been made to prior year consolidated financialstatements to conform to current year’s presentation.

 

### *RecentAccounting Pronouncements*

###  

### In January 2003, theFinancial Accounting Standards Board issued interpretation No. 46 (“FIN 46”),“Consolidation of Variable Interest Entities,” an interpretation of AccountingResearch Bulletin No. 51.  FIN 46requires a variable interest entity to be consolidated by a company if thatcompany is subject to a majority of the risk of loss from the variable interestentity’s activities or entitled to receive a majority of the entity’s residualreturns, or both.  FIN 46 is effectivefor all new variable entities created or acquired after January 31, 2003.  For variable interest entities created oracquired prior to February 1, 2003, the provision of FIN 46 must be applied forthe first interim or annual period beginning after June 15, 2003.  The adoption of FIN 46 does not have anyimpact on the Company’s consolidated financial statements.

###  

### Statement of Financial Accounting Standards No. 149,Amendment of Statement 133 on Derivative Instruments and Hedging Activities(“SFAS No. 149”), was issued in April 2003 and amends and clarifies financialaccounting and reporting for derivative instruments, including certainderivative instruments embedded in other contracts and for hedging activitiesunder Statement of Financial Accounting Standards No. 133, Accounting for DerivativeInstruments and Hedging Activities (“SFAS No. 133”).  SFAS No. 149 provides greater clarification of thecharacteristics of a derivative instrument so that contracts with similarcharacteristics will be accounted for consistently.  In general, SFAS No. 149 is effective for contracts entered intoor modified after June 30, 2003, and for hedging relationships designated afterJune 30, 2003.

 

11

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### The adoption of SFAS No. 149is not expected to have any impact on the Company’s consolidated financialstatements.

 

InMay 2003, Statement of Financial Accounting Standards No. 150, Accounting forCertain Financial Instruments with Characteristics of Both Liabilities andEquity (“SFAS No. 150”), was issued. SFAS No. 150 clarifies the accounting for certain financial instrumentswith characteristics of both liabilities and equity and requires that thoseinstruments be classified as liabilities in statements of financialposition.  Previously, many of thosefinancial instruments were classified as equity.  SFAS No. 150 is effective for financial instruments entered intoor modified after May 31, 2003 and otherwise is effective at the beginning ofthe first interim period beginning after June 15, 2003.  The adoption of SFAS No. 150 is not expectedto have any impact on the Company’s consolidated financial statements.

 

**(2)  BUSINESSCOMBINATIONS**

 

*Acquisition of Now Marketing*

 

OnSeptember 19, 2002, the Company acquired certain assets of Vflash d/b/a NowMarketing (“Now Marketing”), a New York-based marketing services firm.  The acquisition agreement required NowMarketing’s ultimate parent, Elron Electronic Industries Ltd. and Gilbridge,Inc., (together “Now Marketing’s Parent”), to make a $1.25 million investmentin the Company in exchange for 125,000 shares of Series B Preferred Stock.  Accordingly, the total purchaseconsideration of $4.3 million consists of 4.1 million shares of Common Stockvalued at $1.7 million, 125,000 shares of Series B Preferred Stock valued at$2.5 million and $60,000 of transaction costs. The Series B Preferred Stock was convertible into Common Stock of theCompany at any time at the option of the holder thereof at a conversion priceof $0.2066 per share of Common Stock, or 6,050,339 shares of Common Stock on anas-if converted basis.  As of September30, 2003, all Series B Preferred Stock was converted.

 

Theexcess purchase price (excluding the $1.25 million Series B Preferred Stockdiscount) over the fair market value of net tangible assets of approximately$1.8 million has been allocated to acquired technology which is being amortizedover 4 years.  The acquisition wasaccounted for as a purchase business combination in accordance with SFAS No.141, ‘‘Business Combinations’’ and SFAS No. 142, ‘‘Goodwill and OtherIntangible Assets’’.

 

Thenet tangible assets acquired consist of the following:

 

| **Asset/ Liability** |   | **Amount** |   |
|----------------------|--------|------------|--------|
|                 |   |       |   |
| Cash                 |   | $          | 1,250  |   |
| Accrued liabilities  |   | (18        | )      |
|                 |   | $          | 1,232  |   |

 

*Acquisition of the assets of Insight First*

 

OnJanuary 21, 2003, the Company acquired certain assets of Insight First, Inc.(“Seller”), including specific contracts, intangibles and employeerelationships, related to the Seller’s Web analytics solutions, including theintellectual property relating to specific products in exchange for 3,526,093shares of the Company’s common stock valued at approximately $1.0 million, plus$150,000 in cash.  In addition, theCompany has a contingent obligation to pay additional earn-out consideration ofup to $2.2 million, in either cash or common stock, at the Company’s

 

12

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discretion,subject to achievement of earn-out targets relating to revenue generated by theacquired business in fiscal years 2003 and 2004.

 

Thepurchase price in excess of fair value of net tangible assets and liabilitiesacquired of $1.3 million has been allocated to acquired technology.  The acquired technology is being amortizedover the expected benefit period of four years.  The acquisition was accounted for as a purchase businesscombination in accordance with SFAS No. 141, “Business Combinations” and SFASNo. 142, “Goodwill and Other Intangible Assets”.

 

Thenet tangible assets acquired consist of the following:

 

| **Asset/ Liability** |   | **Amount** |   |
|----------------------|--------|------------|--------|
|                 |   |       |   |
| Current Assets       |   | $          | 1      |   |
| Fixed assets         |   | 44         |   |
| Accrued liabilities  |   | (41        | )      |
|                 |   | $          | 3      |   |

 

 

Thefollowing pro forma consolidated amounts give effect to the Company’sacquisition of Now Marketing and Insight First accounted for by the purchasemethod of accounting as if it had occurred at the beginning of the period byconsolidating the results of operations of the acquired entity for the threeand nine month periods ended September 30, 2003 and 2002.

 

Thepro forma consolidated statements of operations are not necessarily indicativeof the operating results that would have been achieved had the transactionsbeen in effect as of the beginning of the periods presented and should not beconstrued as being representative of future operating results.

 
|                                                                |   | **Three  Months Ended****September 30,** |       | **Nine  Months Ended****September 30,** |       |
|---------------------------------------------------------------------|--------|------------------------------------------|------------|-----------------------------------------|------------|
|                                                                |   | **2002**                                 |       | **2003**                                |       | **2002** |   |
|                                                                |   |                                     | ** ** |                                    | ** ** |   | ** ** |
| Total revenues                                                      |   | $                                        | 9,957      |                                    | $          | 36,029 |   | $ | 31,762 |   |
| Net loss                                                            |   | (9,992                                   | )          | (6,261                                  | )          | (24,777 | ) |
| Loss per share                                                      |   | $                                        | (0.17      | )                                       | $          | (0.08 | ) | $ | (0.42 | ) |
| Weighted average shares  used in net loss per share calculation (1) |   | 59,850,914                               |       | 74,313,910                              |       | 58,572,104 |   |

 

----

(1)  The weighted average shares used to computepro forma basic and diluted net loss per share for the three and nine monthperiods ended September 30, 2003 and 2002 includes the 4,100,000 and 3,526,093common shares issued for Now Marketing and Insight First, respectively, as ifthe shares were issued on January 1, 2002.

 

**(3)  DISPOSAL OFNON-CORE ASSETS**

 

*Sale of iPromotions, 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 employees.  Pursuant tothe terms of the Asset Purchase Agreement, the Company sold to the investors,specific contracts, equipment, intangibles, and employee relationships relatedto our iPromotions

 

13

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business,including the intellectual property relating to specific products.  The Company also invested $50,000 in cash inexchange for shares of preferred stock representing a 19.9% interest iniPromotions, Inc. on an as converted basis. Accordingly, the Company effectively sold a majority stake in itsiPromotions business.  Prior to thesale, the carrying value of iPromotions was $0.  Therefore, there was no gain or loss on the transaction.  The cash payment was recorded as aninvestment.

 

**(4)  INTANGIBLEASSETS, NET**

 

The$2.6 million in goodwill as of September 30, 2003 and December 31, 2002 relates$1.1 million to Canada (formerly ClickThrough), $1.1 million to Real Media and$0.4 million to Search.

 

The$5.3 million in Intangible assets, net at September 30, 2003 relates $2.1million to Real Media, $1.4 million to Now Marketing, $1.0 million to InsightFirst and $0.8 million to Search.  The$6.0 million in Intangible assets, net at December 31, 2002 relates $2.8million to Real Media, $1.8 million to Now Marketing and $1.4 million toSearch.

 
|                           |   | **September  30,  2003** |   | **December  31,  2002** |   | **Estimated  Useful Lives** |   |
|--------------------------------|--------|--------------------------|--------|-------------------------|--------|-----------------------------|--------|
|                           |   | **(in thousands)**       |   |                    |   |
|                           |   |                     |   |                    |   |                        |   |
| Goodwill                       |   | $                        | 2,621  |                    | $      | 2,621                       |   |   |   |
|                           |   |                     |   |                    |   |                        |   |
| Technology (1)                 |   | 9,127                    |   | 7,869                   |   | 4                           |   |
| Less accumulated  amortization |   | (4,085                   | )      | (2,216                  | )      |                        |   |
| Net Technology                 |   | 5,042                    |   | 5,653                   |   |                        |   |
|                           |   |                     |   |                    |   |                        |   |
| Trademark                      |   | 500                      |   | 500                     |   | 4                           |   |
| Less accumulated  amortization |   | (247                     | )      | (146                    | )      |                        |   |
| Net Other intangible  assets   |   | 253                      |   | 354                     |   |                        |   |
|                           |   |                     |   |                    |   |                        |   |
| Gross Intangible assets        |   | 9,627                    |   | 8,369                   |   |                        |   |
| Less accumulated  amortization |   | (4,332                   | )      | (2,362                  | )      |                        |   |
| Net Intangible assets          |   | $                        | 5,295  |                    | $      | 6,007                       |   |   |   |

 

----

(1)Technology increased $1.3 million due to the acquisition of the assets ofInsight First, Inc.

 

**(5)  RESTRUCTURING**

 

Thefollowing sets forth the activities in the Company’s restructuring reserve forthe nine month period ended September 30, 2003, which is included in accruedliabilities in the consolidated balance sheet (in thousands):

 

14

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|                           |   | **Beginning  Balance** |   | **Current  year  utilization** |   | **Current  year  reversal** |   | **Ending  Balance** |   |
|--------------------------------|--------|------------------------|--------|--------------------------------|--------|-----------------------------|--------|---------------------|--------|
| Employee termination  benefits |   | $                      | 1,139  |                           | $      | (1,112                      | )      | $                   | — |   | $ | 27 |   |
| Office closing costs           |   | 709                    |   | (517                           | )      | —                      |   | 192                 |   |
| Disposal of assets             |   | 72                     |   | (72                            | )      | —                      |   | —              |   |
| Other exit costs               |   | 12                     |   | (12                            | )      | —                      |   | —              |   |
|                           |   | $                      | 1,932  |                           | $      | (1,713                      | )      | $                   | — |   | $ | 219 |   |

 

**(6)  RELATED PARTYTRANSACTIONS**

 

The Company had issued three Promissory Notes to PubliGroupe, asignificant shareholder, totaling $7.5 million.  One note for $4.5 million had an interest rate of 4.5% withprincipal and interest due on October 30, 2006.  Two notes for $1.5 million each had an interest rate of 6% withprincipal and interest due in January 2005 and May 2005.  On May 23, 2003, PubliGroupe surrendered forcancellation the three Promissory Notes plus accrued interest of approximately$0.5 million in exchange for a cash payment of $1.5 million and 4.8 millionshares of the Company’s common stock, valued at $1.8 million.  The common stock issuance and  $4.7 million gain on cancellation of debtwas recorded as a capital transaction, resulting in a $6.5 million increase ofadditional paid in capital.  Inconnection with the issuance of shares of common stock to PubliGroupe, SunraCapital Holdings Ltd., our primary Series A Preferred stockholder, agreed notto seek conversion of that number of Series A Preferred shares that could beconverted into 4.8 million shares of common stock in order to facilitate theCompany’s issuance of such shares of common stock to PubliGroupe in accordancewith the limit on the Company’s authorized share capital contained in theCompany’s certificate of incorporation.

 

**(7)  2% SUBORDINATEDCONVERTIBLE DEBENTURES**

 

On September 26, 2003, the Company completed the placement to aninstitutional accredited investor of $15.0 million of subordinated convertibledebentures due September 2006 (“Debentures”). The Debentures are convertible into shares of the Company’s common stockat $1.75 per share.  Interest on theDebentures at the rate of 2% is due semi-annually starting in January2004.  The investor also acquired afive-year warrant (the “Warrants”) to purchase 1,802,820 shares of theCompany’s common stock at $1.9137 per share.

 

The maturity date of the Debentures is subject to extension, and theconversion price is subject to adjustment, on the terms and conditions setforth in the Debentures.  In addition,the Company may elect to pay the principal of and interest on the Debentures inshares of its common stock rather than cash. If the Company elects to pay the principal amount due under theDebentures at maturity in shares of its common stock, rather than in cash, thematurity date conversion price will be equal to 90% of the average of the dailyvolume-weighted average prices of the Company’s common stock on the NasdaqSmallCap Market for the fifteen consecutive trading days immediately precedingthe maturity date.  If the Companyelects to make interest payments due under the Debentures in shares of itscommon stock, rather than in cash, the interest conversion price will be equalto 90% of the average of the daily volume-weighted average prices of theCompany’s common stock on the Nasdaq SmallCap Market for the five consecutivetrading days immediately preceding the interest payment date.

 

Additionally, if the specific conditions set forth in the Debenturesare satisfied, the Company may require the holder to convert the Debenturesinto shares of the Company’s common stock, at the

 

15

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conversion rate then in effect, or the Company may prepay theDebentures prior to the maturity date, for an amount in cash equal to 150% ofthe amount prepaid.  In addition, undercertain conditions, the holder of the Debentures also may require the Companyto prepay or redeem the Debentures in specific circumstances.

 

The Company valued the Warrants at $1.8 million using a Black-Scholespricing model with the following factors: risk free interest rate of 1.48%,volatility of 143% and a life of 2.5 years. The aggregate unamortized fair market value of the Warrants is reflectedas a reduction of the face amount of the Debentures on the consolidated balancesheet, which will be amortized over three years, the initial term of theDebentures, using the effective interest method.  Accordingly, the carrying value of the Debentures will beincreased.

 

As a result of the fees paid to the placement agent, legal fees andother expenses in connection with the sale of the Debentures and the Warrants,the Company incurred approximately $1.0 million of debt issuance costs to bepaid in cash.  The Company also recordedthe value of the warrants issued to the placement agent, $0.5 million, usingthe same factors as above.  Collectively,these costs will be amortized over three years, the initial term of theDebentures.  The costs are included inother assets on the consolidated balance sheet.

 

The Company deposited $12.0 million of the proceeds of the sale of theDebentures into an interest-bearing escrow account, to be released to theCompany upon the effectiveness of a registration statement covering the resaleof the shares of common stock underlying the Debentures and the Warrants.  The registration statement was declared effectiveon October 31, 2003 and the $12.0 million has been released.

 

**(8)  COMMON ANDPREFERRED STOCK**

 

As of June 6, 2003, the Companycompleted a private placement (the “Financing”) of approximately $7.18 millionof Series C-1 Nonvoting Convertible Redeemable Preferred Stock (the “Series C-1Preferred Stock”), together with related Common Stock Warrants, to severalinvestment funds and accredited individual investors, including members of theCompany’s management and Board of Directors (the “Investors”).  All outstanding shares converted(collectively, the “Conversion”) into shares of Series C Convertible PreferredStock (the “Series C Preferred Stock”) upon the approval of the Company’sstockholders on July 29, 2003.

 

In connection with the Financing, the Company also issued two warrantsto each Investor to purchase shares of Common Stock at an exercise price equalto the Conversion Price, of which (i) one warrant entitles the Investor topurchase up to an additional 10% of the aggregate number of shares of CommonStock issuable upon the conversion of the Series C Preferred Stock and onlybecomes exercisable upon the effective date of Conversion; and (ii) a secondwarrant entitles the Investors to purchase up to 4.8% of the aggregate numberof shares of Common Stock that would have been issuable upon conversion of theSeries C Preferred Stock and only becomes exercisable in the event theInvestors become entitled to redeem shares of Series C-1 Preferred Stock.  Each warrant will remain exercisable in theevent the Investor becomes entitled to redeem shares of Series C-1 PreferredStock.  Each warrant will remainexercisable until the fifth anniversary of the date on which the warrant firstbecame exercisable.  All warrants issuedpursuant to this transaction may be exercised through a cashless exercise.  The second warrants were cancelled uponConversion on July 29, 2003.

 

Each share of Series C Preferred Stock is convertible into Common Stockat any time at the option of the holder thereof at a conversion price of$0.24158 per share of Common Stock (the

 

16

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“Conversion Price”).  There willbe no change to the conversion ratio of the Series C Preferred Stock based uponthe future trading price of the Common Stock. The conversion price of the Series C Preferred Stock is subject toadjustment in the event future issuances of the Company’s equity is at apurchase price lower than the Conversion Price according to a weighted averageformula.

 

At any time after May 31, 2005, the Company may automatically converteach share of the then outstanding Series C Preferred Stock into the applicablenumber of shares of Common Stock if, among other things, the Common Stock isthen traded, the average per share closing price of the Common Stock is greaterthan three (3) times the Conversion Price over a sixty day (60) trading period,the average daily trading volume of the Common Stock over such a period is atleast 200,000 shares and there is an effective registration statement coveringthe resale of all shares of Common Stock issuable upon conversion of any otheroutstanding shares of Series C Preferred Stock.

 

In the event that all shares of Series C Preferred Stock and warrantsare converted to Common Stock, the Investors collectively will become thebeneficial owners of approximately 32.7 million shares of Common Stock, withoutgiving effect to the conversion of any other outstanding shares of preferredstock, or exercise of outstanding warrants, of the Company.

 

In connection with the Financing, the Company also agreed to file aregistration statement covering the resale of the shares of Common Stockissuable upon conversion of the Series C Preferred Stock and upon exercise ofall warrants issued to the Investors. The Company also granted “piggyback” registration rights to theInvestors, on a pari passu basis with existing registration rights holders,which entitles each of the Investors to participate in registered offerings ofthe Company’s securities by the Company.

 

The Series C will accrue and cumulate 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 preference ofthe Series C payable upon a Liquidation event.

 

The Company agreed to terms of the Series C Preferred Stock when the$0.24158 conversion price approximated fair value of the underlying commonstock.  However, the Series C PreferredStock and associated warrants were subject to stockholder approval whichoccurred on July 29, 2003, at which time the price of the Company’s commonstock was $1.87 per share.  Accordingly,the Series C transaction contained an embedded beneficial conversion feature,which was required to be valued separately. The Company allocated the proceeds received to the Series C PreferredStock and detachable warrants based on a relative fair value basis.  The $5.4 million value ascribed to thefive-year detachable warrants was determined using a Black Scholes pricingmodel (150% volatility, $1.87 fair value at July 29, 2003, $0.24158 exerciseprice, 1.48% discount rate).  Theintrinsic value of the beneficial conversion feature was calculated as thedifference between the conversion price of $0.24158 and the fair value of thecommon stock into which the Series C Preferred Stock was convertible into onthe stockholder approval date of $1.87 per share, or an intrinsic value of$1.63 per share, which is greater than the proceeds allocated.  Therefore, the Company recorded a non-cashcharge of approximately $1.8 million which is included in “Preferred stockconversion discount” on the consolidated statement of operations as of September30, 2003.

 

17

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On May 23, 2003, the Company issued 4.8 million shares, valued atapproximately $1.8 million, plus $1.5 million in cash, to PubliGroupe, inexchange for forgiveness of three promissory notes and the related accruedinterest (see note 6).

 

Approximately 30 employees including members of senior managementvolunteered to receive between 5 and 20% of their compensation in the form ofthe Company’s common stock and options in lieu of cash from April to December2003.  To date, approximately 746,000 shares, valued at $0.1 million, wereissued.

 

On March 17, 2003, the Company issued 1,466,249 shares, valued atapproximately $0.3 million, to employees in lieu of cash for achievingcontractual performance-based 2002 target bonuses.  The bonuses were accrued as of December 31, 2002.

 

From January to July 2002, approximately 58 employees including membersof senior management volunteered to receive between 5 and 20% of theircompensation in the form of the Company’s common stock in lieu of cash. As a result, approximately 1.1 million shares, valued at $0.2 million, wereissued.

 

In April 2002, the Company issued 416,784 shares, valued at $0.1million, principally to the CEO, for 2001 bonuses as reported in the Company’s10-K and accrued as of December 31, 2001.

 

*Additional Paid-in Capital*

 

During the nine months endedSeptember 30, 2003, the Company’s additional paid-in capital increased by $19.9million due to $8.6 million from the issuance of Series C preferred stock, $6.5million in connection with the retirement of PubliGroupe promissory notes, $2.3million from the issuance of warrants for subordinated convertible debentures,$1.1 million of common stock issued in connection with the Insight Firstacquisition, $0.9 million from exercise of options and warrants, $0.8 millionin other stock-based compensation issued to employees offset by ($0.3) millionrelated to the conversion of preferred stock.

 

**(9) STOCK INCENTIVE PLANS**

 

For the nine months ended September 30, 2003, the Company grantedapproximately 1.4 million stock options under the 1998 Stock Incentive Plan,0.6 million stock options under the 2001 Stock Incentive Plan, and 7.0 millionstock options under the 2002 Stock Incentive Plan to employees at exerciseprices based on the fair market value of the Company’s common stock at therespective dates of grant.

 

On July 29, 2003, the shareholders approved an amendment to the 2002Stock Incentive Plan to increase the number of shares that may be subject toawards thereunder by 10,000,000.

 

On January 1, 2003, in accordance with the terms of the 2002 StockIncentive Plan, shares reserved for issuance under the Plan were increased by3,000,000.

 

**(10)  SUPPLEMENTALCASH FLOW INFORMATION**

 

Forthe nine months ended September 30, 2003 and 2002, the amount of cash paid forinterest was $7,000 and $10,000, respectively.

 

18

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Warrantsto purchase 7,084,357 shares of the Company’s common stock at an average of$0.21 per share were exercised during the quarter ended September 30, 2003 inexchange for 6,175,164 shares of the Company’s common stock in cashlessexercises of warrants.

 

**(11) SEGMENTS**

 

TheCompany’s business is comprised of two reportable segments:  Integrated Media Solutions and TechnologySolutions.  The Integrated MediaSolutions segment generates the majority of its revenues by deliveringadvertisements to affiliated Web sites and search engine traffic delivery andmarketing services.  The TechnologySolutions segment generates revenue by providing software licenses, third-partyad serving and other technology services. The Company’s management periodically reviews corporate assets andoverhead expenses for each segment.  Thesummarized segment information as of and for the three and nine month periodsended September 30, 2003 and 2002, are as follows:

 
|                                                     |   | **Three  months ended September 30, 2003** |   | **Three  months ended September 30, 2002** |   |
|----------------------------------------------------------|--------|--------------------------------------------|--------|--------------------------------------------|--------|
|                                                     |   | **Integrated  Media  Solutions**           |   | **Technology  Solutions**                  |   | **Total** |   | **Integrated  Media  Solutions** |   | **Technology  Solutions** |   | **Total** |   |
|                                                     |   | **(in  thousands)**                        |   |
|                                                     |   |                                       |   |                                       |   |   |   |   |   |   |   |   |   |
| Revenues                                                 |   | $                                          | 7,953  |                                       | $      | 4,081 |   | $ | 12,034 |   | $ | 6,379 |   | $ | 3,340 |   | $ | 9,719 |   |
| Amortization of intangibles                              |   | 333                                        |   | 328                                        |   | 661 |   | 216 |   | 250 |   | 466 |   |
| Stock-based compensation (1)                             |   | 279                                        |   | 16                                         |   | 295 |   | 36 |   | 4 |   | 40 |   |
| Loss on sale of assets, net                              |   | —                                     |   | —                                     |   | — |   | 856 |   | — |   | 856 |   |
| Segment (loss) income from  operations                   |   | (1,858                                     | )      | 444                                        |   | (1,414 | ) | (5,639 | ) | (829 | ) | (6,468 | ) |
| Interest expense, net                                    |   | 6                                          |   | —                                     |   | 6 |   | (85 | ) | — |   | (85 | ) |
| Other expenses                                           |   | (9                                         | )      | (8                                         | )      | (17 | ) | — |   | — |   | — |   |
| Segment (loss) income  before provision for income taxes |   | (1,861                                     | )      | 436                                        |   | (1,425 | ) | (5,724 | ) | (829 | ) | (6,553 | ) |
|                                                          |        |                                            |        |                                            |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
|                                            |   | **Nine months  ended September 30, 2003** |   | **Nine months  ended September 30, 2002** |   |
|-------------------------------------------------|--------|-------------------------------------------|--------|-------------------------------------------|--------|
|                                            |   | **Integrated  Media  Solutions**          |   | **Technology  Solutions**                 |   | **Total** |   | **Integrated  Media  Solutions** |   | **Technology  Solutions** |   | **Total** |   |
|                                            |   | **(in  thousands)**                       |   |
|                                            |   |                                      |   |                                      |   |   |   |   |   |   |   |   |   |
| Revenues                                        |   | $                                         | 24,657 |                                      | $      | 11,351 |   | $ | 36,008 |   | $ | 21,224 |   | $ | 9,825 |   | $ | 31,049 |   |
| Amortization of intangibles                     |   | 1,000                                     |   | 970                                       |   | 1,970 |   | 725 |   | 750 |   | 1,475 |   |
| Stock-based compensation  (1)                   |   | 458                                       |   | 31                                        |   | 489 |   | 132 |   | 55 |   | 187 |   |
| Loss on sale of assets, net                     |   | —                                    |   | —                                    |   | — |   | 550 |   | — |   | 550 |   |
| Segment (loss) income from  operations          |   | (5,499                                    | )      | 323                                       |   | (5,176 | ) | (12,389 | ) | (1,878 | ) | (14,267 | ) |
| Interest expense, net                           |   | (141                                      | )      | —                                    |   | (141 | ) | (193 | ) | — |   | (193 | ) |
| Other expenses                                  |   | (9                                        | )      | (840                                      | )      | (849 | ) | — |   | — |   | — |   |
| Segment loss before  provision for income taxes |   | (5,649                                    | )      | (517                                      | )      | (6,166 | ) | (12,582 | ) | (1,878 | ) | (14,460 | ) |
|                                            |   |                                      |   |                                      |   |   |   |   |   |   |   |   |   |
| Total assets:                                   |   |                                      |   |                                      |   |   |   |   |   |   |   |   |   |
| September 30, 2003                              |   | 37,646                                    |   | 11,909                                    |   | 49,555 |   |   |   |   |   |   |   |
| December 31, 2002                               |   | 22,930                                    |   | 11,037                                    |   | 33,967 |   |   |   |   |   |   |   |
|                                                 |        |                                           |        |                                           |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
|                                    |   | **US**             | ** ** | **International** | ** ** | **Total** | ** ** |
|-----------------------------------------|--------|--------------------|------------|-------------------|------------|-----------|------------|
|                                    |   | **(in thousands)** | ** ** |
| **Period  ended September 30, 2003**    |   |               |       |              |       |      |       |
| Revenues for the three  months ended    |   | $                  | 7,269      |              | $          | 4,765     |       | $ | 12,034 |   |
| Revenues for the nine  months ended     |   | 21,911             |       | 14,097            |       | 36,008    |       |
| Long-lived assets                       |   | 12,690             |       | 1,723             |       | 14,413    |       |
|                                    |   |               |       |              |       |      |       |
| **Period  ended September 30, 2002**    |   |               |       |              |       |      |       |
| Revenues for three months  ended        |   | $                  | 6,570      |              | $          | 3,149     |       | $ | 9,719 |   |
| Revenues for nine months  ended         |   | 21,363             |       | 9,686             |       | 31,049    |       |
| Long-lived assets at  December 31, 2002 |   | 14,053             |       | 2,745             |       | 16,798    |       |

 

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(1)Not included are $2,150 and $2,422 for the three and nine month periods endedSeptember 30, 2002, respectively, related to Corporate.

 

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**(12) LITIGATION**

 

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

 

On April 19, 2002, aQuantive, Inc. (formerly Avenue A, Inc.) filed acomplaint against the Company seeking a declaratory judgment that U.S. PatentNo. 6,206,368 is invalid and not infringed by Avenue A.  The complaintalso seeks injunctive relief and recovery of attorney’s fees.  On May 10,2002, the Company filed its answer to the complaint, in which the Companydenied the material allegations of the complaint and asserted a counterclaimfor infringement of the ‘368 patent.  On January 2, 2003, aQuantive fileda motion for summary judgment of non-infringement, to which the Company filedpapers in opposition on April 28, 2003. On July 3,2003, the U.S. Federal Court for the Western District of Washington grantedpartial summary judgment to aQuantive, Inc. and held that, based on the court’sconstruction of the patent’s claims, aQuantive’s Atlas DMT adserving systemdoes not infringe the ‘368 patent.  TheCompany has appealed the court’s ruling to the Court of Appeals for the FederalCircuit and agreed with aQuantive to dismiss the remaining claims in the caseto expedite the appeal.

 

*Brian Anderson*

 

OnJuly 5, 2001, Brian Anderson, former Chief Executive of our AwardTrack, Inc.subsidiary, served us with notice of a lawsuit filed in Superior Court for theState of California in and for the County of Santa Cruz, alleging breach ofcontract, fraud, intentional infliction of emotional distress and breach offiduciary duty, in connection with the acquisition of AwardTrack and subsequentevents.  The Company removed the lawsuit to federal court in Californiaand moved to dismiss the complaint in its entirety; this motion was granted inpart, with leave to remand, and denied in part.  The plaintiff hassubsequently refiled the complaint and the Company has filed a counterclaim.

 

*Chinadotcom Corp.*

 

OnFebruary 19, 2003, the Company filed a complaint against ChinadotcomCorporation for breach of contract, unjust enrichment, breach of duty of goodfaith and fair dealing, and promissory estoppel arising out of a certain equityexchange agreement dated August 16, 2000 between the Company and Chinadotcom,seeking to enforce our right to exchange our stake in 24/7 Asia Ltd. for 1.8 millionshares of Chinadotcom.  Chinadotcomfiled a motion seeking to compel arbitration of the matter, which the courtgranted on May 12, 2003.  We intend to file an arbitration claim relatingto both the equity exchange agreement and other claims that we may have againstchinadotcom.

 

Chinadotcomfiled an action in court in Hong Kong against David Moore, our Chief ExecutiveOfficer, alleging, among other things, breach of fiduciary duty by Mr. Moore inconnection with his serving as a director of Chinadotcom and its subsidiary,24/7 Media Asia Ltd.  The Company will indemnify Mr. Moore and has assumedhis defense.  We believe that the charges are without merit and that theaction was brought solely in retaliation against the Company for asserting itsrights in the matter discussed above. We have filed a motion to dismiss this case.

 

OnJuly 22, 2003, Chinadotcom filed an arbitration claim asserting certainbreaches of contract in connection with the Media Asia Agreement entered intobetween the parties as of June 30, 2000. The claim seeks damages totaling $24.0 million.* *TheCompany intends to file an answer and counterclaim in the matter and tovigorously assert a defense.

 

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ITEM 2.  MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Thisreport includes forward-looking statements within the meaning of the PrivateSecurities Litigation Reform Act of 1995. This Act provides a “safe harbor” for forward-looking statements toencourage companies to provide prospective information about themselves so longas they identify these statements as forward looking and provide cautionarystatements identifying important factors that could cause actual results todiffer from the projected results.  Allstatements other than statements of historical fact, including statementsregarding industry prospects and future results of operations or financialposition, made in this report are forward looking.  We use words such as “anticipate”, “believe”, “expect”, “future”and “intend”, and similar expressions to identify forward-lookingstatements.  Forward-looking statementsreflect management’s current expectations, plans or projections and are inherentlyuncertain.  Our actual results may differsignificantly from management’s expectations, plan or projections.  Readers are cautioned not to place unduereliance on these forward-looking statements, which speak only as of the datehereof.  This section, along with othersections of this report, describes some, but not all, of the factors that couldcause actual to differ significantly from management’s expectations.  We undertake no obligation to publiclyrelease any revisions to these forward-looking statements that may be made toreflect events or circumstances after the date hereof or to reflect theoccurrence of unanticipated events. Readers are urged, however, to review the factors set forth in reportsthat we file from time to time with the Securities and ExchangeCommission.  Unless the context requiresotherwise in this report the terms “24/7 Real Media,” the “Company,” “we,”“us,” and “our” refer to 24/7 Real Media, Inc. and its subsidiaries, andreferences to “24/7 Search” refer to 24/7 Search, Inc., a wholly ownedsubsidiary of 24/7 Real Media.

 

 

### **GENERAL**

 

24/7 Real Media, Inc. is a gateway to the full spectrum of solutionsfor interactive marketing.  Our OpenAdSystemTM platform, based on our patent-protected technology, empowers Internetmarketers to target, convert and retain their best online customers and manageand protect customer relationships.  Wework closely with our customers to implement integrated, value-enhancingsolutions to manage critical aspects of Internet marketing from ad sales andmedia representation to campaign planning, execution and optimization as wellas audience measurement and analysis. We believe our technology solutions, and our media and marketingservices, offer controllable and cost-effective methods for generatingadvertising revenue consistent with the goal of building and protectingcustomer relationships.

 

We generate revenue in two business segments:  Integrated Media Solutions and Technology Solutions.

 

*Integrated Media Solutions*

 

Our Media Solutions consist of the following services: (i) the 24/7 WebAlliance, a global alliance of Web sites where advertisers can run site-specific ad campaigns on brand namesites, campaigns targeted to users in one or more of our content channels orglobal ad campaigns across our entire network of participating Web sitesas well as target campaign by geography, by time or by day part; (ii) 24/7Search, a performance-based search engine paid inclusion service where weperform a custom build-out containing all relevant keywords and keyword phrasesand advertisers pay only when users search on one of those phrases andclick-through to the advertiser’s Web site

 

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from search listings; and (iii) other services including: desktopmessaging services and brokerage activities for internet promotions and e-mailmarketing.  Our 24/7 Web Allianceincludes the 24/7 Network of Web sites, which uses our Open AdStream technologysolutions to deliver and manage Internet advertisements, and our 24/7Portfolio, which consists of Web sites with whom we provide servicesindependent of our 24/7 Network.

 

We generate revenue through the 24/7 Web Alliance from fees paid byclient advertisers.  We typically offeradvertisers a pricing model based on cost-per-thousand-impressions (“CPM”)enabling a client advertiser to pay a fee based on the number of times its adis viewed.  We may also offeradvertisers performance-based pricing models that may include cost-per-click(“CPC”) pricing allowing a client advertiser to pay us only when a user clickson the advertiser’s ad or performs a specific action, such as a clicking on auniform resource link (“URL”), downloading software, registering for membershipor other transactions.

 

We share the revenue generated through the 24/7 Web Alliance with Websites included in the 24/7 Web Alliance. With respect to our 24/7 Network Web sites, our revenue share generallyranges between 40% and 50% depending on, among other things, our Web sitepartner’s audience size, number of unique visitors, impressions and page views,and the prominence of our partner’s brand name.  With respect to our 24/7 Portfolio Web sites, our revenue shareranges between 35% and 45% depending on similar factors.

 

We had approximately 430 unique advertisers during the third quarter of2003.  The following table shows byquarter the number of paid impressions and the average CPM since January 1,2002.

 

 

|    |   | **Number of Paid  Impressions** |   | **Average  CPM** |   |
|---------|--------|---------------------------------|--------|------------------|--------|
|    |   | **(in  billions)**              |   |             |   |   |
| 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 operates a paid inclusion service for advertisers.  Paid inclusion is also known as “trustedfeed” and generally operates by converting an advertiser’s dynamicallygenerated Web site into a data stream similar to what search engine “spiders,”or automated data collection methods, would have collected.  These individual data elements for each pageare then fed directly into the databases of our search engine affiliates as iftheir spider had in fact collected the data. Our 24/7 Search strategy focuses, in part, on helping advertisers moreprecisely develop and expand the range of terms and phrases they can use todrive search engine traffic to their Web sites.  Through our search engine relationships, we help ensure that ourclients are well represented in the search results for the selected keywordphrases. We do not guarantee a position in search results for our advertisers,only inclusion.

 

24/7Search offers advertisers important advantages to other forms of paidinclusion.  In particular, theadvertiser, with our assistance, controls which information on a Web page issubmitted and assures that the most pertinent content is indexed within thesearch engine database.  Further, ourtrusted feeds are updated more regularly than typical results obtained by

 

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automatedsearch engine spiders, which reduces the time lag for inclusion of Web sitesthat have frequently changing content. In addition, our trusted feeds give advertisers the ability to quicklyedit or remove poorly performing listings. Overall, for advertisers with Web pages that change regularly, our paidinclusion service combines a pay for performance model with the benefits ofcontrol, freshness and coverage.

 

24/7 Search also operates and continues to develop a commercial searchengine known as Engine54, located at www.engine54.com.  Through Engine54, we provide an Internetsearch solution that offers advertisers the opportunity to appear in relevantpaid search listings.  We are furtherdeveloping the capabilities of Engine54 to provide businesses of all sizes theopportunity to have listings for their company included in the paid searchresults appearing on Engine54, so that their listings are available to Internetusers at the moment when they are searching for relevant information. Byenabling advertisers to reach large numbers of users in a highly targetedsearch context, we believe Engine54 can provide an effective method ofacquiring customers, converting leads into sales and generating usefulinformation for direct marketing campaigns.

 

Wegenerate revenue through 24/7 Search from performance-based fees paid byadvertisers to have their Web sites included in the databases of our search engineaffiliates and, to a lesser extent, to have their Web sites included in thesearch results of Engine54. We believe search traffic likely results from avariety of search phrases entered into search engines by users.  We use proprietary technology to helpadvertisers determine a set of keyword phrases most relevant to their site andagree on a CPC fee they will pay for traffic directed to their Web sites.

 

We share the revenue generated through 24/7 Search with our searchengine partners and, with respect to Engine 54, with search engine partnersthat have provided their paid search listings to us.  Our revenue share may range between 35% and 45% depending on,among other things, our distribution partner’s size, number of unique visitors,impressions and the number of searches conducted, and the prominence of ourpartner’s brand.

 

24/7 Search had approximately 1600 active client advertiser accounts atSeptember 30, 2003.  The following tableshows by quarter the number of valid visitors and the average CPC for 24/7Search since January 1, 2002.

 

 

|    |   | **Number of  Valid Visitors** |   | **Average  CPC** |   |
|---------|--------|-------------------------------|--------|------------------|--------|
|    |   | **(in millions)**             |   |             |   |
| Q3 2003 |   | 9.0                           |   | $                | 0.24   |   |
| Q2 2003 |   | 11.3                          |   | 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                           |   | 0.21             |   |
|         |        |                               |        |                  |        |  |

 

In order to increase our revenue, we must continue to increase thenumber of advertisers we service, the number of paid ad impressions andclick-throughs on the 24/7 Web Alliance and our portfolio Web sites, the numberof valid visitors to Web sites of our search marketing clients and the CPM orCPC fees that we earn.  We drive adimpressions and click-throughs by increasing the number of Web sites in the24/7 Web Alliance and other Web sites for whom we provide services, and bybuilding relationships with Web sites that have deep, high-quality content and

 

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large audiences.  We drivetraffic to our 24/7 Search clients primarily by adding new search enginedistribution partners and improving our placement with existing distributionpartners.

 

*Technology Solutions*

 

Our Technology Solutions consist of the following products andservices: (i) the Open AdStream® software (“OAS Local”), a turnkey Internetadvertising delivery and management solution installed locally on our clients’servers; (ii) the Open AdStream service (“OAS Central”), an Internetadvertising delivery and management service for website publishers using ourOpen AdStream software distributed centrally from our servers on an applicationservice provider basis; (iii) the Insight analytics service, a service thatuses our proprietary software to measure and analyze audience behavior forclient Web sites; and (iv) the Open AdvertiserTM service (“OAD”), an Internetadvertising delivery and management service for advertisers and ad agenciesdistributed centrally from our servers on an application service providerbasis.

 

We generate revenue from licensing our Open AdStream software to clientWeb sites.  Our license agreementstypically provide for a license fee and a software maintenance and technicalsupport fee.  We negotiate license feesbased on, among other things, the forecasted number of impressions a clientwebsite will deliver using our software and several other factors.  To a much lesser extent, we also generaterevenue by providing professional services charged at an hourly rate.

 

We generate revenue from our Open AdStream service from fees paid byclient Web sites.  We typically offerWeb sites a CPM based pricing model allowing the client Web site to pay usbased on ad impressions delivered.  Forthese client Web sites, an “impression” includes the delivery by us at theirrequest of any advertisement or other marketing material.  Our OAS Central revenue is determined bymultiplying the CPM rate by the number of impressions delivered and istypically billed on a monthly basis.  Toa much lesser extent, we also generate revenue from fees paid to us by ourclient Web sites for trafficking their advertisements.  Trafficking advertisements typically refersto entering advertisement creative material and campaign specifications intoour software engine.

 

We generate revenue from our Insight service from fees paid by clientWeb sites.  We typically offer Web sitespage-view-based pricing enabling the client website to pay us based on how manypage views are measured.  Our servicerevenue is calculated by multiplying the CPM rate by the number of page viewsdelivered.  To a lesser extent, we alsogenerate revenue by providing professional services charged at an hourly rate.

 

We generate revenue from our Open Advertiser service from fees paid byclient advertisers and agencies.  Wehave been generating revenue from Open Advertiser in Europe since mid-2001.  Domestically, we have not generatedsignificant revenue from our Open Advertiser service because it had been underdevelopment and existing customers are in the beta implementation process.  We launched our Open Advertiser service inthe United States in June 2003.

 

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The following table shows by quarter certain metrics for our TechnologySolutions since 2002:

 
|    |   | **OAS Local**                              |   | **OAS  Central, OAD and Insight**          |   |                           |   |
|---------|--------|--------------------------------------------|--------|--------------------------------------------|--------|--------------------------------|--------|
|    |   | **Number of Active Client  Contracts (1)** |   | **Number of Active Client  Contracts (1)** |   | **Number of Paid Impressions** |   | **Annual Revenue per  Contract** |   |
|    |   |                                       |   |                                       |   | **(in billions)**              |   |   |   |
| Q3 2003 |   | 219                                        |   | 162                                        |   | 13.3                           |   | $ | 42,845 |   |
| Q2 2003 |   | 221                                        |   | 156                                        |   | 11.9                           |   | 40,191 |   |
| Q1 2003 |   | 235                                        |   | 164                                        |   | 10.6                           |   | 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 |   |
|         |        |                                            |        |                                            |        |                                |        |  |  |  |

 

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(1)          A client contract may represent multipleclients and websites utilizing Open AdStream products and services.

 

In order to increase our revenue from our Open AdStream solutions, andour Insight and Open Advertiser solutions, we must increase the number ofclient Web publishers and advertisers we service, the number of paid adimpressions delivered using our services, or the licensing or CPM fee that weearn.  We believe we can increase thenumber of clients to whom we provide technology and services, and the licensefees and CPM fees we charge, by developing and providing next generationtechnology products and services, including launching our Open Advertiser service,and by leveraging the design features of our technology and services toincrease our ability to target high-quality audience segments.

 

*Patent Licensing Program*

 

In connection with the continued development of our technologysolutions, we have undertaken an extensive review of the scope of our patentedintellectual property.  Our currentpatent portfolio includes U.S. Patent No. 6,026,368, entitled “On-LineInteractive System And Method For Providing Content And Advertising InformationTo A Targeted Set of Viewers”, U.S. Patent No. 6,601,041, a continuation of our‘368 Patent granting additional claims involving advertisement sequencingwithout priority queues, and U.S. Patent No. 5,446,919, entitled “Communication System and Method withDemographically or Psychographically Defined Audiences.”  In addition, we have several pending patentapplications aimed at protecting other critical aspects of our next generationadvertising delivery and management solutions as well as our web analyticssolutions.  We believe our patentportfolio not only provides 24/7 Real Media with a competitive advantage inadvertising delivery and management, but also encompasses methods used inseveral other areas of interactive marketing including paid-search advertisingand interactive television.

 

In light of the foregoing, we have taken significant steps to develop apatent licensing program involving all of our patented intellectualproperty.  Our patent program includesidentifying, notifying and pursuing commercial discussions with companies thatwe believe practice one or more of our patents.  With any of these companies we may discuss transactions involvinglicensing our patents, buying our patents or jointly developing technology usingour patents.  In addition, in appropriatecircumstances, we will commence enforcement actions against companies thatinfringe our patents.  Our patentlicense arrangements are designed to include an upfront license fee and arunning royalty payable by the licensee for the remaining term of the licensedpatents.  In addition to Doubleclick,Valueclick, Mediaplex and Advertising.com, our initial licensees who made aone-time lump-sum payment to license the ‘368 patent, we have licensed

 

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one or more of our patents to a number of companies who made upfrontpayments and are obligated to pay direct or contingent royalties.

 

**CRITICAL ACCOUNTING POLICIES**

 

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

 

Theconsolidated financial statements of the Company are prepared in conformitywith accounting principles generally accepted in the United States ofAmerica.  As such, the Company isrequired to make certain estimates, judgments and assumptions that managementbelieves 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.

 

Thesignificant accounting policies which the Company believes are the mostcritical to aid in fully understanding and evaluating the reported consolidatedfinancial results include the following:

 

***Revenue Recognition***

 

*Integrated MediaSolutions*

 

24/7 Web Alliance revenues are generated by delivering advertisingimpressions for a fixed fee to third-party Web sites.  24/7 Search revenues are derived from driving traffic to clientWeb 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.

 

*Technology Solutions*

 

Technology Solutions revenues are derived from licensing the Company’ssoftware, hosted ad serving, and software maintenance and technical supportcontracts.  Revenue from softwarelicensing agreements is recognized in accordance with Statements of Position(“SOP”) 97-2, “Software Revenue Recognition,” and Staff Accounting Bulletin No.101, “Revenue Recognition in Financial Statements.”  Generally, theCompany recognizes revenue from software license arrangements upon delivery ofthe software, and there is pervasive evidence of an arrangement,collection is reasonably assured, the fee is fixed or determinable, andvendor-specific objective evidence exists to allocate the total fees to allelements of the arrangement.

 

The Company recently refined its OAS Local strategy to offer customersthe flexibility to adapt to rapidly changing enterprise requirements whilereducing the risks and costs associated with traditional software licensingmodels.  The Company has also adjusted its software arrangements, whichbundle a software license with maintenance and technical supportservices.  As a result, the Company changed the revenue recognition methodfor OAS Local sales, resulting in the deferral of a portion of OAS localrevenue to future periods.  Using thismethod, the Company recognizes as revenue the total value of its softwarearrangements ratably over the term of the software license.  This change will have the effect ofmodestly reducing license fee revenue in 2003 and deferring a portion ofrevenue to future periods.  The Company will recapture the reductionin

 

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upfront license fee revenue in subsequent years as it recognizesdeferred revenue on its software arrangements. Under the prior arrangements, the Company typically recognizedsoftware license revenue immediately upon delivery of the software andrecognized revenue related to maintenance and technical support servicesratably as earned.

 

Revenue from ad serving is recognized upon delivery.  The contracts are usually for a one-yearperiod and are billed on a monthly basis.

 

Expense from the Company’s licensing, maintenance and technical supportrevenues are primarily payroll costs incurred to deliver and support the software.  These expenses are classified as cost ofrevenues in the accompanying consolidated statements of operations.

 

###### ***Accounts Receivable***

 

Weperform ongoing credit evaluations of our customers and adjust credit limitsbased upon payment history and the customer’s current credit worthiness, asdetermined by a review of their current credit information.  We continuously monitor collections andpayments from our customers and maintain a provision for estimated credit lossesbased upon historical experience and any specific customer collection issuesthat have been identified.  While suchcredit losses have historically been within our expectations and the provisionsestablished, we cannot guarantee that we will continue to experience the samecredit loss rates that have been experienced in the past.

 

###### ***Impairment of Long-Lived Assets***

 

EffectiveJanuary 1, 2002, we adopted SFAS No. 142, ‘‘Goodwill and Other IntangibleAssets’’ and SFAS No. 144, “Accounting for the Impairment or Disposal ofLong-Lived Asset’’.  SFAS 142 eliminatesthe amortization of goodwill and indefinite-lived intangible assets, addressesthe amortization of intangible assets with finite lives and addressesimpairment testing and recognition for goodwill and intangible assets.  SFAS No. 144 establishes a single model forthe impairment of long-lived assets.

 

Weassess goodwill for impairment annually unless events occur that require morefrequent reviews.  Long-lived assets,including amortizable intangibles, are tested for impairment whenever events orchanges in circumstances indicate that the carrying amount of an asset may notbe recoverable.  Discounted cash flowanalyses are used to assess non-amortizable intangible impairment whileundiscounted cash flow analyses are used to assess long-lived assetimpairment.  If an assessment indicatesimpairment, the impaired asset is written down to its fair market value basedon the best information available. Estimated fair market value is generally measured with discountedestimated future cash flows.  Considerablemanagement judgment is necessary to estimate undiscounted and discounted futurecash flows.  Assumptions used for thesecash flows are consistent with internal forecasts.

 

Onan on-going basis, management reviews the value and period of amortization ordepreciation of long-lived and other intangible assets. During this review, wereevaluate the significant assumptions used in determining the original cost oflong-lived assets. Although the assumptions may vary from transaction totransaction, they generally include revenue growth, operating results, cashflows and other indicators of value. Management then determines whether therehas been an impairment of the value of long-lived assets based upon events orcircumstances, which have occurred since acquisition. The impairment policy isconsistently applied in evaluating impairment for each of our wholly ownedsubsidiaries and investments.

 

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# ***Contingencies and Litigation***

 

We evaluate contingent liabilities including threatened or pendinglitigation in accordance with SFAS No. 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.

 

# **RESULTS OFOPERATIONS**

 

# **FACTORSAFFECTING COMPARABILITY OF 2003 TO 2002**

 

InMay 2002, the Company completed the sale of certain assets related to the USe-mail management product which had approximately $1.6 million in revenue forthe nine month period ended September 30, 2002.

 

InJanuary 2003, the Company sold a majority stake in iPromotions, Inc.  iPromotions revenue was approximately $0.3 millionand $0.9 million for the three and nine month periods ended September 30, 2002,respectively, and $0.1 million for the nine month period ended September 30,2003 (see note 3).

 

InJanuary 2003, the Company acquired Insight First, Inc., a web analyticscompany.  The impact on the three andnine month periods ended September 30, 2003 was not significant (see note 2).

 

Dueto restructuring initiatives adopted in the fourth quarter of 2002, we reducedour headcount by approximately 26 employees during 2003. The number offull-time employees has decreased by 63 from 272 at September 30, 2002 to 209at September 30, 2003.

 

### The following table comparesthe results of operations for the three and nine month periods ended September30, 2003 to the results of operations for the three and nine month periodsended September 30, 2002 (in thousands):

 

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|                                    |   | **Three  months ended  September 30,** |   | **Dollar  Variance** |       | **Percentage  Variance** |       | **Nine months  ended  September 30,** |       | **Dollar  Variance** |       | **Percentage  Variance** |       |
|-----------------------------------------|--------|----------------------------------------|--------|----------------------|------------|--------------------------|------------|---------------------------------------|------------|----------------------|------------|--------------------------|------------|
|                                    |   | **2003**                               |   | **2002**             |       |                     |       | **2003**                              |       | **2002**             |       |                     |       |
|                                    |   |                                   |   | **(in  thousands)**  |       |                     |       |                                  |       |                 |       | **(in  thousands)**      |       |   |   |   |   |
|                                    |   | **(unaudited)**                        |   |                 | ** ** |                     | ** ** | **(unaudited)**                       | ** ** |                 | ** ** |                     | ** ** |
| Revenues:                               |   |                                   |   |                 |       |                     |       |                                  |       |                 |       |                     |       |   |   |   |   |
| Integrated media solutions              |   | $                                      | 7,953  |                 | $          | 6,379                    |       | $                                     | 1,574      |                 | 24.7       | %                        | $          | 24,657 |   | $ | 21,224 |   | $ | 3,433 |   | 16.2 | % |
| Technology solutions                    |   | 4,081                                  |   | 3,340                |       | 741                      |       | 22.2                                  | %          | 11,351               |       | 9,825                    |       | 1,526 |   | 15.5 | % |
| Total revenues                          |   | 12,034                                 |   | 9,719                |       | 2,315                    |       | 23.8                                  | %          | 36,008               |       | 31,049                   |       | 4,959 |   | 16.0 | % |
|                                    |   |                                   |   |                 |       |                     |       |                                  |       |                 |       |                     |       |   |   |   |   |
| Cost of revenues:                       |   |                                   |   |                 |       |                     |       |                                  |       |                 |       |                     |       |   |   |   |   |
| Integrated media solutions              |   | 4,762                                  |   | 4,334                |       | 428                      |       | 9.9                                   | %          | 15,357               |       | 14,435                   |       | 922 |   | 6.4 | % |
| Technology solutions                    |   | 957                                    |   | 847                  |       | 110                      |       | 13.0                                  | %          | 3,183                |       | 2,586                    |       | 597 |   | 23.1 | % |
| Total cost of revenues                  |   | 5,719                                  |   | 5,181                |       | 538                      |       | 10.4                                  | %          | 18,540               |       | 17,021                   |       | 1,519 |   | 8.9 | % |
|                                    |   |                                   |   |                 |       |                     |       |                                  |       |                 |       |                     |       |   |   |   |   |
| Gross profit                            |   | 6,315                                  |   | 4,538                |       | 1,777                    |       | 39.2                                  | %          | 17,468               |       | 14,028                   |       | 3,440 |   | 24.5 | % |
|                                    |   |                                   |   |                 |       |                     |       |                                  |       |                 |       |                     |       |   |   |   |   |
| Operating expenses:                     |   |                                   |   |                 |       |                     |       |                                  |       |                 |       |                     |       |   |   |   |   |
| Sales and marketing                     |   | 3,116                                  |   | 3,178                |       | (62                      | )          | -2.0                                  | %          | 9,487                |       | 9,456                    |       | 31 |   | 0.3 | % |
| General and administrative              |   | 2,787                                  |   | 3,509                |       | (722                     | )          | -20.6                                 | %          | 8,485                |       | 10,954                   |       | (2,469 | ) | -22.5 | % |
| Product technology                      |   | 870                                    |   | 807                  |       | 63                       |       | 7.8                                   | %          | 2,213                |       | 3,251                    |       | (1,038 | ) | -31.9 | % |
| Amortization of intangible  assets      |   | 661                                    |   | 466                  |       | 195                      |       | 41.8                                  | %          | 1,970                |       | 1,475                    |       | 495 |   | 33.6 | % |
| Stock-based compensation                |   | 295                                    |   | 2,190                |       | (1,895                   | )          | -86.5                                 | %          | 489                  |       | 2,609                    |       | (2,120 | ) | -81.3 | % |
| Loss on sale of assets, net             |   | —                                 |   | 856                  |       | (856                     | )          | -100.0                                | %          | —               |       | 550                      |       | (550 | ) | -100.0 | % |
|                                    |   |                                   |   |                 |       |                     |       |                                  |       |                 |       |                     |       |   |   |   |   |
| Total operating expenses                |   | 7,729                                  |   | 11,006               |       | (3,277                   | )          | -29.8                                 | %          | 22,644               |       | 28,295                   |       | (5,651 | ) | -20.0 | % |
|                                    |   |                                   |   |                 |       |                     |       |                                  |       |                 |       |                     |       |   |   |   |   |
| Loss from operations                    |   | (1,414                                 | )      | (6,468               | )          | 5,054                    |       | 78.1                                  | %          | (5,176               | )          | (14,267                  | )          | 9,091 |   | 63.7 | % |
|                                    |   |                                   |   |                 |       |                     |       |                                  |       |                 |       |                     |       |   |   |   |   |
| Interest expense, net                   |   | 6                                      |   | (85                  | )          | 91                       |       | 107.1                                 | %          | (141                 | )          | (193                     | )          | 52 |   | -26.9 | % |
| Other expense                           |   | (17                                    | )      | —               |       | (17                      | )          | -100.0                                | %          | (849                 | )          | —                   |       | (849 | ) | -100.0 | % |
|                                    |   |                                   |   |                 |       |                     |       |                                  |       |                 |       |                     |       |   |   |   |   |
| Loss before provision for  income taxes |   | (1,425                                 | )      | (6,553               | )          | 5,128                    |       | 78.3                                  | %          | (6,166               | )          | (14,460                  | )          | 8,294 |   | 57.4 | % |
|                                    |   |                                   |   |                 |       |                     |       |                                  |       |                 |       |                     |       |   |   |   |   |
| Provision for income taxes              |   | 12                                     |   | —               |       | 12                       |       | 100.0                                 | %          | 52                   |       | —                   |       | 52 |   | 100.0 | % |
|                                    |   |                                   |   |                 |       |                     |       |                                  |       |                 |       |                     |       |   |   |   |   |
| Net loss                                |   | (1,437                                 | )      | (6,553               | )          | 5,116                    |       | 78.1                                  | %          | (6,218               | )          | (14,460                  | )          | 8,242 |   | 57.0 | % |
|                                         |        |                                        |        |                      |            |                          |            |                                       |            |                      |            |                          |            |  |  |  |  |  |  |  |  |  |  |

 

### **REVENUES**

 

**INTEGRATED MEDIA SOLUTIONS.**Revenue is derived from three sources: 24/7Web Alliance, 24/7 Search and Other Media Services.  24/7 Web Alliance revenue was $5.3 million and $15.4 million forthe three and nine month periods ended September 30, 2003, respectively, ascompared to $4.1 million and $12.7 million for the three and nine month periodsended September 30, 2002, respectively, an increase of 30.0% and 21.2%,respectively.  The increase is due toincreasing the size of the 24/7 Network from 3.0 billion paid impressions in2002 to 5.9 billion paid impressions in 2003.

 

24/7Search revenue was $2.2 million and $7.6 million for the three and nine monthperiods ended September 30, 2003, respectively, as compared to $2.0 million and$6.0 million for the three and nine month periods ended September 30, 2002,respectively, an increase of 9.7% and 27.2%, respectively.  Historically, we generated a significantportion of our 24/7 Search revenue from relationships with a small number ofsearch engines, particularly Inktomi.  Due to changes at our largesttraffic provider, Inktomi, since its acquisition by Yahoo!, the revenue wegenerated from Inktomi began to decline in the second quarter of 2003, and ourcontract with Inktomi expired at the end of May 2003.  This relationshipgenerated approximately $0 million and $2.1 million in revenue for the threeand nine month periods ended September 30, 2003.

 

OtherMedia Services revenue is generated primarily from e-mail and iPromotions.  E-mail for the three month period endedSeptember 30, 2003 and 2002 was $0.5 million and $0 million, respectively.  E-mail revenue decreased $0.1 million or10.5% from $1.6 million to $1.5 million for the nine month periods endedSeptember 30, 2002 and 2003, respectively. The decrease is due to the sale of our US e-mail management productknown as 24/7 Mail, to Naviant on May 3, 2002 offset by the growth ininternational e-mail revenue.  Wemaintain the ability to sell e-mail domestically as a broker through Naviant’s24/7 Mail and internationally without restriction.  In

 

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January2003, we sold our iPromotions unit, which accounted for $0.1 million in thenine month period ended September 30, 2003 and $0.3 million and $0.9 million inthe three and nine month periods ended September 30, 2002.

 

Excludingthe disposed US e-mail management product and iPromotions, Integrated MediaSolutions revenue increased $1.9 million or 31.1% from $6.1 million in thethree month period ended September 30, 2002 to $8.0 million in the three monthperiod ended September 30, 2003.  Forthe nine month period ended September 30, 2002 and 2003, Integrated MediaSolutions revenue increased $5.8 million or 30.9% from $18.7 million to $24.5million.

 

**TECHNOLOGY SOLUTIONS.**Our Technology Solutions revenue was $4.1million and $11.4 million for the three and nine month periods ended September30, 2003, respectively, as compared to $3.3 million and $9.8 million for thethree and nine month periods ended September 30, 2002, respectively,representing an increase of 22.2% and 15.5%, respectively.  Revenue from our products that we host,including OAS Central, OAD and Insight, grew during the quarter as impressionsdelivered climbed from 6.4 billion to 13.2 billion.  OAS Central continues to be an attractive solution as itrequires minimal upfront cost and does not require the customer to dedicatetheir assets to hosting the software. In 2003, we changed to a subscription based contract model for newcustomers for our OAS Local software. Total contract value is recognized ratably over the term of the contractwhereas in 2002 the revenue related to the software license was recognized upondelivery.  Had we changed contracts in2002, approximately $0.2 million in third quarter revenue would have been deferreduntil future periods and reported revenue for the three month period endedSeptember 30, 2002 would have been approximately $3.1 million.  On this comparable basis, revenue increased29.7% versus the prior year.

 

**COST OF REVENUE AND GROSS PROFIT**

 

**INTEGRATED MEDIA SOLUTIONS COST OF REVENUES AND GROSS PROFIT.**The cost of revenuesconsists primarily of fees paid to affiliates, whether it is a Web site (24/7Web Alliance), a list provider (for e-mail) or a traffic provider (for 24/7Website Results), which is usually calculated as a percentage of revenues.  Cost of revenues also includes adservingcosts, which is an intercompany charge from the Technology Solutions segmentbased on a fixed CPM.  Gross marginswere 40.1% and 37.7% for the three and nine month periods ended September 30,2003, respectively, and 32.1% and 32.0% for the three and nine month periodsended September 30, 2002.  The increaseis due to lower adserving costs and increased revenue on the 24/7 Network whichhas a higher margin.  Excluding thedisposed US e-mail management product and iPromotions, gross profit increasedfrom 29.6% to 40.1% and from 29.4% to 37.7% for the three and nine monthperiods ended September 30, 2003 and 2002, respectively.

 

**TECHNOLOGY SOLUTIONS COST OF REVENUES AND GROSS PROFIT.**The cost of technology revenues consists ofthe costs of operating equipment and broadband capacity for our third partyadserving solutions and payroll costs to deliver, modify and support softwareoffset by the portion charged to Integrated Media Solutions for adserving.  Gross margins were 76.5% and 72.0% for thethree and nine month periods ended September 30, 2003 and 74.6% and 73.7% forthe three and nine months ended September 30, 2002, respectively.  Had we changed the OAS Local contracts in2002, gross margin would have been 73.1% and 70.8% for the three and ninemonths ended September 30, 2002, respectively. Margins increased due to the reduction in bandwidth costs.

 

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**SALES AND MARKETING EXPENSES.** Sales and marketing expenses consistprimarily of sales force salaries and commissions, advertising and othermarketing expenditures.  Sales andmarketing expenses were $3.1 million and $9.5 million for the three and ninemonth period ended September 30, 2003, respectively, and $3.2 million and $9.5million for the three and nine month periods ended September 30, 2002,respectively.  As a percentage ofrevenue, the expense decreased from 32.7% to 25.9% for the three month periodsended September 30, 2002 and 2003, respectively, and from 30.5% to 26.3% forthe nine month periods ended September 30, 2002 and 2003, respectively.  This decrease is due to our rationalizationefforts and reduction of discretionary expenses as well as increased revenues.  The number of employees included in salesand marketing decreased from 139 at September 30, 2002 to 115 at September 30,2003.

 

**GENERAL AND ADMINISTRATIVE EXPENSES**. General and administrative expenses consistprimarily of compensation, facilities expenses, professional fees and otheroverhead expenses incurred to support the business.  General and administrative expenses were $2.8 million and $8.5million for the three and nine month periods ended September 30, 2003,respectively, and $3.5 million and $11.0 million for the three and nine monthperiods ended September 30, 2002, respectively.  As a percentage of revenue, the expense decreased from 36.1% to23.2% for the three months ended September 30, 2002 and 2003, respectively, andfrom 35.3% to 23.6% for the nine month periods ended September 30, 2002 and2003, respectively.  The significantdecrease is due to our rationalization efforts in eliminating office space, areduction in personnel and unnecessary expenses.  The number of general and administrative employees at September30, 2003 and 2002 were 48 and 57, respectively.

 

**PRODUCT DEVELOPMENT EXPENSES.** Product development expenses consistprimarily of compensation and related costs incurred to further enhance our adserving and other technology capabilities. Product development expenses were $0.9 million and $2.2 million for thethree and nine month periods ended September 30, 2003, respectively, and $0.8million and $3.3 million for the three and nine month periods ended September30, 2002, respectively.  As a percentageof revenue, the expense decreased from 8.3% to 7.2% for the three month periodsended September 30, 2002 and 2003, respectively, and from 10.5% to 6.1% for thenine month periods ended September 30, 2002 and 2003, respectively.  This decrease is due to our successful rationalizationefforts and reduction of discretionary expenses.  Also, the expense decreased as the costs related to developingour Open Advertiser (OAD) product are being capitalized.  We capitalized approximately $0.4 million inthe nine month period ended September 30, 2003.  General release of Open Advertiser occurred in June 2003.  The number of employees included in productdevelopment decreased from 49 at September 30, 2002 to 29 at September 30,2003.

 

**AMORTIZATION OF INTANGIBLE ASSETS.** Amortization of intangible assets were $0.7million and $2.0 million for the three and nine month periods ended September30, 2003, respectively, and $0.5 million and $1.5 million for the three andnine month periods ended September 30, 2002, respectively.  The increase is due to the amortization ofacquired technology related to the Now Marketing acquisition in September 2002and the Insight First acquisition in January 2003.

 

**STOCK-BASED COMPENSATION**. Stock-based compensation was $0.3 millionand $0.5 million for the three and nine month periods ended September 30, 2003,respectively, and $2.2 million and $2.6 million for the three and nine monthperiods ended September 30, 2002, respectively.  The expense for the nine months ended September 30, 2003 consistof $0.1 million in salary for certain employees who elected to received stockinstead of cash, $0.2 million in stock given as bonuses to certain employeesand $0.2 million in amortization of deferred compensation for restricted sharesissued to certain employees.  Theexpense for the nine months

 

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endedSeptember 30, 2002 consists of $0.2 million in salary for certain employees whoelected to receive stock instead of cash, $0.3 million in amortization ofdeferred compensation for restricted shares issued to certain employees, $0.1million in amortization of deferred compensation from acquisitions, $0.5million in discretionary bonuses paid in stock to executives when the Companymeet certain earnings targets and $1.5 million in stock and option grants toexecutives for restructuring their employment agreements.

 

**LOSS ON SALE OF NON-CORE ASSETS, NET. **The $0.5 million loss for the nine months ended September 30, 2002includes a $1.1 million gain related to the sale of Exactis in May 2001, offsetby a $1.6 million loss on the sale of certain assets related to our US e-mailmanagement product.  As part ofthe sale of Exactis, there were approximately $1.5 million in deferred gainsrelated to an escrow balance and $1.75 million in deferred gains related toprepaid service amounts.  The gains wererecognized as the escrow balance was released and the prepaid services wereutilized.  During the first quarter of2002, we agreed to pay Experian, the acquirer of Exactis, $0.75 million of theescrow balance, with the remainder paid to the Company immediately.  Therefore, $0.75 million of the deferredgain was recognized and $0.75 million was reversed against the escrow balance.  During the nine month period ended September30, 2002, we used approximately $0.2 million in Exactis services and recordedthe related gain.  The $0.1 millionremaining amount of the gain related to the reversal of unnecessary accrualsrelated to Exactis.

 

**INTEREST INCOME (EXPENSE), NET**. Interest income (expense), net includesinterest income from our cash and cash equivalents and short-term investmentsand interest expense, net related to our long term debt and capital leaseobligations.  Interest expense was$2,000 and $0.2 million for the three and nine month periods ended September30, 2003, respectively.

 

**DIVIDENDS ON PREFERRED STOCK**. Preferred stock accrues and cumulates dividends at a rate of 6% peryear, compounded monthly, payable when, as and if declared by our Board ofDirectors.  The dividends start accruingin the month following original issuance.

 

**PREFERRED STOCK CONVERSION DISCOUNT**. ** **In June 2003, we issued Series Cpreferred stock, which is convertible into common stock at prices of $0.24158per share.  At the time we agreed to theinitial terms of the transactions with the third parties, the conversion priceof the preferred stock was a slight discount from fair value of our underlyingcommon stock.  By the time ofstockholder approval, the stock price has risen substantially and, as a result,the preferred stock was issued at a substantial discount to fair marketvalue.  In accordance with GenerallyAccepted Accounting Principles, the beneficial conversion feature, calculatedas the difference between fair market value on the date of issuance and theconversion, is required to be expensed immediately, however the discount waslimited to the amount of cash raised less the amount assigned to the warrantsissued in the transaction.  Accordingly,we recorded a non-cash charge of approximately $1.8 million.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

Sinceour inception we have financed our operations through equity financings andlong-term debt.  During 2003, we haveincreased our liquidity primarily through the receipt of $14.0 million in netproceeds from issuance of convertible debenture and $6.8 million in netproceeds from issuances of preferred stock. Approximately $1.5 million of the proceeds was used in the retirement ofthe three promissory notes held by PubliGroupe.  The remaining proceeds will be used for general corporatepurposes and acquisitions.  In the ninemonth period ended September

 

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30,2002, we enhanced our liquidity through $7.4 million in net proceeds fromissuances of preferred stock, $3.0 million in long-term debt financing fromPubliGroupe, a related party, $2.4 million in proceeds from the sale ofnon-core assets and $1.2 million in net cash acquired in the Now Marketingacquisition.  The proceeds of the 2002debt financing and proceeds from the sale of investments were used to financerestructuring and sustain operations, and previously accrued restructuringcharges.  We used approximately $4.0million and $9.9 million of cash in operating activities during the nine monthsended September 30, 2003 and 2002, respectively, generally as a result of ournet operating losses, adjusted for certain non-cash items included in ouroperating results as well as changes in various components of working capital.

 

Netcash (used in) provided by investing activities was approximately ($13.2)million versus $3.0 in the nine month period ended September 30, 2003 and 2002,respectively.  During 2003, $12.0million of the proceeds from the issuance of subordinated convertibledebentures was held in escrow and has been released in November 2003.  During 2003, we paid $150,000 as part of theacquisition of Insight First, Inc., $1.0 million for capital expenditures,including capitalized software, and $50,000 as an investment in iPromotions,Inc.  Approximately $0.2 million wasreceived for earn-outs related to the sale of a former subsidiary.  During 2002, cash provided by investingactivities related to proceeds received from the sale of our non-core assets.  We also received $1.2 million in cash inconnection with the Now Marketing acquisition.

 

TheCompany has various employment agreements with employees in the U.S., themajority of which are for one year with an automatic renewal.  The potential obligation under thesecontracts is approximately $1.8 million for 2003 including salary andperformance based target bonuses.  Thesecontracts call for severance payments in the event of involuntary terminationwhich generally range in amount from three months to one years’ 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 November 1, 2003, there wereapproximately 63 employees in Europe whose annualized base salaries wereapproximately $4.0 million.

 

Asof September 30, 2003, we had approximately $0.2 million remaining of cashoutlay obligations relating to restructuring and exit costs.  These amounts consist primarily of officeclosing costs and severance costs.

 

AtSeptember 30, 2003, we had material commitments related to operating leases foroffice space and facility leases for our ad serving systems.  Although we have no material commitments forcapital expenditures, we anticipate that our capital expenditures will be a useof cash consistent with the levels of our operations and depend on numerousfactors, including market demand for our services, the capital required tomaintain our technology, and the resources we devote to marketing and sellingour services.  To the extent weencounter additional opportunities to raise cash, we may sell additional equitysecurities, which would result in significant further dilution of our commonstockholders.  Stockholders mayexperience extreme dilution due to both our current stock price and thesignificant amount of financing we may raise. These securities may have rights senior to those of holders of ourcommon stock and, in the case of preferred stock, may have liquidationpreference and participation rights that could diminish or eliminate theproceeds available to our common stockholders, if any, upon a sale of theCompany.  Any indebtedness could containcovenants which would restrict our operations.

 

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Webelieve that our existing cash and cash equivalents will be sufficient to meetour anticipated cash needs for working capital and capital expenditures for atleast the next 12 months.

 

MARKETFOR COMPANY’S COMMON EQUITY

 

We have not declared or paid any dividends on our capital stock sinceour inception and do not anticipate paying dividends in the foreseeable future.Our current policy is to retain earnings, if any, to finance the expansion ofour business. The future payment of dividends will depend on the results ofoperations, financial condition, capital expenditure plans, status of ourpreferred stock, and other factors that we deem relevant and will be at thesole discretion of our Board of Directors.

 

Since our initial public offering on August 13, 1998 until June 2002,our common stock traded on the NASDAQ National Market under the symbol“TFSM.”  In June 2002, we transferredour common stock to the NASDAQ SmallCap Market.

 

**RISK FACTORS**

 

RISKS RELATED TO 24/7 REAL MEDIA, INC.

 

WE HAVE A HISTORY OF LOSSES AND MAY NEVER BE PROFITABLE.

 

We have not achieved profitability in any period and we may not be ableto achieve or sustain profitability in the future.  We incurred net losses of $6.2 million and $14.5 million for thenine month periods ended September 30, 2003 and 2002, respectively.  Each of our predecessors had net losses inevery year of their operation.  We mayincur operating losses for the foreseeable future.  Even if we do achieve profitability, we may not sustain orincrease profitability on a quarterly or annual basis in the future.

 

WEHAVE SUBSTANTIAL DEBT, AND WE MAY NOT GENERATE SUFFICIENT CASH FLOW TO MEET OURDEBT SERVICE OBLIGATIONS.

 

Theamount of our debt could have important consequences, including:

 

•                  impairing our ability to obtain additionalfinancing for working capital, capital expenditures, acquisitions or generalcorporate purposes;

 

•                  requiring us to dedicate a substantialportion of our operating cash flow to paying principal and interest onindebtedness, thereby reducing the funds available for operations;

 

•                  limiting our ability to grow and make capitalexpenditures due to the covenants contained in our debt arrangements;

 

•                  impairing our ability to adjust rapidly tochanging market conditions, invest in new or developing technologies, or takeadvantage of significant business opportunities that may arise;

 

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•                  placing us at a competitive disadvantagecompared to our competitors that have less debt; and

 

•                  making us more vulnerable if the currentgeneral economic downturn continues or if our business experiencesdifficulties.

 

Ifwe cannot generate sufficient additional revenue, we may not be able to meetour debt service obligations, repay our debt when due, or comply with othercovenants in the convertible subordinated debentures. If we breach thedebentures, the investor could require repayment of all amounts owed, and wewould not have sufficient cash reserves to repay such amounts.

 

WEMAY BE UNABLE TO RAISE THE FUNDS NECESSARY TO REPAY OR REFINANCE OURINDEBTEDNESS. THE ISSUANCE OF STOCK UPON REDEMPTION OF OUR CONVERTIBLESUBORDINATED DEBENTURES MAY SUBSTANTIALLY DILUTE THE INTERESTS OF OTHERSECURITY HOLDERS.

 

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. We may electto repay the principal amount of the debentures in cash or in shares of ourcommon stock. If we so elect, payment in shares shall be based upon ninetypercent of the average of the volume weighted average price of the Company’scommon stock on the principal market as reported by Bloomberg Financial L.P.during the 5 trading days immediately prior to the interest payment date, inthe case of an interest payment, or during the 15 trading days immediatelyprior to the maturity date, in the case of the repayment of the principalamount of the debentures.  If there is asharp decline in the price of our common stock, shareholders 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.

 

Ifwe decide to repay the principal in cash we may need additional capital to fundthis obligation. Our ability to arrange financing and the cost of thisfinancing will depend upon many factors, including: general economic andcapital markets conditions generally, and in particular the non-investmentgrade debt market; credit availability from banks or other lenders; investorconfidence in the telecommunications industry generally and our companyspecifically; and provisions of tax and securities law that are conducive toraising capital.

 

Ifwe need additional funds and are unable to raise them, our inability to raisethem will have an adverse effect on our operations. If we decide to raise additionalfunds by incurring debt, we may become subject to additional or morerestrictive financial covenants and ratios. If we fail to make the mandatoryredemptions in cash and if our stock price significantly declines, we couldpotentially be obligated to issue a larger number of shares of our common stockin redemption of the debentures. We are required to register for resale sharesissued upon conversion of the convertible debt to the extent they are notregistered under the registration statement of which this prospectus is a partor future registration statements.

 

WE MAY NEED TO RAISE ADDITIONAL FUNDS TO CONTINUE OPERATIONS.

 

While management believes the Company’s current financial resources aresufficient to fund our operations into 2004, an unforeseen reduction in ourrevenues, an impairment of our receivables,

 

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or an increase in expenses or capital expenditures may require us toraise additional funds to continue operations. To the extent we encounter additional opportunities to raise cash, wemay sell additional equity or debt securities, which would result in furtherdilution of our stockholders. Stockholders may experience extreme dilution due to our current stockprice and the amount of financing we may need to raise and these securities mayhave rights senior to those of holders of our common stock.  We do not have any contractual restrictionson our ability to incur debt.  Anyindebtedness could contain covenants, which may restrict our operatingflexibility.

 

We have limited access to the capital 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 raisecapital in the current market conditions. The amount of capital that a company such as ours is able to raise oftendepends on variables that are beyond our control, such as the share price ofour stock and its trading volume.  As aresult, there is no guarantee that efforts to secure financing on termsattractive to us will be successful, or that we will be able to secureadditional financing on any terms.  Dueto our operating losses, it may be difficult to obtain debt financing.  If we are able to consummate a financingarrangement, there is no guarantee that the amount raised will be sufficient tomeet our future needs.  If adequatefunds are not available on acceptable terms, or at all, our business, resultsof operation, financial condition and continued viability will be materiallyand adversely affected.

 

WE HAVE A LIMITED OPERATING HISTORY ON WHICH AN INVESTOR CAN EVALUATEOUR BUSINESS.

 

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

 

•                  developnew relationships and maintain existing relationships with our Web sites,advertisers, and other third parties;

 

•                  continueto develop and upgrade our technology;

 

•                  respondto competitive developments;

 

•                  implementand improve operational, financial and management information systems;

 

•                  adaptto industry consolidation; and

 

•                  attract,retain and motivate qualified employees.

 

At times in the past and in certain segments, our revenues have grownsignificantly.  Our limited operatinghistory makes prediction of future revenue growth difficult.  Accurate predictions of future revenuegrowth are also difficult because of the rapid changes in our markets and thepossible need by us to sell assets to fund operations.  Accordingly, investors should not rely onpast revenue growth rates as a prediction of future revenue growth.

 

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OUR FUTURE REVENUES AND RESULTS OF OPERATIONS MAY BE DIFFICULT TOFORECAST AND RESULTS IN PRIOR PERIODS MAY NOT BE INDICATIVE OF FUTURE RESULTS.

 

Our results of operations have fluctuated and may continue to fluctuatesignificantly in the future as a result of a variety of factors, many of whichare beyond our control. These factors include:

 

•                  theaddition of new or loss of existing clients;

 

•                  changesin fees paid by advertisers and direct marketers or other clients;

 

•                  changesin service fees payable by us to owners of Web sites or e-mail lists, or adserving fees payable by us to third parties;

 

•                  thedemand by advertisers, Web publishers and direct marketers for our advertisingsolutions;

 

•                  theintroduction of new Internet marketing services by us or our competitors;

 

•                  variationsin the levels of capital or operating expenditures and other costs relating tothe maintenance or expansion of our operations, including personnel costs;

 

•                  changesin governmental regulation of the Internet; and

 

•                  generaleconomic conditions.

 

Our future revenues and results of operations may be difficult toforecast due to the above factors.  Inaddition, our expense levels are based in large part on our investment plansand estimates of future revenues.  Anyincreased expenses may precede or may not be followed by increased revenues, aswe may be unable to, or may elect not to, adjust spending in a timely manner tocompensate for any unexpected revenue shortfall.  As a result, we believe that period-to-period comparisons of ourresults of operations may not be meaningful. You should not rely on past periods as indicators of futureperformance.  In future periods, our resultsof operations may fall below the expectations of securities analysts and investors,which could adversely affect the trading price of our common stock.

 

WE DISCLOSE PRO FORMA INFORMATION.

 

We prepare and release quarterly unaudited financial statementsprepared in accordance with generally accepted accounting principles (“GAAP”).  We also disclose and discuss certain proforma and other non-GAAP information in the related earnings release andinvestor conference call.  This proforma financial information excludes or may exclude certain special charges andother costs.  We believe the disclosureof the pro forma financial information helps investors more meaningfullyevaluate the results of our ongoing operations.  However, we urge investors to carefully review the GAAP financialinformation included as part of our Quarterly Reports on Form 10-Q, our AnnualReports on Form 10-K, and our quarterly earnings releases, and to compare theGAAP financial information with the pro forma financial results disclosed inour quarterly earnings releases and investor calls.

 

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RECENTLY ENACTED AND PROPOSED CHANGES IN SECURITIES LAWS ANDREGULATIONS ARE LIKELY TO INCREASE OUR COSTS.

 

The Sarbanes-Oxley Act of 2002 that became law in July 2002 requireschanges in some of our corporate governance and securities disclosure orcompliance practices.  That Act alsorequires the SEC to promulgate new rules on a variety of subjects, in additionto rule proposals already made, and NASDAQ has proposed revisions to its requirementsfor companies that are NASDAQ-listed. We expect these developments to increase our legal compliancecosts.  We expect these developments tomake it more difficult and more expensive for us to obtain director and officerliability insurance, and we may be required to accept reduced coverage or incursubstantially higher costs to obtain coverage. These developments could make it more difficult for us to attract andretain qualified members of our board of directors, or qualified executiveofficers.  We are presently evaluatingand monitoring regulatory developments and cannot estimate the timing ormagnitude of additional costs we may incur as a result.

 

OUR BUSINESS MAY SUFFER IF WE ARE UNABLE TO SUCCESSFULLY IMPLEMENT OURBUSINESS MODEL.

 

A significant part of our business model is to generate revenue byproviding interactive marketing solutions to advertisers, ad agencies and Webpublishers.  The profit potential forthis business model is unproven.  To besuccessful, both Internet advertising and our solutions will need to achieve broadmarket acceptance by advertisers, ad agencies and Web publishers.  Our ability to generate significant revenuefrom advertisers will depend, in part, on our ability to contract with Webpublishers that have Web sites with adequate available ad space inventory.  Further, these Web sites must generatesufficient user traffic with demographic characteristics attractive to ouradvertisers.  The intense competitionamong Internet advertising sellers has led to the creation of a number ofpricing 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 sales efforts may be necessary to educateprospective advertisers regarding the uses and benefits of, and to generatedemand for, our products and services, including our newer products andservices such as Search, Open Advertiser and Insight.  Enterprises may be reluctant or slow to adopt a new approach thatmay replace, limit or compete with their existing direct marketingsystems.  In addition, since onlinedirect marketing is emerging as a new and distinct business apart from onlineadvertising, potential adopters of online direct marketing services willincreasingly demand functionality tailored to their specific requirements.  We may be unable to meet the demands ofthese clients.  Acceptance of our newsolutions will depend on the continued emergence of Internet commerce,communication and advertising, and demand for its solutions.  We cannot assure you that demand for its newsolutions will emerge or become sustainable.

 

WE HAVE GROWN OUR BUSINESS THROUGH ACQUISITION.

 

We were formed in February 1998 to consolidate three Internetadvertising companies and have since acquired eighteen more companies.  In combining these entities, we have facedrisks and continue to face risks of integrating and improving our financial andmanagement controls, ad serving technology, reporting systems and procedures,and expanding, training and managing our work force.  This process of integration may take a significant period of timeand will require the dedication of management and other resources, which maydistract management’s attention from our other operations.  We may continue pursuing selectiveacquisitions of businesses,

 

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technologies and product lines as a key component of our growthstrategy.  Any future acquisition orinvestment may result in the use of significant amounts of cash, potentiallydilutive issuances of equity securities, incurrence of debt and amortizationexpenses related to intangible assets. In addition, acquisitions involvenumerous risks, including:

 

•                  thedifficulties in the integration and assimilation of the operations,technologies, products and personnel of an acquired business;

 

•                  thediversion of management’s attention from other business concerns;

 

•                  theavailability of favorable acquisition financing for future acquisitions; and

 

•                  thepotential loss of key employees of any acquired business.

 

Our inability to successfully integrate any acquired company couldadversely affect our business.

 

WE COULD BE ADVERSELY AFFECTED BY AN IMPAIRMENT OF A SIGNIFICANT AMOUNTOF GOODWILL AND INTANGIBLE ASSETS ON OUR BALANCE SHEET.

 

In the course of our operating history, we have acquired and disposedof 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 goodwill and/or intangible assets wasrecorded because the fair value of the net assets acquired was less than thepurchase price. We may not realize the full value of the goodwill and/orintangible assets.  As such, we evaluateon at least an annual basis whether events and circumstances indicate that allor some of the carrying value of goodwill and/or intangible assets are nolonger recoverable, in which case we would write off the unrecoverable portionas a charge to our earnings.

 

To improve our operating performance, we may determine to acquire otherassets or businesses complementary to our business and, as a result, we mayrecord additional goodwill and/or intangible assets in the future.  The possible write-off of the goodwilland/or intangible assets could negatively impact our future earnings.  We will also be required to allocate aportion of the purchase price of any acquisition to the value of any intangibleassets that meet the criteria specified in the Statement of FinancialAccounting Standards No. 141, “Business Combinations,” such as marketing,customer or contract-based intangibles. The amount allocated to these intangible assets could be amortized overa fairly short period.  As a result, ourearnings and the market price of our common stock could be negatively affected.

 

THE SUCCESS OF OUR 24/7 SEARCH OPERATIONS DEPENDS ON A SMALL NUMBER OFSEARCH ENGINE AFFILIATES, THE LOSS OF A SINGLE SEARCH ENGINE AFFILIATE COULDRESULT IN A SUBSTANTIAL DECREASE IN OUR 24/7 SEARCH REVENUE.

 

We have generated a significant portion of our 24/7 Search revenue fromrelationships with a small number of search engines, including Google, AltaVista, MyGeek, Overture, and AskJeeves. We expect that a small number of search engine affiliates will continueto generate a majority or more of our 24/7 Search revenue for the foreseeablefuture.  The interruption or loss of anyof our primary search engine relationships could cause a significant decreasein 24/7 Search revenue.  As a result ofconsolidation among search engines, and other search marketing companies, wecould lose one of more of our affiliates or face increased competition from 

 

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affiliates that internally develop or acquire capabilities similar toour service.  In addition, as our searchengine affiliates’ operations continue to evolve, we may be required to adjustour business strategy to maintain relationships with our affiliates which couldhave a material adverse effect on our 24/7 Search revenue.

 

IF WE LOSE OUR CEO OR OTHER SENIOR MANAGERS OUR BUSINESS WILL BEADVERSELY AFFECTED.

 

Our success depends, to a significant extent, upon our seniormanagement and key sales and technical personnel, particularly David J. Moore,Chief Executive Officer.  The loss ofthe services of one or more of these persons could materially and adverselyaffect our ability to develop our business. Our success also depends on our ability to attract and retain qualifiedtechnical, sales and marketing, customer support, financial and accounting, andmanagerial personnel.  We cannot becertain that we will be able to retain our key personnel or that we can attract,integrate or retain other highly qualified personnel in the future.  We have experienced in the past, and maycontinue to experience in the future, difficulty in hiring and retainingcandidates with appropriate qualifications, especially in sales and marketingpositions.

 

OUR CUSTOMERS AND PARTNERS MAY EXPERIENCE ADVERSE BUSINESS CONDITIONSTHAT COULD ADVERSELY AFFECT OUR BUSINESS.

 

As a result of unfavorable conditions in the public equity markets,some of our customers may have difficulty raising sufficient capital to supporttheir long-term operations.  As aresult, these customers have reduced their spending on Internet advertising,which has materially and adversely affected our business, financial conditionand results of operations.  In addition,from time to time, we have entered into strategic business relationships withother companies, the nature of which varies, but generally in the context ofcustomer relationships.  These companiesmay experience similar adverse business conditions that may render them unableto meet our expectations for the strategic business relationship or to fulfilltheir contractual obligations to us. Such an event could have a material adverse impact on our business,financial condition and results of operations.

 

OUR TECHNOLOGY SOLUTIONS MAY NOT BE SUCCESSFUL AND MAY CAUSE BUSINESSDISRUPTION.

 

OAS is our proprietary next generation ad serving technology that isintended to serve as our sole ad serving solution.  We must, among other things, ensure that this technology willfunction efficiently at high volumes, interact properly with our database,offer the functionality demanded by our customers and assimilate our sales andreporting functions.  This developmenteffort could fail technologically or could take more time than expected.  Customers may become dissatisfied by anysystem failure that interrupts our ability to provide our services to them,including failures affecting our ability to deliver advertisements withoutsignificant delay to the viewer. Sustained or repeated system failures would reduce the attractiveness ofour solutions to advertisers, ad agencies and Web publishers and result incontract terminations, fee rebates and make goods, thereby reducingrevenue.  Slower response time or systemfailures may also result from straining the capacity of our deployed softwareor hardware due to an increase in the volume of advertising delivered throughour servers.  To the extent that we donot effectively address any capacity constraints or system failures, ourbusiness, results of operations and financial condition could be materially andadversely affected.

 

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WE MIGHT EXPERIENCE SIGNIFICANT DEFECTS IN OUR PRODUCTS.

 

Software products frequently contain errors or failures, especiallywhen first introduced or when new versions are released.  We might experience significant errors orfailures in our products, or they might not work with other hardware orsoftware as expected, which could delay the enhancement of our products, orwhich could adversely affect market acceptance of our products.  Any significant product errors or designflaws would slow the adoption of our products and cause damage to ourreputation, which would seriously harm our business.  If customers were dissatisfied with product functionality orperformance, we could lose revenue or be subject to liability for service orwarranty costs and claims, and our business, operating results and financialcondition could be adversely affected.

 

SOME OF OUR SOFTWARE IS LICENSED FROM THIRD PARTIES.

 

Some of our products, including one or more modules for our OASplatform, contain software licensed from third parties.  Some of these licenses may not be availableto us in the future or on terms that are acceptable or allow our products toremain competitive.  Our inability touse any of this third party software could result in shipment delays, delays inthe development of future products or enhancements of existing products, orother disruptions in our business, which could materially and adversely affectour business, financial condition and operating results.

 

OUR OPERATIONS ARE VULNERABLE TO NATURALDISASTERS AND OTHER EVENTS, INCLUDING, TERRORIST ATTACKS, BECAUSE WE ONLY HAVELIMITED BACKUP SYSTEMS.

 

We have limited backup systems and have experienced system failures andelectrical outages from time to time in the past, which have disrupted ouroperations.  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.  Our operations are dependent on our abilityto protect our computer systems against these unexpected adverse events.  If any of the foregoing occurs, we mayexperience a complete system shutdown. Any business interruption insurance that we carry is unlikely to besufficient to compensate us for loss of business in the event of a significantcatastrophe.

 

In addition, interruptions in our services could result from thefailure of our telecommunications providers to provide the necessary datacommunications capacity in the time frame we require.  Our OAS technology resides on computer systems located in ourdata centers housed by Exodus Communications in the United States and Level3Communications in Europe.  These systems’continuing and uninterrupted performance 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 ofoperations and financial condition could be materially and adversely affectedby any damage or failure that interrupts or delays our operations.  To improve the performance and to preventdisruption of our services, we may have to make substantial investments todeploy additional servers or one or more copies of our Web sites to mirror ouronline resources.  Although we believewe carry property insurance with adequate coverage limits, our coverage may notbe adequate to compensate us for all losses, particularly with respect to lossof business and reputation, that may occur.

 

In addition, terrorist acts or acts of war may cause damage to ouremployees, facilities, clients, our clients’ customers, and vendors, whichcould significantly impact our revenues, costs and

 

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expenses and financial position. The potential for future terrorist attacks, the national andinternational responses to terrorist attacks or perceived threats to nationalsecurity, and other acts of war or hostility have created many economic andpolitical uncertainties that could adversely affect our business and results ofoperations in ways that cannot be presently predicted.  We are predominantly uninsured for lossesand interruptions caused by terrorist acts and acts of war.

 

OUR REVENUES ARE SUBJECT TO SEASONAL FLUCTUATIONS.

 

We believe that our revenues are subject to seasonal fluctuationsbecause advertisers generally place fewer advertisements during the first andthird calendar quarters of each year and direct marketers mail substantiallymore marketing materials in the third quarter each year.  Furthermore, Internet user traffic typicallydrops during the summer months, which reduces the number of advertisements tosell and deliver.  Expenditures byadvertisers and direct marketers tend to vary in cycles that reflect overalleconomic conditions as well as budgeting and buying patterns.  Our revenue could be materially reduced by adecline in the economic prospects of advertisers, direct marketers or theeconomy in general, which could alter current or prospective advertisers’spending priorities or budget cycles or extend our sales cycle.  Due to such risks, you should not rely onquarter-to-quarter comparisons of our results of operations as an indicator ofour future results.

 

# OUR INTERNATIONAL OPERATIONS MAY POSE LEGALAND CULTURAL CHALLENGES.

 

We have operations in a number of international markets, includingCanada and Europe.  To date, we havelimited experience in marketing, selling and distributing our solutionsinternationally.  Internationaloperations are subject to other risks, including changes in regulatoryrequirements, reduced protection for intellectual property rights in somecountries, potentially adverse tax consequences, general import/exportrestrictions relating to encryption technology and/or privacy, difficulties andcosts of staffing and managing foreign operations, political and economicinstability, fluctuations in currency exchange rates; and seasonal reductionsin business activity during the summer months in Europe and certain other partsof the world.

 

OUR NET OPERATING LOSS CARRYFORWARDS MAY BE LIMITED.

 

Due to the “change in ownership” provisions of the Internal RevenueCode, the availability of 24/7 Real Media’s net operating loss and creditcarryforwards may be subject to an annual limitation against taxable income infuture periods, which could substantially limit the eventual utilization ofthese carryforwards.

 

RISKS RELATED TO THE MARKET FOR OUR COMMON STOCK.

 

WE HAVE A VERY SUBSTANTIAL OVERHANG OF COMMON STOCK AND FUTURE SALES OFOUR COMMON STOCK WILL CAUSE SUBSTANTIAL DILUTION AND MAY NEGATIVELY AFFECT THEMARKET PRICE OF OUR COMMON STOCK.

 

As of November 11, 2003, there were 114.4 million shares of our commonstock outstanding.  We also have anaggregate of 77.0 million shares of common stock that may be sold into themarket in the future including approximately 46.9 million shares of our commonstock issuable upon conversion of our outstanding preferred stock, 17.4 millionshares of our common stock issuable upon exercise of options, 8.5 million uponthe conversion of our subordinated convertible

 

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debentures, 3.9 million common stock warrants and 0.3 million shares ofunvested restricted stock.  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, thatfuture sales of shares of our common stock into the market, or the availabilityof shares of common stock for future sale, will have on the market price of ourcommon stock. Sales of substantial amounts of common stock (including sharesissued upon the exercise of stock options or conversion of shares of preferredstock), or the perception that such sales could occur, may materially and adverselyaffect prevailing market prices for our common stock.

 

THE MARKET PRICE OF OUR SECURITIES MAY BE VERY VOLATILE.

 

From time to time the market price of our common stock may experiencesignificant volatility. Our quarterly results, failure to meet marketexpectations, patents issued or not issued to us or our competitors,announcements by us or our competitors regarding acquisitions or dispositions,loss of existing clients, new procedures or technology, litigation, sales ofsubstantial amounts of our common stock, including shares issued upon theexercise of outstanding options or warrants, rumors concerning any of theforegoing, changes in general conditions in the economy and general marketconditions could cause the market price of the common stock to fluctuatesubstantially.  In addition, the stockmarket has experienced significant price and volume fluctuations that haveparticularly affected the trading prices of equity securities of manytechnology and Internet companies. Frequently, these price and volumefluctuations have been unrelated to the operating performance of the affectedcompanies. In the past, following periods of volatility in the market price ofa company’s securities, securities class action litigation has often beeninstituted against such a company. This type of litigation, regardless of theoutcome, could result in substantial costs and a diversion of management’sattention and resources, which could materially adversely affect our business,prospects, financial condition, and results of operations.

 

WE MAY IMPLEMENT A REVERSE STOCK SPLIT OF OUR COMMON STOCK.

 

Our stockholders approved a series of amendments to our certificate ofincorporation at our July 29, 2003 stockholders meeting.  These amendments authorized our board ofdirectors to effect a reverse split of all outstanding shares of our commonstock at an exchange ratio of between one-for-2, and one-for-15 subject to thediscretion of our board of directors. At any time prior to the 2004 annual meeting of stockholders, the boardof directors has the sole discretion to elect, as it determines to be in thebest interests of our company and our stockholders, whether or not to effect areverse stock split, and if so at which of the approved ratios.  If the board of directors elects toimplement a reverse stock split, the number of issued and outstanding shares ofcommon stock would be reduced in accordance with the exchange ratio for theselected reverse stock split.  The parvalue of the common stock would remain unchanged at $.01 per share and thenumber of authorized shares of common stock would also remain unchanged.  In determining whether or not to implement areverse stock split, and the appropriate exchange ratio, the board would assessa variety of factors, including but not limited to analysis of our most recentfiscal quarter and general conditions, as well as the trading price of ourcommon stock on the days leading up to the date of the reverse stock split.

 

The effect of any reverse stock split upon the market price of ourcommon stock cannot be predicted, and the history of reverse stock splits forcompanies in similar circumstances is varied. The trading price of our common stock may not rise in exact proportionto the reduction in the number of shares of our common stock outstanding as aresult of the reverse stock split and there

 

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may not be a sustained increase in the trading prices of our commonstock after giving effect to the reverse stock split.  Moreover, the trading price may not remain above the thresholdsrequired by the NASDAQ Stock Market and we may not be able to continue to meetthe other continued listing requirements of the NASDAQ Stock Market.

 

THE POWER OF OUR BOARD OF DIRECTORS TO DESIGNATE AND ISSUE SHARES OFSTOCK COULD HAVE AN ADVERSE EFFECT ON HOLDERS OF OUR COMMON STOCK.

 

We are authorized to issue up to 350,000,000 shares of common stockwhich may be issued by our board of directors for such consideration as theymay consider sufficient without seeking stockholder approval. The issuance ofadditional shares of common stock in the future will reduce the proportionateownership and voting power of current stockholders.

 

Our Articles of Incorporation also authorize us to issue up to10,000,000 shares of preferred stock, the rights and preferences of which maybe designated by our board of directors. These designations may be made withoutstockholder approval. The designation and issuance of preferred stock in thefuture could create additional securities which would have dividend andliquidation preferences prior in right to the outstanding shares of commonstock. These provisions could also impede a non-negotiated change in control.

 

SUNRA AND PUBLIGROUPE COLLECTIVELY HOLD A SUBSTANTIAL PORTION OF THETOTAL OUTSTANDING VOTING POWER OF 24/7 REAL MEDIA AND WILL LIKELY BE ABLETO INFLUENCE CERTAIN APPROVAL MATTERS AND PREVENT A CHANGE OF CONTROL.

 

Sunra Capital Holdings Ltd. and affiliated parties are currentlythe beneficial owner of 42.2 million shares of our common stock. PubliGroupe USA Holdings is the beneficial owner of 12.5 million shares of ourcommon stock and has entered into an agreement to vote on all matters inaccordance with the recommendations of our Board of Directors. Additionally, the terms of the Series A Preferred Stock, owned principallyby Sunra, contain certain protective provisions that provide such holdersan effective veto right over certain corporate matters.

 

Based on their voting power, Sunra and PubliGroupe may effectivelybe able to determine the outcome of all matters requiring stockholder approval,including the election of directors, amendment of our charter and approvalof significant corporate transactions, and will likely be in a position toprevent a change in control of 24/7 Real Media even if the otherstockholders were in favor of the transaction.

 

OUR PREFERRED STOCK HAS LIQUIDATION PREFERENCE AND PARTICIPATION RIGHTSTHAT COULD REDUCE OR ELIMINATE ANY PROCEEDS AVAILABLE TO OUR COMMONSTOCKHOLDERS UPON A SALE OF OUR COMPANY.

 

In addition, under certain circumstances, upon the sale, liquidation ordissolution of the Company, our Series A and Series C preferred stockholdersmaybe entitled to receive an aggregate liquidation preference of $10.0 million,before our common stockholders received any payment.  After receipt of this payment, the preferred stockholders mayalso have the right to participate in receiving proceeds payable to the commonstockholders on an as-converted basis. As result, in the event of a sale, liquidation or dissolution of theCompany, including one in which the total proceeds represent a premium to thethen prevailing price per share of our common stock, our common stockholdersmay experience substantial dilution in the amount payable to

 

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them, and if total proceeds are less than or equal to the liquidationpreference, then our common stockholders will not receive any proceeds.

 

WE DO NOT INTEND TO PAY FUTURE CASH DIVIDENDS.

 

We currently do not anticipate paying cash dividends on our commonstock at any time in the near future. We may never pay cash dividends ordistributions on our common stock. Any credit agreements which we may enterinto with institutional lenders may restrict our ability to pay dividends.Whether we pay cash dividends in the future will be at the discretion of ourBoard of Directors and will be dependent upon our financial condition, resultsof operations, capital requirements, and any other factors that the Board of Directorsdecides is relevant.

 

EFFECTS OF ANTI-TAKEOVER PROVISIONS COULD INHIBIT THE ACQUISITION OFOUR COMPANY.

 

Some of the provisions of our certificate of incorporation, our bylawsand Delaware law could, together or separately:

 

•                  discouragepotential acquisition proposals;

 

•                  delayor prevent a change in control;

 

•                  impedethe ability of our stockholders to change the composition of our board ofdirectors in any one year; and

 

•                  limitthe price that investors might be willing to pay in the future for shares ofour common stock.

 

RISKS RELATED TO OUR INDUSTRY.

 

OUR FAILURE TO SUCCESSFULLY COMPETE MAY HINDER OUR GROWTH.

 

The markets for Internet advertising and related products and servicesare intensely competitive and such competition is expected to increase.  Our failure to successfully compete mayhinder our growth.  We believe that ourability to compete depends upon many factors both within and beyond ourcontrol, including:

 

•                  thetiming and market acceptance of new products and enhancements of existingservices developed by us and our competitors;

 

•                  changingdemands regarding customer service and support;

 

•                  shiftsin sales and marketing efforts by us and our competitors; and

 

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

 

Many of our competitors have longer operating histories, greater namerecognition, larger customer bases and significantly greater financial,technical and marketing resources than ours. In addition, current and potential competitors have established or mayestablish cooperative

 

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relationships among themselves or with third parties to increase theability of their products or services to address the needs of our prospectiveclients.  We cannot be certain that wewill be able to successfully compete against current or futurecompetitors.  In addition, the Internetmust compete for a share of advertisers’ total budgets with traditionaladvertising media, such as television, radio, cable and print, as well ascontent aggregation companies and other companies that facilitate Internetadvertising.  To the extent that theInternet is perceived to be a limited or ineffective advertising or directmarketing medium, advertisers and direct marketers may be reluctant to devote asignificant portion of their advertising budgets to Internet marketing, whichcould limit the growth of Internet marketing.

 

OUR BUSINESS MAY NOT GROW IF THE INTERNET ADVERTISING MARKET DOES NOTCONTINUE TO DEVELOP.

 

The Internet as a marketing medium has not been in existence for asufficient period of time to demonstrate its effectiveness.  Our business would be adversely affected ifthe Internet advertising continues to remain soft or fails to develop in thenear future.  There are currently nowidely accepted standards to measure the effectiveness of Internet marketingother than clickthrough rates, which generally have been declining.  We cannot be certain that such standardswill develop to sufficiently support Internet marketing as a significantadvertising medium.  Actual or perceivedineffectiveness of online marketing in general, or inaccurate measurements ordatabase information in particular, could limit the long-term growth of onlineadvertising and cause our revenue levels to decline.

 

WE MAY BE UNABLE TO PROMOTE AND MAINTAIN OUR BRANDS.

 

We believe that establishing and maintaining the brand identities ofour products and services is a critical aspect of attracting and expanding alarge client base.  Promotion and enhancementof our brands will depend largely on our success in continuing to provide highquality service.  If businesses do notperceive our existing services to be of high quality, or if we introduce newservices or enter into new business ventures that are not favorably received bybusinesses, we will risk diluting our brand identities and decreasing theirattractiveness to existing and potential customers.

 

In order to attract and retain customers and to promote and maintainbrands in response to competitive pressures, we may also have to increasesubstantially our financial commitment to creating and maintaining a distinctbrand loyalty among our customers. If we incur significant expenses in anattempt to improve our services or to promote and maintain our brands, ourbusiness, prospects, financial condition, and results of operations could bematerially adversely affected. Moreover, any brand identities we establish maybe diluted as a result of any inability to protect our trademarks and servicemarks or domain names, which could have a material adverse effect on ourbusiness, prospects, financial condition, and results of operations.

 

PRIVACY CONCERNS MAY PREVENT US FROM COLLECTING USER DATA.

 

Growing concerns about the use of “cookies” and data collection maylimit our ability to develop user profiles. Web sites typically place small files of information commonly known as“cookies” on a user’s hard drive, generally without the user’s knowledge orconsent.  Cookie information is passedto the Web site through the Internet user’s browser software.  Our OAS technology targets advertising tousers through the use of identifying data, or “cookies” and othernon-personally-identifying information. OAS enables the use of cookies to deliver targeted advertising and tolimit the frequency with which an advertisement is shown to the user.  Most currently available

 

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Internet browsers allow users to modify their browser settings toprevent cookies from being stored on their hard drive, and a small minority ofusers are currently choosing to do so. Users can also delete cookies from their hard drive at any time.  Some Internet commentators and privacyadvocates have suggested limiting or eliminating the use of cookies.  Any reduction or limitation in the use ofcookies could limit the effectiveness of our sales and marketing efforts andimpair our targeting capabilities. Microsoft Corporation has changed the design and instrumentation of itsWeb browser in such a way as to give users the option to accept or reject thirdparty cookies.  Giving users the optionto decline such cookies could result in a reduction of the number of Internetusers we are capable of profiling anonymously. Such changes also could adversely affect our ability to determine thereach of advertising campaigns sold and delivered by us and the frequency withwhich users of sites in the 24/7 Network see the same advertisement.

 

If the use or effectiveness of cookies is limited, we would likely haveto switch to other technology that would allow us to gather demographic andbehavioral information.  While suchtechnology currently exists, it is substantially less effective than cookies.  Replacement of cookies could requiresignificant reengineering time and resources, might not be completed in time toavoid negative consequences to our business, financial condition or results ofoperations, and might not be commercially feasible.

 

CHANGES IN LAWS AND STANDARDS RELATING TO DATA COLLECTION AND USE PRACTICESAND THE PRIVACY OF INTERNET USERS AND OTHER INDIVIDUALS COULD HARM OURBUSINESS.

 

The U.S. federal and various state governments have recently proposedlimitations on the collection and use of information regarding Internetusers.  In October 1998, the EuropeanUnion adopted a directive that may limit our collection and use of informationregarding Internet users in Europe.  Theeffectiveness of our OAS technology could be limited by any regulation limitingthe collection or use of information 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 information aboutindividuals has led to self-regulation of these practices by the Internetadvertising and direct marketing industry and to increased federal and stateregulation.  The Network AdvertisingInitiative, or NAI, of which 24/7 Real Media is a member along with otherInternet advertising companies, has developed self-regulatory principles foronline preference marketing.  We arealso subject to various federal and state regulations concerning thecollection, distribution and use of information regarding individuals.  These laws include the Children’s OnlinePrivacy Protection Act, and state laws that limit or preclude the use of voterregistration and drivers license information, as well as other laws that governthe collection and use of consumer credit information.  Although our compliance with the NAI’sguidelines and applicable federal and state laws and regulations has not had amaterial adverse effect on us, we cannot assure you that additional, moreburdensome federal or state laws or regulations, including antitrust andconsumer privacy laws, will not be enacted or applied to us or our clients,which could materially and adversely affect our business, financial conditionand results of operations.

 

CHANGES IN GOVERNMENT REGULATION COULD DECREASE OUR REVENUES ANDINCREASE OUR COSTS.

 

Laws and regulations directly applicable to Internet communications,commerce and advertising are becoming more prevalent, and new laws andregulations are under consideration by the United States Congress and statelegislatures.  Any legislation enactedor restrictions arising from

 

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current or future government investigations or policy could dampen thegrowth in use of the Internet generally and decrease the acceptance of theInternet as a communications, commercial and advertising medium.  State governments or governments of foreigncountries might attempt to regulate our transmissions or levy sales or other taxesrelating to our activities.  The EuropeanUnion has enacted its own privacy regulations that may result in limits on thecollection and use of certain user information by us.  The laws governing the Internet, however, remain largelyunsettled, even in areas where there has been some legislative action.  It may take years to determine whether andhow existing laws such as those governing intellectual property, privacy, libeland taxation apply to the Internet and Internet advertising.  In addition, the growth and development ofInternet commerce may prompt calls for more stringent consumer protection laws,both in the United States and abroad, that may impose additional burdens oncompanies conducting business over the Internet.  Our business, results of operations and financial condition couldbe materially and adversely affected by the adoption or modification of laws orregulations relating to the Internet.

 

OUR NETWORK OPERATIONS MAY BE VULNERABLE TO HACKING, VIRUSES AND OTHERDISRUPTIONS, WHICH MAY MAKE OUR PRODUCTS AND SERVICES LESS ATTRACTIVE ANDRELIABLE.

 

Internet usage could decline if any well-publicized compromise ofsecurity occurs.  “Hacking” involvesefforts to gain unauthorized access to information or systems or to causeintentional malfunctions or loss or corruption of data, software, hardware orother computer equipment.  Hackers, ifsuccessful, could misappropriate proprietary information or cause disruptionsin our service.  We may be required toexpend capital and other resources to protect our Web site against hackers. Wecannot assure you that any measures we may take will be effective.  In addition, the inadvertent transmission ofcomputer viruses could expose us to a material risk of loss or litigation andpossible liability, as well as materially damage our reputation and decreaseour user traffic.

 

DEPENDENCE ON PROPRIETARY RIGHTS AND RISK OF INFRINGEMENT.

 

Our success and ability to compete are substantially dependent on ourinternally developed technologies and trademarks, which we protect through acombination 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 toregister our trademarks in the United States and internationally.  We cannot assure you that any of our patentapplications or trademark applications will be approved.  Even if they are approved, such patents ortrademarks may be successfully challenged by others or invalidated.  If our trademark registrations are notapproved because third parties own such trademarks, our use of such trademarkswill be restricted unless we enter into arrangements with such third partiesthat may be unavailable on commercially reasonable terms.

 

We generally enter into confidentiality or license agreements with ouremployees, consultants and corporate partners, and generally control access toand distribution of our technologies, documentation and other proprietaryinformation.  Despite our efforts toprotect our proprietary rights from unauthorized use or disclosure, parties mayattempt to disclose, obtain or use our solutions or technologies.  We cannot assure you that the steps we havetaken will prevent misappropriation of our solutions or technologies,particularly in foreign countries where laws or law enforcement practices maynot protect our proprietary rights as fully as in the United States.

 

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We have licensed, and we may license in the future, elements of our trademarks,trade dress and similar proprietary rights to third parties.  While we attempt to ensure that the qualityof our brand is maintained by these business partners, such partners may takeactions that could materially and adversely affect the value of our proprietaryrights or our reputation.  We cannotassure you that any of our proprietary rights will be of value in the futuresince the validity, enforceability and scope of protection of certainproprietary rights in Internet-related industries is uncertain and stillevolving.

 

We may be subject to claims of alleged infringement of the trademarksand other intellectual property rights of third parties by us or the Webpublishers with Web sites in the 24/7 Network. 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 weprevail, such litigation could be time-consuming and expensive to defend, andcould result in the diversion of our time and attention, any of which couldmaterially and adversely affect our business, results of operations andfinancial 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.

 

In addition to our ongoing litigation against aQuantive, from time totime, we may selectively pursue claims of infringement of our patents and otherintellectual property rights by third parties. Such claims and any resultant litigation present the risk that a courtcould determine, either preliminarily or finally, that some of our patent orother intellectual property rights are not valid.  In addition, even if we prevail, such litigation could betime-consuming and expensive to pursue, 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.

 

INTELLECTUAL PROPERTY LIABILITY.

 

We may be liable for content available or posted on the Web sites ofour 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 counterclaimscould be time consuming, result in costly litigation or divert management’sattention.

 

RISKS ASSOCIATED WITH TECHNOLOGICAL CHANGE.

 

The Internet and Internet advertising markets are characterized byrapidly changing technologies, evolving industry standards, frequent newproduct and service introductions, and changing customer demands.  Our future success will depend on ourability to adapt to rapidly changing technologies and to enhance existingsolutions and develop and introduce a variety of new solutions to address ourcustomers’ changing demands.  We mayexperience difficulties that could delay or prevent the successful design,development, introduction or marketing of our solutions.  In addition, our new solutions orenhancements must meet the requirements of our current and prospectivecustomers and must achieve significant market acceptance.  Material delays in introducing new solutionsand enhancements may cause customers to forego purchases of our solutions andpurchase those of our competitors.

 

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ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK

 

INTEREST RATE RISK

 

The primary objective of our investment activities is to preserveprincipal while at the same time maximizing yields without significantlyincreasing risk.  Cash and cashequivalents are investments with original maturities of three months orless.  Therefore, changes in themarket’s interest rates do not affect the value of the investments as recordedby 24/7 Real Media.  The following tablepresents the amounts of our financial instruments that are subject to interestrate risk by expected maturity and average interest rates as of September 30,2003 (in thousands):

 
|                                    |   | **2003** |       | **2004** |       | **2005** |       | **2006** |       | **Thereafter** |       | **TOTAL** |       |
|-----------------------------------------|--------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| **Assets:**                             |   |     | ** ** |     | ** ** |     | ** ** |     | ** ** |           | ** ** |      | ** ** |
|                                    |   |     | ** ** |     | ** ** |     | ** ** |     | ** ** |           | ** ** |      | ** ** |
| Cash and cash equivalents               |   | $        | 11,779     |     | $          | —   |       | $        | —     |           | $          | —    |       | $ | — |   | $ | 11,779 |   |
| Average interest rate                   |   | 0.45     | %          |     |       |     |       |     |       |           |       | 0.45      | %          |
|                                    |   |     |       |     |       |     |       |     |       |           |       |      |       |
| Restricted cash                         |   | $        | 12,000     |     | $          | —   |       | $        | —     |           | $          | —    |       | $ | — |   | $ | 12,000 |   |
| Average interest rate                   |   | 0.45     | %          |     |       |     |       |     |       |           |       | 0.45      | %          |
|                                    |   |     |       |     |       |     |       |     |       |           |       |      |       |
| **Liabilities:**                        |   |     |       |     |       |     |       |     |       |           |       |      |       |
|                                    |   |     |       |     |       |     |       |     |       |           |       |      |       |
| 2% Subordinated  convertible debentures |   | $        | —     |     | $          | —   |       | $        | —     |           | $          | 15,000    |       | $ | — |   | $ | 15,000 |   |
| Average interest rate                   |   | 2.00     | %          |     |       |     |       |     |       |           |       | 2.00      | %          |

 

The 2% Subordinated Convertible Debentures due 2006 contains aprovision that gives the holder the ability to call a portion of the note uponthe satisfaction of a trading price condition. This condition constitutes an embedded derivate.  The value of this embedded derivative atSeptember 30, 2003 is immaterial to the financial position. The Company willreview the value of the derivative on a quarterly basis in the future, inaccordance with Statement of Financial Accounting Standards No. 133,“Accounting for Derivative Instruments and Hedging Activities.”  As of September 30, 2003, we didnot hold any other 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 Europeancurrencies.  The effect of foreignexchange rate fluctuations for the three and nine month periods ended September30, 2003 and 2002 were not material.  Wedo not use derivative financial instruments to limit our foreign currency riskexposure.  As of September 30, 2003, wehad $2.6 million in cash and cash equivalents denominated in foreigncurrencies.

 

ITEM 4.  CONTROLS AND PROCEDURES

 

(a)  Evaluation of DisclosureControls and Procedures

 

Our management, with the participation of our chief executive officer(CEO) and chief financial officer (CFO), evaluated the effectiveness of ourdisclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)under the Securities Exchange Act) as of September 27, 2003. Based on thisevaluation, our CEO and CFO concluded that, as of September 27, 2003, our

 

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disclosure controls and procedures were (1) designed to ensure thatmaterial information relating to us, including our consolidated subsidiaries,is made known to our CEO and CFO by others within those entities, particularlyduring the period in which this report was being prepared, and (2) effective,in that they provide reasonable assurance that information required to bedisclosed by us in the reports that we file or submit under the SecuritiesExchange Act is recorded, processed, summarized, and reported within the timeperiods specified in the Securities and Exchange Commission’s rules and forms.

 

(b)  Changes in InternalControls Over Financial Reporting

 

During the period ended September 27, 2003, there were no changes inour internal control over financial reporting (as defined in Rules 13a-15(f)and 15d-15(f) under the Securities Exchange Act) that materially affected, orwere reasonably likely to materially affect our internal control over financialreporting.

 

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PART II. OTHER INFORMATION

 

ITEM 1.  LEGAL PROCEEDINGS

 

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

 

On April 19, 2002, aQuantive, Inc. (formerly Avenue A, Inc.) filed acomplaint against the Company seeking a declaratory judgment that U.S. PatentNo. 6,206,368 is invalid and not infringed by Avenue A.  The complaintalso seeks injunctive relief and recovery of attorney’s fees.  On May 10,2002, the Company filed its answer to the complaint, in which the Companydenied the material allegations of the complaint and asserted a counterclaimfor infringement of the ‘368 patent.  On January 2, 2003, aQuantive fileda motion for summary judgment of non-infringement, to which the Company filedpapers in opposition on April 28, 2003. On July 3,2003, the U.S. Federal Court for the Western District of Washington grantedpartial summary judgment to aQuantive, Inc. and held that, based on the court’sconstruction of the patent’s claims, aQuantive’s Atlas DMT adserving systemdoes not infringe the ‘368 patent.  TheCompany has appealed the court’s ruling to the Court of Appeals for the FederalCircuit and agreed with aQuantive to dismiss the remaining claims in the caseto expedite the appeal.

 

*Brian Anderson*

 

OnJuly 5,  2001, Brian Anderson, formerChief Executive of our AwardTrack, Inc. subsidiary, served us with notice of a lawsuit filed in Superior Courtfor the State of California in and for the County of Santa Cruz, allegingbreach of contract, fraud, intentional infliction of emotional distress andbreach of fiduciary duty, in connection with the acquisition of AwardTrack andsubsequent events.  The Company has removed the lawsuit to federal courtin California and has moved to dismiss the complaint in its entirety; this motionwas granted in part, with leave to remand, and denied in part.  Theplaintiff has subsequently refiled the complaint and the Company has filed acounterclaim.

 

*Chinadotcom Corp.*

 

OnFebruary  19, 2003, the Company filed acomplaint against Chinadotcom Corporation for breach of contract, unjustenrichment, breach of duty of good faith and fair dealing, and promissoryestoppel arising out of a certain equity exchange agreement dated August 16,2000 between the Company and Chinadotcom, seeking to enforce our right toexchange our stake in 24/7 Asia Ltd. for 1.8 million shares ofchinadotcom.  Chinadotcom filed a motionseeking to compel arbitration of the matter, which the court granted on May 12,2003.  We intend to file an arbitration claim relating to both the equityexchange agreement and other claims that we may have against chinadotcom.

 

Chinadotcomrecently filed an action in court in Hong Kong against David Moore, our ChiefExecutive Officer, alleging, among other things, breach of fiduciary duty byMr. Moore in connection with his serving as a director of Chinadotcom and itssubsidiary, 24/7 Media Asia Ltd.  The Company will indemnify Mr. Moore andassume his defense.  We believe that the charges are without merit andthat the action was brought solely in retaliation against the Company forasserting its rights in the matter discussed above.  We have filed a motion to dismiss this case.

 

OnJuly 22, 2003, chinadotcom filed an arbitration claim asserting certainbreaches of contract in connection with the Media Asia Agreement entered intobetween the parties as of June 30, 2000.

 

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Theclaim seeks damages totaling $24 million. The Company intends to file an answer and counterclaim in the matter andto vigorously assert a defense.

 

ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS

 

*2% Subordinated Convertible Debentures due2006*

 

Asof September 26, 2003, the Company sold approximately $15 million of 2%Subordinated Convertible Debentures due 2006, together with related warrants topurchase 1,802,820 shares of the Company’s common stock.  The issuance of the Company’sDebentures, and related warrants, was conducted in a private placement to aninstitutional accredited investor pursuant to Regulation D and Section 4(2) ofthe Securities Act of 1933, as amended.  The Debentures are convertibleinto shares of Common Stock at a conversion price of $1.75 per share.  The related warrants are exercisable forshares of Common Stock at an exercise price of $0.19137 per share.

 

TheDebentures contain specific restrictions on the Company’s ability to incuradditional indebtedness or liens and to make payments on any of the Company’soutstanding indebtedness.

 

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITIES HOLDERS

 

None.

 

ITEM 5.  OTHER INFORMATION

 

None.

 

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

 

Reporton Form 8-K dated September 29, 2003 (file no. 0-29768).  The report contained information regardingthe issuance of our 2% subordinated convertible debentures.

 

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ITEM 7.  SIGNATURES

 

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

 
| 24/7 Real Media, Inc.   |                                    |
|-------------------------|-----------------------------------------|
| Date: November 14, 2003 |                                    |
|                    |                                    |
|                    | By:                                     | /s/ David J. Moore |   |
|                    | David J. Moore                          |
|                    | *Chairman  and Chief Executive Officer* |
|                    |                                    |
|                    | By:                                     | /s/ Norman M. Blashka |   |
|                    | Norman M. Blashka                       |
|                    | *EVP  and Chief Financial Officer*      |
|                         |                                         |  |  |  |

 

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