**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-Q**

|                                                                                                                                               |       | ** **                                                              |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|
| **x**                                                                                                                                         |       | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15 (d) OF THE** |
| ** **                                                                                                                                    | ** ** | **SECURITIES EXCHANGE ACT OF 1934**                                     |
| ** **                                                                                                                                    | ** ** | ** **                                                              |
| For the  quarterly period ended March 31, 2006                                                                                           |
|                                                                                                                                          |
| or                                                                                                                                            |
|                                                                                                                                          |
| **o **                                                                                                                                   |       | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE** |
| ** **                                                                                                                                    | ** ** | **SECURITIES EXCHANGE ACT OF 1934**                                     |
| ** **                                                                                                                                    | ** ** | ** **                                                              |
| For the  transition period from                  to |
|                                                                                                                                          |

Commission file number: 1-14355

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

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

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

**132 West 31****st**** Street, New York, NY 10001**

(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

**(212) 231-7100**

(REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)

Indicate by check mark whether the registrant: (1) hasfiled all reports required to be filed by Section 13 or 15 (d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. YES xNO o

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

| LARGE ACCELERATED FILER o | ACCELERATED  FILER x | NON-ACCELERATED  FILER o |
|---------------------------|----------------------|--------------------------|
|                      |                 |                     |

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act). YESo NO x

Indicate the number of shares outstanding of each ofthe issuer’s classes of common stock, as of the latest practicable date.
|                                         | **Class** | ** **         | ** ** | **O**utstanding At  March 31, 2006 | ** ** |
|-----------------------------------------|-----------|--------------------|------------|---------------------------------------------------|------------|
| Common Stock,  par value $.01 per share |      | 48,453,626  Shares |       |

 

 

 

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

**March 31, 2006**

**FORM 10-Q**

**INDEX**

 
| Part I. Financial  Information                                                   | 4      |
|---------------------------------------------------------------------------------------|--------|
| Item 1. Condensed Consolidated Financial Statements                                   | 4      |
| Condensed  Consolidated Balance Sheets as of March 31, 2006 (unaudited) and      |   |
| December 31,  2005                                                               | 4      |
| Condensed  Consolidated Statements of Operations for the three months ended           |   |
| March 31,  2006 and 2005 (unaudited)                                             | 5      |
| Condensed  Consolidated Statements of Cash Flows for the three months ended           |   |
| March 31, 2006 and 2005  (unaudited)                                             | 6      |
| Notes to Unaudited Interim Condensed Consolidated  Financial Statements               | 7      |
| Item 2.  Management’s Discussion and Analysis of Financial Condition and Results |   |
| of Operations                                                                         | 21     |
| Item 3. Quantitative and Qualitative Disclosures about  Market Risk                   | 32     |
| Item  4. Controls and Procedures                                                      | 33     |
|                                                                                  |   |
|                                                                                  |   |
| Part II.  Other Information                                                      | 35     |
| Item  1. Legal Proceedings                                                            | 35     |
| Item 2. Unregistered Sales of Equity Securities and  Use of Proceeds                  | 49     |
| Item 3. Defaults Upon Senior Securities                                               | 49     |
| Item 4. Submission of Matters to a Vote of Security  Holders                          | 49     |
| Item  5. Other Information                                                            | 49     |
| Item 6.  Exhibits                                                                     | 49     |
| Signatures                                                                            | 50     |

 

Open AdStream®, InsightXE®, Insight ACT®, Open Advertiser® and 24/7 Search® are registered trademarksof 24/7 Real Media, Inc. and Open AdSystemTM and Decide DNATM are pendingtrademarks of 24/7 Real Media, Inc. All other brand names ortrademarks appearing herein are the property of their respective holders.

 

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PART I. FINANCIALINFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

**CONDENSED CONSOLIDATED BALANCESHEETS**

**(in thousands, except share data)**
| ** **                                                                                                                            | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                            | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| ** **                                                                                                                            | ** ** | **(unaudited)**    | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                            |       |               |       |                  |       |
| Current assets:                                                                                                                       |       |               |       |                  |       |
| Cash and cash equivalents                                                                                                             |       | $                  | 41,562     |                  | $          | 40,009 |   |
| Accounts receivable, less allowances of $2,486 and  $2,306,  respectively                                                             |       | 41,549             |       | 38,316                |       |
| Prepaid expenses and other current assets                                                                                             |       | 3,135              |       | 2,369                 |       |
|                                                                                                                                  |       |               |       |                  |       |
| Total current assets                                                                                                                  |       | 86,246             |       | 80,694                |       |
|                                                                                                                                  |       |               |       |                  |       |
| Property and  equipment, net                                                                                                          |       | 7,094              |       | 7,131                 |       |
| Goodwill                                                                                                                              |       | 39,573             |       | 39,573                |       |
| Intangible  assets, net                                                                                                               |       | 9,183              |       | 9,715                 |       |
| Other assets                                                                                                                          |       | 5,077              |       | 5,691                 |       |
|                                                                                                                                  |       |               |       |                  |       |
| Total assets                                                                                                                          |       | $                  | 147,173    |                  | $          | 142,804 |   |
|                                                                                                                                  |       |               |       |                  |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                        | ** ** | ** **         | ** ** | ** **            | ** ** |
| Current liabilities:                                                                                                                  |       |               |       |                  |       |
| Accounts payable                                                                                                                      |       | $                  | 21,795     |                  | $          | 19,396 |   |
| Accrued liabilities                                                                                                                   |       | 17,363             |       | 23,987                |       |
| Deferred revenue                                                                                                                      |       | 3,495              |       | 3,218                 |       |
| Subordinated convertible debentures, 2%, due 2006                                                                                     |       | 14,694             |       | 14,542                |       |
|                                                                                                                                  |       |               |       |                  |       |
| Total current liabilities                                                                                                             |       | 57,347             |       | 61,143                |       |
|                                                                                                                                  |       |               |       |                  |       |
| Warrant  liability                                                                                                                    |       | 759                |       | 897                   |       |
| Other long-term  liabilities                                                                                                          |       | 484                |       | 489                   |       |
|                                                                                                                                  |       |               |       |                  |       |
| Total liabilities                                                                                                                     |       | 58,590             |       | 62,529                |       |
|                                                                                                                                  |       |               |       |                  |       |
| Commitments and  contingencies                                                                                                        |       |               |       |                  |       |
| Minority  interests in consolidated subsidiaries                                                                                      |       | 1,514              |       | 1,556                 |       |
|                                                                                                                                  |       |               |       |                  |       |
| Stockholders’ equity:                                                                                                            |       |               |       |                  |       |
| Preferred stock; $.01 par value; 10,000,000 shares  authorized;  1,643,250 shares issued and none outstanding                         |       | —             |       | —                |       |
| Common stock;  $.01 par value; 350,000,000 shares authorized;  48,453,626 and 46,227,772 shares issued and outstanding,  respectively |       | 484                |       | 462                   |       |
| Additional paid-in capital                                                                                                            |       | 1,193,372          |       | 1,177,715             |       |
| Accumulated other comprehensive income                                                                                                |       | 1,083              |       | 896                   |       |
| Accumulated deficit                                                                                                                   |       | (1,107,870         | )          | (1,100,354            | )          |
| Total stockholders’ equity                                                                                                       |       | 87,069             |       | 78,719                |       |
|                                                                                                                                  |       |               |       |                  |       |
| Total  liabilities and stockholders’ equity                                                                                      |       | $                  | 147,173    |                  | $          | 142,804 |   |

 

Seeaccompanying notes to unaudited interim condensed consolidated financialstatements.

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

**CONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS**

**(in thousands, expect share and per share data)**
| ** **                                                                                              | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                              | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| ** **                                                                                              | ** ** | **(unaudited)**                                      | ** ** | **(unaudited)** | ** ** |
| Revenues:                                                                                               |       |                                                 |       |   |   |
| Media                                                                                                   |       | $                                                    | 18,230     |   | $ | 14,229 |   |
| Search                                                                                                  |       | 17,833                                               |       | 9,622 |   |
| Technology                                                                                              |       | 6,878                                                |       | 5,219 |   |
| Total revenues                                                                                          |       | 42,941                                               |       | 29,070 |   |
|                                                                                                    |       |                                                 |       |   |   |
| Cost of revenues:                                                                                       |       |                                                 |       |   |   |
| Media                                                                                                   |       | 12,576                                               |       | 9,627 |   |
| Search                                                                                                  |       | 13,092                                               |       | 6,632 |   |
| Technology  (inclusive of $179 and $8 of stock-based compensation,                                      |       |                                                 |       |   |   |
| respectively)                                                                                           |       | 1,599                                                |       | 1,000 |   |
| Total cost of revenues                                                                                  |       | 27,267                                               |       | 17,259 |   |
|                                                                                                    |       |                                                 |       |   |   |
| Gross profit                                                                                            |       | 15,674                                               |       | 11,811 |   |
|                                                                                                    |       |                                                 |       |   |   |
| Operating expenses:                                                                                     |       |                                                 |       |   |   |
|                                                                                                    |       |                                                 |       |   |   |
| Sales and marketing (inclusive of $1,545 and $120 of  stock-based  compensation, respectively)          |       | 7,985                                                |       | 5,410 |   |
| General and administrative (inclusive of $6,338 and  $335 of  stock-based compensation, respectively)   |       | 11,298                                               |       | 4,919 |   |
| Product development (inclusive of $977 and $50 of  stock-based  compensation, respectively)             |       | 2,758                                                |       | 1,292 |   |
| Amortization of intangible assets and deferred  financing costs                                         |       | 890                                                  |       | 1,140 |   |
| Restructuring costs                                                                                     |       | —                                               |       | 973 |   |
|                                                                                                    |       |                                                 |       |   |   |
| Total operating expenses                                                                                |       | 22,931                                               |       | 13,734 |   |
|                                                                                                    |       |                                                 |       |   |   |
| Loss from operations                                                                                    |       | (7,257                                               | )          | (1,923 | ) |
|                                                                                                    |       |                                                 |       |   |   |
| Interest income  (expense), net                                                                         |       | 65                                                   |       | (88 | ) |
| Change in fair  value of warrant liability                                                              |       | (252                                                 | )          | 150 |   |
| Recovery of  investment                                                                                 |       | —                                               |       | 2,100 |   |
| Impairment of  marketable securities                                                                    |       | —                                               |       | (588 | ) |
| Other income  (expense), net                                                                            |       | 110                                                  |       | (46 | ) |
|                                                                                                    |       |                                                 |       |   |   |
|                                                                                                    |       |                                                 |       |   |   |
| Loss before provision for income taxes and minority  interest  in operations of consolidated subsidiary |       | (7,334                                               | )          | (395 | ) |
|                                                                                                    |       |                                                 |       |   |   |
| Provision for  income taxes                                                                             |       | (230                                                 | )          | (11 | ) |
| Minority  interest in operations of consolidated subsidiary                                             |       | 48                                                   |       | — |   |
|                                                                                                    |       |                                                 |       |   |   |
| Net loss                                                                                                |       | $                                                    | (7,516)    |   | $ | (406 | ) |
|                                                                                                    |       |                                                 |       |   |   |
| Dividends on  preferred stock                                                                           |       | —                                               |       | (12 | ) |
|                                                                                                    |       |                                                 |       |   |   |
| Net loss  attributable to common stockholders                                                           |       | $                                                    | (7,516)    |   | $ | (418 | ) |
|                                                                                                    |       |                                                 |       |   |   |
|                                                                                                    |       |                                                 |       |   |   |
| Basic and diluted net loss per share attributable to  common  stockholders                              |       | $                                                    | (0.16      | ) | $ | (0.01 | ) |
|                                                                                                    |       |                                                 |       |   |   |
| Weighted average  shares outstanding used in basic and diluted  net loss per share                      |       | 46,848,231                                           |       | 44,831,154 |   |

 

Seeaccompanying notes to unaudited interim condensed consolidated financialstatements.

 

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**24/7REAL MEDIA, INC.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands)**

** **
| ** **                                                                                     | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                     | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| ** **                                                                                     | ** ** | **(unaudited)**                                      | ** ** | **(unaudited)** | ** ** |
| Cash flows from  operating activities:                                                         |       |                                                 |       |   |   |
| Net loss                                                                                       |       | $                                                    | (7,516     | ) | $ | (406 | ) |
| Adjustments to reconcile  net loss to net cash provided by                                     |       |                                                 |       |   |   |
| operating activities:                                                                          |       |                                                 |       |   |   |
| Depreciation and  amortization                                                                 |       | 832                                                  |       | 598 |   |
| Provision for  doubtful accounts and sales reserves                                            |       | 459                                                  |       | 604 |   |
| Amortization of  intangible assets and deferred financing costs                                |       | 890                                                  |       | 1,140 |   |
| Amortization of  debt discount                                                                 |       | 152                                                  |       | 152 |   |
| Non-cash  compensation                                                                         |       | 9,039                                                |       | 513 |   |
| Accrued interest  on notes payable                                                             |       | 74                                                   |       | 75 |   |
| Change in fair  value of warrant liability                                                     |       | 252                                                  |       | (150 | ) |
| Impairment of  investments                                                                     |       | —                                               |       | 588 |   |
| Recovery of  investment                                                                        |       | —                                               |       | (2,100 | ) |
| Minority  interest in losses of consolidated subsidiary                                        |       | (48                                                  | )          | — |   |
| Changes in operating  assets and liabilities, net of  effect of acquisitions and dispositions: |       |                                                 |       |   |   |
| Accounts receivable                                                                            |       | (3,693                                               | )          | 25 |   |
| Prepaid expenses and other current assets                                                      |       | (1,120                                               | )          | (690 | ) |
| Other assets                                                                                   |       | 57                                                   |       | (532 | ) |
| Accounts payable and accrued liabilities                                                       |       | 699                                                  |       | 2,126 |   |
| Deferred revenue                                                                               |       | 277                                                  |       | (182 | ) |
|                                                                                           |       |                                                 |       |   |   |
| Net cash provided by operating activities                                                      |       | 354                                                  |       | 1,761 |   |
|                                                                                           |       |                                                 |       |   |   |
| Cash flows from  investing activities:                                                         |       |                                                 |       |   |   |
| Capital expenditures,  including capitalized software                                          |       | (795                                                 | )          | (2,150 | ) |
| Recovery of  investment                                                                        |       | —                                               |       | 2,100 |   |
| Proceeds from  sale / maturities of short-term investments                                     |       | —                                               |       | 648 |   |
|                                                                                           |       |                                                 |       |   |   |
| Net cash provided by (used in) investing activities                                            |       | (795                                                 | )          | 598 |   |
|                                                                                           |       |                                                 |       |   |   |
| Cash flows from  financing activities:                                                         |       |                                                 |       |   |   |
| Proceeds from  exercise of stock options                                                       |       | 2,856                                                |       | 71 |   |
| Proceeds from  note receivable                                                                 |       | 200                                                  |       | — |   |
| Cash paid for  acquisitions                                                                    |       | (1,250                                               | )          | — |   |
| Payment of  capital lease obligations                                                          |       | (3                                                   | )          | (12 | ) |
|                                                                                           |       |                                                 |       |   |   |
| Net cash provided by financing activities                                                      |       | 1,803                                                |       | 59 |   |
|                                                                                           |       |                                                 |       |   |   |
| Net change in cash and cash equivalents                                                        |       | 1,362                                                |       | 2,418 |   |
| Effect of  foreign currency on cash                                                            |       | 191                                                  |       | (61 | ) |
| Cash and cash  equivalents at beginning of year                                                |       | 40,009                                               |       | 27,690 |   |
|                                                                                           |       |                                                 |       |   |   |
| Cash and cash  equivalents at end of period                                                    |       | $                                                    | 41,562     |   | $ | 30,047 |   |

** **

**See accompanying notes to unaudited interimcondensed consolidated financial statements.**

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

24/7 Real Media, Inc.(the “Company”) together with its subsidiaries provides advertising servicesand software solutions for the online advertising needs of Web publishers andadvertisers, including advertising sales, search engine marketing (“SEM”)services, online advertisement serving, analytics and audience management. Asof March 31, 2006, the Company principally operated in North America,Europe, South Korea, Japan and Australia and provided the following productsand services:

*Media*, collectively marketed asthe 24/7 Web Alliance, a global alliance of Web sites represented by theCompany, through which advertisers can place campaign orders directly with theCompany.

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

*Technology,*primarily consistingof Open AdStream and Open Advertiser advertisement delivery and managementsoftware and services, the Insight XE web analytics and audience managementsoftware and services and the Insight ACT behavioral targeting service. TheCompany licenses software products to customers that are hosted locally andprovides services from software hosted centrally on its servers as anapplication service provider.

**NOTE2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

#### (a) Basisof Presentation

The accompanying condensed consolidated financial statements includethe accounts of the Company and its majority-owned and controlled subsidiariesfrom their respective dates of acquisition. The interest of shareholdersother than those of the Company is recorded as minority interest in theaccompanying consolidated statements of operations and consolidated balancesheets. When losses applicable to minority interest holders in a subsidiaryexceed the minority interest in the equity capital of the subsidiary, theselosses are included in the Company’s results, as the minority interest holderhas no obligation to provide further financing to the subsidiary. Allsignificant intercompany transactions and balances have been eliminated inconsolidation.

The accompanying interim consolidated financial statements areunaudited, except for the condensed consolidated balance sheet as of December 31,2005, which has been derived from audited financial statements. In the Company’sopinion, the consolidated financial statements have been prepared on the samebasis as the annual consolidated financial statements and reflect alladjustments, which include only normal recurring adjustments, necessary topresent fairly the financial position and the results of the operations andcash flows of the Company for the interim periods presented. The financialstatements, financial data and other information disclosed in the notes to theconsolidated results are not necessarily indicative of the results expected forthe full fiscal year or any future period.

The accompanying unaudited condensed consolidated financial statements shouldbe read in conjunction with the audited consolidated financial statements forthe year ended December 31,

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** **

2005. Certain information and footnote disclosures normally included infinancial statements prepared in accordance with accounting principlesgenerally accepted in the United States of America have been condensed oromitted pursuant to the rules and regulations of the Securities andExchange Commission (“SEC”).

###### (b) Useof Estimates

The preparation of interim consolidated financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and the disclosureof contingent assets and liabilities at the date of the interim consolidatedfinancial statements and the reported amounts of revenues and expenses duringthe reporting period. Actual results could differ from those estimates. On anongoing basis, the Company evaluates its estimates, including those related torevenue recognition, accruals, allowance for doubtful accounts, fair value ofacquired intangible assets and goodwill, useful lives of intangible assets andproperty and equipment, among others. The Company bases its estimates on historicalexperience and on various other assumptions that are believed to be reasonable,the results of which form the basis for making judgments about the carryingvalues of assets and liabilities.

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

The Companyconsiders all highly liquid securities, with original maturities of threemonths or less from the balance sheet date, to be cash equivalents. Cash andcash equivalents consist principally of money market accounts.

The Companymaintains letters of credit, secured by cash, related to its office leases.Cash secured by letters of credit with maturities of one year or less from thebalance sheet date is classified as other current assets, and cash secured byletters of credit with maturities greater than one year from the balance sheetdate is classified as other assets on the consolidated balance sheets.

(d) Investments

Investments consist of securities with statedmaturities of three months or more and marketable securities consisting ofregistered corporate equity securities. The Company classifies the marketablesecurities as available-for-sale in accordance with Statement of FinancialAccounting Standards (“SFAS”) No. 115, *Accounting for CertainInvestments in Debt and Equity Securities*. Available-for-salesecurities are carried at fair value, with the unrealized gains or losses, netof tax, reported as a separate component of stockholders’ equity. Indetermining realized gains and losses, the cost of securities sold is basedupon specific identification. Realized gains and losses and declines in valuejudged to be other-than-temporary, are included in the consolidated statementsof operations.

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

8

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(e) AccountsReceivable

Accountsreceivable are recorded at the invoiced amount net of allowance for doubtfulaccounts and sales allowance. The Company does not require collateral. TheCompany maintains an allowance for doubtful accounts to reserve for potentiallyuncollectible receivables and a sales allowance to reserve for potentialcredits issued to customers. The allowances are estimates calculated based onan analysis of current business and economic risks, customer credit-worthiness,specific identifiable risks such as bankruptcies, terminations or discontinuedcustomers, or other factors that may indicate a potential loss.

As a normal partof the business, the Company has receivables that are invoiced in the monthfollowing the completion of the earnings process. All unbilled receivables arebilled within 30 days after each month-end.

(f) Concentrationof Credit Risk

Financialinstruments that potentially subject the Company to concentrations of creditrisk consist principally of cash equivalents, accounts receivable anddebentures. The fair value of cash equivalents and accounts receivableinstruments approximate their financial statement amount because of theshort-term maturity of these instruments. The fair value of the debentures approximatestheir financial statement carrying value based on interest rates for similarborrowing.

At times, cash mayexceed the federally insured limits. In addition, the majority of the Company’scash is managed by a few financial institutions.

Accountsreceivable are typically unsecured. To appropriately manage credit risk, theCompany performs ongoing evaluations of customer credit and limits the amountof credit extended, but generally no collateral is required. The Companymaintains reserves for estimated credit losses and these losses have generallybeen within management’s expectations.

(g) SignificantCustomers and Suppliers

No single customer accounted for greater than 10% ofnet revenues for the three months ended March 31, 2006 or 2005.

Substantially allMedia revenue is generated from advertising inventory provided by partner Websites. Search revenue is generated from relationships with search enginedistribution partners, and substantially all Search revenue is derived from twosuch relationships. In each case, with the exception of Lycos,arrangements with the Company’s partners are often short-term or subject totermination upon short notice. The Company may not be successful in renewingany of these agreements, or if they are renewed, they may not be on terms asfavorable as current agreements. The Company may not be successful in enteringinto agreements with new distribution partners on commercially acceptableterms.

On a geographicbasis, the Company may also experience significant concentration among itscustomers or partners. The Company examines this concentration on acountry-by-country basis.

(h) Propertyand Equipment; Capitalized Software

Property andequipment are recorded at cost and are depreciated using the straight-linemethod over the shorter of the estimated useful life of the related asset,generally three to five years, and the lease term.

9

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In accordance withStatement of Position (“SOP”) No. 98-1, *Accounting for the Costs of Computer Software Developed or Obtained forInternal Use*, software development costs incurred during theapplication development stage are capitalized. Costs incurred during thepreliminary project and post implementation stages of an internal use softwareproject are expensed as incurred. The capitalized cost of internal use softwareis charged over the estimated useful life of two to three years.

As required bySFAS No. 86, *Accounting for the Costsof Computer Software To Be Sold, Leased, or Otherwise Marketed*, theCompany requires certain product development costs to be capitalized when aproduct’s technological feasibility has been established by completion of aworking model of the product, and discontinues capitalization when a product isavailable for general release to customers. Capitalized software is depreciatedusing the greater of the amount computed using (a) the ratio that currentgross revenues for a product bears to the sum of current and anticipated futuregross revenue for that product and (b) the straight-line method over theremaining estimated economic life of the software, generally four years.

(i) Business Combinations

The Company’s acquisitions are accounted for as purchase businesscombinations in accordance with SFAS No. 141, *Business Combinations*, and SFAS No. 142, *Goodwill and Other Intangible Assets*.The Company allocates a portion of the purchase price to tangible andintangible assets based on their respective estimated fair values, and recordsas goodwill any remaining unallocated portion of the purchase price. Intangibleassets include trademarks, customer relationships, acquired technology andcovenants not to compete. Such intangible assets are amortized on astraight-line basis over their estimated useful lives, which are generally twoto seven years, except for trademarks that have an indefinite life.

(j) Impairment of Long-Lived Assets

The Company evaluates goodwill and indefinite lived intangible assetson an annual basis and whenever events or changes in circumstances indicatethat the carrying amount may not be fully recoverable. Long-livedassets, including property and equipment, long-term assets and amortizable intangibleassets, are reviewed for impairment whenever events or changes in circumstancesindicate that the carrying amount may not be fully recoverable. Conditions thatwould necessitate an impairment assessment include a significant decline in theobservable market value of an asset, a significant change in the extent towhich or manner in which an asset is used, or a significant adverse change thatindicates that the carrying amount of an asset or group of assets is notrecoverable. The Company assesses impairment in accordance with therequirements of SFAS No. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets*. The Companyassesses the impairment of goodwill and intangible assets in accordance withthe provisions of SFAS No. 142, *Goodwilland Other Intangible Assets*. The Company determines therecoverability of the assets by comparing the carrying amount of the assets tonet future cash flows that the assets are expected to generate. The impairmentrecognized is the amount by which the carrying amount exceeds the fair marketvalue of the assets.

(k) Income Taxes

The Company accounts for income taxes using theasset and liability method. Under this method, deferred tax assets andliabilities are recognized for the future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases, and operating loss and taxcredit carryforwards. Deferred tax assets and liabilities are measured usingenacted tax rates expected to apply to taxable income in the years in whichthose temporary differences

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** **

are expected to be recovered or settled. The effecton deferred tax assets and liabilities of a change in tax rates is recognizedin results of operations in the period that the tax change occurs.

(l) Foreign Currency Translation

Assets and liabilities denominated in foreignfunctional currencies are translated at the exchange rate as of the balancesheet date. Revenues, costs and expenses denominated in foreign functionalcurrencies are translated at the weighted average exchange rate for eachperiod. Translation adjustments are recorded as a separate component of stockholders’equity. Gains or losses from foreign currency transactions are included in theconsolidated statements of operations.

(m) RevenueRecognition; Cost of Revenues; Deferred Revenue

*Media*

Media revenues are generated from fees paid by clientadvertisers for advertising impressions. The Company typically offersadvertisers a pricing model based on a cost-per-thousand impressions, or CPM,which enables a client advertiser to pay a fee based on the number of times itsadvertisement is displayed. E-mail related revenue is derived from deliveringadvertisements to e-mail lists for advertisers. Agreements 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. The Company becomes obligated to make royalty payments to Web sitesand e-mail lists that have contracted with the Company in the period in whichthe advertising impressions or e-mails are delivered. Such expenses areclassified as cost of revenues in the accompanying consolidated statements ofoperations.

*Search*

Search revenue is primarily based on either a percentage of media spendor a cost-per-click, or CPC, fee model paid by client advertisers. These feesare generated each time users click on Web site listings that the Companysubmitted into search engine databases and are directed to our clientadvertisers’ Web sites. To a lesser extent, the Company also generates revenuefrom fees paid by search engines that employ the Company to optimize thesubmission of Web site listings and report on advertising campaigns for theiradvertisers. Agreements 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. The Company becomes obligated to make payments to search enginedistribution partners that have contracted with the Company in the period inwhich the clicks occur. Such expenses are classified as cost of revenues in theaccompanying consolidated statements of operations.

When the Companyprovides SEM services as an agent for a fixed commission, or otherwise intransactions in which it does not have principal risk and reward, the Companyrecognizes revenue on a net basis.

*Technology*

Technologyrevenues are derived primarily from licensing of the Company’s software, hostedadvertisement serving and software maintenance and technical support services. The Company recognizes revenue fromadvertisement serving hosted centrally on its servers upon delivery. Revenuefrom software licensing agreements is recognized in accordance with SOP No. 97-2,*Software Revenue Recognition*, andStaff Accounting Bulletin (“SAB”) No. 104, *Revenue Recognition*, upon delivery of the software, which isgenerally when the software is made available for download, there is persuasiveevidence of an 

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arrangement,collection is reasonably assured, the fee is fixed or determinable andvendor-specific objective evidence exists to allocate the total fees to allelements of the arrangement. Contracts that bundle the software license withmaintenance and technical support are recognized ratably over the contractterm. Revenue from software maintenance and technical support contracts isrecognized ratably over the term of the agreement, which typically does notexceed one year.

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

*DeferredRevenue*

The Company defersrevenues billed or collected in advance of services being completed until theconclusion of the service period to which the advance billing or collectionrelates. Deferred revenues are included on the consolidated balance sheets as acurrent liability until the service is performed, and then recognized in theperiod in which the service is completed. The Company’s deferred revenuesprimarily consist of billings in advance for software license subscriptions andsoftware maintenance and technical support services.

(n) Stock-BasedCompensation

EffectiveJanuary 1, 2006, the Company adopted Statement of Financial AccountingStandards No. 123 (revised 2004) (“SFAS No. 123R”), “*Share-Based Payment*,” using the modifiedprospective transition method. Under this method, stock-based compensationexpense is recognized using the fair-value based method for all awards grantedon or after the date of adoption. Compensation expense for unvested stockoptions and awards that were outstanding on January 1, 2006 will berecognized over the requisite service period based on the grant-date fair valueof those options and awards as previously calculated under the pro formadisclosures under SFAS No. 123. The modified prospective transitionmethod allows that prior interim periods and fiscal years reported will notreflect restated amounts. The Company determined the fair value of these awardsusing the Black-Scholes option pricing model.

(o) Restructuring Estimates

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

(p) Warrant Liability

Warrant liability is presented in accordance with EITF00-19, *Accounting for DerivativeFinancial Instruments Indexed to, and Potentially Settled in, a Company’s OwnStock*. EITF 00-19 requires freestanding contracts that aresettled in a company’s own stock, including common stock warrants, to bedesignated as an equity instrument, asset or liability. Under the provisions ofEITF 00-19, a contract designated as an asset or a liability must becarried at fair value until exercised or expired, with any changes in fairvalue recorded in the results of operations. A contract designated as an equityinstrument must be included within equity, and no fair value adjustments arerequired. The Company reviews the classification of its contracts at eachbalance sheet date.

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(q) Advertising Costs

Costs of advertising and promoting the Company’sproducts and services are expensed as incurred. Such costs are included insales and marketing on the statement of operations.

(r) Basic andDiluted Net Income (Loss) Per Share

Net loss per share ispresented in accordance with the provisions of SFAS No. 128, *Earnings Per Share* (“EPS”). Basic EPSexcludes dilution for potentially dilutive securities and is computed bydividing income (loss) available to common shareholders by the weighted averagenumber of common shares outstanding for the period. Diluted EPS reflects thepotential dilution that could occur if securities or other contracts to issuecommon stock were exercised or converted into common stock and resulted in the issuanceof common stock. Potential common shares consist of incremental common sharesissuable upon the exercise of stock options and warrants and the vesting ofrestricted stock (using the treasury stock method) and the conversion ofsubordinated convertible debentures and preferred stock (using the if-convertedmethod).

Diluted EPS is equal to basic EPS for the three monthperiods ended March 31, 2006 and 2005 since all potentially dilutivesecurities are anti-dilutive. The computation of net loss per share for thethree month periods ended March 31, 2006 and 2005 excludes outstandingoptions to purchase 8.8 million and 8.3 million shares of common stock,respectively; 2.2 million and 1.7 million shares of unvested restricted stock,respectively; the effects of 0.6 million shares of preferred stock for thethree month period ended March 31, 2005; 0.5 million and 0.6 millioncommon stock warrants for the three month periods ended March 31, 2006 and2005, respectively; and 1.7 million shares of common stock for the three monthperiods ended March 31, 2006 and 2005 related to the subordinatedconvertible debentures, on an “as if” converted basis, as the effect of theinclusion is anti-dilutive during each period.

**NOTE 3 — BALANCE SHEET COMPONENTS**

(a) Goodwill

The$39.6 million in goodwill at March 31, 2006 and December 31,2005 related $25.0 million to Decide, $12.0 million to 24/7 RealMedia Korea, $1.1 million to 24/7 Canada (formerly ClickThrough),$1.1 million to Real Media and $0.4 million to 24/7 Search (formerlyWebsite Results).

(b) Intangible Assets, Net

The $9.2 million in intangible assets, net at March 31, 2006related $6.2 million to Decide and $3.0 million to 24/7 Real Media Korea. The $9.7 million in intangibleassets, net at December 31, 2005 related $6.6 million to Decide and$3.1 million to 24/7 Real Media Korea.

**NOTE 4 — RESTRUCTURING COSTS**

The Company’s restructuring reserve related to office closing costsdecreased from $1.2 million at December 31, 2005 to $1.0 million at March 31,2006. The amount is included in accrued liabilities in the consolidated balancesheet.

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**NOTE 5 — 2%SUBORDINATED CONVERTIBLE DEBENTURES**

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

The maturity date of the Debentures is subject toextension, and the conversion price is subject to adjustment, on the terms andconditions set forth in the Debentures. In addition, on the maturity date theCompany may elect to pay the principal of and interest on the Debentures incash, shares of its common stock or a combination of cash and shares of itscommon stock. If the Company elects to pay all or a portion of the principalamount due under the Debentures at maturity in shares of its common stock,rather than in cash, the maturity date conversion price will be equal to 90% ofthe average of the daily volume-weighted average prices of the Company’s commonstock on the NASDAQ National Market (or such other market on which the commonstock are then listed or quoted) for the fifteen consecutive trading daysimmediately preceding the maturity date. The Company may elect to make interestpayments on the Debentures in cash or shares of its common stock. If theCompany elects to make interest payments due under the Debentures in shares ofits common stock, the interest conversion price will be equal to 90% of theaverage of the daily volume-weighted average prices of the Company’s commonstock on the NASDAQ National Market (or such other market on which the commonstock are then listed or quoted) for the five consecutive trading daysimmediately preceding the interest payment date. Interest expense on theDebentures amounted to approximately $0.1 million for each of the threemonth periods ended March 31, 2006 and 2005.

Additionally, if the specific conditions set forth inthe Debentures are satisfied, the Company may require the holder to convert theDebentures into shares of the Company’s common stock at the conversion ratethen in effect, or the Company may prepay the Debentures prior to the maturitydate, for an amount in cash equal to 150% of the amount prepaid. In addition,if at any time on or after the second anniversary of the initial issuance date,the weighted average price of the common stock is less than $8.75 on any fiveconsecutive trading days, the holder shall have the right, in its solediscretion, to require that the Company immediately redeem up to $7.5 millionprincipal amount of the Debentures in cash. The redemption right constitutes anembedded derivative. The value of this embedded derivative at March 31,2006 is immaterial to the financial position of the Company. The Companyreviews the value of the derivative on a quarterly basis, in accordance withSFAS No. 149, *Amendment ofStatement 133 on Derivative Instruments and Hedging Activities*.

The Company valued the Warrants at $1.8 millionusing a Black-Scholes pricing model with the following factors: risk freeinterest rate of 1.48%, volatility of 143%, dividend yield of 0% and a life of2.5 years. The aggregate fair market value of the Warrants was reflectedas a reduction of the face amount of the Debentures on the consolidated balancesheet and is being amortized over three years, the initial term of theDebentures, using the effective interest method. Accordingly, the carryingvalue of the Debentures will be increased over the initial term. Pursuant toEITF Issue No. 00-19, since the effective registration of thesecurities underlying the warrants was an event outside the control of theCompany, the Company recorded the fair value of the warrants as long-termliabilities. In connection with the amendment to the registration rightsagreement entered into during 2004, the Company reclassified the value of thewarrants (approximately $1.0 million) on the amendment date to additional paidin capital. Interest expense attributable to the amortization of the warrantsamounted to $0.2 million for each the three month periods ended March 31,2006 and 2005.

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In connection with the issuance of the Debentures andWarrants, the Company incurred placement agent fees, legal fees and otherexpenses of approximately $1.2 million. In addition to the placement fees,the Company issued warrants to the placement agent. The warrants to purchase86,000 shares of common stock at an exercise price of $10.068 are in the sameform and on the same terms and conditions as the Warrants issued to theinvestor. The Company included the value of the warrants, $0.4 million,using the factors above, and the cash placement fees of $1.2 million in otherassets on the consolidated balance sheet. Collectively, the debt issuance costsof $1.6 million are being amortized over three years, the initial term of theDebentures. For each of the three month periods ended March 31, 2006 and2005, $0.1 million of deferred financing costs are included inamortization expense.

**NOTE 6 -****EQUITY INSTRUMENTS**

Common Stock

*Additional Paid-in Capital*

*Duringthe three month period ended March 31, 2006, the Company’s additionalpaid-in capital increased by $15.7 million primarily due to $8.8 million inemployee stock-based compensation, $2.8 million from exercise of stock options,$3.7 million for stock issued related to the earn out provisions in a prioracquisition, and $0.4 million related to the cashless exercise of warrants.*

**NOTE7 - STOCK INCENTIVE PLANS**

*(a)  Restricted Stock*

InJanuary 2005, the Company entered into agreements to issue 1.7 millionshares of restricted stock to certain employees, subsequently adjusted to 1.5million for forfeitures. Approximately 0.3 million shares were vested andissued in January 2006 and 0.3 million and 0.3 million will be vested andissued in each of January 2007 and 2008 contingent upon employment with theCompany on the dates of vesting. Approximately 0.6 million were vested andissued in March 2006 upon the attainment of a market condition of theCompany’s stock. In accordance with APB 25, upon the attainment of the marketcondition in March 2006, the Company incurred a stock-based compensationexpense of $5.8 million.

InNovember 2005, the Company entered into agreements to issue 0.8million fully vested shares of restricted stock to certain employees overthree years. Approximately 0.1 million shares will be issued in each of November 2006and 2007; and approximately 0.6 million will be issued in November 2008contingent upon employment with the Company on the dates of issuance. TheCompany also entered into agreements to issue 0.8 million fully vested sharesof restricted stock to executives in November 2013. The restricted sharesmay be issued earlier if certain performance targets are met for the year endedDecember 31, 2006 and the three-year period ended December 31, 2008.

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The restricted stock awardsof Company common stock has a fair value equal to the respective market priceof the stock at the date granted. The restricted stock awards require nopayment from the employee and compensation cost was valued based on the marketprice on the grant date and is expensed equally over the vesting period,generally three years. Compensation expense related to vesting of restrictedstock awards totaled $7.3 million and $0.5 million for the three months ended March 31,2006 and 2005, respectively. The following table summarizes the restrictedshare unit awards:
| ** **                          | ** ** | ** **     | ** ** | **Weighted Average**     | ** ** | **Weighted Average**      | ** ** |
|-------------------------------------|------------|----------------|------------|-------------------------------|------------|--------------------------------|------------|
| ** **                          | ** ** | **Restricted** | ** ** | **Grant Date Fair** | ** ** | **Remaining Contractual** | ** ** |
| ** **                          | ** ** | **Shares**     | ** ** | **Value**                     | ** ** | **Life (Years)**          | ** ** |
| Unvested at  December 31, 2005 |       | 3,053,500      |       | $                             | 4.96       |                           |       |   |
| Granted                             |       | 24,000         |       | 6.87                          |       |                           |       |
| Vested                              |       | (865,000       | )          | 3.35                          |       |                           |       |
| Cancelled                           |       | (40,000        | )          | 6.10                          |       |                           |       |
| Unvested at  March 31, 2006    |       | 2,172,500      |       | $                             | 5.60       |                           | 1.9        |   |

* *

As of March 31,2006, there was $8.1 million of total unrecognized compensation costs relatedto unvested restricted stock awards. The $8.1 million is expected to vest overthe weighted average of 2 years.

*(b) StockOptions*

EffectiveJanuary 1, 2006, the Company adopted Statement of Financial AccountingStandards No. 123 (revised 2004) (“SFAS No. 123R”), “*Share-Based Payment*,” using the modifiedprospective transition method. Under this method, stock-based compensationexpense is recognized using the fair-value based method for all awards grantedon or after the date of adoption. Compensation expense for unvested stockoptions and awards that were outstanding on January 1, 2006 will berecognized over the requisite service period based on the grant-date fair valueof those options and awards as previously calculated under the pro formadisclosures under SFAS No. 123. The modified prospective transitionmethod allows that prior interim periods and fiscal years reported will notreflect restated amounts.

Thefair value of each option grant is estimated on the date of grant using theBlack-Scholes option pricing model. The expected life selected for optionsgranted during the quarter represents the period of time that the options areexpected to be outstanding based on historical data of option holder exerciseand termination behavior. Expected volatilities are based upon historicalvolatility of the Company’s monthly stock closing prices over a period equal tothe expected life of each option grant. The risk-free interest rate wasselected based on yields from U.S. Treasury zero-coupon issues with aremaining term equal to the expected term of the options being valued. TheCompany historically has not paid dividends. 

 
| ** **                | ** ** | **March 31,** | ** ** |
|---------------------------|------------|--------------------|------------|
| ** **                | ** ** | **2006**           | ** ** | **2005** | ** ** |
| Expected  dividend yield  |       | 0                  | %          | 0 | % |
| Risk-free  interest rate  |       | 4.10               | %          | 3.05 | % |
| Expected life  (in years) |       | 3.0                |       | 2.5 |   |
| Expected volatility       |       | 65                 | %          | 103 | % |

 

Asa result of adopting the standard, the Company recorded pretax compensationexpense of $1.6 million for the three months ended March 31, 2006. Sharebased compensation is included in each expense category that includes salaryexpense. The Company has recorded a full valuation allowance on the 

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deferredtax asset related to share based compensation and therefore, no tax benefit isrecognized for the three months ended March 31, 2006.

Priorto adoption of SFAS No 123R, the cancellation of stock options was accountedfor based on actual cancellations during the reporting period. Under SFAS No. 123Rthe Company is required to estimate forfeitures.

Thefollowing table summarizes the stock options outstanding: 
| ** **                                     | ** ** | ** **  | ** ** | ** **                | ** ** | **Weighted Average** | ** ** | ** **               | ** ** |
|------------------------------------------------|------------|-------------|------------|---------------------------|------------|---------------------------|------------|--------------------------|------------|
| ** **                                     | ** ** | ** **  | ** ** | ** **                | ** ** | **Remaining**             | ** ** | ** **               | ** ** |
| ** **                                     | ** ** | ** **  | ** ** | **Weighted Average** | ** ** | **Contractual Life** | ** ** | **Aggregate**            | ** ** |
| ** **                                     | ** ** | **Options** | ** ** | **Exercise Price**   | ** ** | **(Years)**               | ** ** | **Intrinsic Value** | ** ** |
| Outstanding at  December 31, 2005         |       | 9,595,378   |       | $                         | 5.74       |                      |       |                     |       |   |
| Granted                                        |       | 174,750     |       | $                         | 5.49       |                      |       |                     |       |   |
| Exercised                                      |       | (896,630    | )          | $                         | 3.19       |                      |       |                     |       |   |
| Cancelled                                      |       | (53,512     | )          | $                         | 4.87       |                      |       |                     |       |   |
| Outstanding at  March 31, 2006            |       | 8,819,986   |       | $                         | 5.98       |                      | 8.5        |                     | $          | 49,447,059 |   |
|                                           |       |        |       |                      |       |                      |       |                     |       |
|                                           |       |        |       |                      |       |                      |       |                     |       |
| Vested and exercisable  at March 31, 2006 |       | 3,866,253   |       | $                         | 6.73       |                      | 7.5        |                     | $          | 24,601,843 |   |

 

Theweighted average fair value per option at the date of grant for options grantedin first quarter 2006 and 2005 was $3.24 and $2.50, respectively. The intrinsicvalue for the options exercised during the three month period ended March 31,2006 was $5.3 million.

 
| **Range of  Exercise  Prices** | ** ** | **Number  Outstanding** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise  Price** |
|-------------------------------------|------------|-------------------------|------------|-----------------------------------------------------|------------|----------------------------------------|------------|-------------------------|------------|----------------------------------------|
| $0.00 - 2.00                        |       | 1,288,191               |       | 6.4                                                 | years      |                                   | $          | 1.12                    |       | 1,284,563                              |   | $ | 1.12 |
| 2.01 - 5.00                         |       | 3,567,455               |       | 8.7                                                 |       |                                   | 4.19       |                    | 1,339,174  |                                   | 4.19 |
| 5.01 - 10.00                        |       | 3,877,174               |       | 9.0                                                 |       |                                   | 6.52       |                    | 1,155,350  |                                   | 6.83 |
| 10.01 - 323.00                      |       | 87,166                  |       | 3.1                                                 |       |                                   | 127.02     |                    | 87,166     |                                   | 127.02 |
|                                |       | 8,819,986               |       | 8.5                                                 |       |                                   | $          | 5.98                    |       | 3,866,253                              |   | $ | 6.73 |

 

As of March 31, 2006,there were $7.8 million of total unrecognized compensation costs related tounvested stock option awards. The $7.8 million is expected to vest over theweighted average of 1.5 years.
| ** **                           | ** ** | ** **  | ** ** | **Weighted Average**   | ** ** |
|--------------------------------------|------------|-------------|------------|-----------------------------|------------|
| ** **                           | ** ** | **Options** | ** ** | **Grante Date  Fair Value** | ** ** |
| Nonvested at  December 31, 2005 |       | 5,470,277   |       | $                           | 2.95       |   |
| Granted                              |       | 174,750     |       | $                           | 2.78       |   |
| Vested                               |       | (647,910    | )          | $                           | 2.93       |   |
| Forfeited                            |       | (45,867     | )          | $                           | 4.24       |   |
| Nonvested at March 31,  2006    |       | 4,951,250   |       | $                           | 3.24       |   |

The total fair value of shares vested duringthe three month period ended March 31, 2006 was $1.9 million.

In general, the Company issues stock optionawards at a price equal to the market value on the date of grant. Typically,stock option awards vest annually from the date of grant, and equally over athree year period.

Priorto adoption, the Company accounted for stock-based compensation arrangementsusing the intrinsic value method under the provisions of Accounting PrinciplesBoard Opinion No. 25 (“APB 25”), *“Accountingfor Stock Issued to Employees.”*Under this method, stockcompensation was recognized to the extent that the exercise price is less thanthe market price for the underlying stock on the date of grant. The followingtable illustrates the effect on net loss and net loss per share if the Companyhad applied the fair value recognition provisions of SFAS No. 123”,to stock-based employee compensation. SFAS No. 123R requires theCompany to present pro forma information for periods prior to the adoption asif it had accounted for all stock-based compensation under the fair valuemethod. Had compensation costs under the Company’s stock option plans beenrecorded for the three month period ended March 31, 2005, the effect onthe Company’s net loss and earnings per share would have been as follows:

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| ** **                                                                                                                           | ** ** | **Three Months**             | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                                           | ** ** | **Ended March 31,**     | ** ** |
| ** **                                                                                                                           | ** ** | **2005 (in thousands,** | ** ** |
| ** **                                                                                                                           | ** ** | **except per share**    | ** ** |
| ** **                                                                                                                           | ** ** | **amounts)**                      | ** ** |
| Net loss, as  reported                                                                                                               |       | $                                 | (406       | ) |
|                                                                                                                                 |       |                              |       |
| Deduct: Total  stock-based compensation expense determined under fair value based method for  all awards, net of related tax effects |       | 1,488                             |       |
|                                                                                                                                 |       |                              |       |
| Pro forma net  loss                                                                                                                  |       | $                                 | (1,894     | ) |
|                                                                                                                                 |       |                              |       |
| Earnings per share:                                                                                                                  |       |                              |       |
|                                                                                                                                 |       |                              |       |
| Basic, as  reported                                                                                                                  |       | (0.01                             | )          |
| Basic, pro forma                                                                                                                     |       | (0.04                             | )          |

 

**NOTE8 — RECOVERY OF INVESTMENT**

In the firstquarter of 2005, the Company received $2.1 million as a return on an investmentin Bidland Systems, Inc. (“Bidland”), and subsequently received another$0.2 million in the fourth quarter of 2005. The return on investment was aresult of the settlement of pending litigation between Bidland and anotherparty and the subsequent dissolution and liquidation of Bidland. In 2000,Bidland ceased operations and, accordingly, the Company recorded an impairmentcharge related to the cost-based investment.

**NOTE9 -****SUPPLEMENTAL CASH FLOW INFORMATION**

For the three month periodsended March 31, 2006 and 2005, the amount of cash paid for interest was$0.2 million and $­­­0.2 million, respectively.

Warrants to purchase 62,091shares of the Company’s common stock at an average price of $1.21 per sharewere exercised in the first quarter of 2006 in exchange for 53,884 shares ofthe Company’s common stock in cashless exercises of warrants.

**NOTE10 — SEGMENTS**

TheCompany’s business is comprised of three reportable segments: Media, Search andTechnology. Revenue isattributed to individual countries primarily based on where sales are generated.The Company adjusted prior periodsegment disclosures to conform to the current presentation. Thesummarized segment information at and for the three month periods ended March 31,2006 and 2005, is as follows:

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| ** **                             | ** ** | **Three Month Period Ended March 31, 2006** | ** ** |
|----------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                             | ** ** | **Media**                                                                 | ** ** | **Search** | ** ** | **Technology** | ** ** | **Total** | ** ** |
| ** **                             | ** ** | **(in thousands)**                                                   | ** ** |
| Revenues                               |       | $                                                                         | 18,230     |   | $ | 17,833 |   | $ | 6,878 |   | $ | 42,941 |   |
| Depreciation                           |       | 318                                                                       |       | 375 |   | 139 |   | 832 |   |
| Amortization of  intangible assets and |       |                                                                      |       |   |   |   |   |   |   |
| deferred  financing costs              |       | 495                                                                       |       | 395 |   | — |   | 890 |   |
| Loss from operations                   |       | (2,415                                                                    | )          | (3,363 | ) | (1,479 | ) | (7,257 | ) |
|                                        |            |                                                                           |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                             | ** ** | **Three Month Period Ended March 31, 2005** | ** ** |
|----------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                             | ** ** | **Media**                                                                 | ** ** | **Search** | ** ** | **Technology** | ** ** | **Total** | ** ** |
| ** **                             | ** ** | **(in thousands)**                                                   | ** ** |
| Revenues                               |       | $                                                                         | 14,229     |   | $ | 9,622 |   | $ | 5,219 |   | $ | 29,070 |   |
| Depreciation                           |       | 125                                                                       |       | 174 |   | 299 |   | 598 |   |
| Amortization of  intangible assets and |       |                                                                      |       |   |   |   |   |   |   |
| deferred  financing costs              |       | 495                                                                       |       | 395 |   | 250 |   | 1,140 |   |
| Restructuring                          |       | 252                                                                       |       | 228 |   | 493 |   | 973 |   |
| Loss from  operations                  |       | (274                                                                      | )          | (1,209 | ) | (440 | ) | (1,923 | ) |
|                                   |       |                                                                      |       |   |   |   |   |   |   |
|                                   |       |                                                                      |       |   |   |   |   |   |   |
| **Total  assets: (1)**                 |       |                                                                      |       |   |   |   |   |   |   |
| March 31,  2006                   |       | $                                                                         | 47,761     |   | $ | 57,365 |   | $ | 11,510 |   | 116,636 |   |
| December 31, 2005                 |       | 47,316                                                                    |       | 53,352 |   | 14,325 |   | 114,993 |   |
|                                        |            |                                                                           |            |  |  |  |  |  |  |  |  |  |  |

----

(1) Notinclusive of corporate segment assets of $30,537 and $27,811, respectively.

 
| ** **                                                     | ** ** | **United**              | ** ** | **United**  | ** ** | **South** | ** ** | **Other -**  | ** ** | ** ** | ** ** |
|----------------------------------------------------------------|------------|-------------------------|------------|-------------|------------|-----------|------------|-------------------|------------|------------|------------|
| ** **                                                     | ** ** | **States**              | ** ** | **Kingdom** | ** ** | **Korea** | ** ** | **International** | ** ** | **Total**  | ** ** |
| ** **                                                     | ** ** | **(in thousands)** | ** ** |
| Revenues for the  three month period ended March 31, 2006 |       | $                       | 18,004     |        | $          | 8,294     |       | $                 | 6,065      |       | $          | 10,578 |   | $ | 42,941 |   |
| Long-lived  assets as of March 31, 2006                   |       | 11,261                  |       | 753         |       | 15,593    |       | 33,320            |       | 60,927     |       |
|                                                           |       |                    |       |        |       |      |       |              |       |       |       |
| Revenues for the  three month period ended March 31, 2005 |       | $                       | 13,868     |        | $          | 6,131     |       | $                 | 2,359      |       | $          | 6,712 |   | $ | 29,070 |   |
| Long-lived assets as of  December 31, 2005                |       | 11,747                  |       | 762         |       | 15,738    |       | 33,863            |       | 62,110     |       |

 

**NOTE 11 - COMMITMENTS AND CONTINGENCIES**

(a) Commitments

*Lycos, Inc.Services Agreements*

TheCompany pre-paid a total of $2.0 million of royalties to Lycos during 2004 and2005 and will retain an additional 25% of quarterly royalties due to Lycosuntil the date on which the full amount of pre-paid royalties has been recoupedor otherwise paid in cash by Lycos. Accordingly, at March 31, 2006 theCompany has a net $0.8 million in prepaid royalties of which $0.5 million isincluded in prepaid expenses and other current assets and the remaining portionof $0.3 million is included in other assets.

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In addition to the royalties, the Company paid Lycos a$4.5 million transition fee, which the Company recorded as an other assetand is amortizing the fee over the term of the agreement of five years.Amortization related to the transition fee was $0.2 million for each of thethree month periods ended March 31, 2006 and 2005. In accordance withSFAS 144, the Company periodically evaluates the recoverability of thisasset.

*AcquisitionEarn-Out Liability*

The Company had contingent obligations related to itsacquisition of Decide. The former Decide stockholders could receive up to anadditional $10.0 million, consisting of up to $2.5 million in cash and upto $7.5 million in common stock, subject to achievement of earn-out targetsrelating to Decide’s operating performance in 2005. In March 2006, theCompany paid $1.3 million and issued 0.4 million shares of common stock relatedto the achievement of 2005 earn-out targets which were accrued at December 31,2005.

*Indemnifications*

Inconnection with the Company’s commercial agreements, it providesindemnifications of varying scope and terms to customers, business partners andother parties with respect to certain matters, including, but not limited to,losses arising out of the Company’s breach of such agreements and out ofintellectual property infringement claims made by third parties.

(b) Litigation

The Company is not involvedin any material pending legal proceedings at this time.

 

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ITEM 2.   MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Quarterly Report on Form 10-Q includesforward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995. This Act provides a “safe harbor” forforward-looking statements to encourage companies to provide prospectiveinformation about themselves so long as they identify these statements asforward-looking and provide meaningful cautionary statements identifyingimportant factors that could cause actual results to differ from the projectedresults. All statements other than statements of historical fact, includingstatements regarding industry prospects and future results of operations orfinancial position, made in this Quarterly Report on Form 10-Q areforward-looking. We use words such as “anticipates,” “believes,” “expects,” “future”and “intends” and similar expressions to identify forward-looking statements. Forward-lookingstatements also include any other passages that relate to expected futureevents or trends that can only be evaluated by events or trends that will occurin the future. Forward-lookingstatements reflect management’s current subjective opinions, expectations,plans or projections and are inherently uncertain. Our actual results maydiffer significantly from management’s current expectations, plans orprojections. Readers are cautioned not to place undue reliance on these forward-lookingstatements, which speak only as of the date hereof. Certain risks anduncertainties that could cause our actual results to differ significantly frommanagement’s expectations are described in the section entitled “Risk Factors”and elsewhere in this Quarterly Report on Form 10-Q. Except asrequired by law, we undertake no obligation to update any forward-looking orother statements, whether as a result of new information, future events orotherwise. Readers are urged, however, to review the risk factors set forth inreports that we file from time to time with the Securities and ExchangeCommission (“SEC”). Unless the context requires otherwise in this QuarterlyReport on Form 10-Q, the terms “24/7 Real Media,” the “Company,” “we,”“us” and “our” refer to 24/7 Real Media, Inc. and its consolidatedsubsidiaries, and references to “24/7 Search” refer to 24/7 Search, Inc.,formerly 24/7 Website Results, Inc., and references to “Decide” refer toDecide Holdings Pty Limited, each a wholly owned subsidiary of 24/7 Real Media, Inc.

### **GENERAL**

24/7 Real Media is a pioneer in the Internetindustry, providing online advertising and search engine marketing (“SEM”)strategies since 1995, and has been publicly traded since 1998. Wehave three distinct lines of business, Media, Search and Technology, andoperate in twelve countries. Our Media business helps advertisers increasetheir reach through sophisticated targeting and a network of over 1,500affiliated Web sites. Our Search business enables marketers to maximize theirSEM spending and achieve optimum returns on their investments. Our Technologybusiness develops and licenses our powerful technology, which serves as theunderlying engine for everything we do.

*Media*

We sell advertising spacefor Web publishers through the 24/7 Web Alliance, a global alliance of Websites with brand names, quality content and global reach. Web publishers jointhe 24/7 Web Alliance to increase advertising revenues from the availableadvertising space on their Web sites, and we pay them a royalty for theiradvertising space. We solicit advertisers seeking online strategies to targetaudiences, build their brands and generate greater customer response.Advertisers purchase space through the 24/7 Web Alliance to make one purchaseacross several Web sites and to increase the return on their advertisingspending. We also use targeting technology to best select advertising spacemade available through the 24/7 Web Alliance for advertisers and to improve theperformance of under-utilized advertising space for Web publishers.

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We generate Media revenuefrom fees paid by client advertisers for advertising space. We typically selladvertising space on a cost-per-thousand-impressions (“CPM”) basis, enabling aclient advertiser to pay a fee based on the number of times its advertisementis displayed. We typically count an advertising impression each time a user’sWeb browser requests that our computer servers transmit the advertisement. Wemay charge higher CPMs to advertisers that purchase our advanced targetingsolutions, such as our behavioral targeting solution, in comparison to thosethat purchase advertising space that requires less specific targeting. We havealso generated limited media revenue from e-mail advertisements and marketingservices.

*Search*

We provide SEM servicesthat connect advertisers with consumers using search engines to findinformation, products and services. We leverage our relationships with searchengines and our understanding of search engine algorithms to help advertisersoptimize their Web pages and achieve better placement in algorithmicsearch engines. We also create Web site listings for advertisers and submittheir listings into the databases of pay-for-placement (“P4P”) andpaid-inclusion (“PI”) search engine platforms. We help advertisers determinethe keywords most relevant to their products and services and use advancedtechnology to manage keyword bidding simultaneously across P4P searchplatforms. Our technology shows advertisers which keywords lead users from searchengines to their Web sites and helps them optimize their advertising spendingto convert click-throughs (users who click on their advertisement and aredirected to their Web site) into sales.

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

*Technology*

We provide onlineadvertisement serving and analytics software to customers from software hostedlocally on the customers’ servers or from software hosted centrally on ourservers. Our technology products and services are all based on our proprietaryOpen AdSystem platform. We generate Technology revenue in the following ways:

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

*Open AdStream Local Software.* Wecharge fees to Web publishers for operating our OAS software locally from theirown servers. Our license agreements typically provide for a license fee, asoftware maintenance and technical support services fee and a training fee. Weoften base license fees on the forecasted number of advertising impressions aWeb publisher will serve using our software, the use of advanced softwaremodules and the license term.

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*Open Advertiser Service.* Wecharge service fees to advertisers and agencies for operating our OpenAdvertiser (“OAD”) advertisement serving software centrally from our servers.We determine our service fee by multiplying the CPM by the number ofadvertising impressions delivered. We typically bill service fees monthly. Theservice fee may vary based on the forecasted number of advertising impressionsa Web publisher will serve using our software and the service term, among otherfactors.

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

*Insight ACT Software.* OurInsight ACT software, which requires our OAS and Insight XE software solutions,enables Web publishers to identify and target segments of their audiences basedon user activity. We generate revenue from Insight ACT on the same basis as theassociated OAS and Insight XE arrangements.

We upgrade and issue new releases of our OAStechnologies from time to time. We recently released a new version, 6.0, of ourOAS platform targeted at Publishers, which builds on the previous 5.8 version,and also incorporates our Insight XE and Insight ACT products as modules,resulting in better integration of these previously stand alone technologies.Future versions on our OAS platform may also incorporate our Decide DNAtechnology, as well as functionalities of our OAD solution targetingAdvertisers.

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

# **RESULTS OF OPERATIONS**

### Thefollowing table compares the results of operations for the three month periodended March 31, 2006 to the results of operations for the three monthperiod ended March 31, 2005:

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| ** **                                                                                             | ** ** | **Three Months Ended March 31,**                 | ** ** | ** **                                                           | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                                                                                             | ** ** | **     2006     ** | ** ** | **     2005     ** | ** ** | **$ Var** | ** ** |
| ** **                                                                                             | ** ** | **(unaudited)**                                                      | ** ** | **(unaudited)**                                                      | ** ** | ** ** | ** ** |
| Revenues:                                                                                              |       |                                                                 |       |                                                                 |       |   |   |
| Media                                                                                                  |       | $                                                                    | 18,230     |                                                                 | $          | 14,229 |   | $ | 4,001 |   |
| Search                                                                                                 |       | 17,833                                                               |       | 9,622                                                                |       | 8,211 |   |
| Technology                                                                                             |       | 6,878                                                                |       | 5,219                                                                |       | 1,659 |   |
| Total revenues                                                                                         |       | 42,941                                                               |       | 29,070                                                               |       | 13,871 |   |
| Cost of revenues:                                                                                      |       |                                                                 |       |                                                                 |       |   |   |
| Media                                                                                                  |       | 12,576                                                               |       | 9,627                                                                |       | 2,949 |   |
| Search                                                                                                 |       | 13,092                                                               |       | 6,632                                                                |       | 6,460 |   |
| Technology (inclusive of $179 and $8 of stock-based  compensation, respectively)                       |       | 1,599                                                                |       | 1,000                                                                |       | — |   |
| Total cost of revenues                                                                                 |       | 27,267                                                               |       | 17,259                                                               |       | 10,008 |   |
| Gross profit                                                                                           |       | 15,674                                                               |       | 11,811                                                               |       | 3,863 |   |
| Operating expenses:                                                                                    |       |                                                                 |       |                                                                 |       |   |   |
| Sales and marketing (inclusive of $1,545 and $120 of  stock-based compensation, respectively)          |       | 7,985                                                                |       | 5,410                                                                |       | (5,410 | ) |
| General and administrative (inclusive of $6,338 and  $335 of stock-based compensation, respectively)   |       | 11,298                                                               |       | 4,919                                                                |       | (4,919 | ) |
| Product development (inclusive of $977 and $50 of  stock-based compensation, respectively)             |       | 2,758                                                                |       | 1,292                                                                |       | (1,292 | ) |
| Amortization of intangible assets and deferred  financing costs                                        |       | 890                                                                  |       | 1,140                                                                |       | (250 | ) |
| Restructuring costs                                                                                    |       | —                                                               |       | 973                                                                  |       | (973 | ) |
| Total operating expenses                                                                               |       | 22,931                                                               |       | 13,734                                                               |       | 9,197 |   |
| Loss from operations                                                                                   |       | (7,257                                                               | )          | (1,923                                                               | )          | (5,334 | ) |
| Interest income (expense), net                                                                         |       | 65                                                                   |       | (88                                                                  | )          | 153 |   |
| Change in fair  value of warrant liability                                                             |       | (252                                                                 | )          | 150                                                                  |       | (402 | ) |
| Recovery of  investment                                                                                |       | —                                                               |       | 2,100                                                                |       | (2,100 | ) |
| Impairment of  marketable securities                                                                   |       | —                                                               |       | (588                                                                 | )          | 588 |   |
| Other income  (expense), net                                                                           |       | 110                                                                  |       | (46                                                                  | )          | 156 |   |
| Loss before provision for income taxes and minority  interest in operations of consolidated subsidiary |       | (7,334                                                               | )          | (395                                                                 | )          | (6,939 | ) |
| Provision for income taxes                                                                             |       | (230                                                                 | )          | (11                                                                  | )          | (219 | ) |
| Minority  interest in operations of consolidated subsidiary                                            |       | 48                                                                   |       | —                                                               |       | 48 |   |
| Net loss                                                                                               |       | $                                                                    | (7,516     | )                                                                    | $          | (406 | ) | $ | (7,110 | ) |

 

**Revenues; Cost ofRevenues and Gross Profit**

*Media*

*Revenue*. We generateMedia revenue primarily from our 24/7 Web Alliance. Web Alliance revenue was$17.8 million for the three month period ended March 31, 2006, as comparedto $14.0 million for the three month period ended March 31, 2005, anincrease of 27.6%. The remaining Media revenue related to our e-mail services.

*Cost ofRevenues*.****Media cost of revenues consisted primarilyof fees paid to Web publishers in our 24/7 Web Alliance. Cost of revenues alsoincluded advertisement serving costs, which are intercompany charges from ourTechnology segment based on a fixed CPM.

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*GrossProfit*. Gross profitincreased $1.1 million or 22.9%, however, gross profit margin decreased to31.0% for the three month period ended March 31, 2006 from 32.3% for thethree month period ended March 31, 2005. The decrease in gross profitmargin was due to the increased contribution from regions with a lower grossprofit percentage, particularly Korea, partially offset by an increase in thepercentage of revenue we keep from Web sites and a decrease in the CPM foradvertisement serving costs. Advertisement serving costs were $0.4 million forboth the three month periods ended March 31, 2006 and 2005.

*Search*

*Revenue*. Search revenue was $17.8 million for thethree month period ended March 31, 2006, as compared to $9.6 million forthe three month period ended March 31, 2005, an increase of 85.3%. Theincrease was due to an increase in the number of accounts under management andan increase in the average revenue per advertiser account.

*Cost ofRevenues*. Search costof revenues consisted primarily of fees paid to our search engine distributionpartners, which are calculated as a percentage of revenues for algorithmicsearch engines and a fixed CPC for pay-for-placement search engines.

*Gross Profit*.Gross profit increased $1.8 million or 58.6%; however, gross profit marginsdecreased to 26.6% for the three month period ended March 31, 2006 from31.1% for the three month period ended March 31, 2005. The decrease ingross profit margin was primarily due to a decrease in margin in our Managed AccountService offering as a result of competition in the marketplace as well as theaddition of higher volume accounts, which usually command a better price. Thisdecrease was partially offset by a higher growth rate in our other, highermargin products primarily as a result of geographic expansion into Japan.

*Technology*

*Revenue*.****Technologyrevenue was $6.9 million for the three month period ended March 31, 2006,as compared to $5.2 million for the three month period ended March 31,2005, representing an increase of 31.8%. The increase primarily reflectsexpanded usage of OAS by existing customers and the addition of new customers.

*Cost of Revenues*.Technology cost of revenues consisted of costs for hosting, bandwidth,third-party license and support fees, support and maintenance of theinfrastructure, and salaries and benefits of related technical personnel, andis inclusive of stock-based compensation. The cost of revenues is offset byintercompany fees charged to our Media segment for advertisement serving.

*Gross Profit*.Gross profit increased $1.1 million or 25.1%; however, gross profit margindecreased to 76.8% for the three month period ended March 31, 2006, from80.8% for the three month period ended March 31, 2005. The decrease in thegross profit margin is due to the inclusion of stock based compensation and adecrease in the CPM for advertisement serving fees charged to the Mediasegment. Stock-based compensation for the three month periods ended March 31,2006 and 2005 was $0.2 million and $8,000, respectively.

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**Sales and Marketing Expenses**

Salesand marketing expenses consisted primarily of compensation and personnelrelated expenses for sales, account management, business development, affiliaterelations and marketing, and marketing costs such as advertising, trade showsand public and investor relations firms.

Sales and marketing expenses were $8.0 million for the three monthperiod ended March 31, 2006, and $5.4 million for the three month periodended March 31, 2005. The increase was primarily due to the inclusion ofstock based compensation of $1.5 million and $0.1 million for the three monthperiods ended March 31, 2006 and 2005, respectively. The remainder of theincrease was due to personnel-related costs as the number of employees includedin sales and marketing increased from 194 at March 31, 2005 to 203 at March 31,2006, increased commissions as a result of higher sales and an increase inmarketing activities. Excluding stock based compensation, sales and marketing expenses decreased as apercentage of revenue from 18.2% for the three month period ended March 31,2005 to 15.0% for the three month period ended March 31, 2006, as wecontinued to gain operating leverage.

**General and Administrative Expenses**

General and administrative expenses consisted primarily of compensationand related expenses for executive and administrative personnel, costs relatedto leasing, maintaining and operating our facilities and systems, insurance,bad debts, fees for professional services, fees associated with the reportingand other obligations of a public company, depreciation and other general andadministrative costs. Feesfor professional services included payments to external lawyers, accountantsand other professionals in connection with operating our business, complianceand evaluating and pursuing new opportunities.

General and administrative expenses were $11.3 million for the threemonth period ended March 31, 2006, and $4.9 million for the three monthperiod ended March 31, 2005. The increase was primarily due to theinclusion of stock-based compensation of $6.3 million and $0.3 million for thethree month periods ended March 31, 2006 and 2005, respectively. Theremaining increase was due primarily increased depreciation due to theimprovement and expansion of our infrastructure, additional professional feesas a result of increased compliance costs as well as additional personnelrelated costs. Excluding stock-based compensation, as a percentage of revenue,the expenses decreased from 15.8% to 11.6% for the three month periods ended March 31,2005 compared to the three month period ended March 31, 2006.

**Product Development Expenses**

Productdevelopment expenses consisted primarily of compensation and relatedexpenses for personnel responsible for the development and maintenance offeatures, enhancements and functionality and quality assurance for our software and services and developmentof new products.

Product development expenses were $2.8 million for the three monthperiod ended March 31, 2006, and $1.3 million for the three month periodended March 31, 2005. These amounts are inclusive of stock-basedcompensation of $1.0 million and $0.1 million for the three month periods endedMarch 31, 2006 and 2005, respectively. The increase reflects our continuedinvestment in the development and enhancement of our existing products andservices, as well as our exploration of new markets and product offerings. Thenumber of employees included in product development increased from 47 at March 31,2005 to 51 at March 31, 2006.

 

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**Amortization of Intangible Assets and Deferred FinancingCosts**

Amortizationexpense related to intangible assets acquired with Real Media in October 2001,24/7 Real Media Korea in January 2004 and Decide in August 2004;deferred financing costs associated with our subordinated convertible debentureoffering in September 2003; and a transition payment to Lycos, Inc.in connection with a strategic business relationship that we entered into in February 2004.

For the three month period ended March 31, 2006, amortizationexpense related $0.4 million to acquired technology, $0.1 million to otherintangible assets, $0.1 million to deferred financing costs, and $0.2 millionto the transition payment to Lycos. For the three month period ended March 31,2005, amortization expense was attributed as follows: $0.6 million to acquiredtechnology, $0.2 million to other intangible assets, $0.1 million to deferredfinancing costs and $0.2 million to the transition payment to Lycos.

**Restructuring Costs**

We recorded a restructuring charge related to our former NewYork headquarters of $1.0 million for the three month period ended March 31, 2005.

**Interest Income (Expense), Net**

Interest income (expense), net, related to our long-term debt andcapital lease obligations offset by interest income related to our cash andcash equivalents. Interest income of $0.1 million and interest expense of $0.2million for the three month periods ended March 31, 2006 and March 31,2005, respectively, primarily related to the $15.0 million of subordinatedconvertible debentures due September 2006 we issued on September 26,2003, of which a portion of the interest incurred relates to a cash payment dueand a portion related to the amortization of warrants issued with thedebentures. Interest expense in these quarterly periods in 2005 and 2006 wasoffset by interest income from cash in overnight deposits and money marketaccounts.

**Change in Fair Value of Warrant Liability**

Our liability relates to warrants outstanding from our preferred stockoffering, and is adjusted to fair value at the end of each reporting period.The expense for the three month period ended March 31, 2006 was due to anincrease in the fair market value of the warrants outstanding, which increasedthe corresponding liability. The increase in the fair market value wasprimarily due to the higher fair market value of our common stock compared tothe fair market value of our common stock at December 31, 2005.

**Recovery of Investment**

In January 2005, wereceived $2.1 million as a return on an investment in Bidland Systems, Inc.(“Bidland”) and subsequently received another $0.2 million in the fourthquarter of 2005. The return was a result of the settlement of pendinglitigation between Bidland and another party and the subsequent dissolution andliquidation of Bidland.

**Minority Interest in Operations of Consolidated Subsidiary**

Minority interest in operations of consolidated subsidiary representsthe percentage share of losses attributable to holders who have a minorityinterest in subsidiaries in which we hold an interest that is greater thanfifty percent, but less than 100 percent, and the results of which weconsolidate in our consolidated financial statements. This amount relates tothe activity of K.K. 24-7 Search, our joint venture with Dentsu. Thecarrying value of the investment was approximately $1.6 million for bothperiods ended March 31, 2006 and December 31, 2005.

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**Other Income (Expense), Net**

Other income (expense), net for the three months ended March 31,2006 consisted of earn-out payments received in excess of amounts recorded,offset by legal fees associated with a former subsidiary that we shut down andrealized foreign currency losses.

Other income (expense), net for the three months ended March 31,2005 consisted primarily of legal fees associated with a former subsidiary thatwe shut down.

**LIQUIDITY AND CAPITAL RESOURCES**

Cash flows for the three month periods ended March 31,2006 and 2005 were as follows (in thousands):

 

|                                                      | ** ** | **Three Months Ended March 31,**                             | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **      2006      ** | ** ** | **      2005      ** | ** ** |
| Net cash  provided by operating activities           |       | $                                                                                | 354        |   | $ | 1,761 |   |
| Net cash  provided by (used in) investing activities |       | $                                                                                | (795       | ) | $ | 598 |   |
| Net cash provided by  financing activities           |       | $                                                                                | 1,803      |   | $ | 59 |   |

 

Historically we have financed our operations through equity financingsand long-term debt and more recently through cash generated by operations. Netcash provided by operating activities was $0.4 million and $1.8 million duringthe three month periods ended March 31, 2006 and 2005, respectively. Netcash provided by operating activities is generally due to our net operatinglosses, adjusted for certain non-cash items included in our net operatingresults, as well as changes in various components of working capital,particularly fluctuations in accounts receivable.

Net cash used in investing activities was approximately $0.8 millionduring the three month period ended March 31, 2006, and consisted ofcapital expenditures for operational purposes. Net cash provided by investingactivities was approximately $0.6 million during the three month period ended March 31,2005, and consisted of $0.6 million of proceeds from maturities of short-terminvestments and $2.1 million from the recovery of an investment, offset by $2.1million in capital expenditures for operational purposes.

Financing activities provided $1.8 million and $59,000 in the threemonth period ended March 31, 2006 and 2005, respectively. Financingactivities during the three month period ended March 31, 2006 wereattributed as follows: $0.2 million of proceeds from the note receivable duefrom IMAKE, and $2.9 million from the exercise of common stock options, offsetby a $1.3 million earn-out payment related to the 2004 acquisition of Decide.Financing activities in the first quarter of 2005 related to proceeds from theexercise of common stock options.

On September 26,2003, we completed the placement to an institutional accredited investor of$15.0 million of our subordinated convertible debentures. If at any time on orafter September 26, 2005, the second anniversary of the initial issuancedate, the weighted average price of our common stock is less than $8.75 on anyfive consecutive trading days, the holder has the right, in its solediscretion, to require that we redeem up to $7.5 million in principal amount ofthe debentures. This condition has been met, and management believes the holdermay exercise its right to require redemption. Management believes existing cashand investments will be sufficient to meet the obligation to redeem, should theholder exercise its right.

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The Companymaintains cash balances at the subsidiary level to meet short-term capitalrequirements and to satisfy local statutory liquidity requirements. Theserequirements, as well as local tax implications, may limit the amount ofcapital that can be repatriated from certain subsidiaries. These funds arefreely available to the subsidiaries for operationalpurposes. Specifically, K.K. 24-7 Search has $2.9 million in cash asof March 31, 2006 that must be kept in Japan for operational purposes.

We continue toincrease capital expenditures and operating lease commitments, which isconsistent with our increased staffing and operational expansion, and weanticipate this will continue in the future as business conditionsmerit. Additionally, we will continue to evaluate possible acquisitionsof, or investments in businesses, products and technologies that arecomplementary to our business, which may require the use of cash. Managementbelieves existing cash and investments will be sufficient to meet operatingrequirements for at least the next twelve months; however, we may selladditional equity or debt securities or obtain credit facilities to furtherenhance our liquidity position. The sale of additional securities could resultin further dilution to our stockholders.

The Company is subjected to routine tax examinations by taxingauthorities at the federal, state and local levels in the US and by variouslevels in foreign countries. As of March 31, 2006, there are severalreviews being conducted and Management is of the opinion that the ultimateoutcome of these examinations would not have a material adverse impact on thefinancial position of the Company or the results of its operations.

**OFF-BALANCESHEET ARRANGEMENTS**

We did not haveany relationships with unconsolidated entities or financial partnerships, suchas entities often referred to as structured finance or special purposeentities, which would have been established for the purpose of facilitating off-balancesheet financial arrangements or other contractually narrow or limited purposesat March 31, 2006. Accordingly, we are not materially exposed to anyfinancing, liquidity, market or credit risk that could arise if we had engagedin such relationships.

Common stock warrants issued in conjunction with our subordinatedconvertible debentures are equity-linked derivatives and accordingly representoff-balance sheet arrangements. In addition, the conversion and redemptionfeatures of the subordinated convertible debentures constitute an embeddedderivative. Some of the common stock warrants and the conversion and redemptionfeatures meet the scope exception in paragraph 11(a) of the Statement ofFinancial Accounting Standards No. 133, *Accountingfor Derivative Instruments and Hedging Activities*(“SFAS 133”), andare accordingly not accounted for as derivatives for purposes of SFAS 133, butinstead are accounted for as equity. See note 5 to the consolidated financialstatements for more information.

**CRITICAL ACCOUNTING POLICIES**

***General***

Ourinterim consolidated financial statements are prepared in conformity withaccounting principles generally accepted in the United States of America. Assuch, management is required to make certain estimates, judgments andassumptions that it believes are reasonable based upon the informationavailable. These estimates, judgments and assumptions affect the reportedamounts of assets and liabilities and the disclosure of contingent assets andliabilities at the dates of the consolidated financial statements and thereported amounts of revenues and expenses during the reporting periods.

The significant accounting policies that we believe are the mostcritical to aid in fully understanding and evaluating the reported consolidatedfinancial results are the following:

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***Revenue Recognition;Cost of Revenue; Deferred Revenue***

*Media*

Our Media revenueis generated from fees paid by client advertisers for advertising impressions.We typically offer advertisers a pricing model based on CPM, which enables aclient advertiser to pay a fee based on the number of times its advertisementis displayed. E-mail related revenue is derived from delivering advertisementsto e-mail lists for advertisers. Agreements are primarily short-term and revenueis recognized as services are delivered, provided that no significantobligations remain outstanding and collection of the resulting receivable isprobable. We become obligated to make royalty payments to Web sites and e-maillists that have contracted with us in the period in which the advertisingimpressions or e-mails are delivered. Such expenses are classified as cost ofrevenue in the consolidated statements of operations.

*Search*

Our revenue fromour Search segment is primarily based on CPC fees paid by client advertisers.CPC fees are generated each time users click on Web site listings that wesubmitted into search engine databases and are directed to our clientadvertisers’ Web sites. To a lesser extent, we also generate revenue from feespaid by search engines that employ us to optimize the submission of Web sitelistings and report on advertising campaigns for their advertisers. Agreementsare primarily short-term and revenue is recognized as services are delivered,provided that no significant obligations remain outstanding and collection ofthe resulting receivable is probable. We become obligated to make payments tosearch engine distribution partners that have contracted with us in the periodin which the clicks occur. Such expenses are classified as cost of revenue inthe consolidated statements of operations. When we provide SEM services as anagent for a fixed commission or in other transactions in which we do not haveprincipal risk and reward, we recognize revenue on a net basis.

*Technology*

Our Technologyrevenue is derived primarily from licensing of our software, hostedadvertisement serving and software maintenance and technical support services.Revenue from advertisement serving hosted centrally on our servers isrecognized upon delivery. Revenue from software licensing agreements isrecognized in accordance with Statement of Position (“SOP”) No. 97-2,*Software Revenue Recognition*, andSEC Staff Accounting Bulletin (“SAB”) No. 104, *Revenue Recognition*, upon delivery of the software, which isgenerally when the software is made available for download, there is persuasiveevidence 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. Contracts that bundle thesoftware license with software maintenance and technical support are recognizedratably over the contract term. Revenue from software maintenance and technicalsupport contracts is recognized ratably over the life of the agreement, whichtypically does not exceed one year.

Expenses relatedto our Technology revenue are primarily payroll costs incurred to deliver andsupport the software, and hosting, bandwidth and license fees paid tothird-party software vendors. These expenses are classified as cost of revenuein the consolidated statements of operations.

*DeferredRevenue*

We defer revenuebilled or collected in advance of services being completed until the conclusionof the service period to which the advance billing or collection relates.Deferred revenue is included on the

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consolidatedbalance sheets as a current liability until the service is performed, and thenrecognized in the period in which the service is completed. Our deferredrevenue primarily consist of advance billings for software licensesubscriptions and software maintenance and technical support services.

***Allowance forDoubtful Accounts; Sales Allowance***

We maintain anallowance for doubtful accounts to reserve for potentially uncollectiblereceivables and a sales allowance to reserve for potential credits issued tocustomers. The allowances are estimates calculated based on an analysis ofcurrent business and economic risks, customer credit-worthiness, specificidentifiable risks such as bankruptcies, terminations or discontinuedcustomers, or other factors that may indicate a potential loss.

***Impairment ofLong-Lived Assets***

We evaluategoodwill and indefinite lived intangible assets on an annual basis and wheneverevents or changes in circumstances indicate that a carrying amount may not befully recoverable. Long-lived assets, including property and equipment,long-term assets and amortizable intangible assets, are reviewed for impairmentwhenever events or changes in circumstances indicate that the carrying amountmay not be fully recoverable. Conditions that would necessitate an impairmentassessment include a significant decline in the observable market value of anasset, a significant change in the extent to which or manner in which an assetis used or a significant adverse change that would indicate that the carryingamount of an asset or group of assets is not recoverable. We assess impairmentin accordance with the requirements of SFAS 144, *Accounting for the Impairment or Disposal of Long-Lived Assets*. We assess the impairment ofgoodwill and intangible assets in accordance with the provisions of SFAS No. 142,*Goodwill and Other Intangible Assets*. We determine the recoverability ofthe assets by comparing the carrying amount of the assets to net future cashflows that the assets are expected to generate. The impairment we recognize isthe amount by which the carrying amount exceeds the fair market value of theassets.

***Business Combinations***

Our acquisitionsare accounted for as purchase business combinations in accordance with SFAS No. 141,*Business Combinations*, and SFAS No. 142,*Goodwill and Other Intangible Assets*. Weallocate a portion of the purchase price to identifiable tangible andintangible assets based on their respective fair values, and record as goodwillany remaining unallocated portion of the purchase price. Intangible assetsinclude trademarks, customer relationships, acquired technology and covenantsnot to compete. Such intangible assets are amortized on a straight-line basisover their estimated useful lives, which are generally two to seven years,except for trademarks that have an indefinite life.

***Contingencies and Litigation***

We evaluatecontingent liabilities, including threatened or pending litigation, in accordancewith SFAS No. 5, *Accounting forContingencies*, and record accruals when the outcome of these mattersis deemed probable and the potential liability is reasonably estimable. We makethese assessments based on the facts and circumstances and in some instancesbased in part on the advice of outside legal counsel.

***RestructuringEstimates***

We account for restructuring activities in accordancewith SFAS No. 146, *Accounting for CostsAssociated with Exit or Disposal Activities*. Restructuring-relatedliabilities include estimates for, among other things, involuntary terminationsof employees and disposition of lease obligations. Key variables in

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determining such estimates include timing of subleaserentals, estimates of sublease rental payment amounts and tenant improvementcosts, and estimates for brokerage and other related costs. We periodicallyevaluate and, if necessary, adjust the estimates based on currently availableinformation.

***Investments***

 Investmentsconsist of securities with stated maturities of three months or more andmarketable securities consisting of registered corporate equity securities. Weclassify the marketable securities as available-for-sale in accordance withSFAS No. 115, *Accounting for CertainInvestments in Debt and Equity Securities*. Available-for-salesecurities are carried at fair value, with the unrealized gains or losses, netof tax, reported as a separate component of stockholders’ equity. Indetermining realized gains and losses, the cost of securities sold is basedupon specific identification. Realized gains and losses and declines in valuejudged to be other-than-temporary, are included in the consolidated statementsof operations.

Investments in non-marketable equity securities ofcompanies in which we own less than 20% of a company’s stock and do not havethe ability to exercise significant influence are accounted for on the costbasis. On an ongoing basis, we assess the need to record impairment losses oninvestments and record such losses when the impairment is determined to beother-than-temporary.

***Stock-BasedCompensation***

Effective January 1, 2006, the Company adopted Statement ofFinancial Accounting Standards No. 123 (revised 2004) (“SFAS No. 123R”),“*Share-Based Payment*,” using themodified prospective transition method. Under this method, stock-basedcompensation expense is recognized using the fair-value based method for allawards granted on or after the date of adoption. Compensation expense forunvested stock options and awards that were outstanding on January 1, 2006will be recognized over the requisite service period based on the grant-datefair value of those options and awards as previously calculated under the proforma disclosures under SFAS No. 123. The modified prospectivetransition methods allows that prior interim periods and fiscal years reportedwill not reflect restated amounts. The Company determines the fair value ofthese awards using the Black-Scholes option pricing model.

**MARKET FOR COMPANY’S COMMON EQUITY**

From our initial public offering on August 13,1998 until June 2002, our common stock was traded on the NASDAQ NationalMarket under the symbol “TFSM.”  In June 2002,we transferred our common stock to the NASDAQ SmallCap Market, where itcontinued to trade under the same symbol. Our common stock was approved forre-listing on the NASDAQ National Market effective November 3, 2005, whereit continues to trade under the symbol “TFSM.”

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

ITEM3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

We are exposed to the impactof interest rate changes and foreign currency fluctuations.

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*Interest Rate Risk*

The primary objective of ourinvestment activities is to preserve capital. Cash and cash equivalents areinvestments with original maturities of three months or less. Therefore,changes in the market’s interest rates do not affect the value of theinvestments as recorded by 24/7 Real Media. The following table presents theamounts of our financial instruments that are subject to interest rate risk by expectedmaturity and average interest rates as of March 31, 2006 (in thousands,except percentages):

 
| ** **                 | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **Thereafter** | ** ** | **Total (1)** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|--------------------|------------|
| Cash and cash  equivalents |       | $        | 41,562     |     | $          | —   |       | $        | —     |     | $          | —         |       | $                  | —     |   | $ | — |   | $ | 41,562 |   |
| Average interest rate      |       | 4.36     | %          |     |       |     |       |     |       |     |       |           |       | 4.36               | %          |
|                            |            |          |            |          |            |          |            |          |            |          |            |                |            |                    |            |  |  |  |  |  |  |  |

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(1) Due to the short-term nature of our cashand cash equivalents, the amounts presented represent the fair value as of March 31,2006.

*Foreign Currency Risk*

International revenuesaccounted for approximately 58.1% of our total revenues during the firstquarter of 2006, as compared to 52.3% during the first quarter of 2005. Thegrowth in our international operations has increased our exposure to foreigncurrency fluctuations. Revenues and related expenses generated from our internationalsubsidiaries are generally denominated in the functional currencies of thelocal countries. Primary currencies include Euros, British Pounds, JapaneseYen, Korean Won, Canadian Dollars and Australian Dollars. The income statementsof our international operations are translated into U.S. dollars at the averageexchange rates in each applicable period. To the extent the U.S. dollar weakensagainst foreign currencies, the translation of these foreign currencydenominated transactions results in increased revenues, operating expenses andnet income for our foreign operations. Similarly, our revenues, operatingexpenses and net income will decrease for our international segments when theU.S. dollar strengthens against foreign currencies. Realized foreign currencytransaction gains (losses) included in other income in the consolidatedstatements of operations were immaterial for the quarters ended March 31,2006 and 2005. We expect to use the assets denominated in foreign currenciesfor project execution expenditures in the currency in which they are held asthe risk of realized translation losses is mitigated.

We considered the historicaltrends in currency exchange rates and determined that it was reasonablypossible that changes in exchange rates of 10% for all currencies could beexperienced in the near term. These changes would have resulted in animmaterial impact on income (loss) before provision for income taxes andminority interest in operations of consolidated subsidiary for the quartersended March 31, 2006 and 2005.

ITEM 4. CONTROLS AND PROCEDURES

*Evaluationof Controls and Procedures*

As of the end of theperiod covered by this Quarterly Report on Form 10-Q, an evaluationof the effectiveness of the design and operation of our disclosure controls andprocedures was carried out by us under the supervision and with theparticipation of our management, including our Chief Executive Officer andChief Financial Officer. Based on that conclusion, our Chief Executive Officerand Chief Financial Officer concluded that our disclosure controls andprocedures have been designed and are being operated in a manner that providesreasonable assurance that the information required to be disclosed in ourExchange Act reports is recorded, processed, summarized and reported within the

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time periods specified inthe SEC’s rules and forms, and that such information is accumulated andcommunicated to our management, including our Chief Executive Officer and ChiefFinancial Officer, as appropriate, to allow timely decisions regarding requireddisclosure. In designing and evaluating the disclosure controls and procedures,our management recognizes that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving thedesired control objectives, and our management necessarily is required to applyits judgment in evaluating the cost-benefit relationship of possible controlsand procedures.

In 2005, as a complementto our existing overall program of internal control, we initiated acompany-wide review of our internal control over financial reporting as part ofthe process for compliance with Section 404 of the Sarbanes-Oxley Act of2002. As a result of the review, we have made improvements to the design andeffectiveness of our internal control through the three month period ended March 31,2006. We anticipate that improvements will continue to be made.

*Disclosure Controls andProcedures*

We have established disclosure controls andprocedures to ensure that material information relating to the Company,including its consolidated subsidiaries, is made known to the officers whocertify the Company’s financial reports and to other members of seniormanagement and the Board of Directors.

Our management, with the participation of our ChiefExecutive Officer and Chief Financial Officer, has evaluated the effectivenessof our “disclosure controls and procedures” (as defined in Exchange Act Rules 13a-15(e) and15d-15(e)) as of the end of the period covered by this report. Based on suchevaluation, our Chief Executive Officer and Chief Financial Officer haveconcluded, as of March 31, 2006, that the Company’s disclosure controlsand procedures are effective to ensure that the information required to bedisclosed by the Company in the reports that it files or submits under theExchange Act is recorded, processed, summarized and reported within the timeperiods specified in SEC rules and forms, and to ensure that informationis accumulated and communicated to our management, including the ChiefExecutive Officer and Chief Financial Officer, as appropriate to allow timelydecisions regarding required disclosure.

Dueto its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies and procedures may deteriorate.

*Changesin Internal Control over Financial Reporting*

There has been no change in our internal control overfinancial reporting (as defined in Exchange Act Rules 13a — 15(f) and15d — 15(f)) during our most recent fiscal quarter that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

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PART II.OTHER INFORMATION

**ITEM 1. LEGAL PROCEEDINGS**

We are not involved in any material pending legalproceedings at this time, and management is not aware of any contemplatedproceeding by any governmental authority.

**ITEM 1A. RISK FACTORS**

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

WE MAY NOT BE ABLE TO SUSTAIN OURPROFITABILITY.

We achieved profitability in accordance with generallyaccepted accounting principles in the United States, or GAAP, for the full yearended December 31, 2005; however, we incurred net losses of $7.5 millionfor the three months ended March 31, 2006 and $0.4 million for the threemonths ended March 31, 2005. We may not achieve profitability for futurequarterly or annual reporting periods. We may incur net losses for theforeseeable future. Even if we do maintain profitability, we may not be able tosustain or increase profitability in the short-term or long-term on a quarterlyor an annual basis.

WE MAY NOT BE ABLE TO SUCCESSFULLY UPGRADE ANDINTEGRATE OUR EXISTING PRODUCTS AND TECHNOLOGY.

Our ability to compete depends, in part, on oursuccess at upgrading and integrating our existing products and technology. Fromtime to time we upgrade and issue new releases of our existing technology tointegrate new functionalities and respond to industry developments. Forexample, we have just released a new version of our flagship platform, OAS 6.0targeted at Publishers, which incorporates the older 5.8 version but also fullyintegrates the previous Insight XE and Insight ACT technologies as modules;only a few of our customers have implemented OAS 6.0 and we will transition theremainder of our central adserving customers to it over the remainder of 2006.Future versions of OAS 6.0 may incorporate our Decide DNA technology. We mayalso build functionalities of our existing OAD solution and create a version ofOAS targeted at Advertisers. We may experience delays, difficulties orincreased costs that could hinder or prevent the successful design,integration, development, introduction, implementation or marketing of newreleases of our technology. In addition, we must ensure that performance levelsof our technology remain steady when we release new versions to our customers. Anymaterial delays in introducing a new release or performance problems couldcause us to lose customers and cause our revenue to decline.

OUR INTERNATIONAL OPERATIONS FACE LEGAL AND CULTURALCHALLENGES AND SUBJECT US TO ADDITIONAL RISKS.

We have operations in a number of internationalmarkets, including Australia, Canada, Europe Japan and South Korea, and wecurrently derive more than half our revenue from non-U.S. markets. To date, wehave limited experience in marketing, selling and distributing our solutionsinternationally. Our international operations are subject to other risks,including:

·                  changesin regulatory requirements;

·                  reducedprotection for intellectual property rights in some countries;

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

·                  localstatutory liquidity requirements for businesses operating in certain foreigncountries;

·                  theneed to maintain cash balances to meet short-term capital requirements;

·                  operationsin foreign countries with higher tax rates than the United States;

·                  theinability to utilize certain foreign tax credits; and

·                  theinability to utilize some or all of losses generated in one or more foreigncountries;

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

·                  difficultiesand costs of staffing and managing foreign operations;

·                  locallaw requirements governing employment contracts, which may impose, among otherthings, minimum notice periods and minimum severance payments for involuntaryterminations;

·                  politicaland economic instability;

·                  fluctuationsin currency exchange rates; and

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

Any or all of these risks could affect our businessoutside of the United States and negatively impact our results of operations.

OUR SEARCH BUSINESS IS CURRENTLY OUR FASTEST GROWINGBUSINESS SEGMENT, AND WE MAY HAVE INEFFICIENCIES IN OUR BUSINESS MODEL OR MAY BEUNABLE TO CAPITALIZE ON CURRENT OR FUTURE SEARCH TRENDS.

Our Search segment has been growing faster than ourother business segments. The search industry is still relatively new,competition is high and there are no set parameters among service providers asto how to run campaigns, track data or include more complex features, such asbehavioral targeting. We are working to develop set standards as our Searchbusiness grows, but our current strategies may not be successful in thelong-run. As a result, it is difficult to predict how our Search segment willperform in the future. For example, revenue in the segment has increasedsignificantly in recent periods, while margins have decreased as our lowergross margin managed SEM services business performed better than other searchareas. Further, we have and may continue to encounter inefficiencies, such asthe under or over-delivery of campaigns due to programming difficulties, orset-backs, such as outdated methodologies and tools that must be reconfiguredor replaced. Furthermore, our success in SEM is dependent in part on ourability to develop and maintain good relationships with our search enginedistribution partners, who both cooperate and compete with us for searchclients. There is no guarantee that our current or future Search 

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software and techniqueswill meet our clients’ needs, successfully manage increasingly complexcampaigns or be profitable for our business.

WE ARE UNDERTAKING SEVERAL GLOBAL INITIATIVES IN ORDERTO BETTER LEVERAGE OUR BUSINESS, AND OUR EFFORTS MAY NOT BE SUCCESSFUL OR MAY NOTBE BENEFICIAL TO EACH OF THE OFFICES IN WHICH WE OPERATE.

In order to realign and better leverage our businesswe have commenced several global initiatives, including harmonizing our globalproduct lines across the offices in which we operate and creating globalstandards for product management, development and marketing, which we willcontinue during the remainder of 2006. In order to synchronize our variousoffices and create a uniform worldwide business model we will need to, amongother things, set up uniform processes, formalize and build out trainingcourses, set up global information sharing and communication processes,identify and track productivity and cost measurements and identify areas ofinefficiency and develop global recovery plans. While we anticipate that theglobal realignment will have cost and efficiency savings for our business,there is no guarantee that our global efforts will be successful over the longrun. Additionally, the global business model that we implement for each of ourbusiness segments may not be the ideal standard for each of our offices, andmay result in increased costs and decreased savings for particular offices andlines of business throughout our organization.

OUR ACQUISITIONS, WHICH HAVE BEEN CRITICAL TO OURGROWTH, MAY NOT BE SUCCESSFUL AND COULD ADVERSELY AFFECT OUR ABILITY TOPROJECT RESULTS.

We were formed in February 1998 to consolidatethree Internet advertising companies, and have since acquired or entered intojoint ventures with many other companies. Most recently, in September 2005,we formed a joint venture with the advertising company Dentsu to provide ourSEM services in Japan. We may continue pursuing selective acquisitions ofbusinesses, technologies and product lines and additional joint ventures as akey component of our growth strategy. If we acquire additional companies orexpand our business lines through joint ventures, we will continue to facerisks of integrating and improving our financial and management controls,advertisement serving technology, reporting systems, infrastructure andprocedures, and expanding, training and managing our work force. This processof integration may take a significant period of time and may require thededication of global resources, personnel and members of management, on a shortor long-term basis, which may distract management’s attention from our otheroperations. Any future acquisition, investment or joint venture may result inthe use of significant amounts of cash, potentially dilutive issuances ofequity securities, the incurrence of debt and amortization expenses related tointangible assets. In addition, acquisitions involve numerous risks, including:

·                  thedifficulties in the integration and assimilation of the operations,technologies, products and personnel of an acquired business and unexpectedexpenses related to the integration and assimilation;

·                  theneed to implement or remediate controls, procedures and policies appropriatefor a U.S. public company at an acquired business that, prior to theacquisition, lacked such controls, procedures and policies;

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

·                  theavailability of favorable acquisition financing for future acquisitions; and

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·                  thepotential loss of key senior managers or employees of any acquired business.

Our inability to successfully integrate any acquiredcompany, or failure to achieve any expected synergies of an acquisition orjoint venture, could adversely affect our business.

OUR FUTURE REVENUES AND RESULTS OF OPERATIONS MAY BEDIFFICULT TO FORECAST AND RESULTS IN PRIOR PERIODS MAY NOT BE INDICATIVEOF FUTURE RESULTS.

At times in the past and in certain segments, ourrevenues have grown significantly and have decreased significantly. Accuratepredictions of future revenues are difficult, among other things, because ofthe rapid changes in the markets and regulatory environment in which weoperate.

Our results of operations have fluctuated and maycontinue to fluctuate significantly in the future as a result of a variety offactors, many of which are beyond our control. These factors include:

·                  theaddition of new clients or the loss of existing clients;

·                  changesin fees paid by advertisers or other clients;

·                  changesin the amount of royalties payable by us to owners of Web sites or theimposition of new charges or fees by Web site owners;

·                  thedemand by advertisers and Web publishers for our advertising solutions;

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

·                  variationsin the levels of capital or operating expenditures, accounts receivable andpayable, and other costs relating to the maintenance or expansion of ouroperations, including personnel costs;

·                  seasonality,which tends to result in lower revenue during the summer months of the thirdquarter and higher revenue in the fourth quarter of each year;

·                  changesin results of operations brought about by newly acquired businesses or newjoint ventures, which may be exceedingly difficult to predict due to management’slack of history with such businesses or joint ventures;

·                  changesin governmental regulation of the Internet or other regulatory requirements;

·                  changesin accounting principles or any determination that one or more of the estimatesor assumptions underlying our financial statements if faulty; and

·                  generaleconomic conditions.

Our future revenues and results of operations may bedifficult to forecast due to the above factors and the time we may need toadequately respond to any changes in them. For example, certain of the searchengines that we partner with in the management of SEM services plan to imposeadditional charges for using their technology interfaces to assist our clients.Our profit margins may suffer if we are unable to pass some of these types ofcosts on to our customers. In addition, our expense levels are based in large

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part on our investment plans and estimates of futurerevenues. Any increased expenses may precede or may not be followed byincreased revenues, as we may be unable to, or may elect not to, adjustspending in a timely manner to compensate for any unexpected revenue shortfall.As a result, we believe that period-to-period and year-to-year comparisons ofour results of operations may not be meaningful.

OUR TECHNOLOGY PRODUCTS AND SERVICES ARE BASED ON OURPROPRIETARY OPEN ADSYSTEM PLATFORM, AND OUR BUSINESS WOULD SUFFER IF OPENADSYSTEM WAS DISRUPTED.

Open AdSystem is our proprietary advertisement servingtechnology and serves as our sole advertisement serving solution. We havedeveloped a variety of products to work on or with this platform, and our Mediabusiness also utilizes Open AdSystem technology. We must, among other things,ensure that the technology will continue to function efficiently at highvolumes, interact properly with our database, offer the functionality demandedby our customers and assimilate our sales and reporting functions. Customersmay become dissatisfied by any system failure that interrupts our ability toprovide our services to them, including failures affecting our ability todeliver advertisements or report on advertisement delivery without significantdelay. Sustained or repeated system failures would reduce the attractiveness ofour solutions to advertisers, advertising agencies and Web publishers andresult in contract terminations, fee rebates and make-goods, thereby reducingour revenue. Slower response time or system failures may also result fromstraining the capacity of our deployed software or hardware due to an increasein the volume of advertising delivered through our servers. To the extent thatwe do not effectively address any capacity constraints or system failures, ourbusiness, results of operations and financial condition could be materially andadversely affected.

OUR REVENUE COULD DECLINE IF WE FAIL TO EFFECTIVELYMANAGE ADVERTISING INVENTORY MADE AVAILABLE TO US, AND OUR GROWTH COULD BEIMPEDED IF WE FAIL TO ACQUIRE ACCESS TO NEW ADVERTISING INVENTORY.

Our success depends in part on our ability toeffectively manage advertising inventory made available to us. The Webpublishers that list their unsold advertising inventory with us are not boundby long-term contracts. In addition, Web publishers can change the amount ofinventory they make available to us at any time. If a Web publisher decides notto make advertising space from its Web sites available to us, we may not beable to replace this advertising space with advertising space from other Websites that have comparable traffic patterns and user demographics quicklyenough to fulfill our advertisers’ requests. This would result in lost revenue.We expect that our customers’ requirements will become increasinglysophisticated as the Web continues to mature as an advertising medium. If wefail to manage our existing advertising space effectively to anticipate or meetour customers’ changing requirements, our revenue could decline. Our growthalso depends on our ability to expand our advertising inventory. To attract newadvertisers, we must maintain a consistent supply of attractive advertisingspace. We intend to expand our advertising inventory by selectively adding toour network new Web publishers that offer attractive demographics, innovativeand quality content and large audiences. Our ability to attract new Webpublishers to our network and to retain Web publishers currently in our networkwill depend on various factors, some of which are beyond our control. Thesefactors include our ability to introduce new and innovative product lines andservices, our ability to efficiently manage our existing advertising inventory,our pricing policies and the cost-efficiency to Web publishers of outsourcingall or part of their advertising sales. In addition, the number of competingintermediaries that purchase advertising inventory from Web publisherscontinues to increase. The size of our inventory may not increase or evenremain constant in the future, which could cause our advertising revenue todecline significantly.

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WE COULD LOSE CUSTOMERS OR ADVERTISING INVENTORY IF WEFAIL TO MEASURE IMPRESSIONS, CLICKS AND ACTIONS ON ADVERTISEMENTS IN A MANNERTHAT IS ACCEPTABLE TO OUR ADVERTISERS AND WEB PUBLISHERS.

We earn advertising revenue and make payments to Webpublishers based on the number of impressions, clicks and actions fromadvertisements delivered on our network. Advertisers’ and Web publishers’willingness to use our services and join our network will depend on the extentto which they perceive our delivery of advertisements and our measurements ofclicks to be accurate and reliable. Advertisers and Web publishers oftenmaintain their own technologies and methodologies for counting clicks, and fromtime to time we have had to resolve differences between our measurements andtheirs or regarding over-delivery of advertising impressions. Further, searchadvertisers are paying much closer attention to allegations of click fraud —which can occur when a user intentionally clicks on an advertisement displayedon a Web site for a reason other than to view the related content — in theindustry generally and have become more willing to inquire about or challengeclick counts related to SEM services. Any significant dispute over the propermeasurement of clicks or other user responses to advertisements could cause usto lose customers, advertising inventory and revenue, could substantiallyreduce the gross profit margin we generate in our media and search businessesand could lead to a class action or other litigation.

CHANGES IN THE ACCOUNTING RULES FOR STOCK-BASEDCOMPENSATION MAY ADVERSELY AFFECT OUR OPERATING RESULTS, OUR STOCK PRICEAND OUR ABILITY TO ATTRACT AND RETAIN EMPLOYEES.

We have a history of using employee stock options andother stock-based compensation to attract, motivate and retain our staff. In December 2004,the Financial Accounting Standards Board issued the revised SFAS No. 123, *Share-Based Payment*, which requires us, as of January 1,2006, to measure compensation costs for all stock-based compensation (includingstock options) at fair value and to recognize these costs as expenses in ourstatements of operations. The recognition of these expenses in our statementsof operations for the fiscal quarter ended March 31, 2006 had a negativeeffect on our earnings per share, which could negatively impact our stockprice. In addition, if we reduce or alter our use of stock-based compensationto minimize the recognition of these expenses, our ability to attract, motivateand retain qualified personnel may be impaired, which could be detrimental toour business.

WE DISCLOSE PRO FORMA INFORMATION, WHICH MAY EXCLUDEITEMS THAT ARE IMPORTANT TO AN INVESTOR’S UNDERSTANDING OF OUR RESULTS OFOPERATIONS.

We prepare and release quarterly financial statementsprepared in accordance with GAAP. We also disclose and discuss certain proforma and other non-GAAP information in the related earnings releases andinvestor conference calls. This pro forma financial information excludes or mayexclude certain special charges and other costs. We believe the disclosure ofthe pro forma financial information helps investors more meaningfully evaluatethe results of our ongoing operations. However, we urge investors to carefullyreview the GAAP financial information included as part of our Quarterly Reportson Form 10-Q, our Annual Reports on Form 10-K, and ourquarterly earnings releases, and to compare the GAAP financial information tothe pro forma financial results disclosed in our quarterly earnings releasesand investor calls.

OUR NET OPERATING LOSS CARRYFORWARDS MAY BELIMITED.

Due to the “change in ownership” provisions of theInternal Revenue Code, the availability of our 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.

 

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WE COULD BEADVERSELY AFFECTED BY AN IMPAIRMENT OF A SIGNIFICANT AMOUNT OF GOODWILL AND/ORINTANGIBLE ASSETS ON OUR BALANCE SHEET.

In the course ofour operating history, we have acquired and disposed of numerous assets andbusinesses. Some of our acquisitions have resulted in the recording of asignificant amount of goodwill and/or intangible assets on our balance sheet.The goodwill and/or intangible assets were recorded because the fair value ofthe net assets acquired was less than the purchase price. We may not realizethe full value of the goodwill and/or intangible 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 no longerrecoverable, in which case we would write off the unrecoverable portion as acharge to our earnings.

To improve ouroperating performance, we may decide to acquire other assets or businessescomplementary to our business and, as a result, we may record additionalgoodwill and/or intangible assets on our balance sheet in the future. Thepossible write-off of the goodwill and/or intangible assets could negativelyimpact our future earnings. We will also be required to allocate a portion ofthe purchase price of any acquisition to the value of any intangible assetsthat meet the criteria specified in the Statement of Financial AccountingStandards No. 141, “*BusinessCombinations*,” such as marketing, customer or contract-basedintangibles. The amount allocated to these intangible assets could be amortizedover a fairly short period. As a result, our earnings and the market price ofour common stock could be negatively affected.

THE SUCCESS OF OUR24/7 SEARCH OPERATIONS DEPENDS ON A FEW SEARCH ENGINE DISTRIBUTION PARTNERS,AND THE LOSS OF ONE OF THEM COULD RESULT IN A SUBSTANTIAL DECREASE IN OUR 24/7SEARCH REVENUE.

We have generatedthe majority of our global Search revenue from clicks originating on Google andOverture, which is a subsidiary of Yahoo!, through relationships in manycountries in which we operate. We expect that these search engines willcontinue to generate a majority or more of our 24/7 Search revenue for theforeseeable future. The interruption or loss of our relationship with Google orOverture would cause a significant decrease in search revenue. As a result ofconsolidation among search engines, and other SEM companies, we could lose oneor more of our clients or face increased competition from clients thatinternally develop or acquire capabilities similar to our service. In addition,as our search engine clients’ operations continue to evolve, we may be requiredto adjust our business strategy to maintain relationships with our clients. Theloss of, or a change in, one or more of these relationships could have amaterial adverse effect on our Search revenue.

OUR MAJOR BUSINESSPARTNERS MAY EXPERIENCE ADVERSE BUSINESS CONDITIONS THAT COULD ADVERSELYAFFECT OUR BUSINESS.

We have a jointventure with Dentsu to promote SEM services in Japan, a strategic businessrelationship with Lycos, we have major search engine distribution partners,such as Google and Overture, and we may enter into similar relationships withother companies. A substantial portion of our revenue is, directly orindirectly, attributable to these major relationships. If one or more of thesecompanies experiences 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 materialadverse impact on our business, financial condition and results of operations.

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

 

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Our successdepends, to a significant extent, upon our senior management and key sales andtechnical personnel, particularly our Chief Executive Officer, our ChiefFinancial Officer and our Chief Executive Officer of Europe. The competitionfor experienced and talented executives, senior managers and technical andsales personnel has become intense in our industry. The loss of the services ofone or more of these persons, other similarly positioned members of managementor other key personnel could materially and adversely affect our ability todevelop our business.

IN ORDER TOCONTINUE TO OPERATE EFFICIENTLY AND TO GROW OUR BUSINESS, WE WILL NEED TOATTRACT AND RETAIN QUALIFIED PERSONNEL AND MANAGE OUR COSTS, WHICH WE MAY BEUNABLE TO DO.

Our successdepends on our ability to attract and retain qualified technical, sales andmarketing, customer support, financial and accounting, and managerial personnel.We may expand our total workforce and will need to continue to attractqualified personnel in order to grow our business successfully. Additionally,as our business has escalated, we have increased our reliance on contractorsand outside firms for development. We may not be able to attract, integrate andretain the numbers and types of candidates that we desire, and we may not beable to retain our contractors and outside firms and may not be able to replacethem. Even if we are successful in attracting new staff and retaining existingstaff, we may not be able to increase revenue quickly enough to offset thecosts of the additional personnel or increased costs of retaining personnel. Anyof these contingencies could cause our business to suffer.

We are experiencing,and may continue to experience in the future, particular difficulty in hiringand retaining qualified SEM staff. Competition for staff throughout all ourbusiness segments and geographies is very high, and training is difficultbecause the required skill set is complex and there is no industry standard. Ifwe are unable to attract, train and retain qualified staff, we may not remaincompetitive and could lose business and our customers, which could have anadverse effect on revenue.

OUR OPERATIONS AREVULNERABLE TO NATURAL DISASTERS AND OTHER EVENTS, INCLUDING TERRORIST ATTACKS,BECAUSE WE HAVE LIMITED BACKUP SYSTEMS.

We have limitedbackup systems and have experienced system failures and electrical outages fromtime to time in the past, which have disrupted our operations. We have alimited disaster recovery plan in the event of damage from fire, floods,typhoons, earthquakes, power loss, telecommunications failures, break-ins andsimilar events. Our operations are dependent on our ability to protect ourcomputer systems against these unexpected adverse events.

If any of theforegoing occurs, we may experience a complete system shutdown. Any businessinterruption insurance that we carry is unlikely to be sufficient to compensateus for loss of business in the event of a significant catastrophe.

In addition,interruptions in our services could result from the failure of ourtelecommunications providers to provide the necessary data communicationscapacity in the time frame we require. Our Open AdSystem technology resides oncomputer systems located in our data centers housed by Equinix and Savvis inthe United States and Level 3 Communications in Europe. These systems’continuing and uninterrupted performance is critical to our success, as asubstantial portion of the revenue depend on the continuing availability ofthese systems. Despite precautions that we have taken, unanticipated problemsaffecting our systems have from time to time in the past caused, and in thefuture could cause, interruptions in the delivery of our solutions. Ourbusiness, results of operations and financial condition could be materially andadversely affected by any damage or failure that interrupts or delays ouroperations. To improve the performance and to prevent disruption of ourservices, we may have to make substantial investments to 

 

 

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deploy additionalservers or one or more copies of our Web sites to mirror our online resources.Although we believe we carry property insurance with adequate coverage limits,our coverage may not be adequate to compensate us for all losses, particularlywith respect to loss of business and reputation that may occur.

In addition,terrorist acts or acts of war may cause damage to our employees, facilities,clients, our clients’ customers and vendors, which could significantly impactour revenues, costs and expenses and financial position. The potential forfuture terrorist attacks, the national and international responses to terroristattacks or perceived threats to national security, and other acts of war orhostility have created many economic and political uncertainties that couldadversely affect our business and results of operations in ways that cannot bepresently predicted. We are predominantly uninsured for losses andinterruptions caused by terrorist acts and acts of war.

OUR NETWORKOPERATIONS MAY BE VULNERABLE TO HACKING, VIRUSES AND OTHER DISRUPTIONS,WHICH MAY MAKE OUR PRODUCTS AND SERVICES LESS ATTRACTIVE AND RELIABLE.

Internetusage could decline if any well-publicized compromise of security occurs. “Hacking”involves efforts to gain unauthorized access to information or systems or tocause intentional malfunctions or loss or corruption of data, software,hardware or other computer equipment. Hackers have made many attempts to breachthe security of our network operations, with minimal disruption to date. Ifhackers are successful in the future, they could misappropriate proprietaryinformation or cause substantial disruptions in our service. We may be requiredto expend capital and other resources to protect our Web site against hackers.Any measures we may take may not be effective. In addition, the inadvertenttransmission of computer viruses could expose us to a material risk of loss orlitigation and possible liability, as well as materially damage our reputationand decrease our user traffic.

WE DEPEND ONPROPRIETARY RIGHTS, AND WE FACE THE RISK OF INFRINGEMENT.

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

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

We have from timeto time licensed, and we may license in the future, elements of our trademarks,trade dress and similar proprietary rights to third parties. While we attemptto ensure that the quality of our brand is maintained by these businesspartners, such partners may take actions that could materially and adverselyaffect the value of our proprietary rights or our reputation. The value of ourproprietary rights 

 

 

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could decline inthe future since the validity, enforceability and scope of protection ofcertain proprietary rights in Internet-related industries is uncertain andstill evolving.

We have, from timeto time, been, and may in the future be, subject to claims of allegedinfringement of the trademarks and other intellectual property rights of thirdparties by us or by Web publishers with Web sites in our 24/7 Web Alliance, orby customers who employ our Technology solutions. We may be required, or mayelect, to indemnify these parties against such claims. Such claims and anyresultant litigation could subject us to significant liability for damages andcould result in the invalidation of our proprietary rights. In addition, evenif we prevail, such litigation could be time-consuming and expensive to defend,and could result in the diversion of our time and attention, any of which couldmaterially and adversely affect our business, results of operations andfinancial condition. Any claims or litigation from third parties may alsoresult in limitations on our ability to use the trademarks and otherintellectual property subject to such claims or litigation unless we enter intoarrangements with the third parties responsible for such claims or litigation,which may be unavailable on commercially reasonable terms, if at all.

From time to time,we may selectively pursue claims of infringement of our patents and otherintellectual property rights by third parties. Such claims and any resultantlitigation present the risk that a court could determine, either preliminarilyor finally, that some of our patents or other intellectual property rights arenot valid, which may make it difficult to sell our technology solutions and maylead to a loss of and an inability to generate licensing revenue from ourpatents. In addition, even if we prevail, such litigation could be time-consumingand expensive to pursue, and could result in the diversion of our time andattention, any of which could materially and adversely affect our business,results of operations and financial condition.

**RISKS RELATED TO OUR COMMON STOCK AND THE MARKETFOR OUR COMMON STOCK.**

THETRADING PRICE OF OUR COMMON STOCK HAS BEEN VOLATILE HISTORICALLY ANDMAY CONTINUE TO BE VOLATILE IN RESPONSE TO VARIOUS INTERNAL AND EXTERNALFACTORS.

The trading price of our common stock has beenvolatile historically and may continue to be unstable. For example, during thepast twelve months, the closing sales price of our common stock on the NASDAQNational Market has ranged from a high of $11.79 per share to a low of $2.79per share. The trading price of our common stock may fluctuate widely inresponse to various events and factors, some of which are beyond our control,such as quarterly or annual variations in our statements of operations or theoperating results  and stock priceperformance of our competitors or business partners; announcements by us or ourcompetitors of acquisitions, new or improved products or services or businessrelationships; guidance and reports by securities analysts and changes infinancial earnings estimates and recommendations; announcements about our earningsthat are not in line with analyst expectations or prior Company guidance;announcements by our competitors about their earnings, especially if they arenot in line with analyst expectations; sales of stock by us or by ourstockholders; and new reports relating to trends in our markets and generaleconomic conditions.

In addition, the stock market in general, and themarket prices for technology or Internet-related companies in particular, haveexperienced extreme price and volume fluctuations that have often beenunrelated or disproportionate to the operating performance of those companies.These broad market and industry fluctuations may negatively impact the marketprice for our common stock, regardless of our actual operating performance. Inthe past, following periods of volatility in the overall market and the 

 

 

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market price of a company’s securities, securitiesclass action litigation has often been instituted against these companies. Thislitigation, if instituted against us, could result in substantial costs and adiversion of our management’s attention and resources. Additionally, volatilityor a lack of positive performance in our stock price may adversely affect ourability to retain key employees, all of whom have been granted stock options orother equity-based awards.

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

As of March 31,2006, there were approximately 48.5 million shares of our common stockoutstanding. As of that date, we also had an aggregate of approximately13.2 million shares of common stock that may be sold into the market inthe future, including approximately 8.8 million shares of our common stockissuable upon exercise of options, approximately 0.1 million shares of ourcommon stock issuable upon the exercise of the warrants related to ourpreferred stock, approximately 2.2 million shares of our common stock issuableupon vesting of restricted shares, and approximately 2.2 million shares ofour common stock issuable upon conversion of the debentures and exercise of therelated warrants. In addition, if we undertake an additional acquisition orfinancing involving securities convertible into shares of our common stock, theaggregate number of shares into which those securities are convertible willfurther increase our overhang.

We cannot predictthe effect, if any, that future sales of shares of our common stock into themarket, or the availability of shares of common stock for future sale, willhave on the market price of our common stock. Sales of substantial amounts ofcommon stock (including the sale of securities convertible into shares of ourcommon stock), or the perception that such sales could occur, or the grant of alarge number of options, may materially and adversely affect prevailing marketprices for our common stock.

OUR ABILITY TOGENERATE SUFFICIENT CASH FLOW TO REPAY OUR INDEBTEDNESS DEPENDS ON MANYFACTORS, SOME OF WHICH ARE BEYOND OUR CONTROL.

On September 26,2003, we issued to a single holder $15.0 million in principal amount of our 2%subordinated convertible debentures due 2006. On January 1, 2004, webegan making semi-annual interest payments, which, thus far, we have elected topay with cash flow from operations. The entire principal amount of thedebentures matures on September 26, 2006. We need to ensure that we willhave sufficient cash on hand to cover any portion of the balance that we electto pay in cash at maturity, or, if the holder elects to exercise its redemptionright with respect to $7.5 million in principal amount of the debentures, anyamount thereof that we elect to redeem in cash. Our ability to generate cashflow is subject to economic, financial, competitive, regulatory and otherfactors beyond our control. If we are unable to generate sufficient cash flowto meet our debt service obligations, we may need to, among other things, seekadditional financing, refinance or restructure our debt or reduce or issue alarge amount of common stock, which, if possible, would be very dilutive ordelay planned expenditures.

THE TERMS OF THEDEBENTURES HAVE ANTI-DILUTION PROVISIONS FAVORING THE HOLDER, WHICH DISCOURAGEUS FROM ENGAGING IN TRANSACTIONS IN WHICH THE ISSUANCE OF COMMON STOCK MIGHT BEREQUIRED AND WHICH OTHERWISE MIGHT BE BENEFICIAL TO OUR BUSINESS.

The terms of thedebentures provide that, subject to certain exceptions, if, for financingpurposes, we issue or sell any shares of our common stock at a price less thanthe conversion price of the debentures, which is $8.75 per share of our commonstock, the conversion price of the debentures will be reduced to the price atwhich we issue new shares. This device, which is anti-dilutive for thedebenture holder, may 

 

 

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discourage us fromengaging in a transaction that might otherwise be beneficial to our securityholders, if we would be required to issue common stock at a price below $8.75per share.

THE POWER OF OURBOARD OF DIRECTORS TO DESIGNATE AND ISSUE SHARES OF STOCK COULD HAVE AN ADVERSEEFFECT ON HOLDERS OF OUR COMMON STOCK.

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

EFFECTS OFANTI-TAKEOVER PROVISIONS COULD INHIBIT THE ACQUISITION OF OUR COMPANY.

Some of theprovisions of our Amended and Restated Certificate of Incorporation, ourBy-laws and Delaware law could, among other things, together or separately:

·                  discourage,delay or prevent potential acquisition proposals;

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

·                  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 for shares of our commonstock.

These provisionsmay apply even if the action that is limited or prevented might be in the bestinterest of our shareholders.

WE DO NOT INTENDTO PAY FUTURE CASH DIVIDENDS.

We currently donot anticipate paying cash dividends on our common stock at any time in thenear future. We may never pay cash dividends or distributions on our commonstock. In addition, the terms of our debentures restrict our ability to paycash dividends on our common stock. Whether we pay cash dividends in the futurewill be at the discretion of our Board of Directors and will be dependent uponour financial condition, results of operations, capital requirements,contractual restrictions and any other factors that the Board of Directorsdecides is relevant.

**RISKSRELATED TO OUR INDUSTRY.**

OUR FAILURE TOCOMPETE SUCCESSFULLY MAY HINDER OUR GROWTH.

The markets forInternet advertising and related products and services are intenselycompetitive and such competition is expected to increase. Our failure tocompete successfully may hinder our growth. We believe that our ability tocompete depends upon many factors both within and beyond our control,including:

 

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·                  thedevelopment of new online advertising media and methods;

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

·                  theability to attract and retain qualified personnel;

·                  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.

Some of ourcompetitors have longer operating histories, greater name recognition, largercustomer bases and significantly greater financial, technical and marketingresources than ours. In addition, current and potential competitors haveestablished or may establish cooperative relationships among themselves or withthird parties to increase the ability of their products or services to addressthe needs of our prospective clients. In addition, most online advertisingcompanies are seeking to broaden their business models, so that companies thatdo not currently compete directly with us may decide to compete more directlywith us in the future. We may be unable to compete successfully against currentor future competitors.

CHANGES INGOVERNMENT REGULATION COULD DECREASE OUR REVENUES AND INCREASE OUR COSTS.

Laws andregulations directly applicable to Internet communications, commerce andadvertising are becoming more prevalent, and new laws and regulations are underconsideration by the United States Congress and state legislatures. Anylegislation enacted or restrictions arising from current or future governmentinvestigations or policy could dampen the growth in use of the Internetgenerally and decrease the acceptance of the Internet as a communications,commercial and advertising medium. State governments or governments of foreigncountries might attempt to regulate our transmissions or levy sales or othertaxes relating to our activities. The laws governing the Internet, however,remain largely unsettled, even in areas where there has been some legislativeaction. It may take years to determine whether and how existing laws such asthose governing intellectual property, privacy, libel and taxation apply to theInternet 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, which may impose additional burdens oncompanies conducting business over the Internet. Our business, results ofoperations and financial condition could be materially and adversely affectedby the adoption or modification of laws or regulations relating to theInternet.

CHANGES INDOMESTIC OR INTERNATIONAL LAWS AND STANDARDS RELATING TO DATA COLLECTION ANDUSE PRACTICES AND THE PRIVACY OF INTERNET USERS, OR RELATED LITIGATION, COULDHARM OUR BUSINESS.

The U.S. federaland various state governments have recently proposed limitations on thecollection and use of information regarding Internet users. In 2004 and 2005,the U.S. Congress proposed several new pieces of legislation that would limitthe use of technologies deemed to be “spyware”, which some bills have definedto include cookies, Web beacons and javascript, which are required by ourproducts and services. The effectiveness of our Open AdSystem products andservices could be significantly limited by 

 

 

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federal and stateregulations limiting the collection or use of information regarding Internetusers that are inconsistent with our policies and practices. Since many of theproposed federal and state laws or regulations are being developed, we cannotyet determine the impact these regulations may have on our business. Inaddition, growing public concern about privacy and the collection, distributionand use of personal information has led to self-regulation of these practicesby the Internet advertising and direct marketing industry, and to increasedfederal and state regulation. Lastly, a number of civil actions have beenbrought by federal and state authorities against companies alleged to havedistributed “spyware” without the proper consent of users. The NetworkAdvertising Initiative, of which we are a member, has developed self-regulatoryprinciples for online preference marketing. We are also subject to variousfederal and state regulations concerning the collection, distribution and useof personal information. These laws include the Children’s Online PrivacyProtection 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. While we monitorlegislative initiatives, in the event that more onerous federal or state lawsor regulations are enacted or applied to us or to our clients, our business,financial condition and results of operations could be materially and adverselyaffected.

We also face risks associated with international data and privacyprotection. The interpretation and application of data protection laws inEurope and elsewhere are still uncertain and subject to change. It is possiblethat one or more of these laws may be interpreted and applied in a manner thatis inconsistent with our policies on data collection and use, or that new lawsmay be enacted that conflict with our data collection and use. If so, we couldbe subjected to fines, face increased compliance costs, be required to changeour data practices or be exposed to lawsuits, any one of which could have amaterial adverse effect on our business and results of operations.

PRIVACY CONCERNS MAY PREVENTUS FROM COLLECTING USER DATA.

Growing concernsabout the use of cookies and data collection may limit our ability to developuser profiles. Web sites typically place small files of information, commonlyknown as “cookies,” on a user’s hard drive, generally without the user’sknowledge or consent. Cookie information is passed to the Web site through theInternet user’s browser software. Our Open AdSystem technology enables the useof cookies and other non-personally-identifying information to deliver targetedadvertising and to limit the frequency with which an advertisement is shown toa user. Most currently available Internet browsers allow users to modify theirbrowser settings to prevent cookies from being stored on their hard drive, andMicrosoft Corporation changed the design and instrumentation of its Web browserto give users the option to accept or reject third-party cookies. A smallminority of users are currently choosing to prevent certain cookies. Users canalso delete cookies from their hard drive or modify them at any time. SomeInternet commentators and privacy advocates have suggested limiting oreliminating the use of cookies. Any reduction or limitation in the use ofcookies or increase in the number of users blocking cookies could limit theeffectiveness of our sales and marketing efforts and impair our profiling andtargeting capabilities. Such changes also could adversely affect our ability todetermine the reach of advertising campaigns sold and delivered by us and thefrequency with which users of sites in the 24/7 Web Alliance see the sameadvertisement.

If the use oreffectiveness of cookies is limited, we would likely have to switch to othertechnology that would allow us to gather demographic and behavioralinformation. While such technology currently exists, it is substantially lesseffective than cookies. Replacement of cookies could require significantengineering time and resources, might not be completed in time to avoid negativeconsequences to our business, financial condition or results of operations, andmight not be commercially feasible.

WE FACE RISKSASSOCIATED WITH TECHNOLOGICAL CHANGE.

 

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The Internet andInternet advertising markets are characterized by rapidly changingtechnologies, evolving industry standards, frequent new product and serviceintroductions and changing customer demands. Our future success will depend onour ability 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 may experience difficulties that could delay orprevent the successful design, development, introduction or marketing of oursolutions. In addition, our new solutions or enhancements must meet therequirements of our current and prospective customers and must achievesignificant market acceptance. Material delays in introducing new solutions andenhancements may cause customers to forego purchases of our solutions andpurchase those of our competitors.

In addition, the development of commercial softwareand technology that blocks, eliminates or otherwise screens out Internetadvertising may reduce the value of advertising inventory on our 24/7 WebAlliance and the benefits of our technology solutions to our customers. Wecannot guarantee that a new commercial software or technology, for end-users orenterprises, will not be capable of eliminating a portion or all of theadvertisement formats, including banners, pop-ups, pop-unders and otherformats, that we utilize through our 24/7 Web Alliance or that we currentlydeliver through our technology solutions. To the extent that our customersrefuse to pay for advertisements that are blocked, or if the use of blocking softwareexceeds our expectations, our business, results of operations and financialcondition may be materially and adversely affected.

ITEM 2. UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. DEFAULTSUPON SENIOR SECURITIES

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS

None.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

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

 

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*                    Filedherewith.

†                     Furnishedherewith.

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**SIGNATURES**

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.
|                         | 24/7 REAL MEDIA, INC. |
|-------------------------|-----------------------|
|                    | *(Registrant)*        |
|                    |                  |   |
| Date: May 10, 2006 | By:                   |  /s/ DAVID J.  MOORE |
| * *                |                  | David J. Moore |
|                    |                  | Chairman and Chief Executive Officer* * |
|                    |                  | *(Principal Executive Officer)* |
| * *                |                  |   |

 

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