**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark one)**

 

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

 

**For thequarterly period ended March 31, 2004**

 

**or**

 

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

 

**For thetransition 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  INCORPORATION OR ORGANIZATION) |   | (IRS  EMPLOYER  IDENTIFICATION NO.) |
|                                                             |   |   |
| **1250 BROADWAY, NEW YORK, NY**                                  |   | **10001** |
| (ADDRESS  OF PRINCIPAL EXECUTIVE OFFICES)                        |   | (ZIP  CODE) |
|                                                             |   |   |
| **(212) 231-7100**                                               |
| (REGISTRANT’S  TELEPHONE NUMBER, INCLUDING AREA CODE)       |

 

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

 

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

 

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

 
| **CLASS**                               |   | **OUTSTANDING AT May 12 , 2004** |
|-----------------------------------------|--------|--------------------------------------------|
| Common  Stock, par value $.01 per share |   | 34,124,045 Shares                     |

 

 

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

**March 31, 2004**

**FORM 10-Q**

**INDEX**

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

 

 

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

 

1

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PART I. FINANCIALINFORMATION

 

ITEM 1. CONSOLIDATEDFINANCIAL STATEMENTS

 

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

**CONSOLIDATEDBALANCE SHEETS**

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

** **
|                                                                                                                                                                       |   | **March 31,**   |    | **December  31,** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------|---------|-------------------|--------|
|                                                                                                                                                                       |   | **2004**        |    | **2003**          |   |
|                                                                                                                                                                       |   | **(unaudited)** |    |              |   |
| **ASSETS**                                                                                                                                                                 |   |            |    |              |   |
| Current assets:                                                                                                                                                            |   |            |    |              |   |
| Cash and cash equivalents                                                                                                                                                  |   | $               | 52,829  |              | $      | 21,645 |   |
| Accounts receivable, less allowances of  $938 and $971, respectively                                                                                                       |   | 16,977          |    | 11,603            |   |
| Prepaid expenses and other current assets                                                                                                                                  |   | 1,729           |    | 1,669             |   |
|                                                                                                                                                                       |   |            |    |              |   |
| Total current assets                                                                                                                                                       |   | 71,535          |    | 34,917            |   |
|                                                                                                                                                                       |   |            |    |              |   |
| Property and equipment, net                                                                                                                                                |   | 2,889           |    | 2,862             |   |
| Goodwill                                                                                                                                                                   |   | 18,740          |    | 2,621             |   |
| Intangible assets, net                                                                                                                                                     |   | 2,807           |    | 3,352             |   |
| Other assets                                                                                                                                                               |   | 7,080           |    | 2,428             |   |
|                                                                                                                                                                       |   |            |    |              |   |
| Total assets                                                                                                                                                               |   | $               | 103,051 |              | $      | 46,180 |   |
|                                                                                                                                                                       |   |            |    |              |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                              |   |            |    |              |   |
| Current liabilities:                                                                                                                                                       |   |            |    |              |   |
| Accounts payable                                                                                                                                                           |   | $               | 11,076  |              | $      | 6,266 |   |
| Accrued liabilities                                                                                                                                                        |   | 14,451          |    | 10,086            |   |
| Deferred revenue                                                                                                                                                           |   | 2,617           |    | 2,544             |   |
|                                                                                                                                                                       |   |            |    |              |   |
| Total current liabilities                                                                                                                                                  |   | 28,144          |    | 18,896            |   |
|                                                                                                                                                                       |   |            |    |              |   |
| Subordinated convertible debentures, 2%,  due 2006                                                                                                                         |   | 13,473          |    | 13,320            |   |
| Warrant liability                                                                                                                                                          |   | 2,595           |    | 3,595             |   |
| Other long term liabilities                                                                                                                                                |   | 315             |    | 332               |   |
|                                                                                                                                                                       |   |            |    |              |   |
| Total liabilities                                                                                                                                                          |   | 44,527          |    | 36,143            |   |
|                                                                                                                                                                       |   |            |    |              |   |
| Commitments and contingencies                                                                                                                                              |   |            |    |              |   |
|                                                                                                                                                                       |   |            |    |              |   |
| Stockholders’ equity:                                                                                                                                                 |   |            |    |              |   |
| Preferred stock; $.01 par value; 10,000,000  shares authorized, 713,362 and 828,250 shares issued and outstanding,  respectively (liquidation preference of $10 per share) |   | 7               |    | 8                 |   |
| Common stock; $.01 par value; 350,000,000 shares  authorized; 33,090,299 and 23,367,421 shares issued and outstanding,  respectively                                       |   | 331             |    | 234               |   |
| Additional paid-in capital                                                                                                                                                 |   | 1,155,535       |    | 1,106,984         |   |
| Deferred stock compensation                                                                                                                                                |   | (182            | )       | (257              | )      |
| Accumulated other comprehensive income                                                                                                                                     |   | 462             |    | 305               |   |
| Accumulated deficit                                                                                                                                                        |   | (1,097,629      | )       | (1,097,237        | )      |
| Total stockholders’ equity                                                                                                                                            |   | 58,524          |    | 10,037            |   |
|                                                                                                                                                                       |   |            |    |              |   |
| Total liabilities and stockholders’ equity                                                                                                                            |   | $               | 103,051 |              | $      | 46,180 |   |

 

See accompanying notes to unaudited interimconsolidated financial statements.

 

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

**CONSOLIDATED STATEMENTS OF OPERATIONS**

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

** **
|                                                                                                              |   | **Three  months ended March 31,** |   |
|-------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                                                              |   | **2004**                          |   | **2003** |   |
|                                                                                                              |   | **(unaudited)**                   |   | **(unaudited)** |   |
|                                                                                                              |   |                              |   |   |   |
| Revenues:                                                                                                         |   |                              |   |   |   |
| Integrated media solutions                                                                                        |   | $                                 | 13,039 |   | $ | 8,343 |   |
| Technology solutions                                                                                              |   | 4,342                             |   | 3,481 |   |
| Total revenues                                                                                                    |   | 17,381                            |   | 11,824 |   |
|                                                                                                              |   |                              |   |   |   |
| Cost of revenues:                                                                                                 |   |                              |   |   |   |
| Integrated media solutions                                                                                        |   | 9,441                             |   | 5,510 |   |
| Technology solutions                                                                                              |   | 822                               |   | 1,165 |   |
| Total cost of revenues                                                                                            |   | 10,263                            |   | 6,675 |   |
|                                                                                                              |   |                              |   |   |   |
| Gross profit                                                                                                      |   | 7,118                             |   | 5,149 |   |
|                                                                                                              |   |                              |   |   |   |
| Operating expenses:                                                                                               |   |                              |   |   |   |
| Sales and marketing (exclusive of $24 and  $8, respectively, reported below as stock-based compensation)          |   | 3,316                             |   | 3,144 |   |
| General and administrative (exclusive of  $172 and $38, respectively, reported below as stock-based compensation) |   | 2,982                             |   | 2,922 |   |
| Product development (exclusive of $3 and  $1, respectively, reported below as stock-based compensation)           |   | 1,051                             |   | 588 |   |
| Amortization of intangible assets and  deferred financing costs                                                   |   | 788                               |   | 647 |   |
| Stock-based compensation                                                                                          |   | 199                               |   | 47 |   |
|                                                                                                              |   |                              |   |   |   |
| Total operating expenses                                                                                          |   | 8,336                             |   | 7,348 |   |
|                                                                                                              |   |                              |   |   |   |
| Loss from operations                                                                                              |   | (1,218                            | )      | (2,199 | ) |
|                                                                                                              |   |                              |   |   |   |
| Interest expense, net                                                                                             |   | (182                              | )      | (91 | ) |
| Change in fair value of warrant liability                                                                         |   | 928                               |   | — |   |
| Other income, net                                                                                                 |   | 180                               |   | — |   |
|                                                                                                              |   |                              |   |   |   |
| Loss before provision for income taxes                                                                            |   | (292                              | )      | (2,290 | ) |
|                                                                                                              |   |                              |   |   |   |
| Provision for income taxes                                                                                        |   | 100                               |   | 7 |   |
|                                                                                                              |   |                              |   |   |   |
| Net loss                                                                                                          |   | (392                              | )      | (2,297 | ) |
|                                                                                                              |   |                              |   |   |   |
| Dividends on preferred stock                                                                                      |   | (118                              | )      | (129 | ) |
| Net loss attributable to common  stockholders                                                                     |   | $                                 | (510   | ) | $ | (2,426 | ) |
|                                                                                                              |   |                              |   |   |   |
| Loss per common share - basic and diluted                                                                         |   |                              |   |   |   |
| Net loss                                                                                                          |   | $                                 | (0.02  | ) | $ | (0.18 | ) |
| Dividends on preferred stock                                                                                      |   | (0.00                             | )      | (0.01 | ) |
| Net loss attributable to common  stockholders                                                                     |   | $                                 | (0.02  | ) | $ | (0.19 | ) |
|                                                                                                              |   |                              |   |   |   |
| Weighted average shares outstanding                                                                               |   | 25,618,029                        |   | 12,894,663 |   |

 

See accompanying notes to unaudited interimconsolidated financial statements.

 

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands)**

** **
|                                                                                          |   | **Three  months ended March 31,** |   |
|-----------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                                          |   | **2004**                          |   | **2003** |   |
|                                                                                          |   | **(unaudited)**                   |   |
| Cash flows from operating activities:                                                         |   |                              |   |   |   |
| Net loss                                                                                      |   | $                                 | (392   | ) | $ | (2,297 | ) |
| Adjustments to reconcile net loss to net cash  used in operating activities:                  |   |                              |   |   |   |
| Depreciation and amortization                                                                 |   | 488                               |   | 658 |   |
| Provision for doubtful accounts and sales  reserves                                           |   | 175                               |   | 213 |   |
| Loss on disposal of fixed assets                                                              |   | —                            |   | — |   |
| Amortization of intangible assets and  deferred financing costs                               |   | 788                               |   | 647 |   |
| Amortization of warrants                                                                      |   | 153                               |   | — |   |
| Non-cash compensation                                                                         |   | 199                               |   | 47 |   |
| Accrued interest on notes payable                                                             |   | 75                                |   | 99 |   |
| Change in fair value of warrant liability                                                     |   | (928                              | )      | — |   |
| Changes in operating assets and  liabilities, net of effect of acquisitions and dispositions: |   |                              |   |   |   |
| Accounts receivable                                                                           |   | (478                              | )      | (1,538 | ) |
| Prepaid assets and other current assets                                                       |   | (31                               | )      | 560 |   |
| Other assets                                                                                  |   | (4,553                            | )      | (57 | ) |
| Accounts payable and accrued liabilities                                                      |   | 3,015                             |   | (1,226 | ) |
| Deferred revenue                                                                              |   | 62                                |   | 334 |   |
|                                                                                          |   |                              |   |   |   |
| Net cash used in operating activities                                                         |   | (1,427                            | )      | (2,560 | ) |
|                                                                                          |   |                              |   |   |   |
| Cash flows from investing activities:                                                         |   |                              |   |   |   |
| Cash paid for acquisitions, net                                                               |   | (1,574                            | )      | (150 | ) |
| Capital expenditures, including capitalized  software                                         |   | (345                              | )      | (325 | ) |
| Cash paid for investment                                                                      |   | —                            |   | (50 | ) |
|                                                                                          |   |                              |   |   |   |
| Net cash used in investing activities                                                         |   | (1,919                            | )      | (525 | ) |
|                                                                                          |   |                              |   |   |   |
| Cash flows from financing activities:                                                         |   |                              |   |   |   |
| Proceeds from issuance of common stock                                                        |   | 33,840                            |   | — |   |
| Proceeds from exercise of stock options and  conversion of warrants                           |   | 545                               |   | 42 |   |
| Payment of capital lease obligations                                                          |   | (12                               | )      | (12 | ) |
|                                                                                          |   |                              |   |   |   |
| Net cash provided by financing activities                                                     |   | 34,373                            |   | 30 |   |
|                                                                                          |   |                              |   |   |   |
| Net change in cash and cash equivalents                                                       |   | 31,027                            |   | (3,055 | ) |
| Effect of foreign currency on cash                                                            |   | 157                               |   | (44 | ) |
| Cash and cash equivalents at beginning of  year                                               |   | 21,645                            |   | 7,674 |   |
|                                                                                          |   |                              |   |   |   |
| Cash and cash equivalents at end of period                                                    |   | $                                 | 52,829 |   | $ | 4,575 |   |

 

See accompanying notes to unaudited interimconsolidated financial statements.

 

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

 

# **Nature ofOperations**

 

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

 

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

 

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

 

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

 

# **Organizationand Basis of Presentation**

 

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

 

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

 

The accompanying interim consolidatedfinancial statements are unaudited.  Inthe Company’s opinion, the unaudited consolidated financial statements havebeen prepared on the same basis as the annual consolidated financial statementsand reflect all adjustments, which include only normal recurring adjustments,necessary to present fairly the financial position and the results of theoperations and cash flows of the Company for the interim periodspresented.  The financial statements,financial data and other information disclosed in these notes to the consolidatedresults are not necessarily indicative of the results expected for the fullfiscal year or any future period.

 

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

 

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

 

###### The preparation ofconsolidated financial statements in accordance with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and the disclosure of contingent assets and liabilities at the dateof the consolidated financial statements and the reported amounts of revenuesand expenses during the reporting period. Actual results could differ from those estimates.

 

On an ongoing basis, the Company evaluates its estimates, includingthose related to revenue recognition, accruals, allowance for doubtfulaccounts, fair value of acquired intangible assets and goodwill, useful livesof intangible assets and property and equipment, among others.  The Company bases its estimates onhistorical experience and on various other assumptions that are believed to bereasonable, the results of which form the basis for making judgments about thecarrying values of assets and liabilities.

 

###### *(c)  Cash and Cash Equivalents*

 

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

######  

*(d)  Concentration of Credit Risk and SignificantCustomers*

 

Financial instruments that potentially subject theCompany to concentrations of credit risk consist principally of cashequivalents and accounts receivable. Cash equivalents consist of money market funds, which, at times, exceedfederally insured limits.  Accountsreceivable are typically unsecured and are derived from revenues earned fromcustomers primarily located in the United States, Europe and Korea.  Many of those customers are in the Internetindustry.  To appropriately managecredit risk, the Company performs ongoing evaluations of customer credit andlimits the amount of credit extended, but generally no collateral isrequired.  The Company maintainsreserves for estimated credit losses and these losses have generally beenwithin management’s expectations.

 

No single customer accounted for greater than 10% ofnet revenues for the three months ended March 31, 2004 and 2003.

 

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

######  

Accountsreceivable are recorded at the invoiced amount and are non-interestbearing.  The Company maintains anallowance for doubtful accounts to reserve for potentially uncollectiblereceivables.  Management reviews theaccounts receivable by aging category to identify specific customers with knowndisputes or collectibility issues.  Indetermining the amount of the reserve, management makes judgments about thecreditworthiness of significant customers based on ongoing creditevaluations.  The Company also maintainsa sales allowance to reserve for potential credits issued to customers.  The amount of the reserve is determinedbased on historical credits issued.

######  

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

######  

At March 31, 2004 and December 31, 2003,accounts receivable included approximately $6.4 million and $4.4 million,respectively, of earned but unbilled receivables, which are a normal part of theCompany’s business, as receivables are usually invoiced in the month followingthe completion of the earning process.  All unbilled receivables have beensubsequently billed.

 

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

 

In accordance with Statement of Financial AccountingStandards (“SFAS”) No. 86, *Accountingfor the Costs of Computer Software To Be Sold, Leased, or Otherwise Marketed*,the Company requires certain product development costs to be capitalized when aproduct’s technological feasibility has been established by completion of aworking model of the product and ending when a product is available for generalrelease to customers.  Generally, thecompletion of the working model coincides with general release.  The Company capitalized approximately$1.2 million in connection with the development of its Open Advertiseradvertisement serving software product, which is included in property andequipment, net on the consolidated balance sheet.  The product was released in June 2003 and is being amortizedusing the straight-line method over the estimated useful life of the software,or four years.  Amortization for thethree month period ended March 31, 2004 was $0.1 million and accumulatedamortization as of March 31, 2004 was $0.2 million.

 

*(i)  Revenue Recognition; Cost of Revenues*

 

*Integrated Media Solutions*

 

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

 

The Company becomes obligated to make payments tothird-party Web sites, search engine distribution partners and e-mail listswhich have contracted with the Company to be part of the 24/7 Network, in theperiod the advertising impressions, valid visitors or e-mails are delivered.Such expenses are classified as cost of revenue in the accompanyingconsolidated statements of operations.

 

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*Technology Solutions*

 

TechnologySolutions revenues are derived primarily from licensing of our software, hostedadvertisement serving, and software maintenance and technical supportservices.  Revenue from softwarelicensing agreements is recognized in accordance with Statements of Position(“SOP”) No. 97-2, *Software RevenueRecognition*, and Staff Accounting Board (“SAB”) No. 104, *Revenue Recognition*, upon delivery of thesoftware, which is generally when the software is made available for download,there is persuasive evidence of an arrangement, collection is reasonablyassured, the fee is fixed or determinable, and vendor-specific objectiveevidence exists to allocate the total fees to all elements of the arrangement.  Contracts that bundle the software licensewith maintenance and technical support are recognized ratably over the contractterm.  Revenue from advertisementserving is recognized upon delivery. Revenue from software maintenance and technical support contracts isrecognized ratably over the life of the agreement, which typically does notexceed one year.

 

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

 

*Deferred Revenue*

 

Revenues that are billed in advance of services being completed are deferred until the conclusion of the period of the service for which the advance billing relates.  Deferred revenues are included on the consolidated balance sheet as a current liability until the service is performed and then recognized in the period in which the service is completed.  The Company’s deferred revenues primarily consist of billings in advance for software license subscriptions and software maintenance and technical support services. Deferred revenues at March 31, 2004 and December 31, 2003 were approximately $2.6 million and $2.5 million, respectively.

 

###### *(j)  Warrant Liability*

 

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

 

In connection with the placement of theCompany’s preferred stock and subordinated convertible debentures, the Companyissued warrants to investors to purchase shares of the Company’s commonstock.  The Company agreed to registerthe shares issuable upon exercise of the warrants and to pay penalties for adelayed filing or a failure to file a registration statement prior to theagreed deadline.  The Company alsoagreed to pay penalties if the registration statement becomes temporarily orpermanently unavailable for use by the warrant holders.  Accordingly, pursuant to EITF 00-19, theCompany reflected the value of the warrants as a warrant liability on the consolidatedbalance sheet and the liability will be reclassified to equity upon exercise orconversion.  The fair value of theoutstanding warrants is evaluated at each reporting period with any resultingchange in the fair value being reflected in the consolidated statement ofoperations.  As a result of suchevaluation, the Company decreased the warrant liability at March 31, 2004 by

 

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$0.9 million on the consolidated balancesheet and recorded a change in fair value of warrant liability on theconsolidated statement of operations.

 

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

 

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

 

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

 
|                                                                                                                                 |   | **For the  Three Months Ended March 31,**     |   |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------|--------|
|                                                                                                                                 |   | **2004**                                      |   | **2003** |   |
|                                                                                                                                 |   | **(in  thousands, except per share amounts)** |   |
| Net loss:                                                                                                                            |   |                                          |   |   |   |
| As reported                                                                                                                          |   | $                                             | (392   | ) | $ | (2,297 | ) |
| Deduct: Total stock-based employee  compensation expense determined under fair-value-based method for all awards,  net of tax effect |   | 1,768                                         |   | 2,210 |   |
| Pro forma                                                                                                                            |   | $                                             | (2,160 | ) | $ | (4,507 | ) |
| Net loss attributable to common  stockholders per share:                                                                             |   |                                          |   |   |   |
| As reported                                                                                                                          |   | $                                             | (0.02  | ) | $ | (0.19 | ) |
| Pro forma                                                                                                                            |   | (0.09                                         | )      | (0.36 | ) |

 

The per share weighted-average fair value of stock options granted forthe three months ended March 31, 2004 and 2003 is $4.63 and $0.85,respectively, on the date of grant using the Black-Scholes method with thefollowing weighted-average assumptions:

 
|                     |   | **2004** |   | **2003** |   |
|--------------------------|--------|----------|--------|----------|--------|
|                     |   |     |   |     |   |
| Expected dividend yield  |   | 0        | %      | 0        | %      |
| Risk-free interest rate  |   | 2.23     | %      | 2.47     | %      |
| Expected life (in years) |   | 2.5      |   | 4.0      |   |
| Volatility               |   | 131      | %      | 103      | %      |

 

The Company accounts for non-employeestock-based awards in which goods or services are the consideration receivedfor the equity instruments issued based on the fair value of the equityinstruments issued in accordance with the EITF No. 96-18, *Accounting For Equity Instruments*

* *

9

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*That Are Issued To OtherThan Employees For Acquiring, or in Conjunction With Selling Goods or Services*.

 

###### *(l)  PreferredStock*

 
|       |   | **Shares**     |   | **Price Per** |   | **Conversion** |   | **Shares  Ouststanding at** |   |
|------------|--------|----------------|--------|---------------|--------|----------------|--------|-----------------------------|--------|
| **Series** |   | **Authorized** |   | **Share**     |   | **Rate**       |   | **March 31,  2004**         |   | **December  31, 2003** |   |
| A          |   | 800,000        |   | $             | 10.00  |           | $      | 1.02675                     |   | 635,362 |   | 750,000 |   |
| C          |   | 718,250        |   | 10.00         |   | 1.20790        |   | 78,000                      |   | 78,250 |   |
|       |   |           |   |          |   |           |   | 713,362                     |   | 828,250 |   |
|            |        |                |        |               |        |                |        |                             |        |  |  |  |  |

 

During the first quarter of 2004, 114,638 shares ofSeries A and 250 shares of Series C Preferred Stock were converted into1,116,513 and 2,070 shares of common stock, respectively.  The preferred stock accrues and cumulatesdividends at a rate of 6% per year, compounded monthly, payable when, as and ifdeclared by the Company’s Board of Directors. All accrued dividends must be paid before any dividends may be declaredor paid on the common stock, and shall be paid as an increase in theliquidation preference payable upon the sale, merger, liquidation, dissolutionor winding up of the Company.  Accruedbut unpaid dividends are cancelled upon conversion.  At March 31, 2004, there are approximately $0.6 million of accruedbut unpaid dividends.

 

In the event of a liquidation, dissolution or winding up of theCompany, the holders of the preferred stock are entitled to a liquidationpreference payment per share equal to the purchase price, plus anydividends accrued but unpaid as of such date before any payment to holders ofcommon stock.  After payment of theforegoing preference, the holders of each share of preferred stock would thenparticipate *pro rata* with theholders of the common stock, on an as converted basis, in the distribution ofthe proceeds from such a liquidation event to the holders of the common stockuntil such time as the holders of preferred stock shall have received an amountequal to three times the purchase price (inclusive of their liquidation preference).  A merger, consolidation or sale of theCompany will be treated as a liquidation event unless such transaction has beenapproved by the holders of a majority of the outstanding preferred stock.

 

###### *(m)  Comprehensive Loss*

 

Total comprehensive loss for the three monthsended March 31, 2004 and 2003 was $(0.2) million and $(2.3) million,respectively.  Comprehensive lossresulted from net losses of $(0.4) million and $(2.3) million, and in 2004foreign currency translation adjustment of $0.2 million.

 

### *(n)  Loss Per Share*

 

Loss per share is presented in accordancewith the provisions of SFAS No. 128, *EarningsPer Share* (“EPS”).  Basic EPSexcludes dilution for potentially dilutive securities and is computed bydividing loss available to common shareholders by the weighted average numberof common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur ifsecurities or other contracts to issue common stock were exercised or convertedinto common stock and resulted in the issuance of common stock.  Diluted net loss per share is equal to basicnet loss per share since all potentially dilutive securities are anti-dilutivefor each of the periods presented. Diluted net loss per common share for the three months ended March 31,2004 and 2003 does not include the effects of options to purchase 4.9 millionand 3.9 million shares of

 

10

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common stock, respectively; 0.6 million and1.1 million common stock warrants, respectively; 1.7 million shares of commonstock in 2004 related to subordinated convertible debentures, on an “as if”converted basis; and 6.8 million and 8.0 million shares of preferred stock,respectively, on an “as if” converted basis, as the effect of their inclusionis anti-dilutive during each period.

 

### *(o)  Reclassifications*

 

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

 

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

 

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

 

On January 6, 2004, the Company completed theacquisition of Real Media Korea Co., Ltd., by acquiring the approximately90.4% of the outstanding shares of RMK that the Company did not alreadyown.  The Company paid totalconsideration of $20.1 million in exchange for the RMK shares, whichconsisted of $5.0 million in cash, approximately 2.1 million sharesof the Company’s common stock valued at $14.6 million and approximately$0.5 million in transaction costs. Approximately 0.9% of the outstandingshares of RMK are held in an employee stock union established under Korean law.The employee shareholders agreed to transfer their RMK shares to the Companyupon vesting in accordance with the terms and conditions of the stock union andKorean law.  For accounting purposes theeffective date of the acquisition is January 1, 2004.

 

The purchase price in excess of fair value ofnet tangible assets and liabilities acquired of $16.1 million has beenpreliminarily allocated to goodwill. The Company is in the process of obtaining an external valuation.  The acquisition was accounted for as apurchase business combination in accordance with SFAS No. 141, *Business Combinations*, and SFAS No. 142, *Goodwill and Other Intangible Assets*.

 

The net tangible assets acquired consist ofthe following:

 

| **Asset/ Liability**      |   | **Amount** |   |
|---------------------------|--------|------------|--------|
|                      |   |       |   |
| Cash and cash equivalents |   | $          | 3,469  |   |
| Other current assets      |   | 5,151      |   |
| Fixed assets              |   | 169        |   |
| Non-current assets        |   | 385        |   |
| Accrued liabilities       |   | (5,119     | )      |
|                      |   | $          | 4,055  |   |

 

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

 

On January 21, 2003, the Company acquiredcertain assets of Insight First, Inc., including specific contracts,intangibles and employee relationships, related to Insight First’s Webanalytics solutions, including the intellectual property relating to specificproducts, in exchange for approximately 0.7 million shares of the Company’scommon stock valued at approximately $1.1 million, plus $150,000 in cash.  In addition, the Company has a contingentobligation to pay additional earn-out consideration of up to $1.0 million, ineither cash or common stock, at the Company’s discretion, subject toachievement of earn-out targets relating to revenue generated by the acquiredbusiness in fiscal year 2004.

 

11

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

 

The net tangible assets acquired consist ofthe following:

 

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

 

*(c)  Unaudited Pro Forma Summary*

 

The following pro forma consolidated amountsgive effect to the Company’s RMK and Insight First acquisition accounted for bythe purchase method of accounting as if they had occurred at the beginning ofthe period by consolidating the results of operations of the acquired entitiesfor the three months ended March 31, 2004 and 2003.

 

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

 
|                                                                |   | **Three  Months Ended****March 31,**       |   |
|---------------------------------------------------------------------|--------|--------------------------------------------|--------|
|                                                                |   | **2004**                                   |   | **2003** |   |
|                                                                |   | **(in thousands, except per share  data)** |   |
| Total revenues                                                      |   | $                                          | 17,381 |   | $ | 14,262 |   |
| Net loss                                                            |   | (392                                       | )      | (2,338 | ) |
| Loss per share                                                      |   | $                                          | (0.02  | ) | $ | (0.15 | ) |
| Weighted average shares used in net loss  per share calculation (1) |   | 25,758,232                                 |   | 15,185,635 |   |

 

----

(1) The weighted average shares used to compute pro forma basic and dilutednet loss per share for the three months ended March 31, 2004 and 2003 includesthe 2.1 million and 0.7 million shares of common stock issued for RMK andInsight First, respectively, as if the shares were issued on January 1, 2003.

 

12

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

 

*Sale ofiPromotions, Inc.*

 

On January 31, 2003, the Company entered into anAsset Purchase Agreement with iPromotions, Inc., a corporation formed byprivate investors including some of the Company’s former employees.  Pursuant to the terms of the Asset PurchaseAgreement, the Company sold to the investors, specific contracts, equipment,intangibles, and employee relationships related to our iPromotions business,including the intellectual property relating to specific products.  The Company also invested $50,000 in cash inexchange for shares of preferred stock representing a 19.9% interest iniPromotions, Inc. on a converted basis. Accordingly, the Company effectively sold a majority stake in itsiPromotions business.  Prior to thesale, the carrying value of iPromotions was $0, therefore, there was no gain orloss on the transaction.  The cashpayment was recorded as an investment.

 

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

 

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

 

On an ongoing basis, management reviews thatvalue and period of amortization of goodwill and intangible assets.  No event occurred or circumstanceschanged during the first quarter of 2004 that would have, more likely than not,reduced the fair value of goodwill and intangible assets below the amountsreflected in the consolidated balance sheet and accordingly, no impairmentcharge was recorded for the three month period ended March 31, 2004.

 

*(a)  Goodwill*

 

The $18.7 million in goodwill at March 31,2004 relates $16.1 million to RMK, $1.1 million to 24/7 Canada, $1.1 million toReal Media and $0.4 million to 24/7 Search. The $2.6 million in goodwill at December 31, 2003 relates $1.1 millionto 24/7 Canada, $1.1 million to Real Media and $0.4 million to 24/7 Search.

 

*(b)  Intangible Assets, Net*

 

The $2.8 million in intangible assets, net atMarch 31, 2004 relates $1.6 million to Real Media, $0.9 million to InsightFirst and $0.3 million to 24/7 Search. The $3.4 million in intangible assets, net at December 31, 2003 relates$1.8 million to Real Media, $1.0 million to Insight First and $0.6 million to24/7 Search.

* *

13

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|                          |   | **March 31,**       |   | **December  31,** |   | **Estimated**     |   |
|-------------------------------|--------|---------------------|--------|-------------------|--------|-------------------|--------|
|                          |   | **2004**            |   | **2003**          |   | **Useful  Lives** |   |
|                          |   | **(in  thousands)** |   |              |   |
|                          |   |                |   |              |   |              |   |
| Goodwill (1)                  |   | $                   | 18,740 |              | $      | 2,621             |   |   |   |
|                          |   |                |   |              |   |              |   |
| Technology                    |   | $                   | 7,263  |              | $      | 7,263             |   | 4 |   |
| Less accumulated amortization |   | (4,655              | )      | (4,142            | )      |              |   |
| Net Technology                |   | 2,608               |   | 3,121             |   |              |   |
|                          |   |                |   |              |   |              |   |
| Trademark                     |   | 500                 |   | 500               |   | 4                 |   |
| Less accumulated amortization |   | (301                | )      | (269              | )      |              |   |
| Net Other intangible assets   |   | 199                 |   | 231               |   |              |   |
|                          |   |                |   |              |   |              |   |
| Gross Intangible assets       |   | 7,763               |   | 7,763             |   |              |   |
| Less accumulated amortization |   | (4,956              | )      | (4,411            | )      |              |   |
| Net Intangible assets         |   | $                   | 2,807  |              | $      | 3,352             |   |   |   |

 

----

(1) Goodwill increased $16.1 million due tothe acquisition of RMK.

 

**(5)  RESTRUCTURING**

 

The following sets forth theactivities in the Company’s restructuring reserve for the three month periodended March 31, 2004, which is included in accrued liabilities in theconsolidated balance sheet (in thousands):

 
|                          |   | **Beginning   Balance** |   | **Current  Year  Utilization** |   | **Ending  Balance** |   |
|-------------------------------|--------|-------------------------|--------|--------------------------------|--------|---------------------|--------|
| Employee termination benefits |   | $                       | 470    |                           | $      | (438                | )      | $ | 32 |   |
| Office closing costs          |   | 1,165                   |   | (170                           | )      | 995                 |   |
| Other exit costs              |   | 28                      |   | (28                            | )      | —              |   |
|                          |   | $                       | 1,663  |                           | $      | (636                | )      | $ | 1,027 |   |

 

**(6)  RELATED PARTY TRANSACTIONS**

 

The Company had issued three Promissory Notes to PubliGroupe, asignificant shareholder, totaling $7.5 million.  Mr. Wuttke, a member of the Company’s board of directors, is anofficer of PubliGroupe SA, the parent company of PubliGroupe.  One note for $4.5 million had an interestrate of 4.5% with principal and interest due in October 30, 2006.  Two notes for $1.5 million each had aninterest rate of 6% with principal and interest due in January 2005 and May2005.  On May 23, 2003, PubliGroupe surrenderedfor cancellation the three Promissory Notes plus accrued interest of approximately$0.5 million in exchange for a cash payment of $1.5 million and approximately1.0 million shares of the Company’s common stock, valued at $1.8 million.

 

Interest expense related to these notes for the three month periodended March 31, 2003 was approximately $0.1 million.

 

14

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**(7)  2% SUBORDINATED CONVERTIBLE DEBENTURES**

 

OnSeptember 26, 2003, the Company completed the placement to aninstitutional accredited investor of $15.0 million of subordinatedconvertible debentures due September 2006 (“Debentures”).  The Debentures are convertible into sharesof the Company’s common stock at $8.75 per share.  Interest on the Debentures at the rate of 2% is due semi-annuallystarting in January 2004.  The investoralso acquired a five-year warrant (the “Warrants”) to purchase 0.4 millionshares of the Company’s common stock at $9.5685 per share.

 

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

 

Additionally, if the specific conditions set forth in the Debenturesare satisfied, the Company may require the holder to convert the Debenturesinto shares of the Company’s common stock, at the conversion rate then ineffect, or the Company may prepay the Debentures prior to the maturity date,for an amount in cash equal to 150% of the amount prepaid.  In addition, if at any time on or after thesecond anniversary of the initial issuance date, the weighted average price ofthe common stock is less than $8.75 on any five consecutive trading days aftersuch second anniversary, the holder shall have the right, in its solediscretion, to require that the Company redeem up to $7.5 million principalamount of this Debentures.  Theredemption right constitutes an embedded derivative.  The value of this embedded derivative at March 31, 2004 isimmaterial to the financial position of the Company.  The Company will continue to review the value of the derivativeon a quarterly basis, in accordance with SFAS No. 149, *Amendment of Statement 133 on DerivativeInstruments and Hedging Activities*.

 

The Company valued the Warrants at $1.8 million using aBlack-Scholes pricing model with the following factors: risk free interest rateof 1.48%, volatility of 143%, dividend yield of 0% and a life of2.5 years.  The aggregate fairmarket value of the Warrants was reflected as a reduction of the face amount ofthe Debentures on the consolidated balance sheet and is being amortized overthree years, the initial term of the Debentures, using the effective interestmethod.  Accordingly, the carrying valueof the Debentures will be increased over the initial term.

 

In connection with the issuance of the Debentures and Warrants, theCompany incurred placement agent fees, legal fees and other expenses ofapproximately $1.2 million to be paid in cash.  In addition to the placement fees, the Company issued warrants tothe placement agent.  The warrants topurchase 86,000 shares of common stock at an exercise price of $10.068 are inthe same form and on the same terms and conditions as the Warrants issued tothe investor.  The Company included thevalue of the warrants, $0.4 million, using the factors above, and the cashplacement fees of $1.2 million in other assets on the consolidated balance sheet.  Collectively, the debt issuance costs of $1.6million are being amortized over three years, the initial term of theDebentures.  In 2004, approximately $0.1million of these costs are included in amortization

 

15

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expense and at March 31, 2004, the unamortized portion of the debtissuance costs is $1.3 million.

 

**(8) ****EQUITY INSTRUMENTS**

 

PREFERRED STOCK

 

During the quarter, 114,638 shares of Series A and 250 shares of SeriesC Preferred Stock were converted into 1,116,513 and 2,070 shares of common stock,respectively.

 

COMMON STOCK

 

*(a)  SecondaryStock Offering*

 

On March 30, 2004, the Company completed a secondary stock offering inwhich a total of 8.0 million shares of common stock were sold at $6.00 pershare.  Of the shares sold, the Companysold 6.0 million shares and selling stockholders sold 2.0 million shares.  The Company and the selling stockholdersreceived proceeds net of underwriting discounts and commission, and beforeother offering expenses, of $33.8 million and $11.3 million, respectively.  Other offering expenses estimated atapproximately $1.0 million were accrued at March 31, 2004.  The Company will pay all offering expenses(including the offering expenses of the selling stockholders).

 

In connection with this offering, the Company and selling stockholdersgranted to the underwriters an option to purchase up to an additional 1.2millions shares of common stock at $6.00 per share less underwriter discountsand commissions for the purpose of covering over-allotments.  Of the additional shares offered,approximately 0.8 million shares and 0.4 million shares were offered by theCompany and by the selling stockholders, respectively (see note 13).

 

*(b)  ReverseStock Split*

 

On February 27, 2004, the Company completed a one-for-five reversesplit of its common stock. As a result of the reverse split, every five sharesof the Company’s common stock were combined into one share of common stock. Thereverse split does not affect the number of shares of preferred stock andwarrants outstanding, however, the conversion ratio is adjusted.  All figures relating to common stock,preferred stock, stock options, warrants and other equity-linked instrumentshave been adjusted in this Form 10-Q to reflect the reverse stock split.

 

*(c)  OtherIssuances*

 

On January 6, 2004, the Company issued approximately 2.1 millionshares, valued at $14.6 million, in connection with the acquisition of RMK.

 

On March 17, 2003, the Company issued approximately 0.3 million shares,valued at $0.3 million, to employees in lieu of cash for achieving contractualperformance-based 2002 targets bonuses. The bonuses were accrued at December 31, 2002.

 

On January 21, 2003, the Company issued approximately 0.7 millionshares, valued at $1.1 million, in connection with the acquisition of InsightFirst.

 

16

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*(d)  Additional Paid-in Capital*

 

*During the three month periodended March 31, 2004, the Company’s additional paid-in capital increased by$48.6 million primarily due to $32.8 million in connection with the Company’ssecondary offering of common stock, $14.6 million in connection with theacquisition of RMK, $0.6 million in other stock-based compensation issued toemployees and $0.6 million from exercise of stock options and warrants.*

 

**(9)  STOCK INCENTIVE PLANS**

 

For the three month periodended March 31, 2004, the Company granted 1.8 million stock options under the2002 Stock Incentive Plan to employees at exercise prices based on the fairmarket value of the Company’s common stock at the respective dates of grant.

 

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

 

**(10)  SUPPLEMENTAL CASH FLOW INFORMATION**

 

*Cash Paidfor Interest*

 

For the three months ended March 31, 2004 and2003, the amount of cash paid for interest was $81,000 and $3,000,respectively.

 

**(11)  SEGMENTS**

 

The Company’s business is comprised of tworeportable segments:  Integrated MediaSolutions and Technology Solutions.  TheIntegrated Media Solutions segment generates the majority of its revenues bydelivering advertisements and promotions to affiliated Web sites and searchengine traffic delivery and marketing services.  The Technology Solutions segment generates revenue by providingthird-party advertisement serving and other technology services.  The Company’s management periodicallyreviews corporate assets and overhead expenses for each segment.  The summarized segment information asof and for the three months ended March 31, 2004 and 2003, is as follows:

 

17

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|                                                            |   | **Three  months ended March 31, 2004** |   |
|-----------------------------------------------------------------|--------|----------------------------------------|--------|
|                                                            |   | **Integrated**                         |   |   |   |   |   |   |   |
|                                                            |   | **Media**                              |   | **Technology** |   |   |   |   |   |
|                                                            |   | **Solutions**                          |   | **Solutions** |   | **Corporate** |   | **Total** |   |
|                                                            |   | **(in  thousands)**                    |   |
|                                                            |   |                                   |   |   |   |   |   |   |   |
| Revenues                                                        |   | $                                      | 13,039 |   | $ | 4,342 |   | $ | — |   | $ | 17,381 |   |
| Depreciation                                                    |   | 247                                    |   | 224 |   | 17 |   | 488 |   |
| Amortization of intangible assets and  deferred financing costs |   | 327                                    |   | 329 |   | 132 |   | 788 |   |
| Stock-based compensation                                        |   | 28                                     |   | — |   | 171 |   | 199 |   |
| Segment income (loss) from operations                           |   | (165                                   | )      | 739 |   | (1,792 | ) | (1,218 | ) |
| Interest income (expense), net                                  |   | 23                                     |   | — |   | (205 | ) | (182 | ) |
| Other income (expense), net                                     |   | (9                                     | )      | — |   | 189 |   | 180 |   |
| Income tax expense                                              |   | (100                                   | )      | — |   | — |   | (100 | ) |
| Segment income (loss)                                           |   | (251                                   | )      | 739 |   | (880 | ) | (392 | ) |
|                                                                 |        |                                        |        |  |  |  |  |  |  |  |  |  |  |

 
|                                                            |   | **Three  months ended March 31, 2003** |   |
|-----------------------------------------------------------------|--------|----------------------------------------|--------|
|                                                            |   | **Integrated**                         |   |   |   |   |   |   |   |
|                                                            |   | **Media**                              |   | **Technology** |   |   |   |   |   |
|                                                            |   | **Solutions**                          |   | **Solutions** |   | **Corporate** |   | **Total** |   |
|                                                            |   | **(in  thousands)**                    |   |
|                                                            |   |                                   |   |   |   |   |   |   |   |
| Revenues                                                        |   | $                                      | 8,343  |   | $ | 3,481 |   | $ | — |   | $ | 11,824 |   |
| Depreciation                                                    |   | 434                                    |   | 193 |   | 31 |   | 658 |   |
| Amortization of intangible assets and  deferred financing costs |   | 333                                    |   | 314 |   | — |   | 647 |   |
| Stock-based compensation                                        |   | 20                                     |   | — |   | 27 |   | 47 |   |
| Segment loss from operations                                    |   | (492                                   | )      | (42 | ) | (1,665 | ) | (2,199 | ) |
| Interest income (expense), net                                  |   | 1                                      |   | — |   | (92 | ) | (91 | ) |
| Income tax expense                                              |   | (7                                     | )      | — |   | — |   | (7 | ) |
| Segment loss                                                    |   | (497                                   | )      | (42 | ) | (1,758 | ) | (2,297 | ) |
|                                                            |   |                                   |   |   |   |   |   |   |   |
| Total assets:                                                   |   |                                   |   |   |   |   |   |   |   |
| March 31, 2004                                                  |   | 36,159                                 |   | 10,473 |   | 56,419 |   | 103,051 |   |
| December 31, 2003                                               |   | 10,381                                 |   | 11,173 |   | 24,626 |   | 46,180 |   |
|                                                            |   |                                   |   |   |   |   |   |   |   |
|                                                            |   | **US**                                 |   | **International** |   | **Total** |   |   |   |
|                                                            |   | **(in  thousands)**                    |   |   |   |
| Three months ended March 31, 2004                               |   |                                   |   |   |   |   |   |   |   |
| Revenues                                                        |   | $                                      | 8,423  |   | $ | 8,958 |   | $ | 17,381 |   |   |   |
| Long-lived assets                                               |   | 13,027                                 |   | 18,489 |   | 31,516 |   |   |   |
|                                                            |   |                                   |   |   |   |   |   |   |   |
| Three months ended March 31, 2003                               |   |                                   |   |   |   |   |   |   |   |
| Revenues                                                        |   | $                                      | 7,440  |   | $ | 4,384 |   | $ | 11,824 |   |   |   |
| Long-lived assets at December 31, 2003                          |   | 9,548                                  |   | 1,715 |   | 11,263 |   |   |   |
|                                                                 |        |                                        |        |  |  |  |  |  |  |  |  |  |  |

 

18

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**(12)  COMMITMENTS AND CONTINGENCIES**

 

COMMITMENTS

 

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

 

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

 

The agreement requires the Company to pay Lycos the greater of 65% ofall net advertising sales revenue generated by the Company in respect of Lycos’U.S. Web properties, or specified minimum required annual payments.  For 2004, the minimum annual payment is$10.0 million and is payable $2.5 million 45 days after each quarter end.  To the extent that Lycos’ 65% revenue shareexceeds the quarterly amount of the minimum annual payment, the Company maycredit such excess against the next succeeding quarterly payment of the minimumannual payment.  Management believesthat the minimums will be met, resulting in no additional expense for thequarter.

 

The Company also will pay Lycos a transition payment of  $4.5 million in equal installments ateach quarter end in 2004.  The amountwas recorded as an other long-term asset and a current liability.  The asset will be amortized over the term ofthe agreement or five years.

 

***Indemnifications***

 

While the Company hasvarious indemnification obligations included in contracts in the normal courseof business, these indemnities do not represent significant commitments orcontingent liabilities of the indebtedness of others.  Accordingly, the Company has not recorded a liability related toindemnification provisions.

 

LITIGATION

 

*aQuantive, Inc. (formerly AvenueA, Inc.)*

 

On April 19, 2002, aQuantive, Inc. (formerly AvenueA, Inc.) filed a complaint against the Company seeking a declaratoryjudgment that U.S. Patent No. 6,206,368 is invalid and not infringed byaQuantive. The complaint also seeks injunctive relief and recovery ofattorney’s fees. On May 10, 2002, the Company filed its answer to thecomplaint, in which the Company denied the material allegations of thecomplaint and asserted a counterclaim for infringement of the ‘368 patent. On January 2,2003, aQuantive filed a motion for summary judgment of non-infringement, towhich the Company filed papers in opposition on April 28, 2003. OnJuly 3, 2003, the U.S. Federal Court for the Western District ofWashington granted partial summary judgment to aQuantive, Inc. and heldthat, based on the court’s construction of the patent’s claims, aQuantive’sAtlas DMT advertisement serving system does not infringe the ‘368 patent. TheCompany appealed the court’s ruling to the Court of Appeals for the FederalCircuit and agreed with aQuantive to dismiss the remaining claims in the caseto expedite the appeal.  In March 2004,the Federal Circuit Court of Appeals affirmed, without opinion, the decision ofthe U.S. Federal Court for the Western District of Washington.  The Company filed a request for rehearingbefore the Federal Court of Appeals which has been denied on May 7, 2004.

 

*Brian Anderson*

 

On July 5, 2001, Brian Anderson, former Chief Executive of ourAwardTrack, Inc. subsidiary, served the Company with notice of a lawsuitfiled in Superior Court for the State of California in and for the County ofSanta Cruz, alleging breach of contract, fraud, 

 

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intentional infliction of emotional distress and breach of fiduciaryduty, in connection with the acquisition of AwardTrack and subsequent events.The Company removed the lawsuit to federal court in California and moved todismiss the complaint in its entirety. The motion was granted in part, withleave to amend, and denied in part. The plaintiff has subsequently refiled thecomplaint and the Company filed a counterclaim. Discovery has concluded, andthe Company has moved for summary judgment to dismiss the complaint in itsentirety.

 

*chinadotcom Corporation*

 

On February 19, 2003, the Company filed a complaint in federalcourt against chinadotcom Corporation for breach of contract, unjustenrichment, breach of duty of good faith and fair dealing, and promissoryestoppel arising out of a certain equity exchange agreement datedAugust 16, 2000 between chinadotcom and the Company, seeking to enforcethe Company’s right to exchange its stake in 24/7 Media-Asia Ltd. for1.8 million shares of chinadotcom. chinadotcom filed a motion seeking tocompel arbitration of the matter, which the court granted on May 12, 2003.

 

On April 29, 2003, chinadotcom filed an action in court in HongKong against David Moore, our Chief Executive Officer, alleging, among otherthings, breach of fiduciary duty by Mr. Moore in connection with hisservice as a director of chinadotcom and its subsidiary, 24/7Media-Asia Ltd. On November 24, 2003, the Hong Kong Court dismissedchinadotcom’s complaint against Mr. Moore in its entirety, andMr. Moore has requested chinadotcom to reimburse him for all of his legalexpenses. chinadotcom has appealed the dismissal of its claim and that appealis pending.  The Company has assumedMr. Moore’s defense and will indemnify him in the event of any liability.  The Company believes that the claims againstMr. Moore are without merit and that the action was brought solely inretaliation against the Company for asserting its rights in the matterdiscussed above.

 

On July 22, 2003, chinadotcom filed an arbitration claim with theInternational Court of Commerce asserting certain alleged breaches of contractin connection with the Media Asia Agreement entered into between the parties asof June 30, 2000.  The claim seeksdamages totaling $24.0 million. The Company believes that chinadotcom’s claims are without merit. TheCompany has filed an Answer and Counterclaim in the matter and intends todefend itself vigorously against these claims.

 

*General*

 

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

 

**(13)****           SUBSEQUENT EVENTS**

 

*Offering of Common Stock – Exercise ofUnderwriters’ Over-Allotment Option*

 

In April 2004,the underwriters exercised the option to purchase an additional 1.2 millionshares of our common stock for the purpose of covering over-allotments.  The Company and selling stockholdersreceived additional proceeds of $4.3 million and $2.3 million, respectively,net of underwriting discounts and commissions and before other offeringexpenses.

 

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

 

This report includes forward-looking statements within the meaning ofthe Private Securities Litigation Reform Act of 1995. This Act provides a “safeharbor” for forward-looking statements to encourage companies to provideprospective information about themselves so long as they identify thesestatements as forward looking and provide meaningful cautionary statementsidentifying important factors that could cause actual results to differ fromthe projected results. All statements other than statements of historical fact,including statements regarding industry prospects and future results ofoperations or financial position, made in this Quarterly Report are forwardlooking. We use words such as “anticipates,” “believes,” “expects,” “future”and “intends” and similar expressions to identify forward-looking statements.Forward-looking statements reflect management’s current expectations, plans orprojections and are inherently uncertain. Our actual results may differsignificantly from management’s expectations, plans or projections. Readers arecautioned not to place undue reliance on these forward-looking statements,which speak only as of the date hereof. Certain risks and uncertainties thatcould cause our actual results to differ significantly from management’sexpectations are described in the section entitled “Risk Factors” and elsewherein this Quarterly Report. We undertake no obligation to publicly release anyrevisions to these forward-looking statements that may be made to reflectevents or circumstances after the date hereof or to reflect the occurrence ofunanticipated events. Readers are urged, however, to review the risk factorsset forth in reports that we file from time to time with the Securities andExchange Commission. Unless the context requires otherwise in this QuarterlyReport the terms “24/7 Real Media,” the “Company,” “we,” “us” and “our” referto 24/7 Real Media, Inc. and its subsidiaries, and references to “24/7Search” refer to 24/7 Search, Inc., formerly 24/7 Website Results, Inc.,a wholly owned subsidiary of 24/7 Real Media, Inc.

 

### **GENERAL**

 

We offer a comprehensive suite of media andtechnology products for the online advertising needs of Web publishers andadvertisers, including Web representation, advertisement serving, analytics andsearch services. Our 24/7 Web Alliance of over 800 affiliated Web sitesaggregates advertising inventory online and targets audience segments toattract advertisers worldwide. Our Open AdSystem technology helps Webpublishers and advertisers target, convert and retain online customers,maintain customer relationships and safeguard the privacy of Web users. Through24/7 Search, we connect advertisers with consumers who use search engines tofind information about products and services.

 

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

 

*IntegratedMedia Solutions*

 

Our Integrated Media Solutions consist of the 24/7Web Alliance, a global alliance of Web sites represented by us through whichadvertisers can run campaign orders directly with us, 24/7 Search, an Internetsearch marketing service designed to connect advertisers with consumers usingsearch engines to find product information, and Other Media Services. Our 24/7Search solution uses proprietary technology to help advertisers determine thekeywords most relevant to their products and services in order to lead usersfrom search engines to the advertisers’ Web sites.

 

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We generate revenue through the 24/7 Web Alliancefrom fees paid by client advertisers. We typically offer advertisers a pricingmodel based on cost-per-thousand-impressions (“CPM”) enabling a clientadvertiser to pay a fee based on the number of times its advertisement is viewed.

 

We share the revenue generated through the 24/7 WebAlliance with Web publishers included in the 24/7 Web Alliance. With respect toour 24/7 Network, a network of hundreds of Web sites offering a variety ofcontent based in the U.S., we generally retain between 40% and 50% of revenuesfrom advertisers depending on, among other things, a Web publisher’s audiencesize, the number of unique visitors, impressions and page views, and theprominence of the Web publisher’s brand name. With respect to our 24/7 Portfolio,a select global portfolio of brand name Web sites, we generally retain between20% and 40% depending on similar factors, including geography.

 

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

 

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

 

24/7 Search providesservices necessary for the inclusion of an advertiser’s Web site into bothpay-for-placement and algorithmic search engines.  These services are commonly referred to as bidded services andpaid inclusion, respectively.  Our 24/7Search content builders review advertiser Web site content for relevancy tosatisfy both advertiser conversion metrics and search engine editorialstandards. Our 24/7 Search optimization team produces a content feed forinsertion into the databases of our search distribution partners and helps ouradvertisers select the most relevant Web site landing page for visitors.  Through relationships with our searchdistribution partners, we submit advertiser content via automated data feeds.The feeds we submit are regularly refreshed by us to maintain relevancy andaccuracy.  Our selection of relevantcontent is intended to help our advertiser Web sites appear within searchresults for relevant search queries, improve user experience and improveadvertiser conversions.  Our servicesonly provide that our client advertisers’ Web site content will be included inour search engine distribution partners’ databases.  We do not guarantee our client advertisers any particular rankingwithin search results listings displayed by our search engine distributionpartners to users.

 

Generally, we offer performance-based pricing forour 24/7 Search services.  Our clientadvertisers pay a predetermined cost-per-click, or CPC, for each valid visitordelivered to their Web sites.  For ourbidded service, which constitutes a larger portion of our 24/7 Search revenue,we agree on a CPC price with our client advertisers and then we place CPC bidsfor various keywords and phrases with our search engine distributionpartners.  We pay the CPC bid price toour distribution partner when a valid visitor links to one of our clientadvertisers’ Web sites by

 

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clicking a link displayed in the search results forsuch keywords or phrases.  We generallykeep the spread between the CPC price charged to our client advertiser and theCPC bid price paid to our distribution partner.  For our paid inclusion service, we share the revenue generated byour 24/7 Search services with our search engine distribution partners thatinclude our client advertisers’ Web site content in their databases.  We generally retain between 30% and 45% of therevenue depending on the size of our distribution partner, the number of validvisitors, the number of searches conducted and the prominence of ourdistribution partner’s brand name, among other factors.  To a lesser extent, we provide searchmanagement services.  For these clients,we place CPC bids and manage keyword purchases with our distribution partnersand charge client advertisers our CPC plus a commission for each valid visitordelivered to the client.

 

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

 

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

 

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

 

*Technology Solutions*

 

Our Technology Solutions are primarily based on ourpatent-protected Open AdSystem technology platform for Internet advertisementdelivery, management and analytics, and consist of:

 

•                  Open AdStreamLocal, which we license to Web publishers to run on their proprietary, localservers;

 

•                  Open AdStreamCentral, which we provide to Web publishers from software hosted centrally onour servers; and

 

•                  Open Advertiser,which we provide to advertisers and advertising agencies from software hostedcentrally on our servers.

 

We designed our Insight software solutions to fullyintegrate with our Open AdSystem (“OAS”) technology to offer Web publishers activecampaign reporting and marketing intelligence and help advertisers measure,analyze and manage online audiences. In addition to our Insight XE solution,which is currently available, we launched two additional analytics products inthe first quarter of 2004 that will integrate with OAS. We have designed ourInsight ACT solution to

 

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enable a Web publisher to enhance the value of itsadvertising inventory by identifying and targeting segments of its audience whomay be receptive to a specific advertiser’s message. We have designed ourInsight SE solution to allow an advertiser to create targeted campaigns usingkeywords and phrases, and generate performance metrics that track visitors fromspecific search engines throughout the entire sales cycle, from prospecting bynew customers to the final sale. We may provide these solutions, includingInsight XE, to our customers from software hosted on our servers or fromsoftware hosted on a customer’s server that is administrated by us.

 

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

 

We generate revenue from our Open AdStream Centraland Open Advertiser services from fees paid by Web publishers and advertisersand agencies, respectively. We typically offer Web publishers or advertisers aCPM-based pricing model allowing the Web publisher or advertiser to pay usbased on advertising impressions. For these customers, an “impression” includesthe delivery by us at their request of any advertising material. Our servicerevenue is determined by multiplying the CPM rate by the number of impressionsdelivered and is typically billed on a monthly basis. We have been generatingrevenue from Open Advertiser in Europe since mid-2001. We launched our OpenAdvertiser service in the United States in June 2003 but we have notgenerated significant revenue in the U.S. from this service from our initialbeta or commercial customers.

 

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

 

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

 
|    |   | **OAS Local**                                |   | **OAS  Central, OAD and Insight XE**        |   |                                                           |   |
|---------|--------|----------------------------------------------|--------|---------------------------------------------|--------|----------------------------------------------------------------|--------|
|    |   | **Number of  Active Client   Contracts (1)** |   | **Number of  Active Client  Contracts (1)** |   | **Number of  Paid   Impressions /   Pageviews(in   billions)** |   | **Annual  Revenue   per Contract** |   |
| Q1 2004 |   | 201                                          |   | 170                                         |   | 19.7                                                           |   | 46,814 |   |
| Q4 2003 |   | 199                                          |   | 150                                         |   | 14.9                                                           |   | 45,009 |   |
| Q3 2003 |   | 219                                          |   | 162                                         |   | 13.3                                                           |   | 42,845 |   |
| Q2 2003 |   | 221                                          |   | 156                                         |   | 11.9                                                           |   | 40,191 |   |
| Q1 2003 |   | 235                                          |   | 164                                         |   | 10.6                                                           |   | 34,897 |   |
| Q4 2002 |   | 258                                          |   | 162                                         |   | 7.5                                                            |   | 37,457 |   |
| Q3 2002 |   | 273                                          |   | 159                                         |   | 6.4                                                            |   | 30,926 |   |
| Q2 2002 |   | 271                                          |   | 153                                         |   | 5.1                                                            |   | 30,660 |   |
| Q1 2002 |   | 274                                          |   | 152                                         |   | 4.9                                                            |   | 30,376 |   |

 

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

 

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

 

 

# **RESULTS OFOPERATIONS**

 

# **FACTORSAFFECTING COMPARABILITY OF 2004 TO 2003**

 

In January 2004, we acquired Real Media KoreaCo., Ltd. (“RMK”), a leader in interactive marketing in Seoul, Korea.  Revenue was approximately $3.2 million inthe first quarter of 2004.

 

### The following table comparesthe results of operations for the three month period ended March 31, 2004 tothe results of operations for the three month period ended March 31, 2003 (inthousands):

 
|                                                            |   | **Three  months ended March 31,** |   | **Dollar**          |   | **Percentage** |   |
|-----------------------------------------------------------------|--------|-----------------------------------|--------|---------------------|--------|----------------|--------|
|                                                            |   | **2004**                          |   | **2003**            |   | **Variance**   |   | **Variance** |   |
|                                                            |   |                              |   | **(in  thousands)** |   |           |   |   |   |
|                                                            |   | **(unaudited)**                   |   | **(unaudited)**     |   |           |   |   |   |
| Revenues:                                                       |   |                              |   |                |   |           |   |   |   |
| Integrated media solutions                                      |   | $                                 | 13,039 |                | $      | 8,343          |   | $ | 4,696 |   | 56.3 | % |
| Technology solutions                                            |   | 4,342                             |   | 3,481               |   | 861            |   | 24.7 | % |
| Total revenues                                                  |   | 17,381                            |   | 11,824              |   | 5,557          |   | 47.0 | % |
|                                                            |   |                              |   |                |   |           |   |   |   |
| Cost of revenues:                                               |   |                              |   |                |   |           |   |   |   |
| Integrated media solutions                                      |   | 9,441                             |   | 5,510               |   | 3,931          |   | 71.3 | % |
| Technology solutions                                            |   | 822                               |   | 1,165               |   | (343           | )      | -29.4 | % |
| Total cost of revenues                                          |   | 10,263                            |   | 6,675               |   | 3,588          |   | 53.8 | % |
|                                                            |   |                              |   |                |   |           |   |   |   |
| Gross profit                                                    |   | 7,118                             |   | 5,149               |   | 1,969          |   | 38.2 | % |
|                                                            |   |                              |   |                |   |           |   |   |   |
| Operating expenses:                                             |   |                              |   |                |   |           |   |   |   |
| Sales and marketing                                             |   | 3,316                             |   | 3,144               |   | 172            |   | 5.5 | % |
| General and administrative                                      |   | 2,982                             |   | 2,922               |   | 60             |   | 2.1 | % |
| Product development                                             |   | 1,051                             |   | 588                 |   | 463            |   | 78.7 | % |
| Amortization of intangible assets and  deferred financing costs |   | 788                               |   | 647                 |   | 141            |   | 21.8 | % |
| Stock-based compensation                                        |   | 199                               |   | 47                  |   | 152            |   | 323.4 | % |
|                                                            |   |                              |   |                |   |           |   |   |   |
| Total operating expenses                                        |   | 8,336                             |   | 7,348               |   | 988            |   | 13.4 | % |
|                                                            |   |                              |   |                |   |           |   |   |   |
| Loss from operations                                            |   | (1,218                            | )      | (2,199              | )      | 981            |   | 44.6 | % |
|                                                            |   |                              |   |                |   |           |   |   |   |
| Interest expense, net                                           |   | (182                              | )      | (91                 | )      | (91            | )      | -100.0 | % |
| Change in fair value of warrant liability                       |   | 928                               |   | —              |   | 928            |   | 100.0 | % |
| Other income, net                                               |   | 180                               |   | —              |   | 180            |   | 100.0 | % |
|                                                            |   |                              |   |                |   |           |   |   |   |
| Loss before provision for income taxes                          |   | (292                              | )      | (2,290              | )      | 1,998          |   | 87.2 | % |
|                                                            |   |                              |   |                |   |           |   |   |   |
| Provision for income taxes                                      |   | 100                               |   | 7                   |   | 93             |   | 1328.6 | % |
|                                                            |   |                              |   |                |   |           |   |   |   |
| Net loss                                                        |   | $                                 | (392   | )                   | $      | (2,297         | )      | $ | 1,905 |   | 82.9 | % |

 

### **REVENUES**

 

**INTEGRATEDMEDIA SOLUTIONS.**Revenueis derived from three sources: 24/7 Web Alliance, 24/7 Search and Other MediaServices.  24/7 Web Alliance revenue was$9.7 million and $4.7 million for the three months ended March 31, 2004 and2003, respectively, an increase of 107.5%. The increase is primarily due to an increase in impressions sold from6.1 billion in

 

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2003 to 9.6 billion in 2004.  Excluding RMK, Web Alliance revenueincreased $2.0 million or 42.6%.

 

24/7 Search revenue was $3.0 million and $3.1million for the three months ended March 31, 2004 and 2003, respectively, adecrease of 2.2%.  Historically, wegenerated a significant portion of our 24/7 Search revenue from relationshipswith a small number of search engine distribution partners, particularly Inktomi,which accounted for approximately 55.6% of our 24/7 Search revenue in the firstquarter of 2003.  Inktomi was acquiredby Yahoo! in the first quarter of 2003 and certain changes implemented byInktomi caused the revenue we generate from Inktomi to decline, and ourcontract with Inktomi expired in May 2003. The loss of revenue from Inktomi was partially offset by increased validvisitors from expanded relationships with our other distribution partners andnew search relationships.

 

*Other Media Services revenue isgenerated primarily from e-mail.  E-mailrevenue decreased from $0.5 million to $0.3 million for the three months endedMarch 31, 2004 and 2003, respectively. The decrease was due to less emphasis placed on e-mail as we focus onour core businesses.*

 

**TECHNOLOGYSOLUTIONS.**OurTechnology Solutions revenue was $4.3 million and $3.5 million for the threemonths ended March 31, 2004 and 2003, respectively, representing an increase of24.7%.  Revenue from products that wehost, including Open AdStream Central, Open Advertiser and Insight XE, grew asimpressions and pageviews delivered climbed from 10.6 billion to 19.7 billionas we added new customers.  ExcludingRMK, our Technology revenues increased $0.7 million or 21.3%.

 

**COST OFREVENUE AND GROSS PROFIT**

 

**INTEGRATEDMEDIA SOLUTIONS COST OF REVENUES AND GROSS PROFIT.**Our cost of revenues consists primarily offees paid to affiliates, whether it is a Web site (24/7 Web Alliance), a listprovider (for e-mail) or a search engine distribution partner (for 24/7Search), which is usually calculated as a percentage of revenues.  Cost of revenues also includes advertisementserving costs, which is an intercompany charge from the Technology Solutionssegment based on a fixed CPM.  Grossprofit margin decreased from 34.0% for the three months ended March 31, 2003 to27.6% for the three months ended March 31, 2004.  This decrease is due to the addition of RMK, which has a lowergross profit margin than existing businesses, and increased upward pressure onthe cost of traffic for 24/7 Search.  Inaddition, 24/7 Search generated a greater portion of its revenue frombid-for-placement and search management services, which have a lower grossmargin than paid inclusion.

 

**TECHNOLOGYSOLUTIONS COST OF REVENUES AND GROSS PROFIT.**Our cost of technology revenues consists ofthe costs of operating equipment and broadband bandwidth capacity centrallyhosted technology solutions and payroll costs to deliver and support softwareoffset by the portion charged to Integrated Media Solutions for advertisementserving.  Gross margins were 81.1% and66.5% for the three month periods ended March 31, 2004 and 2003,respectively.  The increase in grossmargins is due to declining hosting and bandwidth costs and leveraging theexisting support infrastructure over a higher revenue base.

 

**SALES ANDMARKETING EXPENSES.**Sales and marketing expenses consist primarily of sales force salaries andcommissions, advertising expenditures and cost of trade shows, conventions andmarketing materials.  Sales andmarketing expenses were $3.3 million and $3.1 million for the three monthsended March 31, 2004 and 2003, respectively. Sales and marketing expenses decreased as a percentage of revenue from26.6% for the three month period ended

 

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March 31, 2003 to 19.1% for the three monthperiod ended March 31, 2004 as we were able to gain operating leverage off theexisting cost structure.  The number ofemployees included in sales and marketing increased from 129 at March 31, 2003to 133 at March 31, 2004, as a result of terminations and the addition of 30employees from RMK.

 

**GENERAL ANDADMINISTRATIVE EXPENSES**.General and administrative expenses consist primarily of compensation,facilities expenses and other overhead expenses incurred to support thebusiness.  General and administrativeexpenses were $3.0 million and $2.9 million for the three months ended March31, 2004 and 2003, respectively.  As apercentage of revenue, the expenses decreased from 24.7% to 17.2% for the threemonths ended March 31, 2003 and 2004, respectively.  The decrease as a percentage of revenue reflects an increasedrevenue base with low additional costs. The number of general and administrative employees at March 31, 2004 and2003 was 47 and 45, respectively.

 

**PRODUCTDEVELOPMENT EXPENSES.**Product development expenses consist primarily of compensation and relatedoperating expenses incurred to perform research and development, furtherenhance and maintain our existing products and provide quality assurance.  Product development expenses were $1.1million and $0.6 million for the three months ended March 31, 2004 and 2003,respectively.  We capitalizedapproximately $0.2 million for the three months ended March 31, 2003 andcontinued to capitalize the costs until Open Advertiser was commerciallyreleased in June 2003.  The remainingincrease is related to the development of our Insight SE and Insight ACTproducts and further enhancements to our Insight XE and Open AdStreamproducts.  The number of employees includedin product development increased from 31 at March 31, 2003 to 41 at March 31,2004.

 

**AMORTIZATIONOF INTANGIBLE ASSETS AND DEFERRED FINANCING COST.** Amortization expense relates to intangibleassets acquired with 24/7 Search in August 2000, certain assets acquired fromInsight First in January 2003, deferred financing costs associated with thesubordinated convertible debentures offering in September 2003 and thetransition payment to Lycos in February 2004. Amortization expense increased from $0.6 million for the three monthsended March 31, 2003 to $0.8 million for the three months ended March 31,2004.  Amortization expense for thethree months ended March 31, 2004 relates $0.5 million to acquired technology,$0.2 million to deferred financing costs and $0.1 million to the transitionpayment to Lycos.  Amortization expensefor the three months ended March 31, 2003 related $0.6 million to acquiredtechnology.

 

**STOCK-BASEDCOMPENSATION**.Stock-based compensation was $0.2 million and $47,000 for the three monthsended March 31, 2004 and 2003, respectively. The expense for the three months ended March 31, 2004 consists of $0.1million in amortization of deferred compensation for restricted shares issuedto certain employees and $0.1 million in discretionary bonuses paid instock.  The expense for the three monthsended March 31, 2003 represents the amortization of deferred compensation forrestricted shares issued to certain employees.

 

**INTERESTEXPENSE, NET**.Interest expense, net relates to our long term debt and capital leaseobligations offset by interest income related to our cash and cashequivalents.  Interest expense, net was$0.2 million and $0.1 million for the three months ended March 31, 2004 and2003, respectively.  Interest expense in2004 primarily relates to subordinated convertible debt issued in the thirdquarter of 2003.  Interest in 2003primarily related to the PubliGroupe debt that was settled in the secondquarter of 2003.  Interest expense inboth periods was offset by interest income from cash in overnight deposits andmoney market accounts.

 

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**CHANGE INFAIR VALUE OF WARRANT LIABILITY**. Each quarter the liability related to warrants outstanding from ourpreferred stock and subordinated convertible debenture offerings will beadjusted to fair value.  The $0.9million gain is due to a decrease in the fair value of the warrants outstandingwhich reduced the corresponding liability. The decrease in the fair value is primarily due to a lower stock priceat the end of the first quarter compared to when the warrants were issued.

 

**OTHERINCOME, NET**. The $0.2million in 2004 primarily relates to amounts recovered from a former subsidiarythat was shut down.

 

**PROVISIONFOR INCOME TAXES**. Theprovision for income taxes recorded for the three month period ended March 31,2004 of $0.1 million consist primarily of income taxes on earnings of ourforeign subsidiaries.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

***Operating Activities***

 

Since our inception we have financed ouroperations through equity financings and long-term debt.  We used approximately $1.4 million and $2.6million of cash in operating activities during the first quarter of 2004 and2003, respectively, generally as a result of our net operating losses, adjustedfor certain non-cash items included in our operating results as well as changesin various components of working capital.

 

***Investing and Financing Activities***

 

Net cash used by investing activities wasapproximately $1.9 million and $0.5 million during the first quarter of 2004and 2003, respectively.  Investingactivities during the first quarter of 2004 related $1.6 million to theacquisition of RMK and $0.3 million to capital expenditures for generaloperational purposes.  During 2003, we paid$0.2 million as part of the acquisition of certain assets of Insight First,Inc. and as an investment in iPromotions, Inc. and $0.3 million for capitalexpenditures, including capitalized software.

 

Financing activities provided $34.4 millionand $30,000 in the three months ended March 31, 2004 and 2003,respectively.  Financing activities in2004 primarily related to proceeds from our secondary offering of common stockand the exercise of stock options. Financing activities in 2003 primarily related to the exercise of stockoptions.

 

***CertainContingencies and Capital Requirements***

* *

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

* *

*Pursuant to our agreement withLycos, Inc. there is $3.4 million related to the transition payment due  in equal installments at each quarter end in2004 and specified minimum annual payments. For 2004, the minimal annual payment is $10.0 million and is payable$2.5 million 45 days after each quarter end.*

* *

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* *

*The operating lease agreementsrelate to our offices throughout the United States and internationally withoriginal lease periods expiring between 2004 and 2008.*

* *

*The Company has various employmentagreements with employees, the majority of which are for one year with anautomatic renewal.  The potentialobligation under these contracts is approximately $4.1 million for 2004including salary and performance based target bonuses.  These contracts call for severance paymentsin the event of involuntary termination which generally range in amount fromthree months to one year’s salary.  Allnon-U.S. employees have employment contracts as required by local law.  The majority of these contracts allow forresignation or termination by either party at any time, according to the noticeperiod provisions contained in the employment contracts, or according to the minimumnotice period as mandated by local law. The contracts or, if no expressed provision is included in the contract,local law also require severance for involuntary terminations ranging from oneto six months.  As of March 31, 2004,there were approximately 63 employees in Europe whose annualized base salariesare approximately $4.7 million.*

 

As of March 31, 2004, we had approximately$1.0 million remaining of cash outlay obligations relating to restructuring andexit costs consisting of severance and rent. We expect to pay approximately $0.3 in the remainder of 2004, $0.2million in each year from 2005 to 2007 and $0.1 million in 2008.

 

Our capital requirements depend on numerousfactors, including market demand of our services, the capital required tosupport and maintain our technology, and the resources we devote to marketingand selling our services.  We may selladditional equity or debt securities that would result in further dilution toour stockholders.  Stockholders manyexperience extreme dilution due to both our common stock price and thesignificant amount of financing we may raise. These securities may have rights senior to those holders of our commonstock.  Any indebtedness could containcovenants, which restrict our operations. Our subordinated convertible debentures limit our ability to incuradditional debt.

 

We believe that our existing cash and cashequivalents and cash flow from operating activities will be sufficient to meetour anticipated cash needs for working capital and capital expenditures for atleast the next 12 months.

 

**OFF-BALANCESHEET ARRANGEMENTS**

 

We did not have any relationships with unconsolidated entities orfinancial partnerships, such as entities often referred to as structuredfinance or special purpose entities, which would have been established for thepurpose of facilitating off-balance sheet financial arrangements or othercontractually narrow or limited purposes at March 31, 2004. Accordingly, we arenot materially exposed to any financing, liquidity, market or credit risk thatcould arise if we had engaged in such relationships.

 

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# **CRITICAL ACCOUNTING POLICIES**

 

We continue toinvest resources to the process of comprehensively documenting and analyzingour system of internal controls. We have identified areas of our internalcontrols requiring improvement, and we are in the process of designing enhancedprocesses and controls to address any issues identified through this review.Areas for improvement include streamlining our domestic and internationalbilling processes, further limiting internal access to certain data systems andcontinuing to improve coordination across business functions. Although webelieve that our efforts have strengthened our internal controls, we arecontinuing to work to improve our internal controls, including in the areas ofaccess and security. Accordingly, we plan to continue to invest the resourcesnecessary to ensure the effectiveness of our internal controls and procedures,including in the areas of access and security.

 

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

 

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

 

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

 

***RevenueRecognition***

 

*Integrated Media Solutions*

 

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

 

We are obligated to make payments tothird-party Web sites, search engine distribution partners and e-mail listswhich have contracted with us to be part of our Network, in the period theadvertising impressions, valid visitors or e-mails are delivered.  Such expenses are classified as cost ofrevenue in accompanying consolidated statements of operations.

 

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*TechnologySolutions*

 

TechnologySolutions revenues are derived primarily from licensing of our software, hostedadvertisement serving, and software maintenance and technical supportservices.  Revenue from softwarelicensing agreements is recognized in accordance with Statements of Position(“SOP”) No. 97-2, *Software RevenueRecognition*, and Staff Accounting Board (“SAB”) No. 104, *Revenue Recognition*, upon delivery of thesoftware, which is generally when the software is made available for download,there is persuasive evidence of an arrangement, collection is reasonablyassured, the fee is fixed or determinable, and vendor-specific objectiveevidence exists to allocate the total fees to all elements of thearrangement.  Contracts that bundle thesoftware license with maintenance and technical support are recognized ratablyover the contract term.  Revenue fromadvertisement serving is recognized upon delivery.  Revenue from software maintenance and technical support contractsis recognized ratably over the life of the agreement, which typically do notexceed one year.

 

Expenses from the Company’slicensing, maintenance and technical support revenues are primarily payrollcosts incurred to deliver and support the software.  These expenses are classified as cost of revenues in theaccompanying consolidated statements of operations.

 

*DeferredRevenue*

 

Revenues that are billed in advance of services being completed are deferred until the conclusion of the period of the service for which the advance billing relates.  Deferred revenues are included on the consolidated balance sheet as a current liability until the service is performed and then recognized in the period in which the service is completed.  The Company’s deferred revenues primarily consist of billings in advance for software license subscriptions and software maintenance and technical support services. Deferred revenues at March 31, 2004 and December 31, 2003 were approximately $2.6 million and $2.5 million, respectively.

 

***Accounts Receivable***

 

We perform ongoing creditevaluations of our customers and adjust credit limits based upon paymenthistory and the customer’s current credit worthiness, as determined by a reviewof their current credit information. We regularly monitor collections andpayments from our customers and maintain a provision for estimated creditlosses based upon historical experience and any specific customer collectionissues that have been identified. While such credit losses have historicallybeen within our expectations and the provisions established, we cannotguarantee that we will continue to experience the same credit loss rates thathave been experienced in the past.

 

***Valuation of goodwill and intangible assets***

 

Effective January 1,2002, we adopted SFAS No. 142, *Goodwilland Other Intangible Assets* and SFAS No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets*. SFAS 142 eliminates the amortization ofgoodwill and indefinite-lived intangible assets, addresses the amortization ofintangible assets with finite lives and addresses impairment testing andrecognition for goodwill and intangible assets. SFAS No. 144 establishes asingle model for the impairment of long-lived assets.

 

We assess goodwill forimpairment annually unless events occur that require more frequent reviews.Long-lived assets, including amortizable intangibles, are tested for impairmentwhenever events or changes in circumstances indicate that the carrying amountof an asset may not be

 

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recoverable. Discounted cashflow analyses are used to assess nonamortizable intangible impairment whileundiscounted cash flow analyses are used to assess long-lived asset impairment.If an assessment indicates impairment, the impaired asset is written down toits fair market value based on the best information available. Estimated fairmarket value is generally measured with discounted estimated future cash flows.Considerable management judgment is necessary to estimate undiscounted anddiscounted future cash flows. Assumptions used for these cash flows areconsistent with internal forecasts.

 

On an on-going basis,management reviews the value and period of amortization or depreciation oflong-lived assets, including goodwill and other intangible assets. During thisreview, we re-evaluate the significant assumptions used in determining theoriginal cost of long-lived assets. Although the assumptions may vary fromtransaction to transaction, they generally include revenue growth, operatingresults, cash flows and other indicators of value. Management then determineswhether there has been an impairment of the value of long-lived assets basedupon events or circumstances that have occurred since acquisition. Theimpairment policy is consistently applied in evaluating impairment for each ofour wholly owned subsidiaries and investments.

 

# ***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 liability is reasonably estimable. We make theseassessments based on the facts and circumstances and in some instances based inpart on the advice of outside legal counsel.

 

**MARKET FOR COMPANY’S COMMON EQUITY**

 

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

 

Since our initial public offering on August 13, 1998 untilJune 2002, our common stock traded on the Nasdaq National Market under thesymbol “TFSM.”  In June 2002, wetransferred our common stock to the Nasdaq SmallCap Market, where it currentlytrades under the same symbol.

 

**RISK FACTORS**

** **

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

 

WE MAY NEVER BEPROFITABLE.

 

We have not achieved profitability in accordance with generallyaccepted accounting principles, or GAAP, in any period and we may not be ableto achieve or sustain profitability in the future.

 

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We incurred net losses of $0.4 million and $2.3 million forthe three months ended March 31, 2004 and 2003, respectively. Each of ourpredecessors had net losses in every year of their operation. We may incuroperating losses for the foreseeable future. Even if we do achieve GAAPprofitability, we may not sustain or increase profitability on a quarterly orannual basis in the future.

 

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

 

We have a limited operating history. You must consider the risks,expenses and difficulties typically encountered by companies with limitedoperating histories, particularly companies in new and rapidly expandingmarkets such as Internet advertising. These risks include our ability to:

 

•                  develop newrelationships and maintain existing relationships with our Web sites,advertisers, search engine providers and other third parties;

 

•                  continue todevelop and upgrade our technology;

 

•                  respond tocompetitive developments;

 

•                  implement andimprove operational, financial and management information systems;

 

•                  adapt toindustry consolidation; and

 

•                  attract, retainand motivate qualified employees.

 

Our limited operating history makes it difficult to predict futurerevenues and operating expenses.

 

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

 

A significant part of our business model is to generate revenue byproviding interactive marketing solutions to advertisers, advertising agenciesand Web publishers. The profit potential for this business model is unproven.To be successful, both Internet advertising and our solutions will need toachieve broad market acceptance by advertisers, advertising agencies and Webpublishers. Our ability to generate significant revenue from advertisers willdepend, in part, on our ability to contract with Web publishers that have Websites with adequate available advertisement space inventory. Further, these Websites must generate sufficient user traffic with demographic characteristicsattractive to our advertisers. The intense competition among Internetadvertising sellers has led to the creation of a number of pricing alternativesfor Internet advertising. These alternatives make it difficult for us toproject future levels of advertising revenue and applicable gross margin thatcan be sustained by us or the Internet advertising industry in general.

 

Intensive marketing and sales efforts may be necessary to educateprospective advertisers regarding the uses and benefits of, and to generatedemand for, our products and services, including our newer products andservices such as 24/7 Search, Open Advertiser and Insight. Enterprises may bereluctant or slow to adopt a new approach that may replace, limit or competewith their existing direct marketing systems. In addition, since online directmarketing is

 

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emerging as a new and distinct business apart from online advertising,potential adopters of online direct marketing services will increasingly demandfunctionality tailored to their specific requirements. We may be unable to meetthe demands of these clients. Acceptance of our new solutions will depend onthe continued emergence of Internet commerce, communication and advertising.Demand for our new solutions may not emerge or become sustainable.

 

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

 

At times in the past and in certain segments, our revenues have grownsignificantly and also have decreased during certain periods and in certainsegments. Accurate predictions of future revenues are difficult because of therapid changes in our markets and our possible need to sell assets to fundoperations. We have also acquired or disposed of various subsidiaries andproduct lines over the last several years. Accordingly, investors should notrely on past revenue growth rates as an indicator of future revenue growth.

 

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

 

•                  the addition ofnew or loss of existing clients;

 

•                  changes in feespaid by advertisers or other clients;

 

•                  changes inservice fees payable by us to owners of Web sites, or advertisement servingfees payable by us to third parties;

 

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

 

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

 

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

 

•                  changes ingovernmental regulation of the Internet; and

 

•                  general economicconditions.

 

Our future revenues and results of operations may be difficult toforecast due to the above factors. In addition, our expense levels are based inlarge part on our investment plans and estimates of future revenues. Anyincreased expenses may precede or may not be followed by increased revenues, aswe may be unable to, or may elect not to, adjust spending in a timely manner tocompensate for any unexpected revenue shortfall. As a result, we believe thatperiod-to-period comparisons of our results of operations may not bemeaningful.

 

You should not rely on past periods as indicators of futureperformance. In future periods, our results of operations may fall below theexpectations of securities analysts and investors, which could adversely affectthe trading price of our common stock.

 

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OUR REVENUES ARE SUBJECT TO FLUCTUATIONS BY SEASON AND DUE TO GENERALECONOMIC CONDITIONS.

 

We believe that our revenues are subject to seasonal fluctuationsbecause advertisers generally place fewer advertisements during the first andthird calendar quarters of each year. Furthermore, Internet user traffictypically drops during the summer months, which reduces the number ofadvertisements to sell and deliver. Expenditures by advertisers tend to vary incycles that reflect overall economic conditions as well as budgeting and buyingpatterns. Our revenue could be materially reduced by a decline in the economicprospects of advertisers or the economy in general, which could alter currentor prospective advertisers’ spending priorities or budget cycles or extend oursales cycle. Due to such risks, you should not rely on quarter-to-quartercomparisons of our results of operations as an indicator of our future results.

 

OUR REVENUE COULD DECLINE IF WE FAIL TO EFFECTIVELY MANAGE OUR EXISTINGADVERTISING INVENTORY AND OUR GROWTH COULD BE IMPEDED IF WE FAIL TO ACQUIREACCESS TO NEW ADVERTISING INVENTORY.

 

Our success depends in part on our ability to effectively manage ourexisting advertising inventory. The Web publishers that list their unsoldadvertising inventory with us are not bound by long-term contracts. Inaddition, Web publishers can change the amount of inventory they make availableto us at any time. If a Web publisher decides not to make advertising spacefrom its Web sites available to us, we may not be able to replace thisadvertising space with advertising space from other Web sites that havecomparable traffic patterns and user demographics quickly enough to fulfill ouradvertisers’ requests. This would result in lost revenue. We expect that ourcustomers’ requirements will become more sophisticated as the Web matures as anadvertising medium. If we fail to manage our existing advertising spaceeffectively to meet our customers’ changing requirements, our revenue coulddecline. Our growth also depends on our ability to expand our advertisinginventory. To attract new advertisers, we must maintain a consistent supply ofattractive advertising space. We intend to expand our advertising inventory byselectively adding to our network new Web publishers that offer attractivedemographics, innovative and quality content and large audiences. Our abilityto attract new Web publishers to our network and to retain Web publisherscurrently in our network will depend on various factors, some of which arebeyond our control. These factors include our ability to introduce new andinnovative product lines and services, our ability to efficiently manage ourexisting advertising inventory, our pricing policies and the cost-efficiency toWeb publishers of outsourcing all or part of their advertising sales. Inaddition, the number of competing intermediaries that purchase advertisinginventory from Web publishers continues to increase. The size of our inventorymay not increase or even remain constant in the future.

 

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

 

Open AdSystem is our proprietary advertisement serving technology thatis intended to serve as our sole advertisement serving solution. We havedeveloped a variety of products to work on or with this platform. Some of theseproducts, such as our Open Advertiser, Insight ACT and Insight SE products, arenot yet available or are only available in beta version to some or all of ourcustomers. We must, among other things, ensure that the technology willfunction efficiently at high volumes, interact properly with our database,offer the functionality demanded by our customers and assimilate our sales andreporting functions. We must further complete development of our beta products.This development effort could fail technologically or could take more time thanexpected. Customers may become dissatisfied by any system failure thatinterrupts our ability to provide our services to them, including failuresaffecting our ability to deliver advertisements without significant delay tothe viewer. Sustained or repeated system failures would reduce theattractiveness of our solutions to advertisers, advertising agencies and Webpublishers and result in contract terminations, fee rebates and make-goods,thereby reducing our revenue. Slower response time or system failures may alsoresult from straining the capacity of our deployed software or hardware due toan increase in the volume of advertising delivered through our servers. To theextent that we do not effectively address any capacity constraints or systemfailures, our business, results of operations and financial condition could bematerially and adversely affected.

 

WE HAVE SUBSTANTIAL DEBT, AND WE MAY NOT GENERATE SUFFICIENT CASH FLOWTO MEET OUR DEBT SERVICE OBLIGATIONS.

 

In September 2003, we issued to a single holder a 2% subordinatedconvertible debenture in the principal amount of $15.0 million thatmatures in September 2006. The amount of our debt could have importantconsequences, including:

 

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

 

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

 

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

 

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

 

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

 

•                  making us morevulnerable if there is an economic downturn or if our business experiencesdifficulties.

 

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If we cannot generate sufficient additional cash flow, we may not beable to meet our debt service obligations, repay our debt when due, or complywith other covenants in the subordinated convertible debentures. If we breachthe debentures, the investor could require repayment of all amounts owed, andwe may not have sufficient cash reserves to repay such amounts.

 

WE MAY BE UNABLE TO RAISE THE FUNDS NECESSARY TO REPAY OR REFINANCE OURINDEBTEDNESS. THE ISSUANCE OF STOCK UPON REDEMPTION OF OUR SUBORDINATEDCONVERTIBLE DEBENTURES MAY SUBSTANTIALLY DILUTE THE INTERESTS OF OTHER SECURITYHOLDERS.

 

Stockholders could experience substantial dilution resulting from ourelection to pay the semi-annual accrued interest due in common stock or repay theprincipal amount in common stock. We are obligated to make semi-annual interestpayments on January 1 and July 1 of each year and the entireprincipal face amount of the debentures is due and payable onSeptember 26, 2006. We may elect to pay interest in cash, in shares of ourcommon stock or in additional debentures. In addition, if, afterSeptember 26, 2005, the price of our common stock does not exceed theconversion price of the debentures for a period of five consecutive tradingdays we may be required to repurchase $7.5 million in principal amount ofthe debentures on September 26, 2005. We may elect to repay the principalamount of the debentures in cash or in shares of our common stock. If we soelect, payment in shares shall be based upon ninety percent of the average ofthe volume weighted average price of our common stock on the principal marketas reported by Bloomberg Financial L.P. during the five trading daysimmediately prior to the interest payment date, in the case of an interestpayment, or during the 15 trading days immediately prior to the maturity date,in the case of the repayment of the principal amount of the debentures.

 

If we decide to repay the principal in cash we will need additionalcapital to fund this obligation. Our ability to arrange financing and the costof this financing will depend upon many factors, including: general economicand capital market conditions generally, and in particular the non-investmentgrade debt market; credit availability from banks or other lenders; investorconfidence in our industry generally and our company specifically; andprovisions of tax and securities law that are conducive to raising capital.

 

If we need additional funds and are unable to raise them, our inabilityto raise them will have an adverse effect on our operations. If we decide toraise additional funds by incurring debt, we may become subject to additionalor more restrictive financial covenants and ratios. If we fail to make themandatory redemptions in cash and if our stock price significantly declines, wecould potentially be obligated to issue a larger number of shares of our commonstock in redemption of the debentures.

 

WE MAY NEED TO RAISE ADDITIONAL FUNDS TO CONTINUE OPERATIONS.

 

A significant acquisition, an unforeseen reduction in our revenues, animpairment of our receivables, or an increase in expenses or capitalexpenditures may require us to raise additional funds to continue operations.To the extent we encounter additional opportunities to raise cash, we may sell additionalequity or debt securities, which would result in further dilution of ourstockholders. Stockholders may experience extreme dilution due to our currentstock price and the amount of financing we may need to raise and thesesecurities may have rights senior to those of holders of our common stock. Oursubordinated convertible debentures limit our ability to incur additional debt,and any future indebtedness that we may incur could contain covenants thatrestrict our operating flexibility.

 

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We have limited access to the capital markets to raise capital. Thecapital markets have been unpredictable in the past, especially forunprofitable companies such as ours. In addition, it is difficult to raise capitalin the current market conditions. The amount of capital that a company such asours is able to raise often depends on variables that are beyond our control,such as the share price of our stock and its trading volume. As a result,efforts to secure financing on terms attractive to us may not be successful,and we may not be able to secure additional financing on any terms.

 

Due to our operating losses, it may be difficult to obtain debtfinancing. If we are able to consummate a financing arrangement, the amountraised may not be sufficient to meet our future needs. If adequate funds arenot available on acceptable terms, or at all, our business, results ofoperation, financial condition and continued viability will be materially andadversely affected.

 

WE DISCLOSE PRO FORMA INFORMATION, WHICH MAY EXCLUDE ITEMS THAT AREIMPORTANT TO AN INVESTOR’S UNDERSTANDING OF OUR RESULTS OF OPERATIONS.

 

We prepare and release quarterly unaudited financial statementsprepared in accordance with GAAP. We also disclose and discuss certain proforma and other non-GAAP information in the related earnings release andinvestor conference call. This pro forma financial information excludes or mayexclude certain special charges and other costs. We believe the disclosure of thepro forma financial information helps investors more meaningfully evaluate theresults 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 our quarterlyearnings releases, and to compare the GAAP financial information with the proforma financial results disclosed in our quarterly earnings releases andinvestor calls.

 

OUR ACQUISITIONS MAY NOT BE SUCCESSFUL.

 

We were formed in February 1998 to consolidate three Internetadvertising companies and have since acquired other companies. We may continuepursuing selective acquisitions of businesses, technologies and product linesas a key component of our growth strategy. If we acquire additional companies,we will continue to face risks of integrating and improving our financial andmanagement controls, advertisement serving technology, reporting systems andprocedures, and expanding, training and managing our work force. This processof integration may take a significant period of time and will require thededication of management and other resources, which may distract management’sattention from our other operations. Any future acquisition or investment mayresult in the use of significant amounts of cash, potentially dilutiveissuances of equity securities, incurrence of debt and amortization expensesrelated to intangible assets. In addition, acquisitions involve numerous risks,including:

 

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

 

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

 

•                  the availabilityof favorable acquisition financing for future acquisitions; and

 

•                  the potentialloss of key employees of any acquired business.

 

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Our inability to successfully integrate any acquired company, orfailure to achieve any expected synergies, could adversely affect our business.

 

WE MAY NOT BE ABLE TO SUCCESSFULLY INTEGRATE REAL MEDIA KOREACO., LTD. INTO OUR COMPANY.

 

In January 2004, we completed our acquisition of Real Media KoreaCo., Ltd. We may not realize the anticipated financial and strategic goalsof this acquisition, and this acquisition may not be successful. The success ofthis acquisition will depend in part on our ability to expand the business ofReal Media Korea into new geographical markets in the region. We may havedifficulty integrating the business and operations of Real Media Korea orretaining their key personnel as well as implementing and maintainingstandards, controls, procedures and policies that are consistent with ours.Additionally, our ongoing business and management’s attention may be disruptedor diverted by transition or integration issues and the complexity of managinggeographically and culturally diverse locations. These factors could have amaterial adverse effect on our business, results of operations and financialcondition or cash flows.

 

OUR NET OPERATING LOSS CARRYFORWARDS MAY BE LIMITED.

 

Due to the “change in ownership” provisions of the Internal RevenueCode, the availability of our net operating loss and credit carryforwards maybe subject to an annual limitation against taxable income in future periods,which could substantially limit the eventual utilization of thesecarryforwards.

 

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

 

In the course of our operating history, we have acquired and disposedof numerous assets and businesses. Some of our acquisitions have resulted inthe recording of a significant amount of goodwill and/or intangible assets onour financial statements. The goodwill and/or intangible assets were recordedbecause the fair value of the net assets acquired was less than the purchaseprice. We may not realize the full value of the goodwill and/or intangibleassets. As such, we evaluate on at least an annual basis whether events andcircumstances indicate that all or some of the carrying value of goodwilland/or intangible assets are no longer recoverable, in which case we wouldwrite off the unrecoverable portion as a charge to our earnings.

 

To improve our operating performance, we may determine to acquire otherassets or businesses complementary to our business and, as a result, we mayrecord additional goodwill and/or intangible assets in the future. The possiblewrite-off of the goodwill and/or intangible assets could negatively impact ourfuture earnings. We will also be required to allocate a portion of the purchaseprice of any acquisition to the value of any intangible assets that meet thecriteria specified in the Statement of Financial Accounting Standards No. 141,“Business Combinations,” such as marketing, customer or contract-basedintangibles. The amount allocated to these intangible assets could be amortizedover a fairly short period. As a result, our earnings and the market price ofour common stock could be negatively affected.

 

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

 

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We have generated a significant portion of our 24/7 Search revenue fromrelationships with a small number of search engines, including Alta Vista, AskJeeves, Google, MyGeek and Overture. We expect that a small number of searchengine distribution partners will continue to generate a majority or more ofour 24/7 Search revenue for the foreseeable future. The interruption or loss ofany of our primary search engine relationships could cause a significantdecrease in 24/7 Search revenue. As a result of consolidation among searchengines, and other search marketing companies, we could lose one of more of ourdistribution partners or face increased competition from search engines(including our current search engine distribution partners) that internallydevelop or acquire capabilities similar to our service. In addition, as theoperations and strategies of our search engine distribution partners continueto evolve, we may be required to adjust our business strategy to maintain relationshipswith our clients, which could have a material adverse effect on our 24/7 Searchrevenue.

 

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

 

As a result of unfavorable conditions in the capital markets, some ofour customers may have difficulty raising sufficient capital to support theirlong-term operations. As a result, these customers have reduced their spendingon Internet advertising, which has materially and adversely affected ourbusiness, financial condition and results of operations. In addition, we haveentered into a strategic business relationship with Lycos, and may enter intosimilar relationships with other companies. These companies may experiencesimilar adverse business conditions that may render them unable to meet ourexpectations for the strategic business relationship or to fulfill theircontractual obligations to us. Such an event could have a material adverseimpact on our business, financial condition and results of operations.

 

WE HAVE SIGNIFICANT OBLIGATIONS UNDER OUR AGREEMENT WITH LYCOS AND WEEXPECT LYCOS TO REPRESENT A SIGNIFICANT PORTION OF OUR REVENUES.

 

We recently entered into an agreement with Lycos, Inc. to providemedia sales, advertisement serving and analytics technology services to Lycos’U.S. Web properties.  We expect thatLycos will generate a significant portion of our revenues.  As part of our agreement with Lycos, we musthire additional personnel and implement additional controls and procedures toprovide advertising sales, billing and other important services related to theLycos Web properties.  To the extentthat we cannot hire additional personnel or adequately implement additionalcontrols and procedures, our relationship with Lycos may suffer and ourobligations under this agreement may materially and adversely affect ourbusiness, results of operations and financial condition.

 

Our agreement with Lycos requires us to make a minimum annual paymentof $10 million in 2004, along with an initial payment of $4.5 millionto be paid to Lycos over the course of 2004. We are also required to makeminimum annual payments in each subsequent year during the term of theagreement. Our minimum annual payments under this agreement could increaseduring the term of the agreement. To the extent that we fail to sell adequateadvertising space on Lycos’ Web properties, or if prices for advertising spacefall below our expectations, our obligations under this agreement maymaterially and adversely affect our business, results of operations andfinancial condition.

 

Lycos may have the right to terminate our agreement if Lycos or we areacquired.  Terra Lycos, the parentcompany of Lycos, recently engaged an investment banker to consider and adviseon a possible sale of the Lycos property. If our agreement with Lycos is terminated, although we would not have tomake minimum annual

 

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payments, we would lose a significant portion of our revenues whichcould materially and adversely affect our business, results of operations andfinancial condition.

 

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

 

Our success depends, to a significant extent, upon our seniormanagement and key sales and technical personnel, particularly David J. Moore,our Chief Executive Officer, David Hills, our President, Media Solutions, andTony Schmitz, our Chief Technology Officer and President, Technology Solutions.The loss of the services of one or more of these persons could materially andadversely affect our ability to develop our business. Our success also dependson our ability to attract and retain qualified technical, sales and marketing,customer support, financial and accounting, and managerial personnel. We may beunable to retain our key personnel or attract, integrate or retain other highlyqualified personnel in the future. We have experienced in the past, and maycontinue to experience in the future, difficulty in hiring and retaining candidateswith appropriate qualifications, especially in sales and marketing positions.

 

WE MIGHT EXPERIENCE SIGNIFICANT DEFECTS IN OUR PRODUCTS.

 

Software products frequently contain errors or failures, especiallywhen first introduced or when new versions are released. We might experiencesignificant errors or failures in our products, or they might not work withother hardware or software as expected, which could delay the enhancement ofour products, or which could adversely affect market acceptance of ourproducts. Any significant product errors or design flaws would slow theadoption of our products and cause damage to our reputation, which wouldseriously harm our business. If customers were dissatisfied with productfunctionality or performance, we could lose revenue or be subject to liabilityfor service or warranty costs and claims, and our business, operating resultsand financial condition could be adversely affected.

 

SOME OF OUR SOFTWARE IS LICENSED FROM THIRD PARTIES.

 

Some of our products, including one or more modules for our OpenAdSystem platform, contain software licensed from third parties. Some of theselicenses may not be available to us in the future or on terms that areacceptable or allow our products to remain competitive. Our inability to useany of this third party software could result in shipment delays, delays in thedevelopment of future products or enhancements of existing products, or otherdisruptions in our business, which could materially and adversely affect ourbusiness, financial condition and operating results.

 

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

 

We have limited backup systems and have experienced system failures andelectrical outages from time to time in the past, which have disrupted ouroperations. We have a limited disaster recovery plan in the event of damagefrom fire, floods, typhoons, earthquakes, power loss, telecommunicationsfailures, break-ins and similar events. Our operations are dependent on ourability to protect our computer systems against these unexpected adverseevents.

 

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If any of the foregoing occurs, we may experience a complete systemshutdown. Any business interruption insurance that we carry is unlikely to besufficient to compensate us for loss of business in the event of a significantcatastrophe.

 

In addition, interruptions in our services could result from thefailure of our telecommunications providers to provide the necessary datacommunications capacity in the time frame we require. Our Open AdSystemtechnology resides on computer systems located in our data centers housed byCable & Wireless in the United States and Level3 Communications inEurope. These systems’ continuing and uninterrupted performance is critical toour success. 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 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 ouremployees, facilities, clients, our clients’ customers and vendors, which couldsignificantly impact our revenues, costs and expenses and financial position.The potential for future terrorist attacks, the national and internationalresponses to terrorist attacks or perceived threats to national security, andother acts of war or hostility have created many economic and politicaluncertainties that could adversely affect our business and results ofoperations in ways that cannot be presently predicted. We are predominantlyuninsured for losses and interruptions caused by terrorist acts and acts ofwar.

 

OUR INTERNATIONAL OPERATIONS FACE LEGAL AND CULTURAL CHALLENGES.

 

We have operations in a number of international markets, includingAsia, Canada and Europe. To date, we have limited experience in marketing,selling and distributing our solutions internationally. Internationaloperations are subject to other risks, including:

 

•                  changes inregulatory requirements;

 

•                  reducedprotection for intellectual property rights in some countries;

 

•                  potentiallyadverse tax consequences;

 

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

 

•                  difficulties andcosts of staffing and managing foreign operations;

 

•                  political andeconomic instability;

 

•                  fluctuations incurrency exchange rates; and

 

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

 

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WE MAY BE UNABLE TO PROMOTE AND MAINTAIN OUR BRANDS.

 

We believe that establishing and maintaining the brand identities ofour products and services is a critical aspect of attracting and expanding alarge client base. Promotion and enhancement of our brands will depend largelyon our success in continuing to provide high quality service. If businesses donot perceive our existing services to be of high quality, or if we introducenew services or enter into new business ventures that are not favorablyreceived by businesses, we will risk diluting our brand identities and decreasingtheir attractiveness to existing and potential customers.

 

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

 

***RISKSRELATED TO THE MARKET FOR OUR COMMON STOCK.***

 

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

 

As of April 30, 2004, there were approximately 34.1 millionshares of our common stock outstanding. As of that date, we also had anaggregate of approximately 13.8 million shares of common stock that may besold into the market in the future, including approximately 4.9 millionshares of our common stock issuable upon exercise of options, 6.7 millionshares of our common stock issuable upon conversion of our outstandingpreferred stock and exercise of the related warrants and 2.2 millionshares of our common stock issuable upon conversion of the debentures andexercise of the related warrants. In addition, if we undertake an additionalfinancing 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 predict the effect, if any, that future sales of shares ofour common stock into the market, or the availability of shares of common stockfor future sale, will have on the market price of our common stock. Sales ofsubstantial amounts of common stock (including shares issued upon the exerciseof stock options or conversion of shares of preferred stock), or the perceptionthat such sales could occur, may materially and adversely affect prevailingmarket prices for our common stock.

 

OUR SHARE PRICE MAY BE VOLATILE AND COULD DECLINE SUBSTANTIALLY.

 

The market price of our common stock has fluctuated in the past and maycontinue to be volatile. In addition, the stock market has experienced extremeprice and volume fluctuations. The market prices of the securities ofInternet-related companies have been especially volatile. Investors may beunable to resell their shares of our common stock at or above the purchase price.In the past, following periods of volatility in the market price of aparticular company’s securities, securities class action litigation has oftenbeen brought against that company. Many companies in our industry have beensubject to this type of litigation in the past. We may also become involved in

 

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this type of litigation. Litigation is often expensive and divertsmanagement’s attention and resources, which could materially and adverselyaffect our business, financial condition and results of operations.

 

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

 

We are authorized to issue up to 350,000,000 shares of common stock,which may be issued by our board of directors for such consideration as theymay consider sufficient without seeking stockholder approval. The issuance ofadditional shares of common stock in the future will reduce the proportionateownership and voting power of current stockholders. Our Certificate ofIncorporation also authorizes us to issue up to 10,000,000 shares of preferredstock, the rights and preferences of which may be designated by our board ofdirectors. These designations may be made without stockholder approval. Thedesignation and issuance of preferred stock in the future could createadditional securities that would have dividend and liquidation preferencesprior in right to the outstanding shares of common stock. These provisions couldalso impede a change in control.

 

SUNRA CAPITAL HOLDINGS, LTD. AND PUBLIGROUPE USA HOLDING, INC.COLLECTIVELY CONTROL A SUBSTANTIAL PORTION OR OUR TOTAL OUTSTANDING VOTINGPOWER AND WILL LIKELY BE ABLE TO INFLUENCE CERTAIN APPROVAL MATTERS.

 

Sunra Capital HoldingsLtd. and affiliated parties are currently the beneficial owners of asignificant percentage of our common stock, including shares of our SeriesA Preferred Stock which benefit from protective provisions regarding specificcorporate matters.  PubliGroupe USAHoldings also owns a significant percentage of our common stock, and has agreedto vote on all corporate matters in accordance with the recommendations ofour Board of Directors.

 

Based on their voting power, Sunra and PubliGroupe may be able toinfluence the outcome of matters requiring stockholder approval,including the election of directors, amendment of our charter and approvalof significant corporate transactions. Sunra and PubliGroupe also could

 

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deter a change in control of 24/7 Real Media, despite the approvalof other stockholders, if, for example, a third party required their consent asa condition to closing a transaction with us.

 

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

 

Under certain circumstances, upon our sale, liquidation or dissolution,our Series A and Series C preferred stockholders may be entitled toreceive an aggregate liquidation preference of $7.1 million plus accrueddividends, before our common stockholders receive any payment. After receipt ofthis payment, the preferred stockholders may also have the right to participatein receiving proceeds payable to the common stockholders on an as-convertedbasis. As a result, in the event of our sale, liquidation or dissolution,including one in which the total proceeds represent a premium to the thenprevailing price per share of our common stock, our common stockholders mayexperience substantial dilution in the amount payable to them, and if totalproceeds are less than or equal to the liquidation preference, then our commonstockholders will not receive any proceeds.

 

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

 

Some of the provisions of our Certificate of Incorporation, our Bylawsand Delaware law could, together or separately:

 

•                  discouragepotential acquisition proposals;

 

•                  delay or preventa change in control;

 

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

 

•                  limit the pricethat investors might be willing to pay in the future for shares of our commonstock.

 

WE DO NOT INTEND TO PAY FUTURE CASH DIVIDENDS.

 

We currently do not anticipate paying cash dividends on our commonstock at any time in the near future. We may never pay cash dividends ordistributions on our common stock. In addition, our subordinated convertibledebentures restrict our ability to pay cash dividends on our common stock.Whether we pay cash dividends in the future will be at the discretion of ourBoard of Directors and will be dependent upon our financial condition, resultsof operations, capital requirements, contractual restrictions and any otherfactors that the Board of Directors decides is relevant.

 

***RISKSRELATED TO OUR INDUSTRY.***

 

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

 

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The Internet as a marketing medium has not been in existence for asufficient period of time to demonstrate its effectiveness. Our business wouldbe adversely affected if the Internet advertising market fails to develop inthe near future. There are currently no widely accepted standards to measurethe effectiveness of Internet advertising other than clickthrough rates, whichgenerally have been declining. Such standards may not develop to sufficientlysupport the Internet as a significant advertising medium. Actual or perceivedineffectiveness of online advertising in general, or inaccurate measurements ordatabase information in particular, could limit the long-term growth of onlineadvertising and cause our revenue levels to decline.

 

OUR FAILURE TO COMPETE SUCCESSFULLY MAY HINDER OUR GROWTH.

 

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

 

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

 

•                  changing demandsregarding customer service and support;

 

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

 

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

 

Some of our competitors have longer operating histories, greater namerecognition, larger customer bases and significantly greater financial,technical and marketing resources than ours. In addition, current and potentialcompetitors have established or may establish cooperative relationships amongthemselves or with third parties to increase the ability of their products orservices to address the needs of our prospective clients. We may be unable tocompete successfully against current or future competitors. In addition, theInternet must compete for a share of advertisers’ total budgets withtraditional advertising media, such as television, radio, cable and print, aswell as content aggregation companies and other companies that facilitateInternet advertising. To the extent that the Internet is perceived to be alimited or ineffective advertising medium, advertisers may be reluctant todevote a significant portion of their advertising budgets to Internetadvertising, which could limit the growth of Internet advertising.

 

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

 

Laws and regulations directly applicable to Internet communications,commerce and advertising are becoming more prevalent, and new laws andregulations are under consideration by the United States Congress and statelegislatures. Any legislation enacted or restrictions arising from current orfuture government investigations or policy could dampen the growth in use ofthe Internet generally and decrease the acceptance of the Internet as acommunications, commercial and advertising medium. State governments orgovernments of foreign countries might attempt to regulate our transmissions orlevy sales or other taxes relating to our activities. The laws governing theInternet, however, remain largely unsettled, even in areas where there has beensome legislative action. It may take years to determine whether and howexisting laws such as those governing intellectual property, privacy, libel andtaxation apply to the Internet and Internet

 

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advertising. In addition, the growth and development of Internetcommerce may prompt calls for more stringent consumer protection laws, both inthe United States and abroad, that may impose additional burdens on companies conductingbusiness over the Internet. Our business, results of operations and financialcondition could be materially and adversely affected by the adoption ormodification of laws or regulations relating to the Internet.

 

CHANGES IN LAWS AND STANDARDS RELATING TO DATA COLLECTION AND USEPRACTICES AND THE PRIVACY OF INTERNET USERS AND OTHER INDIVIDUALS COULD HARMOUR BUSINESS.

 

The U.S. federal and various state governments have recently proposedlimitations on the collection and use of information regarding Internet users.In October 1998, the European Union adopted a directive that may limit ourcollection and use of information regarding Internet users in Europe. Theeffectiveness of our Open AdSystem technology could be limited by anyregulation limiting the collection or use of information regarding Internetusers. Since many of the proposed laws or regulations are just being developed,we cannot yet determine the impact these regulations may have on its business.In addition, growing public concern about privacy and the collection,distribution and use of personal information has led to self-regulation ofthese practices by the Internet advertising and direct marketing industry andto increased federal and state regulation. The Network Advertising Initiative,or NAI, of which we are an associate member along with other Internetadvertising companies, has developed self-regulatory principles for onlinepreference marketing. We are also subject to various federal and stateregulations concerning the collection, distribution and use of personalinformation. These laws include the Children’s Online Privacy Protection Act,and state laws that limit or preclude the use of voter registration and driverslicense information, as well as other laws that govern the collection and useof consumer credit information. While we monitor legislative initiatives, inthe event that more onerous federal or state laws or regulations are enacted orapplied to us or our clients, our business, financial condition and results ofoperations could be materially and adversely affected.

 

PRIVACY CONCERNS MAY PREVENT US FROM COLLECTING USER DATA.

 

Growing concerns about the use of cookies and data collection may limitour ability to develop user profiles, offer our behavioral targeting andotherwise provide Internet advertisement services and technology. Web sitestypically place small files of information, commonly known as “cookies”, on auser’s hard drive, generally without the user’s knowledge or consent. Cookieinformation is passed to the Web site through the Internet user’s browsersoftware. Our Open AdSystem technology targets advertising to users through theuse of cookies and other non-personally-identifying information. Open AdSystemenables the use of cookies to deliver targeted advertising and to limit thefrequency with which an advertisement is shown to a user. Most currentlyavailable Internet browsers allow users to modify their browser settings toprevent cookies from being stored on their hard drive, and a small minority ofusers are currently choosing to do so. Users can also delete cookies from theirhard drive or modify them at any time. Some Internet commentators and privacyadvocates have suggested limiting or eliminating the use of cookies. Anyreduction or limitation in the use of cookies could limit the effectiveness ofour sales and marketing efforts and impair our targeting capabilities.Microsoft Corporation has changed the design and instrumentation of its Webbrowser in such a way as to give users the option to accept or reject thirdparty cookies. Giving users the option to decline such cookies could result ina reduction of the number of Internet users that we can profile anonymously.Such changes also could adversely affect our ability to determine the reach ofadvertising campaigns sold and delivered by us and the frequency with whichusers of sites in the 24/7 Network see the same advertisement.

 

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

 

WE DEPEND ON PROPRIETARY RIGHTS, AND WE FACE THE RISK OF INFRINGEMENT.

 

Our success and ability to compete are substantially dependent on ourinternally developed technologies and trademarks, which we protect through acombination of patent, copyright, trade secret and trademark law. We havereceived two patents in the United States, and have filed and intend to fileadditional patent applications in the United States. In addition, we apply toregister our trademarks in the United States and internationally. Our patentapplications or trademark applications may not be approved. Even if they areapproved, such patents or trademarks may be successfully challenged by othersor invalidated. If our trademark registrations are not approved because thirdparties own such trademarks, our use of such trademarks will be restrictedunless we enter into arrangements with such third parties that may beunavailable on commercially reasonable terms.

 

We generally enter into confidentiality or license agreements with ouremployees, consultants and corporate partners, and generally control access toand distribution of our technologies, documentation and other proprietaryinformation. Despite our efforts to protect our proprietary rights fromunauthorized use or disclosure, parties may attempt to disclose, obtain or useour solutions or technologies. The steps we have taken may not preventmisappropriation of our solutions or technologies, particularly in foreigncountries where laws or law enforcement practices may not protect ourproprietary rights as fully as in the United States.

 

We have licensed, and we may license in the future, elements of ourtrademarks, trade dress and similar proprietary rights to third parties. Whilewe attempt to ensure that the quality of our brand is maintained by thesebusiness partners, such partners may take actions that could materially andadversely affect the value of our proprietary rights or our reputation. Thevalue of our proprietary rights could decline in the future since the validity,enforceability and scope of protection of certain proprietary rights inInternet-related industries is uncertain and still evolving.

 

We may be subject to claims of alleged infringement of the trademarksand other intellectual property rights of third parties by us or the Webpublishers with Web sites in the 24/7 Network. Such claims and any resultantlitigation could subject us to significant liability for damages and couldresult in the invalidation of our proprietary rights. In addition, even if weprevail, such litigation could be time-consuming and expensive to defend, andcould result in the diversion of our time and attention, any of which couldmaterially and adversely affect our business, results of operations andfinancial condition. Any claims 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.

 

From time to time, we may selectively pursue claims of infringement ofour patents and other intellectual property rights by third parties. Suchclaims and any resultant litigation, such as our ongoing litigation withaQuantive, Inc., present the risk that a court could determine, either

 

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preliminarily or finally, that some of our patents or otherintellectual property rights are not valid, which may make it difficult to sellour technology solutions and may lead to a loss of and an inability to generatelicensing revenue from our patents. In addition, even if we prevail, suchlitigation could be time-consuming and expensive to pursue, and could result inthe diversion of our time and attention, any of which could materially andadversely affect our business, results of operations and financial condition.

 

WE MAY BE SUBJECT TO INTELLECTUAL PROPERTY LIABILITY.

 

We may be liable for content available or posted on the Web sites ofour publishers. We may be liable to third parties for content in theadvertising we serve if the music, artwork, text or other content involvedviolates the copyright, trademark or other intellectual property rights of suchthird parties or if the content is defamatory. Any claims or counterclaimscould be time consuming, result in costly litigation or divert management’sattention.

 

WE FACE RISKS ASSOCIATED WITH TECHNOLOGICAL CHANGE.

 

The Internet and Internet advertising markets are characterized byrapidly changing technologies, evolving industry standards, frequent newproduct and service introductions and changing customer demands. Our futuresuccess will depend on our ability to adapt to rapidly changing technologiesand to enhance existing solutions and develop and introduce a variety of newsolutions to address our customers’ changing demands. We may experiencedifficulties that could delay or prevent the successful design, development,introduction or marketing of our solutions. In addition, our new solutions orenhancements must meet the requirements of our current and prospectivecustomers and must achieve significant market acceptance. Material delays inintroducing new solutions and enhancements may cause customers to foregopurchases of our solutions and purchase those of our competitors.

 

In addition, the development of commercial software and technology thatblocks, eliminates or otherwise screens out Internet advertising may reduce thevalue of advertising inventory on our 24/7 Web Alliance and the benefits of ourtechnology solutions to our customers. We cannot guarantee that a new commercial software or technology, forend-users or enterprises, will not be capable of eliminating a portion or allof the advertisement 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 customers refuse to pay for advertisements thatare blocked, or if the use of blocking software exceeds our expectations, ourbusiness, results of operations and financial condition may be materially andadversely affected.

 

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

 

Internet usage could decline if any well-publicized compromise ofsecurity occurs. “Hacking” involves efforts to gain unauthorized access toinformation or systems or to cause intentional malfunctions or loss orcorruption of data, software, hardware or other computer equipment. Hackers, ifsuccessful, could misappropriate proprietary information or cause disruptionsin our service. We may be required to expend capital and other resources toprotect our Web site against hackers. Any measures we may take may not beeffective. In addition, the inadvertent transmission of computer viruses couldexpose us to a material risk of loss or litigation and possible liability, aswell as materially damage our reputation and decrease our user traffic.

 

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ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK

 

INTEREST RATE RISK

 

The primary objective of our investment activities is to preservecapital.  Cash and cash equivalents areinvestments with original maturities of three months or less.  Therefore, changes in the market’s interestrates do not affect the value of the investments as recorded by 24/7 RealMedia.  The following table presents theamounts of our financial instruments that are subject to interest rate risk byexpected maturity and average interest rates as of March 31, 2004 (inthousands):

 
|                      |   | **2004** |   | **2005** |   | **2006** |   | **Thereafter** |   | **TOTAL** |   |
|---------------------------|--------|----------|--------|----------|--------|----------|--------|----------------|--------|-----------|--------|
| Cash and cash equivalents |   | $        | 52,829 |     | $      | —   |   | $              | — |      | $      | — |   | $ | 52,829 |   |
| Average interest rate     |   | 0.90     | %      |     |   |     |   |           |   | 0.90      | %      |
|                      |   |     |   |     |   |     |   |           |   |      |   |
| Loan payable              |   | $        | — |     | $      | —   |   | $              | 15,000 |      | $      | — |   | $ | 15,000 |   |
| Loan payable              |   |     |   |     |   | 2.00     | %      |           |   | 2.00      | %      |

 

The 2% subordinated convertible debentures due 2006 contain a provisionthat gives the holder the ability to call a portion of the note upon thesatisfaction of a trading price condition. This condition constitutes anembedded derivative. The value of this embedded derivative at March 31,2004 is immaterial to our financial position. We will review the value of thederivative on a quarterly basis in the future, in accordance with SFASNo. 149, *Amendment of Statement 133 onDerivative Instruments and Hedging Activities*.  As of March 31, 2004, we did not holdany other derivative financial instruments.

 

FOREIGN CURRENCY RISK

 

We transact business in a variety of foreign countries and are thussubject to exposure from adverse movements in foreign currency exchangerates.  This exposure is primarilyrelated to revenue and operating expenses denominated in European and Koreancurrencies.  The effect of foreignexchange rate fluctuations for the three months ended March 31, 2004 and2003 were not material.  We do not usederivative financial instruments to limit our foreign currency riskexposure.  As of March 31, 2004, wehad $7.2 million in cash and cash equivalents denominated in foreigncurrencies.

 

ITEM 4. CONTROLS AND PROCEDURES

 

***Evaluation of Controls and Procedures***

 

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

 

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management, including our Chief Executive Officer and Chief FinancialOfficer, 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 2003, as a complement to our existing overall program of internalcontrol, we initiated a company-wide review of our internal control overfinancial reporting as part of the process of preparing for compliance withSection 404 of the Sarbanes-Oxley Act of 2002. As a result of the review,we have made numerous improvements to the design and effectiveness of ourinternal control through the quarter ended March 31, 2004.  Weanticipate that improvements will continue to be made.

 

***Changes in Internal Control***

 

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

 

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

 

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

 

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**PART II****.  OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

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

 

On April 19, 2002, aQuantive, Inc. (formerly AvenueA, Inc.) filed a complaint against us seeking a declaratory judgment thatU.S. Patent No. 6,206,368 is invalid and not infringed by aQuantive. Thecomplaint also seeks injunctive relief and recovery of attorney’s fees. OnMay 10, 2002, we filed our answer to the complaint, in which we denied thematerial allegations of the complaint and asserted a counterclaim forinfringement of the ‘368 patent. On January 2, 2003, aQuantive filed amotion for summary judgment of non-infringement, to which we filed papers inopposition on April 28, 2003. On July 3, 2003, the U.S. Federal Courtfor the Western District of Washington granted partial summary judgment to aQuantive, Inc.and held that, based on the court’s construction of the patent’s claims,aQuantive’s Atlas DMT advertisement serving system does not infringe the ‘368patent. We have appealed the court’s ruling to the Court of Appeals for theFederal Circuit and agreed with aQuantive to dismiss the remaining claims inthe case to expedite the appeal.

 

In March 2004, the Federal Circuit Court of Appeals affirmed,without opinion, the decision of the U.S. Federal Court for the WesternDistrict of Washington that granted summary judgment to aQuantive, Inc. Wehave filed a request for rehearing before the Federal Circuit Court of Appeals.

 

*Brian Anderson*

 

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

 

*chinadotcomCorporation*

 

On February 19, 2003, we filed a complaint in federal courtagainst chinadotcom Corporation for breach of contract, unjust enrichment,breach of duty of good faith and fair dealing, and promissory estoppel arisingout of a certain equity exchange agreement dated August 16, 2000 betweenchinadotcom and us, seeking to enforce our right to exchange our stake in 24/7Media-Asia Ltd. for 1.8 million shares of chinadotcom. chinadotcomfiled a motion seeking to compel arbitration of the matter, which the courtgranted on May 12, 2003.

 

On April 29, 2003, chinadotcom filed an action in court in HongKong against David Moore, our Chief Executive Officer, alleging, among otherthings, breach of fiduciary duty by Mr. Moore in connection with hisservice as a director of chinadotcom and its subsidiary, 24/7Media-Asia Ltd. On November 24, 2003, the Hong Kong Court dismissedchinadotcom’s complaint against Mr. Moore in its entirety, andMr. Moore has requested

 

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chinadotcom to reimburse him for all of his legal expenses. chinadotcomhas appealed the dismissal of its claim and that appeal is pending. We haveassumed Mr. Moore’s defense and will indemnify him in the event of anyliability. We believe that the claims against Mr. Moore are without meritand that the action was brought solely in retaliation against us for assertingour rights in the matter discussed above.

 

On July 22, 2003, chinadotcom filed an arbitration claim with theInternational Court of Commerce asserting certain alleged breaches of contractin connection with the Media Asia Agreement entered into between the parties asof June 30, 2000. The claim seeks damages totaling $24.0 million. Webelieve that chinadotcom’s claims are without merit. We have filed an Answerand Counterclaim in the matter and we intend to defend ourselves vigorouslyagainst these claims.

 

*General*

 

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

 

**Item 2.  Changes in Securities and Use ofProceeds**

 

*Reverse Stock Split*

 

On February 27, 2004, we completed a one-for-fivereverse stock split of our common stock. As a result, every five shares of our common stock were combined intoone share of common stock.  The reversesplit does not affect the number of shares of preferred stock and warrantsoutstanding, however, the conversion ratio is adjusted.  All figures relating to common stock,preferred stock, stock options, warrants and other equity-linked instrumentshave been adjusted in this Form 10-Q to reflect the reverse split.

 

*Acquisition of Real Media KoreaCo., Ltd*

 

On January 6, 2004, the Company completed theacquisition of Real Media Korea Co., Ltd. pursuant to the terms andconditions of the share acquisition agreement, dated as of December 16,2003, by and among the Company, RMK and RMK’s selling shareholders.  The Company paid total consideration of $20.1 millionin exchange for the RMK shares of RMK’s selling shareholders, which consistedof $5.0 million in cash, approximately 2.1 million shares valued at$14.6 million and approximately $0.5 million in transactioncosts.  Approximately 0.9% of theoutstanding shares of RMK are held in an employee stock union established underKorean law.  The common stock portion ofthe purchase price was issued in a private placement pursuant to Section 4(2)of the U.S. Securities Act of 1933, as amended.

 

**Item 3.  Defaults Upon Senior Securities**

 

None.

 

**Item 4.  Submission of Matters to a Vote ofSecurities Holders**

 

None.

 

**Item 5.  Other Information**

 

None.

 

**Item 6.  Exhibits and Reports on Form 8-K**

 

(a)                                  Exhibits.

 
| Exhibit 10.1 |   | Share Acquisition Agreement, dated as of December 16, 2003, by and among the Company, Real Media Korea Co., Ltd. and the Selling Shareholders. (Incorporated by reference to Exhibit 2.1 to the Registrant’s filing on Form 8-K filed January 12, 2004) |
|--------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |   |                                                                                                                                                                                                                                                                             |
| Exhibit 10.2 |   | Escrow Agreement, dated as of January 6, 2004, by and among the Company, the Selling Shareholders and The Bank of New York, as escrow agent.  (Incorporated                                                                                                            |

 

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|         |   | by reference  to Exhibit 2.2 to the Registrant’s filing on Form 8-K filed  January 12, 2004)                                                                                                                                     |
|--------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |   |                                                                                                                                                                                                                                                 |
| Exhibit 10.3 |   | Registration Rights Agreement, dated as of January 6, 2004, by and among the Company and the Selling Shareholders. (Incorporated by reference to Exhibit 2.3 to the Registrant’s filing on Form 8-K filed January 12, 2004) |
|         |   |                                                                                                                                                                                                                                                 |
| Exhibit 10.4 |   | Services Agreement between Lycos, Inc. and 24/7 Real Media, Inc. dated February 11, 2004. Incorporated by reference to Exhibit 99.2 to the Registrant’s filing on Form 8-K filed February 11, 2004)                         |
|         |   |                                                                                                                                                                                                                                                 |
| Exhibit 10.5 |   | Employment Agreement between Jonathan K. Hsu and 24/7 Real Media, Inc. dated January 1, 2004.  Filed herewith.                                                                                                                             |
|         |   |                                                                                                                                                                                                                                                 |
| Exhibit 31.1 |   | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                             |
|         |   |                                                                                                                                                                                                                                                 |
| Exhibit 31.2 |   | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                             |
|         |   |                                                                                                                                                                                                                                                 |
| Exhibit 32.1 |   | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2003.*                                                                                        |
|         |   |                                                                                                                                                                                                                                                 |
| Exhibit 32.2 |   | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2003.*                                                                                        |

 

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(*)                                 This certification accompanies this QuarterlyReport on Form 10-Q, is not deemed filed with the SEC and is not to beincorporated by reference into any filing of the Company under the SecuritiesAct of 1933, as amended, or the Securities Exchange Act of 1934, as amended(whether made before or after the date of this Quarterly Report on Form 10-Q),irrespective of any general incorporation language contained in such filing.

 

(b)           Reports on Form8-K.

 

Reporton Form 8-K dated January 6, 2004 (file no. 0-29768) filed under Item 2.Acquisition or Disposition of Assets. The report contained information regarding our acquisition of Real MediaKorea Co., Ltd.

 

Reporton Form 8-K dated February 11, 2004 (file no. 0-29768) filed under Item 5.Other Events.  The report containedinformation regarding our services and related agreements with Lycos, Inc.

 

Reporton Form 8-K dated March 11, 2004 (file no. 0-29768) filed under Item 5.Other Events.  The report containedinformation regarding the summary judgment granted to aQuantive, Inc. in alawsuit where we alleged aQuantive of infringing on our U.S. patent number6,026,368.

 

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Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized, in the city of NewYork, State of New York on May 14, 2004.

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

 

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