**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark one)**

 

| **ý****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE  SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                             |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                |
| **For the  quarterly period ended June 30, 2003**                                                                                                                                                                                                                                                                   |
|                                                                                                                                                                                                                                                                                                                |
| **or**                                                                                                                                                                                                                                                                                                              |
|                                                                                                                                                                                                                                                                                                                |
| **o****TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE  SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                                |
|                                                                                                                                                                                                                                                                                                                |
| **For the  transition period from                          to                        ** |

 

**Commission file number 1-14355**

 

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

(Exactname of registrant as specified in its charter)

 

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

 

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

 

APPLICABLEONLY TO CORPORATE ISSUERS:

 

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

 
| **CLASS**                               |   | **OUTSTANDING AT August 12, 2003** |
|-----------------------------------------|--------|------------------------------------|
| Common  Stock, par value $.01 per share |   | 79,117,665                         |

 

 

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

**June 30, 2003**

**FORM 10-Q**

**INDEX**

 
| Part  I.  Financial Information                                                                                       |
|----------------------------------------------------------------------------------------------------------------------------|
| Item  1.  Consolidated Financial Statements                                                                           |
| Consolidated Balance Sheets  as of June 30, 2003 (unaudited) and December 31, 2002                                         |
| Consolidated  Statements of Operations for the three and six month periods ended June 30,  2003 and  2002 (unaudited) |
| Consolidated  Statements of Cash Flows for the six month periods ended June 30, 2003 and  2002 (unaudited)                 |
| Notes  to Unaudited Interim Consolidated Financial Statements                                                              |
| Item  2.  Management’s Discussion and  Analysis of Financial Condition and Results of Operations                 |
| Item  3.  Quantitative and Qualitative  Disclosure about Market Risk                                                  |
| Item  4.  Controls and Procedures                                                                                     |
| Part  II.  Other Information                                                                                          |
| Item  1.  Legal Proceedings                                                                                           |
| Item  2.  Changes in Securities and Use of  Proceeds                                                                  |
| Item  3.  Defaults Upon Senior Securities                                                                             |
| Item 4.   Submission of Matters to a Vote of Security Holders                                                         |
| Item  5.  Other Information                                                                                           |
| Item  6.  Exhibits and Reports on Form 8-K                                                                            |
| Item  7.  Signatures                                                                                                  |

 

2

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PART I. FINANCIAL INFORMATION

 

ITEM1. CONSOLIDATED FINANCIAL STATEMENTS

 

**24/7 REAL MEDIA, INC.CONSOLIDATED BALANCE SHEETS(in thousands, except share data)**

** **
|                                                                                                                                                         |   | **June 30,****2003** |   | **December 31,****2002** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------|--------|--------------------------|--------|
|                                                                                                                                                         |   | **(unaudited)**      |   |                     |   |
| **ASSETS**                                                                                                                                                   |   |                 |   |                     |   |
| Current assets:                                                                                                                                              |   |                 |   |                     |   |
| Cash and cash equivalents                                                                                                                                    |   | $                    | 9,120  |                     | $      | 7,674 |   |
| Accounts receivable, less  allowances of $1,664 and $1,369, respectively                                                                                     |   | 11,439               |   | 9,799                    |   |
| Notes and amounts  receivable from disposition                                                                                                               |   | 420                  |   | 720                      |   |
| Prepaid expenses and other  current assets                                                                                                                   |   | 1,039                |   | 1,565                    |   |
|                                                                                                                                                         |   |                 |   |                     |   |
| Total current assets                                                                                                                                         |   | 22,018               |   | 19,758                   |   |
|                                                                                                                                                         |   |                 |   |                     |   |
| Property and equipment, net                                                                                                                                  |   | 3,300                |   | 3,988                    |   |
| Goodwill                                                                                                                                                     |   | 2,621                |   | 2,621                    |   |
| Intangible assets, net                                                                                                                                       |   | 5,957                |   | 6,007                    |   |
| Notes and amounts  receivable from disposition                                                                                                               |   | 1,235                |   | 1,045                    |   |
| Other assets                                                                                                                                                 |   | 549                  |   | 548                      |   |
|                                                                                                                                                         |   |                 |   |                     |   |
| Total assets                                                                                                                                                 |   | $                    | 35,680 |                     | $      | 33,967 |   |
|                                                                                                                                                         |   |                 |   |                     |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                |   |                 |   |                     |   |
| Current liabilities:                                                                                                                                         |   |                 |   |                     |   |
| Accounts payable                                                                                                                                             |   | $                    | 4,848  |                     | $      | 4,039 |   |
| Accrued liabilities                                                                                                                                          |   | 9,410                |   | 12,015                   |   |
| Current installments of  obligations under capital leases                                                                                                    |   | 41                   |   | 47                       |   |
| Deferred revenue                                                                                                                                             |   | 3,461                |   | 2,748                    |   |
|                                                                                                                                                         |   |                 |   |                     |   |
| Total current liabilities                                                                                                                                    |   | 17,760               |   | 18,849                   |   |
|                                                                                                                                                         |   |                 |   |                     |   |
| Obligations under capital  leases, excluding current installments                                                                                            |   | 48                   |   | 66                       |   |
| Loan payable - related  party                                                                                                                                |   | —               |   | 7,876                    |   |
| Other long term liabilities                                                                                                                                  |   | 338                  |   | 292                      |   |
|                                                                                                                                                         |   |                 |   |                     |   |
| Total liabilities                                                                                                                                            |   | 18,146               |   | 27,083                   |   |
|                                                                                                                                                         |   |                 |   |                     |   |
| Commitments and contingencies                                                                                                                                |   |                 |   |                     |   |
|                                                                                                                                                         |   |                 |   |                     |   |
| Stockholders’ equity:                                                                                                                                   |   |                 |   |                     |   |
| Preferred stock; $.01 par  value; 10,000,000 shares authorized, 1,518,250 and 925,000 shares issued,  respectively (liquidation preference of $10 per share) |   | 15                   |   | 9                        |   |
| Common stock; $.01 par  value; 140,000,000 shares authorized; 77,568,203 and 59,219,844 shares  issued, respectively                                         |   | 776                  |   | 592                      |   |
| Additional paid-in capital                                                                                                                                   |   | 1,106,539            |   | 1,089,575                |   |
| Deferred stock compensation                                                                                                                                  |   | (114                 | )      | (209                     | )      |
| Accumulated other  comprehensive income                                                                                                                      |   | 320                  |   | 358                      |   |
| Accumulated deficit                                                                                                                                          |   | (1,090,002           | )      | (1,083,441               | )      |
| Total stockholders’ equity                                                                                                                              |   | 17,534               |   | 6,884                    |   |
|                                                                                                                                                         |   |                 |   |                     |   |
| Total liabilities and  stockholders’ equity                                                                                                             |   | $                    | 35,680 |                     | $      | 33,967 |   |

 

See accompanying notes tounaudited interim consolidated financial statements.

 

3

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**24/7 REAL MEDIA, INC.CONSOLIDATED STATEMENTS OFOPERATIONS(in thousands, expect share and per share data)**

 

** **
|                                                                                                                           |   | **Three months ended June 30,** |   | **Six months ended June 30,** |   |
|--------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                                                                                                           |   | **2003**                        |   | **2002**                      |   | **2003** |   | **2002** |   |
|                                                                                                                           |   | **(unaudited)**                 |   | **(unaudited)**               |   |
| Revenues:                                                                                                                      |   |                            |   |                          |   |   |   |   |   |
| Integrated media solutions                                                                                                     |   | $                               | 8,362  |                          | $      | 7,330 |   | $ | 16,705 |   | $ | 14,845 |   |
| Technology solutions                                                                                                           |   | 3,788                           |   | 3,250                         |   | 7,269 |   | 6,485 |   |
| Total revenues                                                                                                                 |   | 12,150                          |   | 10,580                        |   | 23,974 |   | 21,330 |   |
|                                                                                                                           |   |                            |   |                          |   |   |   |   |   |
| Cost of revenues:                                                                                                              |   |                            |   |                          |   |   |   |   |   |
| Integrated media solutions                                                                                                     |   | 5,084                           |   | 4,866                         |   | 10,594 |   | 10,101 |   |
| Technology solutions  (exclusive of $10, $0, $10 and $7, respectively, reported below as  stock-based compensation             |   | 1,062                           |   | 887                           |   | 2,227 |   | 1,739 |   |
| Total cost of revenues                                                                                                         |   | 6,146                           |   | 5,753                         |   | 12,821 |   | 11,840 |   |
|                                                                                                                           |   |                            |   |                          |   |   |   |   |   |
| Gross profit                                                                                                                   |   | 6,004                           |   | 4,827                         |   | 11,153 |   | 9,490 |   |
|                                                                                                                           |   |                            |   |                          |   |   |   |   |   |
| Operating expenses:                                                                                                            |   |                            |   |                          |   |   |   |   |   |
| Sales and marketing  (exclusive of $33, $13, $41 and $54, respectively, reported below as  stock-based compensation)           |   | 3,227                           |   | 3,234                         |   | 6,371 |   | 6,278 |   |
| General and administrative  (exclusive of $67, $129, $105 and $315, respectively, reported below as  stock-based compensation) |   | 2,776                           |   | 3,476                         |   | 5,698 |   | 7,446 |   |
| Product development  (exclusive of $36, $7, $38 and $42, respectively, reported below as  stock-based compensation)            |   | 755                             |   | 1,105                         |   | 1,342 |   | 2,443 |   |
| Amortization of intangible  assets                                                                                             |   | 661                             |   | 466                           |   | 1,308 |   | 1,008 |   |
| Stock-based compensation                                                                                                       |   | 146                             |   | 149                           |   | 194 |   | 418 |   |
| Loss (gain) on sale of  assets, net                                                                                            |   | —                          |   | 568                           |   | — |   | (305 | ) |
|                                                                                                                           |   |                            |   |                          |   |   |   |   |   |
| Total operating expenses                                                                                                       |   | 7,565                           |   | 8,998                         |   | 14,913 |   | 17,288 |   |
|                                                                                                                           |   |                            |   |                          |   |   |   |   |   |
| Loss from operations                                                                                                           |   | (1,561                          | )      | (4,171                        | )      | (3,760 | ) | (7,798 | ) |
|                                                                                                                           |   |                            |   |                          |   |   |   |   |   |
| Interest expense, net                                                                                                          |   | (51                             | )      | (70                           | )      | (142 | ) | (109 | ) |
| Other expense                                                                                                                  |   | (839                            | )      | —                        |   | (839 | ) | — |   |
|                                                                                                                           |   |                            |   |                          |   |   |   |   |   |
| Loss before provision for  income taxes                                                                                        |   | (2,451                          | )      | (4,241                        | )      | (4,741 | ) | (7,907 | ) |
|                                                                                                                           |   |                            |   |                          |   |   |   |   |   |
| Provision for income taxes                                                                                                     |   | 33                              |   | —                        |   | 40 |   | — |   |
|                                                                                                                           |   |                            |   |                          |   |   |   |   |   |
| Net loss                                                                                                                       |   | (2,484                          | )      | (4,241                        | )      | (4,781 | ) | (7,907 | ) |
|                                                                                                                           |   |                            |   |                          |   |   |   |   |   |
| Dividends on preferred  stock                                                                                                  |   | (158                            | )      | —                        |   | (287 | ) | — |   |
| Preferred stock conversion  discount                                                                                           |   | (1,780                          | )      | —                        |   | (1,780 | ) | — |   |
| Net loss attributable to  common stockholders                                                                                  |   | $                               | (4,422 | )                             | $      | (4,241 | ) | $ | (6,848 | ) | $ | (7,907 | ) |
|                                                                                                                           |   |                            |   |                          |   |   |   |   |   |
| Loss per common share -  basic and diluted                                                                                     |   |                            |   |                          |   |   |   |   |   |
| Net Loss                                                                                                                       |   | $                               | (0.03  | )                             | $      | (0.08 | ) | $ | (0.07 | ) | $ | (0.16 | ) |
| Preferred stock dividends  and conversion discount                                                                             |   | (0.03                           | )      | —                        |   | (0.03 | ) | — |   |
| Net loss attributable to  common stockholders                                                                                  |   | $                               | (0.06  | )                             | $      | (0.08 | ) | $ | (0.10 | ) | $ | (0.16 | ) |
|                                                                                                                           |   |                            |   |                          |   |   |   |   |   |
| Weighted average shares  outstanding                                                                                           |   | 72,377,559                      |   | 50,802,199                    |   | 68,448,282 |   | 50,665,338 |   |

 

See accompanying notes tounaudited interim consolidated financial statements.

 

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

** **
|                                                                                          |   | **Six Months Ended June 30,** |   |
|-----------------------------------------------------------------------------------------------|--------|-------------------------------|--------|
|                                                                                          |   | **2003**                      |   | **2002** |   |
|                                                                                          |   | **(unaudited)**               |   | **(unaudited)** |   |
| Cash flows from operating  activities:                                                        |   |                          |   |   |   |
| Net loss                                                                                      |   | $                             | (4,781 | ) | $ | (7,907 | ) |
| Adjustments to reconcile  net loss to net cash used in operating activities:                  |   |                          |   |   |   |
| Depreciation and  amortization                                                                |   | 1,238                         |   | 2,062 |   |
| Provision for doubtful  accounts and sales reserves                                           |   | 293                           |   | 215 |   |
| Amortization of intangible  assets                                                            |   | 1,308                         |   | 1,008 |   |
| Non-cash compensation                                                                         |   | 194                           |   | 418 |   |
| Accrued interest on notes  payable                                                            |   | 166                           |   | 150 |   |
| Gain on sale of non-core  assets, net                                                         |   | —                        |   | (305 | ) |
| Loss on disposal of fixed  assets                                                             |   | —                        |   | 24 |   |
| Changes in operating assets  and liabilities, net of effect of acquisitions and dispositions: |   |                          |   |   |   |
| Accounts receivable                                                                           |   | (1,933                        | )      | 1,494 |   |
| Prepaid assets and other  current assets                                                      |   | 532                           |   | 548 |   |
| Notes and amounts  receivable from disposition                                                |   | 110                           |   | 34 |   |
| Other assets                                                                                  |   | 43                            |   | 513 |   |
| Accounts payable and  accrued liabilities                                                     |   | (1,405                        | )      | (6,768 | ) |
| Deferred revenue                                                                              |   | 671                           |   | (187 | ) |
|                                                                                          |   |                          |   |   |   |
| Net cash used in operating  activities                                                        |   | (3,564                        | )      | (8,701 | ) |
|                                                                                          |   |                          |   |   |   |
| Cash flows from investing  activities:                                                        |   |                          |   |   |   |
| Proceeds from sale of  non-core assets, net of expenses                                       |   | —                        |   | 2,238 |   |
| Cash paid for acquisition                                                                     |   | (150                          | )      | — |   |
| Cash paid for investment                                                                      |   | (50                           | )      | — |   |
| Capital expenditures,  including capitalized software                                         |   | (506                          | )      | (52 | ) |
|                                                                                          |   |                          |   |   |   |
| Net cash (used in) provided  by investing activities                                          |   | (706                          | )      | 2,186 |   |
|                                                                                          |   |                          |   |   |   |
| Cash flows from financing  activities:                                                        |   |                          |   |   |   |
| Proceeds from issuance of  preferred stock, net                                               |   | 6,792                         |   | — |   |
| Proceeds from issuance of  note payable - related party                                       |   | —                        |   | 3,000 |   |
| Payment of capital lease  obligations                                                         |   | (24                           | )      | (20 | ) |
| Retirement of debt                                                                            |   | (1,500                        | )      | — |   |
| Proceeds from exercise of  stock options                                                      |   | 486                           |   | — |   |
|                                                                                          |   |                          |   |   |   |
| Net cash provided by  financing activities                                                    |   | 5,754                         |   | 2,980 |   |
|                                                                                          |   |                          |   |   |   |
| Net change in cash and cash  equivalents                                                      |   | 1,484                         |   | (3,535 | ) |
| Effect of foreign currency  on cash                                                           |   | (38                           | )      | 96 |   |
| Cash and cash equivalents  at beginning of period                                             |   | 7,674                         |   | 6,974 |   |
|                                                                                          |   |                          |   |   |   |
| Cash and cash equivalents  at end of period                                                   |   | $                             | 9,120  |   | $ | 3,535 |   |

 

See accompanying notes tounaudited interim consolidated financial statements.

 

5

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

 

# **Summary of Operations**

 

24/7 Real Media, Inc. (the“Company”), together with its subsidiaries, develops and provides solutions forinteractive marketing.  The Company isorganized into two principal lines of business: Integrated Media Solutions andTechnology Solutions.

 

Integrated Media Solutionsconnects advertisers to audiences through the following sources:

 

•      24/7 Web Alliance - a globalalliance of Web sites where advertisers can run site-specific ad campaigns onbrand name sites, campaigns targeted to users in one or more of our contentchannels or global ad campaigns across our entire network of participating Websites.

 

•      24/7 Website Results -performance paid inclusion and search engine optimization services.

 

•      Other services including aninteractive desktop information and messaging tool, known as 24/7 Messenger,and brokerage services for online promotions and e-mail.

 

Technology Solutionsprovides advertising delivery and management technology and services to Websites, ad agencies and advertisers.  TheCompany’s primary software product, Open AdStream ®, is based on patented technologyand available to customers in enterprise and centrally distributedsolutions.  The Company also provides anad serving product for ad agencies, advertisers and direct marketers, known asOpen Advertiser, as well as a web analytics solution known as Open Insight.

 

The Company’s business ischaracterized by rapid technological change, new product development andevolving industry standards.  TheCompany’s success may depend, among other factors, upon the continued expansionof the Internet as a communications medium, prospective product developmentefforts and the continued acceptance of the Company’s solutions by themarketplace.

 

**FactorsAffecting Comparability of 2003 and 2002**

 

In May 2002, the Company completed the saleof certain assets related to the US e-mail management product which hadapproximately $0.4 million and $1.6 million in revenue for the three and sixmonth periods ended June 30, 2002.

 

In January 2003, the Company sold a majoritystake in iPromotions, Inc.  iPromotionsrevenue was approximately $0.3 million and $0.6 million for the three and sixmonth periods ended June 30, 2002, respectively, and $0.1 million for the threeand six month periods ended June 30, 2003 (see note 3).

 

In January 2003, the Company acquired InsightFirst, Inc., a web analytics company. The impact on the three and six month periods ended June 30, 2003 wasnot significant (see note 2).

 

Due to restructuring initiatives adopted inthe fourth quarter of 2002, we reduced our headcount by approximately 26employees during 2003. The number of full-time employees has decreased by 67from 285 at June 30, 2002 to 218 at June 30, 2003.

 

6

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# **Organization and Basis ofPresentation**

 

# *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 theCompany’s operations and cash flows for the interim periods presented.  The financial statements, financial data andother information disclosed in these notes to the consolidated results are notnecessarily indicative of the results expected for the full fiscal year or anyfuture period.

 

The accompanying consolidated financialstatements should be read in conjunction with the audited consolidatedfinancial statements for the year ended December 31, 2002.  Certain information and footnote disclosuresnormally included in audited 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.

 

# *Use of Estimates*

 

The preparation of consolidated financialstatements in accordance with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect that reported amounts of assets and liabilities and the disclosureof contingent assets and liabilities at the date of the consolidated financialstatements and the reported amounts of revenue and expenses during thereporting period.  These estimates andassumptions related to estimates of collectibility of accounts receivable, therealization of goodwill and other intangible assets, accruals and otherfactors.  Actual results could differfrom those estimates.

#  

# *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.

######  

*Concentrationof Credit Risk*

 

The Company maintains cash in bank depositaccounts which, at times, exceed the federally insured limits.  The Company has not experienced any lossesin these accounts.

 

###### *Unbilled Receivables*

######  

At June 30, 2003 and December 31, 2002,accounts receivable included approximately $5.6 million and $5.1 million,respectively, of earned but unbilled receivables, which are a normal part

 

7

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of the Company’s business.  Advertising contracts are typically invoicedmonthly, in the period subsequent to when the revenue has been earned.

 

*Capitalized Software*

 

In accordance with Statement of Financial Accounting Standards No. 86,Accounting for the Costs of Computer Software To Be Sold, Leased, or OtherwiseMarketed (“SFAS No. 86”), the Company requires certain product developmentcosts to be capitalized commencing when a product’s technological feasibilityhas been established by completion of a working model of the product and endingwhen a product is available for general release to customers.  As of June 30, 2003, the Company hadcapitalized approximately $1.2 million in connection with the development ofour Open Advertiser ad serving software product.  The product was released in June 2003.  Depreciation is calculated under the straight-line method over the estimateduseful life of the software, or 4 years.

 

*Revenue and Expense Recognition*

 

*Integrated Media Solutions*

 

24/7 Web Alliance revenues are generated bydelivering advertising impressions for a fixed fee to third-party Websites.  24/7 Website Results revenuesare derived from driving valid visitors to client Web sites.  E-mail related revenues are derived fromdelivering advertisements to e-mail lists for advertisers and Web sites.  Agreements in each of our media businessesare primarily short term and revenues are recognized as services are deliveredprovided that no significant Company obligations remain outstanding andcollection of the resulting receivable is probable.

 

*Technology Solutions*

 

Technology Solutions revenues are derivedprimarily from licensing the Company’s software and from our ad serving andsoftware maintenance and technical support contracts.  Revenue from software licensing agreements is recognized inaccordance with Statements of Position (“SOP”) 97-2, “Software RevenueRecognition,” and Staff Accounting Bulletin No. 101, “Revenue Recognition inFinancial Statements.”  Generally, the Company begins to recognize revenuefrom software license arrangements upon delivery of the software, andthere is pervasive 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.

 

The Company recently refined its OAS Localstrategy to offer customers the flexibility to adapt to rapidly changingenterprise requirements while reducing the risks and costs associated withtraditional software licensing models.  The Company has also adjusted itssoftware arrangements, which bundle a software license with maintenance andtechnical support services.  As a result, the Company changed the revenuerecognition method for OAS Local sales, resulting in the deferral of aportion of OAS local revenue to future periods.  Using this method, the Company recognizes as revenue the totalvalue of its software arrangements ratably over the term of the softwarelicense.  This change will have theeffect of modestly reducing license fee revenue in 2003 and deferring a portionof revenue to future periods. The Company will recapture the reduction in upfront license feerevenue in subsequent years as it recognizes deferred revenue on its softwarearrangements.  Under the priorarrangements, the Company typically recognized software license revenueimmediately upon delivery of the software and recognized revenue related tosoftware maintenance and technical support services ratably as earned.

 

8

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Revenue from ad serving is recognized upondelivery.  The contracts are usually fora one-year period and are billed on a monthly basis.

 

Expenses from the Company’s licensing,maintenance and technical support revenues are primarily payroll costs incurredto deliver and support the software. These expenses are classified as cost of revenues in the accompanyingconsolidated statements of operations.

 

###### *Stock-Based Compensation*

 

The Company accounts for stock-based employeecompensation arrangements in accordance with provisions of APB No. 25,“Accounting for Stock Issued to Employees,” and FASB interpretation No. 44,“Accounting for Certain Transactions Involving Stock Compensation – aninterpretation of APB Opinion No. 25,” and complies with the disclosureprovisions of SFAS No. 123, “Accounting for Stock-Based Compensation” and SFASNo. 148, “Accounting for Stock-Based Compensation – Transition andDisclosure.”  Under APB No. 25,compensation cost is recognized based on the difference, if any, on the date ofgrant between the fair value of the Company’s common stock and the amount anemployee must pay to acquire the common stock. SFAS No. 148 requires more prominent and more frequent disclosures inboth interim and annual financial statements about the method of accounting forstock-based compensation and the effect of the method used on reportedresults.  We adopted the disclosureprovisions of SFAS No. 148 as of December 31, 2002 and continue to apply themeasurement provisions of APB No. 25.

 

Had the Company determined compensation costbased on the fair value at the grant date for its stock options under SFAS No.123, the Company’s net loss would have been increased to the pro forma amountsindicated below:

 
|                                                                                                                                 |   | **Three  Months Ended  June 30,**             |   | **Six Months  Ended  June 30,** |   |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------|--------|---------------------------------|--------|
|                                                                                                                                 |   | **2003**                                      |   | **2002**                        |   | **2003** |   | **2002** |   |
|                                                                                                                                 |   | **(in  thousands, except per share amounts)** |   |
| Net loss                                                                                                                             |   |                                          |   |                            |   |   |   |   |   |
| As reported                                                                                                                          |   | $                                             | (2,484 | )                               | $      | (4,241 | ) | $ | (4,781 | ) | $ | (7,907 | ) |
| Deduct: Total stock-based employee compensation  expense determined under fair-value-based method for all awards, net of tax  effect |   | 1,204                                         |   | 3,934                           |   | (3,414 | ) | 8,419 |   |
| Pro forma                                                                                                                            |   | (3,688                                        | )      | $                               | (8,175 | ) | (8,195 | ) | $ | (16,326 | ) |
| Net loss attributable to common stockholders per  share:                                                                             |   |                                          |   |                            |   |   |   |   |   |
| As reported                                                                                                                          |   | $                                             | (0.06  | )                               | $      | (0.08 | ) | $ | (0.10 | ) | $ | (0.16 | ) |
| Pro forma                                                                                                                            |   | (0.08                                         | )      | (0.16                           | )      | (0.15 | ) | (0.32 | ) |

 

The per share weighted-average fair value ofstock options granted for the three and six month periods ended June 30, 2003is $0.10 and $0.16, respectively, and the per share weighted average fair valueof stock options granted for the three and six month periods ended June 30,2002 is $0.11 and $0.16, respectively, on the grant date with the followingweighted average assumptions:

 

|                     |   | **Three  Months Ended   June 30** |   | **Six Months  Ended   June 30** |   |
|--------------------------|--------|-----------------------------------|--------|---------------------------------|--------|
|                     |   | **2003**                          |   | **2002**                        |   | **2003** |   | **2002** |   |
| Expected dividend yield  |   | 0                                 | %      | 0                               | %      | 0 | % | 0 | % |
| Risk-free interest rate  |   | 1.13                              | %      | 1.03                            | %      | 1.42 | % | 1.08 | % |
| Expected life (in years) |   | 1.5                               |   | 1.0                             |   | 2.4 |   | 2.3 |   |
| Volatility               |   | 94                                | %      | 107                             | %      | 132 | % | 143 | % |

 

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 equity

 

9

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instruments issued in accordance with theEITF 96-18, Accounting For Equity Instruments That Are Issued To Other ThanEmployees For Acquiring, or in Conjunction With Selling Goods or Services.

 

###### *Preferred Stock*

 

| **Series**         |   | **Shares  Authorized** |   | **Price Per  Share** |   | **Conversion  Rate** |   | **Ouststanding  at** |   |
|--------------------|--------|------------------------|--------|----------------------|--------|----------------------|--------|----------------------|--------|
| **June 30,  2003** |   | **December  31, 2002** |
| A                  |   | 800,000                |   | $                    | 10.00  |                 | $      | 0.20535              |   | 800,000 |   | 800,000 |   |
| B                  |   | 125,000                |   | 10.00                |   | 0.20660              |   | —               |   | 125,000 |   |
| C                  |   | 718,250                |   | 10.00                |   | 0.24158              |   | 718,250              |   | — |   |
|               |   |                   |   |                 |   |                 |   | 1,518,250            |   | 925,000 |   |
|                    |        |                        |        |                      |        |                      |        |                      |        |  |  |  |  |

 

In June 2003, the Company sold 718,250 sharesof Series C Preferred Stock to several investment funds and individualaccredited investors, including members of management and the Board ofDirectors (see note 7).

 

In May 2003, 25,000 shares of Series BPreferred Stock were converted into 1,210,068 shares of common stock.  In February 2003, 100,000 shares of Series BPreferred Stock were converted into 4,840,271 shares of common stock.

 

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.  As of June 30, 2003, there are approximately $0.4 million ofaccrued but unpaid dividends.

 

In the event of a liquidation, dissolution orwinding up of the Company, the holders of the Preferred Stock are entitled to aliquidation preference payment per share equal to the purchase price,plus any dividends accrued but unpaid as of such date, before any payment toholders of Common Stock.  After paymentof the foregoing preference, the holders of each share of Preferred Stock wouldthen participate *pro rata* withthe holders of the Common Stock, on an as converted basis, in the distributionof the proceeds from such a liquidation event to the holders of the CommonStock until such time as the holders of Preferred Stock shall have received anamount equal to three times the purchase price (inclusive of their liquidationpreference).  A merger, consolidation orsale of the Company will be treated as a liquidation event unless such transactionhas been approved by the holders of a majority of the outstanding PreferredStock.

 

###### *Comprehensive Loss*

 

Total comprehensive loss for the six monthperiods ended June 30, 2003 and 2002 was $(4.8) million and $(7.8) million,respectively.  Comprehensive lossesresulted primarily from net losses of $(4.8) million and $(7.9) million,respectively, as well as foreign currency translation adjustments of $0.1million in 2002.

 

### *Loss Per Share*

 

Loss per share is presented in accordancewith the provisions of SFAS No. 128, “Earnings Per Share” (“EPS”).  Basic EPS excludes dilution for potentiallydilutive securities and is computed

 

10

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by dividing losses available to commonshareholders by the weighted average number of common shares outstanding forthe period.  Diluted EPS reflects thepotential dilution that could occur if securities or other contracts to issuecommon stock were exercised or converted into common stock and resulted in theissuance of common stock.  Diluted netloss per share is equal to basic net loss per share since all potentiallydilutive securities are anti-dilutive for each of the periods presented.  Diluted net loss per common share for thesix month periods ended June 30, 2003 and 2002 does not include the effects ofoptions to purchase 18.7 million and 10.3 million shares of common stock,respectively; 9.6 million and 4.0 million common stock warrants, respectively,and 68.7 million shares of Preferred Stock in 2003, on an “as if” convertedbasis, as the effect of their inclusion is anti-dilutive during each period.

 

### *Reclassifications*

 

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

 

### *Recent Accounting Pronouncements*

 

### Statement of Financial Accounting Standards No. 149, Amendmentof Statement 133 on Derivative Instruments and Hedging Activities (“SFAS No.149”), was issued in April 2003 and amends and clarifies financial accountingand reporting for derivative instruments, including certain derivativeinstruments embedded in other contracts and for hedging activities underStatement of Financial Accounting Standards No. 133, Accounting for DerivativeInstruments and Hedging Activities (“SFAS No. 133”).  SFAS No. 149 provides greater clarification of thecharacteristics of a derivative instrument so that contracts with similarcharacteristics will be accounted for consistently.  In general, SFAS No. 149 is effective for contracts entered intoor modified after June 30, 2003, and for hedging relationships designated afterJune 30, 2003.  As the Company does notcurrently have any derivative financial instruments, the adoption of SFAS No.149 is not expected to have any impact on the Company’s consolidated financialstatements.

 

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

 

**(2)  BUSINESS COMBINATIONS**

 

*Acquisitionof Now Marketing*

 

OnSeptember 19, 2002, the Company acquired certain assets of Vflash d/b/a NowMarketing (“Now Marketing”), a New York-based marketing services firm.  The acquisition agreement required NowMarketing’s ultimate parent, Elron Electronic Industries Ltd. and Gilbridge,Inc., (together “Now Marketing’s Parent”), to make a $1.25 million investmentin the Company in exchange for 125,000 shares of Series B Preferred Stock.  Accordingly, the total purchaseconsideration of $4.3 million consists of 4.1 million shares of Common Stockvalued at $1.7

 

11

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million,125,000 shares of Series B Preferred Stock valued at $2.5 million and $60,000of transaction costs.  The Series BPreferred Stock was convertible into Common Stock of the Company at any time atthe option of the holder thereof at a conversion price of $0.2066 per share ofCommon Stock, or 6,050,339 shares of Common Stock on an as-if convertedbasis.  As of June 30, 2003, all SeriesB Preferred Stock was converted.

 

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

 

Thenet tangible assets acquired consist of the following:

 

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

 

*Acquisitionof the assets of Insight First*

 

On January 21, 2003, the Company acquiredcertain assets of Insight First, Inc. (“Sellers”), including specificcontracts, intangibles and employee relationships, related to the Seller’s Webanalytics solutions, including the intellectual property relating to specificproducts in exchange for 3,526,093 shares of the Company’s common stock valuedat approximately $1.0 million, plus $150,000 in cash.  In addition, the Company has a contingent obligation to payadditional earn-out consideration of up to $2.2 million, in either cash orcommon stock, at the Company’s discretion, subject to achievement of earn-outtargets relating to revenue generated by the acquired business in fiscal years2003 and 2004.

 

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

 

The net tangible assets acquired consist ofthe following:

 

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

 

The following pro forma consolidated amountsgive effect to the Company’s acquisition of Now Marketing and Insight Firstaccounted for by the purchase method of accounting as if it had occurred at thebeginning of the period by consolidating the results of operations of theacquired entity for the three and six month periods ended June 30, 2003 and2002.

 

12

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The pro forma consolidated statements ofoperations are not necessarily indicative of the operating results that would havebeen achieved had the transactions been in effect as of the beginning of theperiods presented and should not be construed as being representative of futureoperating results.

 
|                                                                |   | **Three  Months Ended****June 30,** |       | **Six Months  Ended****June 30,** |       |
|---------------------------------------------------------------------|--------|-------------------------------------|------------|-----------------------------------|------------|
|                                                                |   | **2002**                            |       | **2003**                          |       | **2002** |   |
|                                                                |   |                                | ** ** |                              | ** ** |   | ** ** |
| Total revenues                                                      |   | $                                   | 10,818     |                              | $          | 23,995 |   | $ | 21,805 |   |
| Net loss                                                            |   | (7,680                              | )          | (4,824                            | )          | (14,785 | ) |
| Loss per share                                                      |   | $                                   | (0.13      | )                                 | $          | (0.07 | ) | $ | (0.25 | ) |
| Weighted average shares used in net loss per share  calculation (1) |   | 58,428,292                          |       | 68,837,905                        |       | 58,291,431 |   |

 

----

(1) The weighted average shares used to compute pro forma basic and dilutednet loss per share for the three and six month periods ended June 30, 2003 and2002 includes the 4,100,000 and 3,526,093 common shares issued for NowMarketing and Insight First, respectively, as if the shares were issued onJanuary 1, 2002.

 

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

 

*Sale ofiPromotions, Inc.*

 

On January 31, 2003, the Company entered intoan Asset Purchase Agreement with iPromotions, Inc., a corporation formed by privateinvestors including some of the Company’s employees.  Pursuant to the terms of the Asset Purchase Agreement, theCompany sold to the investors, specific contracts, equipment, intangibles, andemployee relationships related to our iPromotions business, including theintellectual property relating to specific products.  The Company also invested $50,000 in cash in exchange for sharesof preferred stock representing a 19.9% interest in iPromotions, Inc. on an asconverted basis.  Accordingly, the Companyeffectively sold a majority stake in its iPromotions business.  Prior to the sale, the carrying value ofiPromotions was $0.  Therefore, therewas no gain or loss on the transaction. The cash payment was recorded as an investment.

 

**(4)  INTANGIBLE ASSETS, NET**

 

The $2.6 million in goodwill as of June 30,2003 and December 31, 2002 relates $1.1 million to Canada (formerlyClickThrough), $0.4 million to WSR and $1.1 million to Real Media.

 

The $6.0 million in Intangible assets, net atJune 30, 2003 relates $1.0 million to WSR, $2.4 million to Real Media, $1.5million to Now Marketing and $1.1 million to Insight First.  The $6.0 million in Intangible assets, netat December 31, 2002 relates $1.4 million to WSR, $2.8 million to Real Mediaand $1.8 million to Now Marketing.

 

13

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|                          |   | **June 30,  2003** |   | **December 31,  2002** |   | **Estimated  Useful Lives** |   |
|-------------------------------|--------|--------------------|--------|------------------------|--------|-----------------------------|--------|
|                          |   | **(in thousands)** |   |                   |   |
|                          |   |               |   |                   |   |                        |   |
| Goodwill                      |   | $                  | 2,621  |                   | $      | 2,621                       |   |   |   |
|                          |   |               |   |                   |   |                        |   |
| Technology (1)                |   | 9,127              |   | 7,869                  |   | 4                           |   |
| Less accumulated amortization |   | (3,462             | )      | (2,216                 | )      |                        |   |
| Net Technology                |   | 5,665              |   | 5,653                  |   |                        |   |
|                          |   |               |   |                   |   |                        |   |
| Trademark                     |   | 500                |   | 500                    |   | 4                           |   |
| Less accumulated amortization |   | (208               | )      | (146                   | )      |                        |   |
| Net Other intangible assets   |   | 292                |   | 354                    |   |                        |   |
|                          |   |               |   |                   |   |                        |   |
| Gross Intangible assets       |   | 9,627              |   | 8,369                  |   |                        |   |
| Less accumulated amortization |   | (3,670             | )      | (2,362                 | )      |                        |   |
| Net Intangible assets         |   | 5,957              |   | 6,007                  |   |                        |   |
|                               |        |                    |        |                        |        |                             |        |  |  |

 

----

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

 

**(5)  RESTRUCTURING**

 

The following sets forth the activities inthe Company’s restructuring reserve for the six months ended June 30, 2003,which is included in accrued liabilities in the consolidated balance sheet (inthousands):

 
|                          |   | **Beginning  Balance** |   | **Current  year  utilization** |   | **Current  year  reversal** |   | **Ending  Balance** |   |
|-------------------------------|--------|------------------------|--------|--------------------------------|--------|-----------------------------|--------|---------------------|--------|
| Employee termination benefits |   | $                      | 1,139  |                           | $      | (1,022                      | )      | $                   | — |   | $ | 117 |   |
| Office closing costs          |   | 709                    |   | (321                           | )      | —                      |   | 388                 |   |
| Disposal of assets            |   | 72                     |   | (57                            | )      | —                      |   | 15                  |   |
| Other exit costs              |   | 12                     |   | (12                            | )      | —                      |   | —              |   |
|                          |   | $                      | 1,932  |                           | $      | (1,412                      | )      | $                   | — |   | $ | 520 |   |

 

**(6)  RELATED PARTY TRANSACTIONS**

 

The Company had issued threePromissory Notes to PubliGroupe, a significant shareholder, totaling $7.5million.  One note for $4.5 million hadan interest rate of 4.5% with principal and interest due on 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, PubliGroupesurrendered for cancellation the three Promissory Notes plus accrued interestof approximately $0.5 million in exchange for a cash payment of $1.5 millionand 4.8 million shares of the Company’s common stock, valued at $1.8million.  As a result of thetransaction, additional paid-in capital increased $6.5 million - $1.8 millionfrom the issuance of stock and $4.7 million gain on the retirement ofdebt.  In connection with the issuanceof shares of common stock to PubliGroupe, Sunra Capital Holdings Ltd., ourprimary Series A Preferred stockholder, agreed not to seek conversion of thatnumber of Series A Preferred shares that could be converted into 4.8 millionshares of common stock in order to facilitate the Company’s issuance of suchshares

 

14

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of common stock toPubliGroupe in accordance with the limit on the Company’s authorized sharecapital contained in the Company’s certificate of incorporation.

 

**(7)****COMMON AND PREFERRED STOCK**

 

As of June 6, 2003, the Company completed aprivate placement (the “Financing”) of approximately $7.18 million of SeriesC-1 Nonvoting Convertible Redeemable Preferred Stock (the “Series C-1 PreferredStock”), together with related Common Stock Warrants, to several investmentfunds and accredited individual investors, including members of the Company’smanagement and Board of Directors (the “Investors”).  The private placement of the Company’s Series C-1 Preferred Stockwas conducted in two tranches. Investors in the first tranche purchased approximately $3.4 million ofthe Series C-1 Preferred Stock. Investors in the second tranche purchased approximately $3.78 million ofthe Series C-1 Preferred Stock.

 

All outstanding shares converted wereautomatically (collectively, the “Conversion”) into shares of Series CConvertible Preferred Stock (the “Series C Preferred Stock”) upon the approvalof the Company’s stockholders on July 29, 2003.

 

In connection with the Financing, the Companyalso issued two warrants to each Investor to purchase shares of Common Stock atan exercise price equal to the Conversion Price, of which (i) one warrantentitles the Investor to purchase up to an additional 10% of the aggregatenumber of shares of Common Stock issuable upon the conversion of the Series CPreferred Stock and only becomes exercisable upon the effective date ofConversion; and (ii) a second warrant entitles the Investor to purchase up to4.8% of the aggregate number of shares of Common Stock that would have beenissuable upon conversion of the Series C Preferred Stock and only becomesexercisable in the event the Investor becomes entitled to redeem shares ofSeries C-1 Preferred Stock.  Eachremaining warrant is exercisable until July 29, 2008 and may be exercisedthrough a cashless exercise.  The secondwarrants were cancelled upon the Conversion on July 29, 2003.

 

Each share of Series C Preferred Stock isconvertible into Common Stock at any time at the option of the holder thereofat a conversion price of $0.24158 per share of Common Stock (the “ConversionPrice”).  There will be no change to theconversion ratio of the Series C Preferred Stock based upon the future tradingprice of the Common Stock.  Theconversion price of the Series C Preferred Stock is subject to adjustment inthe event future issuances of the Company equity at a purchase price lower thanthe Conversion Price according to a weighted average formula.

 

At any time after May 31, 2005, the Companymay automatically convert each share of the then outstanding Series C PreferredStock into the applicable number of shares of Common Stock if, among otherthings, the Common Stock is then traded, the average per share closing price ofthe Common Stock is greater than three (3) times the Conversion Price over asixty day (60) trading day period, the average daily trading volume of theCommon Stock over such a period is at least 200,000 shares and there is aneffective registration statement covering the resale of all shares of CommonStock issuable upon conversion of any other outstanding shares of Series CPreferred Stock.

 

In the event that all shares of Series CPreferred Stock and warrants are converted to Common Stock, the Investorscollectively will become the beneficial owners of approximately 32.7 million

 

15

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shares of Common Stock, without giving effectto the conversion of any other outstanding shares of preferred stock, orexercise of outstanding warrants, of the Company.

 

In connection with the Financing, the Companyalso agreed to file a registration statement covering the resale of the sharesof Common Stock issuable upon conversion of the Series C Preferred Stock andupon exercise of all warrants issued to the Investors.  The Company also granted “piggyback”registration rights to the Investors, on a *paripassu*basis with existing registration rights holders, whichentitles each of the Investors to participate in registered offerings of theCompany’s securities by the Company.

 

The Series C will accrue and cumulatedividends 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 of the Series C payable upon a Liquidation event.

 

The Company agreed to terms of the Series CPreferred Stock when the $0.24158 conversion price approximated fair value ofthe underlying common stock.  However,the Series C Preferred Stock and associated warrants were subject tostockholder approval which occurred on July 29, 2003, at which time the priceof the Company’s common stock was $1.87 per share.  Accordingly, the Series C transaction contained an embeddedbeneficial conversion feature, which was required to be valued separately.  The Company allocated the proceeds receivedto the Series C Preferred Stock and detachable warrants based on a relativefair value basis.  The $5.4 millionvalue ascribed to the five-year detachable warrants was determined using aBlack Scholes pricing model (150% volatility, $1.87 fair value at July 29, 2003,$0.24158 exercise price, 1.48% discount rate). The intrinsic value of the beneficial conversion feature was calculatedas the difference between the conversion price of $0.24158 and the fair valueof the common stock into which the Series C Preferred Stock was convertibleinto on the stockholder approval date of $1.87 per share, or an intrinsic valueof $1.63 per share, which is greater than the proceeds allocated.  Therefore, the Company recorded a non-cashcharge of approximately $1.8 million which is included in “Preferred stockconversion discount” on the consolidated statement of operations as of June 30,2003.

 

On May 23, 2003, the Company issued 4.8million shares, valued at approximately $1.8 million, plus $1.5 million incash, to PubliGroupe, in exchange for forgiveness of three promissory notes andthe related accrued interest (see note 6).

 

From April to June 2003, approximately 30employees including members of senior management volunteered to receive between5 and 20% of their compensation in the form of the Company’s common stock andoptions in lieu of cash.  As a result, approximately 371,000 shares,valued at $0.1 million, were issued.

 

On March 17, 2003, the Company issued1,466,249 shares, valued at approximately $0.3 million, to employees in lieu ofcash for achieving contractual performance-based 2002 target bonuses.  The bonuses were accrued as of December 31,2002.

 

From January to July 2002, approximately 58employees including members of senior management volunteered to receive between5 and 20% of their compensation in the form of the Company’s common stock inlieu of cash.  As a result, approximately 1.1 million shares, valued at$0.2 million, were issued.

 

16

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In April 2002, the Company issued 416,784shares, valued at $0.1 million, principally to the CEO, for 2001 bonuses asreported in the Company’s 10-K and accrued as of December 31, 2001.

 

*AdditionalPaid-in Capital*

 

During the six months ended June 30, 2003,the Company’s additional paid-in capital increased by $17.0 million due to $6.5million in connection with the retirement of PubliGroupe promissory notes, $8.6million from the issuance of Series C preferred stock, $1.1 million of commonstock issued in connection with the Insight First acquisition, $0.5 millionfrom exercise of options, $0.4 million in other stock-based compensation issuedto employees offset by ($0.1) million related to the conversion of preferredstock.

 

**(8)  STOCK INCENTIVE PLANS**

 

For the six months ended June 30, 2003, theCompany granted approximately 2.7 million stock options under the 1998 StockIncentive Plan and 6.0 million stock options under the 2002 Stock IncentivePlan to employees at exercise prices based on the fair market value of theCompany’s common stock at the respective dates of grant.

 

On January 1, 2003, in accordance with theterms of the 2002 Stock Incentive Plan, shares reserved for issuance under thePlan were increased by 3,000,000.

 

**(9)  SUPPLEMENTAL CASH FLOW INFORMATION**

 

For the six months ended June 30, 2003 and2002, the amount of cash paid for interest was $5,000 and $7,000, respectively.

 

**(10)  SEGMENTS**

 

The Company’s business is comprised of tworeportable segments:  Integrated MediaSolutions and Technology Solutions.  TheIntegrated Media Solutions segment generates the majority of its revenues bydelivering advertisements to affiliated Web sites and search engine trafficdelivery and marketing services.  TheTechnology Solutions segment generates revenue by providing software licenses,third-party ad serving and other technology services.  The Company’s management periodically reviews corporate assetsand overhead expenses for each segment. The summarized segment information as of and for the three and sixmonth periods ended June 30, 2003 and 2002, are as follows:

 

17

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|                                            |   | **Three  months ended June 30, 2003** |   | **Three  months ended June 30, 2002** |   |
|-------------------------------------------------|--------|---------------------------------------|--------|---------------------------------------|--------|
|                                            |   | **Integrated  Media  Solutions**      |   | **Technology  Solutions**             |   | **Total** |   | **Integrated  Media  Solutions** |   | **Technology  Solutions** |   | **Total** |   |
|                                            |   | **(in  thousands)**                   |   |
|                                            |   |                                  |   |                                  |   |   |   |   |   |   |   |   |   |
| Revenues                                        |   | $                                     | 8,362  |                                  | $      | 3,788 |   | $ | 12,150 |   | $ | 7,330 |   | $ | 3,250 |   | $ | 10,580 |   |
| Amortization of intangibles                     |   | 333                                   |   | 328                                   |   | 661 |   | 216 |   | 250 |   | 466 |   |
| Stock-based compensation  (1)                   |   | 131                                   |   | 15                                    |   | 146 |   | 38 |   | — |   | 149 |   |
| Gain on sale of assets, net                     |   | —                                |   | —                                |   | — |   | 568 |   | — |   | 568 |   |
| Segment income (loss) from  operations          |   | (1,702                                | )      | 141                                   |   | (1,561 | ) | (3,866 | ) | (305 | ) | (4,171 | ) |
| Interest expense, net                           |   | (51                                   | )      | —                                |   | (51 | ) | (70 | ) | — |   | (70 | ) |
| Other expenses                                  |   | —                                |   | (839                                  | )      | (839 | ) | — |   | — |   | — |   |
| Segment loss before  provision for income taxes |   | (1,753                                | )      | (698                                  | )      | (2,451 | ) | (3,936 | ) | (305 | ) | (4,241 | ) |
|                                                 |        |                                       |        |                                       |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
|                                            |   | **Six months  ended June 30, 2003** |   | **Six months  ended June 30, 2002** |   |
|-------------------------------------------------|--------|-------------------------------------|--------|-------------------------------------|--------|
|                                            |   | **Integrated  Media  Solutions**    |   | **Technology  Solutions**           |   | **Total** |   | **Integrated  Media  Solutions** |   | **Technology  Solutions** |   | **Total** |   |
|                                            |   | **(in  thousands)**                 |   |
|                                            |   |                                |   |                                |   |   |   |   |   |   |   |   |   |
| Revenues                                        |   | $                                   | 16,705 |                                | $      | 7,269 |   | $ | 23,974 |   | $ | 14,845 |   | $ | 6,485 |   | $ | 21,330 |   |
| Amortization of intangibles                     |   | 666                                 |   | 642                                 |   | 1,308 |   | 508 |   | 500 |   | 1,008 |   |
| Stock-based compensation  (1)                   |   | 179                                 |   | 15                                  |   | 194 |   | 75 |   | — |   | 418 |   |
| Gain on sale of assets, net                     |   | —                              |   | —                              |   | — |   | (305 | ) | — |   | (305 | ) |
| Segment income (loss) from  operations          |   | (3,858                              | )      | 98                                  |   | (3,760 | ) | (7,098 | ) | (700 | ) | (7,798 | ) |
| Interest expense, net                           |   | (142                                | )      | —                              |   | (142 | ) | (109 | ) | — |   | (109 | ) |
| Other expenses                                  |   | —                              |   | (839                                | )      | (839 | ) | — |   | — |   | — |   |
| Segment loss before  provision for income taxes |   | (4,000)                             |   | (741                                | )      | (4,741 | ) | (7,207 | ) | (700 | ) | (7,907 | ) |
| Total assets:                                   |   |                                |   |                                |   |   |   |   |   |   |   |   |   |
| June 30, 2003                                   |   | 23,083                              |   | 12,597                              |   | 35,680 |   |   |   |   |   |   |   |
| December 31, 2002                               |   | 22,930                              |   | 11,037                              |   | 33,967 |   |   |   |   |   |   |   |
|                                                 |        |                                     |        |                                     |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
|                                         |   | **US**              |   | **International** |   | **Total** |   |
|----------------------------------------------|--------|---------------------|--------|-------------------|--------|-----------|--------|
|                                         |   | **(in  thousands)** |   |
| **Period  ended June 30, 2003**              |   |                |   |              |   |      |   |
| Revenues for the three  months ended         |   | $                   | 7,202  |              | $      | 4,948     |   | $ | 12,150 |   |
| Revenues for the six months  ended           |   | 14,642              |   | 9,332             |   | 23,974    |   |
| Long-lived assets                            |   | 11,876              |   | 1,786             |   | 13,662    |   |
|                                         |   |                |   |              |   |      |   |
| **Period  ended June 30, 2002**              |   |                |   |              |   |      |   |
| Revenues for three months  ended             |   | $                   | 7,245  |              | $      | 3,335     |   | $ | 10,580 |   |
| Revenues for six months  ended               |   | 14,794              |   | 6,536             |   | 21,330    |   |
| Long-lived assets  at December 31, 2002 |   | 12,249              |   | 1,960             |   | 14,209    |   |

 

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(1) Not included are $111 and $343 for the three and six month periodsended June 30, 2002, respectively, related to corporate.

 

**(11)  LITIGATION**

 

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

 

On April 19, 2002, aQuantive, Inc. (formerlyAvenue A, Inc.) filed a complaint against the Company seeking a declaratoryjudgment that U.S. Patent No. 6,206,368 (the “'368 Patent”)is invalid andnot infringed by aQuantive.  The complaint also seeks injunctive reliefand recovery of attorney’s fees.  On May 10, 2002, the Company filed itsanswer to the complaint, in which the Company denied the material allegationsof the complaint and asserted a counterclaim for infringement of the ‘368patent.  On January 2, 2003, aQuantive filed a motion for summary judgmentof non-infringement, to which the Company filed papers in opposition on April28, 2003.  On July 3, 2003, the U.S.Federal Court for the Western District of Washington granted partial summaryjudgment to aQuantive, Inc. and held that, based on the court’s construction ofthe patent’s claims, aQuantive’s Atlas DMT adserving system does not infringethe ‘368 patent.  The Company willappeal the court’s ruling to the Court of Appeals for the Federal Circuit andhas agreed with aQuantive to dismiss the remaining claims in the case toexpedite the appeal.

 

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*Beate Uhse*

 

The Company’s German subsidiary Real MediaGermany and Beate Uhse New Medi@ GmbH (“Beate Uhse”) reached a final settlementon their breach of contract claim on July 2, 2003.  Under the terms of the settlement, Real Media Germany retainedapproximately $0.2 million of funds attached from Beate Uhse in January 2002,and remitted approximately $0.2 million to Beate Uhse.  All cash transactions related to thesettlement were completed on July 14, 2003, and all future claims by bothparties related to the subject matter of the lawsuit were extinguished as aresult.

 

*Brian Anderson*

 

On July 5,  2001, BrianAnderson, former Chief Executive of our AwardTrack, Inc.  subsidiary, served us with notice of alawsuit filed in Superior Court for the State of California in and for the County of Santa Cruz, alleging breachof  contract, fraud, intentionalinfliction of emotional distress and breach of fiduciary duty, in connection with the acquisition of AwardTrack andsubsequent  events.  The Companyhas removed the  lawsuit to federalcourt in California and has moved to dismiss the complaint  in its entirety; this motion was granted inpart, with leave to remand, and  deniedin part.  The plaintiff has subsequently refiled the complaint and the Company has filed acounterclaim.

 

*Chinadotcom Corp.*

 

On February  19, 2003, theCompany filed a complaint against Chinadotcom Corporation for  breach of contract, unjust enrichment,breach of duty of good faith and fair dealing, and promissory estoppel arising out of a certain equityexchange  agreement dated August 16,2000 between the Company and Chinadotcom, seeking to enforce our right toexchange our stake in 24/7 Asia Ltd. for 1.8 million sharesof Chinadotcom.  Chinadotcom fileda motion seeking to compel arbitration of the matter in England, which thecourt  granted on May 12, 2003.  Weintend to file an arbitration claim relating to both the equity exchange  agreement and other claims that we may haveagainst Chinadotcom.

 

Chinadotcom  recently filed anaction in court in Hong Kong against David Moore, our Chief  Executive Officer, alleging, among otherthings, breach of fiduciary duty by  Mr.Moore in connection with his serving as a director of Chinadotcom and itssubsidiary, 24/7 Media Asia Ltd.  The Company will indemnify Mr. Moore and assume his defense.  Webelieve that the charges are completely without merit and that the action wasbrought solely in retaliation against the Company for asserting its rights in the matter discussed above.

 

On July 22, 2003, Chinadotcom filed an arbitration claim assertingcertain breaches of contract in connection with an agreement relating to 24/7Media Asia Ltd. entered into between the parties as of June 30, 2000.   The claim seeks damages that it statestotal $24.0 million.  The Companyintends to file an answer and counterclaim in the matter and to vigorouslyassert a defense.  The Company does notbelieve that this matter will have a material adverse effect on our financialcondition or results of operations.

 

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**(12)  SUBSEQUENT EVENTS**

 

***Annual Meeting***

 

The Annual Meeting of stockholders of 24/7 RealMedia, Inc. was held at the offices of the Company July 29,2003.  At the Company’s Annual Meeting the following seven proposalswere approved by the stockholders upon the recommendation of the Company’sboard of directors:

 

1.               a proposal toelect Mssrs. Robert Perkins, Joseph J. Waechter and Moritz Wuttke asClass II directors to serve until the 2006 Annual Meeting of Stockholdersor until their successors have been duly elected and qualified;

 

2.               a proposal to approve the conversion ofour outstanding Series C-1 Preferred Stock into Series C PreferredStock and the exercisability of associated warrants to purchase our commonstock;

 

3.               a proposal to consider and vote upon anamendment to the Company’s Certificate of Incorporation to increase itsauthorized share capital from 150,000,000 to 360,000,000 shares.

 

4.               a proposal to consider and act upon aproposed amendment to the Company’s Certificate of Incorporation, if the Boardof Directors determines that such action is in the best interests of theCompany and its stockholders, to amend the Company’s Certificate ofIncorporation to effect a reverse split of our outstanding common stock at anexchange ratio anywhere between the range of an exchange ratio of one-to-twoand an exchange ratio of one-to-15, with our Board of Directors retainingdiscretion regarding whether to implement the reverse stock split and whichexchange ratio to implement;

 

5.               a proposal to consider and act upon aproposal to approve an amendment to the Company’s 2002 Stock Incentive Plan toincrease the number of shares that may be subject to awards thereunder by10,000,000 and make certain other tax-related technical amendments thereto;

 

6.               a proposal to consider and act upon aproposal to clarify the approval of awards under amendments to executiveemployment agreements; and

 

7.               a proposal to ratify the appointment ofGoldstein Golub Kessler LLP as our independent certified public accountants forthe year ending December 31, 2003.

 

*Warrants*

 

In July 2003, 1,072,320 shares were issued in exchange for 1,300,000warrants in a cashless exercise.  The warrants had a weighted averageexercise price of approximately $0.24.

 

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

 

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

 

### **GENERAL**

 

24/7 Real Media, Inc. is a gateway to thefull spectrum of solutions for interactive marketing.  Our Open AdSystemTM platform, based on our patent-protectedtechnology, empowers Internet marketers to target, convert and retain theirbest online customers and manage and protect customer relationships.  We work closely with our customers toimplement integrated, value-enhancing solutions to manage critical aspects ofInternet marketing from ad sales and media representation to campaign planning,execution and optimization as well as audience measurement and analysis.  We believe our technology solutions, and ourmedia and marketing services, offer controllable and cost-effective methods forgenerating advertising revenue consistent with the goal of building andprotecting customer relationships.

 

We generate revenue in two businesssegments:  Integrated Media Solutionsand Technology Solutions.

 

*IntegratedMedia Solutions*

 

Our Media Solutions consist of the followingservices: (i) the 24/7 Web Alliance, a global alliance of Web sites where advertiserscan run site-specific ad campaigns on brand name sites, campaigns targetedto users in one or more of our content channels or global ad campaigns acrossour entire network of participating websites as well as target campaignby geography, by time or by day part; (ii) 24/7 Website Results, aperformance-based search engine paid inclusion service where we perform acustom buildout containing all relevant keywords and keyword phrases andadvertisers pay only when users search on one of those phrases andclick-through to the

 

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advertiser’s website from search listings;and (iii) other services including: desktop messaging services and brokerageactivities for internet promotions and e-mail marketing.  Our 24/7 Web Alliance includes the 24/7Network of Web sites, which uses our Open AdStream technology solutions todeliver and manage Internet advertisements, and our 24/7 Portfolio, whichconsists of Web sites with whom we provide services independent of our 24/7Network.

 

We generate revenue through the 24/7 WebAlliance from fees paid by client advertisers. We typically offer advertisers a pricing model based oncost-per-thousand-impressions (“CPM”) enabling a client advertiser to pay a feebased on the number of times its ad is viewed. We may also offer advertisers performance-based pricing models that mayinclude cost-per-click (“CPC”) pricing allowing a client advertiser to pay usonly when a user clicks on the advertiser’s ad or performs a specific action,such as a clicking on a uniform resource link (“URL”), downloading software,registering for membership or other transactions.

 

We share the revenue generated through the24/7 Web Alliance with Web sites included in the 24/7 Web Alliance.  With respect to our 24/7 Network Web sites,our revenue share generally ranges between 40% and 50% depending on, amongother things, our Web site partner’s audience size, number of unique visitors,impressions and page views, and the prominence of our partner’s brandname.  With respect to our 24/7Portfolio Web sites, our revenue share ranges between 35% and 45% depending onsimilar factors.

 

The following table shows by quarter thenumber of unique advertisers and the number of paid impressions since January1, 2002.

 

|    |   | **Number of Unique  Advertisers** |   | **Number of Paid  Impressions** |   |
|---------|--------|-----------------------------------|--------|---------------------------------|--------|
|    |   |                              |   | **(in billions)**               |   |
| Q2 2003 |   | 497                               |   | 6.2                             |   |
| Q1 2003 |   | 425                               |   | 6.1                             |   |
| Q4 2002 |   | 429                               |   | 4.8                             |   |
| Q3 2002 |   | 380                               |   | 3.0                             |   |
| Q2 2002 |   | 417                               |   | 3.3                             |   |
| Q1 2002 |   | 481                               |   | 4.2                             |   |

 

24/7 Website Results operates a paid inclusion service foradvertisers.  Paid inclusion is alsoknown as “Trusted Feed” and generally operates by converting an advertiser’sdynamically generated Web site into a data stream similar to what search engine“spiders”, or automated data collection methods, would have collected.  These individual data elements for each pageare then fed directly into the databases of our search engine affiliates as iftheir spider had in fact collected the data. Our 24/7 Website Results strategy focuses, in part, on helpingadvertisers more precisely develop and expand the range of terms and phrasesthey can use to drive search engine traffic to their Web sites.  Through our search engine relationships, wehelp ensure that our clients are well represented in the search results for theselected keyword phrases. We do not guarantee a position in search results forour advertisers, only inclusion.

 

24/7 Website Results offers advertisers important advantages to otherforms of paid inclusion.  In particular,the advertiser, with our assistance, controls which information on a Web pageis submitted and assures that the most pertinent content is indexed within thesearch engine database.  Further, ourtrusted feeds are updated more regularly than typical results obtained by automatedsearch engine spiders, which reduces the time lag for inclusion of Web sitesthat have frequently changing content. In addition, our trusted feeds give advertisers the ability to quickly

 

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edit or remove poorly performing listings.  Overall, for advertisers with Web pages that change regularly,our paid inclusion service combines a pay for performance model with thebenefits of control, freshness and coverage.

 

24/7 Website Results also operates andcontinues to develop a commercial search engine known as Engine54, located atwww.engine54.com.  Through Engine54, weprovide an Internet search solution that offers advertisers the opportunity toappear in relevant paid search listings. We are further developing the capabilities of Engine54 to providebusinesses of all sizes the opportunity to have listings for their companyincluded in the paid search results appearing on Engine54, so that theirlistings are available to Internet users at the moment when they are searchingfor relevant information. By enabling advertisers to reach large numbers ofusers in a highly targeted search context, we believe Engine54 can provide aneffective method of acquiring customers, converting leads into sales and generatinguseful information for direct marketing campaigns.

 

We generate revenue through 24/7 Website Results from performance-basedfees paid by advertisers to have their Web sites included in the databases ofour search engine affiliates and, to a lesser extent, to have their Web sitesincluded in the search results of Engine54. We believe search traffic likelyresults from a variety of search phrases entered into search engines byusers.  We use proprietary technology tohelp advertisers determine a set of keyword phrases most relevant to their siteand agree on a CPC fee they will pay for traffic directed to their Web sites.

 

We share the revenue generated throughWebsite Results with our search engine partners and, with respect to Engine 54,with search engine partners that have provided their paid search listings tous.  Our revenue share may range between35% and 45% depending on, among other things, our distribution partner’s size,number of unique visitors, impressions and the number of searches conducted,and the prominence of our partner’s brand.

 

The following table shows by quarter thenumber of active advertiser accounts and the number of valid visitors for 24/7Website Results since January 1, 2002.

 

|    |   | **Number of Active  Client Accounts** |   | **Number of  Valid Visitors** |   |
|---------|--------|---------------------------------------|--------|-------------------------------|--------|
|    |   |                                  |   | **(in millions)**             |   |
| Q2 2003 |   | 1379                                  |   | 11.3                          |   |
| Q1 2003 |   | 626                                   |   | 16.5                          |   |
| Q4 2002 |   | 472                                   |   | 12.5                          |   |
| Q3 2002 |   | 358                                   |   | 9.6                           |   |
| Q2 2002 |   | 294                                   |   | 10.7                          |   |
| Q1 2002 |   | 298                                   |   | 8.4                           |   |

 

In order to increase our revenue, we mustcontinue to increase the number of advertisers we service, the number of paidad impressions and click-throughs on the 24/7 Web Alliance and our portfolioWeb sites, the number of valid visitors to Web sites of our search marketingclients and the CPM or CPC fees that we earn. We drive ad impressions and click-throughs by increasing the number ofWeb sites in the 24/7 Web Alliance and other Web sites for whom we provideservices, and by building relationships with Web sites that have deep,high-quality content and large audiences. We drive traffic to our Website Results clients primarily by adding newsearch engine distribution partners and improving our placement with existingdistribution partners.

 

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*TechnologySolutions*

 

Our Technology Solutions consist of thefollowing products and services:  (i)the Open AdStream® software (“OAS Local”), a turnkey Internet advertisingdelivery and management solution installed locally on our clients’ servers;(ii) the Open AdStream service (“OAS Central”), an Internet advertisingdelivery and management service for website publishers using our Open AdStreamsoftware distributed centrally from our servers on an application serviceprovider basis; (iii) the Open InsightTM service, a service that uses our proprietarysoftware to measure and analyze audience behavior for client Web sites; and(iv) the Open AdvertiserTM service (“OAD”), an Internet advertising delivery andmanagement service for advertisers and ad agencies distributed centrally fromour servers on an application service provider basis.

 

We generate revenue from licensing our OpenAdStream software to client Web sites. Our license agreements typically provide for a license fee and asoftware maintenance and technical support fee.  We negotiate license fees based on, among other things, theforecasted number of impressions a client website will deliver using oursoftware and several other factors.  Toa much lesser extent, we also generate revenue by providing professionalservices charged at an hourly rate.

 

We generate revenue from our Open AdStreamservice from fees paid by client Web sites. We typically offer Web sites a CPM based pricing model allowing theclient Web site to pay us based on ad impressions delivered.  For these client Web sites, an “impression”includes the delivery by us at their request of any advertisement or othermarketing material.  Our OAS Centralrevenue is determined by multiplying the CPM rate by the number of impressionsdelivered and is typically billed on a monthly basis.  To a much lesser extent, we also generate revenue from fees paidto us by our client Web sites for trafficking their advertisements.  Trafficking advertisements typically refersto entering advertisement creative material and campaign specifications intoour software engine.

 

We generate revenue from our Open Insightservice from fees paid by client Web sites. We typically offer Web sites page-view-based pricing enabling the clientwebsite to pay us based on how many page views are measured.  Our service revenue is calculated bymultiplying the CPM rate by the number of page views delivered.  To a lesser extent, we also generate revenueby providing professional services charged at an hourly rate.

 

We generate revenue from our Open Advertiserservice from fees paid by client advertisers and agencies.  We have been generating revenue from OpenAdvertiser in Europe since mid-2001. Domestically, we have not generated significant revenue from our OpenAdvertiser service because it had been under development and existing customersare in the beta implementation process. We launched our Open Advertiser service in the United States in June2003.

 

The following table shows by quarter certainmetrics for our Technology Solutions since 2002.

 
|    |   | **OAS Local**                              |   | **OAS Central,  OAD and OI**               |   |                           |   |
|---------|--------|--------------------------------------------|--------|--------------------------------------------|--------|--------------------------------|--------|
|    |   | **Number of Active Client  Contracts (1)** |   | **Number of Active Client  Contracts (1)** |   | **Number of Paid Impressions** |   | **Annual Revenue per  Contract** |   |
|    |   |                                       |   |                                       |   | **(in billions)**              |   |   |   |
| 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 clientcontract may represent multiple clients and websites utilizing Open AdStreamproducts and services.

 

In order to increase our revenue from ourOpen AdStream solutions, and our Open Insight and Open Advertiser solutions, wemust increase the number of client web publishers and advertisers we service,the number of paid ad impressions delivered using our services, or thelicensing or CPM fee that we earn.  Webelieve we can increase the number of clients to whom we provide technology andservices, and the license fees and CPM fees we charge, by developing andproviding next generation technology products and services, including launchingour Open Advertiser service, and by leveraging the design features of ourtechnology and services to increase our ability to target high-quality audiencesegments.

 

*PatentLicensing Program*

 

In connection with the continued developmentof our technology solutions, we have undertaken an extensive review of thescope of our patented intellectual property. Our current patent portfolio includes U.S. Patent No. 6,026,368,entitled “On-Line Interactive System And Method For Providing Content AndAdvertising Information To A Targeted Set of Viewers”, U.S. Patent No.6,601,041, a continuation of our ‘368 Patent granting additional claimsinvolving advertisement sequencing without priority queues, and U.S. Patent No.5,446,919, entitled “Communication System and Method with Demographicallyor Psychographically Defined Audiences.” In addition, we have several pending patent applications aimed atprotecting other critical aspects of our next generation advertising deliveryand management solutions as well as our web analytics solutions.  We believe our patent portfolio not onlyprovides 24/7 Real Media with a competitive advantage in advertising deliveryand management, but also encompasses methods used in several other areas ofinteractive marketing including paid-search advertising and interactivetelevision.

 

In light of the foregoing, we have takensignificant steps to develop a patent licensing program involving all of ourpatented intellectual property.  Ourpatent program includes identifying, notifying and pursuing commercialdiscussions with companies that we believe practice one or more of our patents.  With any of these companies we may discusstransactions involving licensing our patents, buying our patents or jointlydeveloping technology using our patents. In addition, in appropriate circumstances, we will commence enforcementactions against companies that infringe our patents.  Our patent license arrangements are designed to include anupfront license fee and a running royalty payable by the licensee for theremaining term of the licensed patents. In addition to Doubleclick, Valueclick, Mediaplex and Advertising.com, ourinitial licensees who made a one-time lump-sum payment to license the ‘368patent, we have licensed one or more of our patents to a number of companieswho pay periodic royalties.

 

**CRITICALACCOUNTING POLICIES**

 

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

 

The consolidated financial statements of theCompany are prepared in conformity with accounting principles generallyaccepted in the United States of America. As such, the Company is required to make certain estimates, judgmentsand assumptions that management believes are reasonable based upon theinformation available.  These estimatesand assumptions affect the

 

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reported amounts of assets and liabilitiesand the disclosure 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 theCompany believes are the most critical to aid in fully understanding andevaluating the reported consolidated financial results include the following:

 

***Revenue Recognition***

 

*Integrated Media Solutions*

 

24/7 Web Alliance revenues are generated bydelivering advertising impressions for a fixed fee to third-party Websites.  24/7 Website Results revenuesare derived from driving traffic to client Web sites.  E-mail related revenues are derived from deliveringadvertisements to e-mail lists for advertisers and Web sites.  Agreements are primarily short term andrevenues are recognized as services are delivered provided that no significantCompany obligations remain outstanding and collection of the resultingreceivable is probable.

 

*Technology Solutions*

 

Technology Solutions revenues are derivedfrom licensing the Company’s software, hosted ad serving, and softwaremaintenance and technical support contracts. Revenue from software licensing agreements is recognized in accordancewith Statements of Position (“SOP”) 97-2, “Software Revenue Recognition,” andStaff Accounting Bulletin No. 101, “Revenue Recognition in FinancialStatements.”  Generally, the Company recognizes revenue from softwarelicense arrangements upon delivery of the software, and there is pervasiveevidence of an arrangement, collection is reasonably assured, the fee is fixedor determinable, and vendor-specific objective evidence exists to allocate thetotal fees to all elements of the arrangement.

 

The Company recently refined its OAS Localstrategy to offer customers the flexibility to adapt to rapidly changingenterprise requirements while reducing the risks and costs associated withtraditional software licensing models.  The Company has also adjusted itssoftware arrangements, which bundle a software license with maintenance andtechnical support services.  As a result, the Company changed the revenuerecognition method for OAS Local sales, resulting in the deferral of aportion of OAS local revenue to future periods.  Using this method, the Company recognizes as revenue the totalvalue of its software arrangements ratably over the term of the softwarelicense.  This change will have theeffect of modestly reducing license fee revenue in 2003 and deferring a portionof revenue to future periods.  The Company will recapture thereduction in upfront license fee revenue in subsequent years as it recognizesdeferred revenue on its software arrangements. Under the prior arrangements, the Company typically recognizedsoftware license revenue immediately upon delivery of the software andrecognized revenue related to maintenance and technical support servicesratably as earned.

 

Revenue from ad serving is recognized upondelivery.  The contracts are usually fora one-year period and are billed on a monthly basis.

 

Expense from the Company’s licensing,maintenance and technical support revenues are primarily payroll costs incurredto deliver and support the software. These expenses are classified as cost of revenues in the accompanyingconsolidated statements of operations.

 

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###### ***AccountsReceivable***

 

We perform ongoing credit evaluations of ourcustomers and adjust credit limits based upon payment history and thecustomer’s current credit worthiness, as determined by a review of theircurrent credit information.  Wecontinuously monitor collections and payments from our customers and maintain aprovision for estimated credit losses based upon historical experience and anyspecific customer collection issues 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.

 

###### ***Impairment ofLong-Lived Assets***

 

Effective January 1, 2002, we adopted SFASNo. 142, ‘‘Goodwill and Other Intangible Assets’’ and SFAS No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Asset’’.  SFAS 142 eliminates the amortization of goodwill andindefinite-lived intangible assets, addresses the amortization of intangibleassets with finite lives and addresses impairment testing and recognition forgoodwill and intangible assets.  SFASNo. 144 establishes a single model for the impairment of long-lived assets.

 

We assess goodwill for impairment annually unless events occur thatrequire more frequent reviews. Long-lived assets, including amortizable intangibles, are tested forimpairment whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable.  Discounted cash flow analyses are used to assess nonamortizableintangible impairment while undiscounted cash flow analyses are used to assesslong-lived asset impairment.  If anassessment indicates impairment, the impaired asset is written down to its fairmarket value based on the best information available.  Estimated fair market value is generally measured with discountedestimated future cash flows. Considerable management judgment is necessary to estimate undiscountedand discounted future cash flows. Assumptions used for these cash flows are consistent with internalforecasts.

 

On an on-going basis, management reviews thevalue and period of amortization or depreciation of long-lived and otherintangible assets. During this review, we reevaluate the significantassumptions used in determining the original cost of long-lived assets.Although the assumptions may vary from transaction to transaction, theygenerally include revenue growth, operating results, cash flows and otherindicators of value. Management then determines whether there has been animpairment of the value of long-lived assets based upon events orcircumstances, which have occurred since acquisition. The impairment policy isconsistently applied in evaluating impairment for each of our wholly ownedsubsidiaries and investments.

 

# ***Contingencies andLitigation***

 

We evaluate contingent liabilities includingthreatened or pending litigation in accordance with SFAS No. 5,“Accounting for Contingencies” and record accruals when the outcome of thesematters is deemed probable and the liability is reasonably estimable. We makethese assessments based on the facts and circumstances and in some instancesbased in part on the advice of outside legal counsel.

 

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# **RESULTS OF OPERATIONS**

 

# **FACTORS AFFECTING COMPARABILITY OF2003 TO 2002**

 

In May 2002, the Company completed the saleof certain assets related to the US e-mail management product which hadapproximately $0.4 million and $1.6 million in revenue for the three and sixmonth periods ended June 30, 2002.

 

In January 2003, the Company sold a majoritystake in iPromotions, Inc.  iPromotionsrevenue was approximately $0.3 million and $0.6 million for the three and sixmonth periods ended June 30, 2002, respectively, and $0.1 million for the threeand six month periods ended June 30, 2003 (see note 3).

 

In January 2003, the Company acquired InsightFirst, Inc., a web analytics company. The impact on the three and six month periods ended June 30, 2003 wasnot significant (see note 2).

 

Due to restructuring initiatives adopted inthe fourth quarter of 2002, we reduced our headcount by approximately 26employees during 2003. The number of full-time employees has decreased by 67from 285 at June 30, 2002 to 218 at June 30, 2003.

 

### The following table compares the results ofoperations for the three and six month periods ended June 30, 2003 to theresults of operations for the three and six month periods ended June 30, 2002(in thousands):

 

 
|                                                                                                                           |   | **Three  months ended June 30,** |     | **Dollar  Variance** |     | **Percentage  Variance** |   | **Six months  ended June 30,** |   | **Dollar  Variance** |   | **Percentage  Variance** |   |
|--------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|----------|----------------------|----------|--------------------------|--------|--------------------------------|--------|----------------------|--------|--------------------------|--------|
| **2003**                                                                                                                       |   | **2002**                         | **2003** |                 | **2002** |
|                                                                                                                           |   |                             |     | **(in  thousands)**  |     |                     |   |                           |   |                 |   | **(in  thousands)**      |   |   |   |   |   |
|                                                                                                                           |   | **(unaudited)**                  |     |                 |     |                     |   | **(unaudited)**                |   |                 |   |                     |   |
| Revenues:                                                                                                                      |   |                             |     |                 |     |                     |   |                           |   |                 |   |                     |   |   |   |   |   |
| Integrated media solutions                                                                                                     |   | $                                | 8,362    |                 | $        | 7,330                    |   | $                              | 1,032  |                 | 14.1   | %                        | $      | 16,705 |   | $ | 14,845 |   | $ | 1,860 |   | 12.5 | % |
| Technology solutions                                                                                                           |   | 3,788                            |     | 3,250                |     | 538                      |   | 16.6                           | %      | 7,269                |   | 6,485                    |   | 784 |   | 12.1 | % |
| Total revenues                                                                                                                 |   | 12,150                           |     | 10,580               |     | 1,570                    |   | 14.8                           | %      | 23,974               |   | 21,330                   |   | 2,644 |   | 12.4 | % |
|                                                                                                                           |   |                             |     |                 |     |                     |   |                           |   |                 |   |                     |   |   |   |   |   |
| Cost of revenues:                                                                                                              |   |                             |     |                 |     |                     |   |                           |   |                 |   |                     |   |   |   |   |   |
| Integrated media solutions                                                                                                     |   | 5,084                            |     | 4,866                |     | 218                      |   | 4.5                            | %      | 10,594               |   | 10,101                   |   | 493 |   | 4.9 | % |
| Technology solutions  (exclusive of $10, $0, $10 and $7, respectively, reported below as  stock-based compensation             |   | 1,062                            |     | 887                  |     | 175                      |   | 19.7                           | %      | 2,227                |   | 1,739                    |   | 488 |   | 28.1 | % |
| Total cost of revenues                                                                                                         |   | 6,146                            |     | 5,753                |     | 393                      |   | 6.8                            | %      | 12,821               |   | 11,840                   |   | 981 |   | 8.3 | % |
|                                                                                                                           |   |                             |     |                 |     |                     |   |                           |   |                 |   |                     |   |   |   |   |   |
| Gross profit                                                                                                                   |   | 6,004                            |     | 4,827                |     | 1,177                    |   | 24.4                           | %      | 11,153               |   | 9,490                    |   | 1,663 |   | 17.5 | % |
|                                                                                                                           |   |                             |     |                 |     |                     |   |                           |   |                 |   |                     |   |   |   |   |   |
| Operating expenses:                                                                                                            |   |                             |     |                 |     |                     |   |                           |   |                 |   |                     |   |   |   |   |   |
| Sales and marketing  (exclusive of $33, $13, $41 and $54, respectively, reported below as  stock-based compensation)           |   | 3,227                            |     | 3,234                |     | (7                       | )      | -0.2                           | %      | 6,371                |   | 6,278                    |   | 93 |   | 1.5 | % |
| General and administrative  (exclusive of $67, $129, $105 and $315, respectively, reported below as  stock-based compensation) |   | 2,776                            |     | 3,476                |     | (700                     | )      | -20.1                          | %      | 5,698                |   | 7,446                    |   | (1,748 | ) | -23.5 | % |
| Product technology  (exclusive of $36, $7, $38 and $42, respectively, reported below as  stock-based compensation)             |   | 755                              |     | 1,105                |     | (350                     | )      | -31.7                          | %      | 1,342                |   | 2,443                    |   | (1,101 | ) | -45.1 | % |
| Amortization of intangible  assets                                                                                             |   | 661                              |     | 466                  |     | 195                      |   | 41.8                           | %      | 1,308                |   | 1,008                    |   | 300 |   | 29.8 | % |
| Stock-based compensation                                                                                                       |   | 146                              |     | 149                  |     | (3                       | )      | -2.0                           | %      | 194                  |   | 418                      |   | (224 | ) | -53.6 | % |
| Loss (gain) on sale of  assets, net                                                                                            |   | —                           |     | 568                  |     | (568                     | )      | -100.0                         | %      | —               |   | (305                     | )      | 305 |   | -100.0 | % |
|                                                                                                                           |   |                             |     |                 |     |                     |   |                           |   |                 |   |                     |   |   |   |   |   |
| Total operating expenses                                                                                                       |   | 7,565                            |     | 8,998                |     | (1,433                   | )      | -15.9                          | %      | 14,913               |   | 17,288                   |   | (2,375 | ) | -13.7 | % |
|                                                                                                                           |   |                             |     |                 |     |                     |   |                           |   |                 |   |                     |   |   |   |   |   |
| Loss from operations                                                                                                           |   | (1,561                           | )        | (4,171               | )        | 2,610                    |   | 62.6                           | %      | (3,760               | )      | (7,798                   | )      | 4,038 |   | 51.8 | % |
|                                                                                                                           |   |                             |     |                 |     |                     |   |                           |   |                 |   |                     |   |   |   |   |   |
| Interest expense, net                                                                                                          |   | (51                              | )        | (70                  | )        | 19                       |   | 27.1                           | %      | (142                 | )      | (109                     | )      | (33 | ) | 30.3 | % |
| Other expense                                                                                                                  |   | (839                             | )        | —               |     | (839                     | )      | -100.0                         | %      | (839                 | )      | —                   |   | (839 | ) | -100.0 | % |
|                                                                                                                           |   |                             |     |                 |     |                     |   |                           |   |                 |   |                     |   |   |   |   |   |
| Loss before provision for  income taxes                                                                                        |   | (2,451                           | )        | (4,241               | )        | 1,790                    |   | 42.2                           | %      | (4,741               | )      | (7,907                   | )      | 3,166 |   | 40.0 | % |
|                                                                                                                           |   |                             |     |                 |     |                     |   |                           |   |                 |   |                     |   |   |   |   |   |
| Provision for income taxes                                                                                                     |   | 33                               |     | —               |     | 33                       |   | 100.0                          | %      | 40                   |   | —                   |   | 40 |   | 100.0 | % |
|                                                                                                                           |   |                             |     |                 |     |                     |   |                           |   |                 |   |                     |   |   |   |   |   |
| Net loss                                                                                                                       |   | $                                | (2,484   | )                    | $        | (4,241                   | )      | $                              | 1,757  |                 | 41.4   | %                        | $      | (4,781 | ) | $ | (7,907 | ) | $ | 3,126 |   | 39.5 | % |
|                                                                                                                                |        |                                  |          |                      |          |                          |        |                                |        |                      |        |                          |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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### **REVENUES**

 

**INTEGRATEDMEDIA SOLUTIONS.**Revenue is derived from three sources: 24/7 WebAlliance, 24/7 Website Results and Other Media Services.  24/7 Web Alliance revenue was $5.5 millionand $10.1 million for the three and six month periods ended June 30, 2003,respectively, as compared to $4.3 million and $8.7 million for the three andsix month periods ended June 30, 2002, respectively, an increase of 26.4% and17.1%, respectively.  The increase isdue to increasing the size of the 24/7 Network from 3.3 billion paidimpressions in 2002 to 6.2 billion paid impressions in 2003.

 

24/7 Website Results revenue was $2.3 millionand $5.4 million for the three and six month periods ended June 30, 2003,respectively, as compared to $2.3 million and $4.0 million for the three andsix month periods ended June 30, 2002, respectively, an increase of 1.8% and35.9%, respectively.  We generated asignificant portion of our 24/7 Website Results revenue from relationships witha small number of search engines, particularly Inktomi.  Due tochanges at our largest traffic provider, Inktomi, since its recent acquisitionby Yahoo!, the revenue we generated from Inktomi began to decline in the secondquarter of 2003.  Further, our contract with Inktomi expired at theend of May 2003.  This relationship generated approximately $0.4 millionand $2.1 million in revenue for the three and six month periods ended June 30,2003.

 

Other Media Services revenue is generatedprimarily from e-mail and iPromotions. E-mail revenue increased $0.1 million or 38.3% from $0.4 million to $0.5million for the three month periods ended June 30, 2002 and 2003, respectively.  E-mail revenue decreased $0.6 million or39.5% from $1.6 million to $1.0 million for the six month periods ended June30, 2002 and 2003, respectively.  Thedecrease is due to the sale of our US e-mail management product known as 24/7Mail, to Naviant on May 3, 2002 offset by the growth in international e-mailrevenue.  We maintain the ability tosell e-mail domestically as a broker through Naviant’s 24/7 Mail andinternationally, without restriction. In January 2003, we sold our iPromotions unit, which accounted for $0.1million in the three and six month periods ended June 30, 2003, respectively,and $0.3 million and $0.5 million in the three and six month periods ended June30, 2002.

 

Excluding the disposed US e-mail managementproduct and iPromotions, Integrated Media Solutions revenue increased $1.7million or 25.5% from $6.6 million in the three month period ended June 30,2002 to $8.3 million in the three month period ended June 30, 2003.  For the six month period ended June 30, 2002and 2003, Integrated Media Solutions revenue increased $3.9 million or 30.9%from $12.6 million to $16.6 million.

 

**TECHNOLOGYSOLUTIONS.**Our Technology Solutions revenue was $3.8 millionand $7.3 million for the three and six month periods ended June 30, 2003,respectively, as compared to $3.3 million and $6.5 million for the three andsix month periods ended June 30, 2002, respectively, representing an increaseof 16.6% and 12.1%, respectively. Revenue from our products that we host, including OAS Central and OAD,grew during the quarter as impressions delivered climbed from 5.1 billion to11.9 billion.  OAS Centralcontinues to be an attractive solution as it requires minimal upfront cost anddoes not require the customer to dedicate their assets to hosting thesoftware.  In 2003, we changed to a subscriptionbased contract model for new customers for our OAS Local software.  Total contract value is recognized ratablyover the term of the contract whereas in 2002 the revenue related to thesoftware license was recognized upon delivery. Had we changed contracts in 2002, approximately $0.3 million in secondquarter revenue would have been deferred until future periods and reportedrevenue for the three month period ended June 30, 2002 would have beenapproximately $2.9 million.  On thiscomparable basis, revenue would have increased 29.6% versus the prior year.

 

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**COST OFREVENUE AND GROSS PROFIT**

 

**INTEGRATEDMEDIA SOLUTIONS COST OF REVENUES AND GROSS PROFIT.**The cost ofrevenues consists primarily of fees paid to affiliates, whether it is a Website (24/7 Web Alliance), a list provider (for e-mail) or a traffic provider(for 24/7 Website Results), which is usually calculated as a percentage ofrevenues.  Cost of revenues alsoincludes adserving costs, which is an intercompany charge from the TechnologySolutions segment based on a fixed CPM. Gross margins were 39.2% and 36.6% for the three and six month periodsended June 30, 2003, respectively, and 33.6% and 32.0% for the three and sixmonth periods ended June 30, 2002.  Theincrease is due to lower adserving costs and increased revenue on the 24/7Network which has a higher margin. Excluding the disposed US e-mail management product and iPromotions,gross profit increased from 31.7% to 39.4% and from 29.4% to 36.5% for thethree and six month periods ended June 30, 2003 and 2002, respectively.

 

**TECHNOLOGYSOLUTIONS COST OF REVENUES AND GROSS PROFIT.**The cost of technologyrevenues consists of the costs of operating equipment and broadband capacityfor our third party adserving solutions and payroll costs to deliver, modifyand support software offset by the portion charged to Integrated MediaSolutions for adserving.  Gross marginswere 72.0% and 69.4% for the three and six month periods ended June 30, 2003and 72.7% and 73.2% for the three and six months ended June 30, 2002,respectively.  Had we changed the OASLocal contracts in 2002, gross margin would have been 69.7% and 69.5% for thethree and six months ended June 30, 2002, respectively.

 

**SALES AND MARKETINGEXPENSES.** Sales and marketing expenses consist primarily ofsales force salaries and commissions, advertising and other marketingexpenditures.  Sales and marketingexpenses were $3.2 million and $6.4 million for the three and six month periodended June 30, 2003, respectively, and $3.2 million and $6.3 million for thethree and six month periods ended June 30, 2002, respectively.  As a percentage of revenue, the expensedecreased from 30.6% to 26.6% for the three month periods ended June 30, 2002 and2003, respectively, and from 29.4% to 26.6% for the six month periods endedJune 30, 2002 and 2003, respectively. This decrease is due to our rationalization efforts and reduction ofdiscretionary expenses as well as increased revenues.  The number of employees included in sales and marketing decreasedfrom 141 at June 30, 2002 to 122 at June 30, 2003.

 

**GENERAL ANDADMINISTRATIVE EXPENSES**. General and administrative expenses consistprimarily of compensation, facilities expenses, professional fees and otheroverhead expenses incurred to support the business.  General and administrative expenses were $2.8 million and $5.7million for the three and six month periods ended June 30, 2003, respectively,and $3.5 million and $7.4 million for the three and six month periods endedJune 30, 2002, respectively.  As apercentage of revenue, the expense decreased from 32.9% to 22.8% for the threemonths ended June 30, 2002 and 2003, respectively, and from 34.9% to 23.8% forthe six month periods ended June 30, 2002 and 2003, respectively.  The significant decrease is due to ourrationalization efforts in eliminating office space, a reduction in personneland unnecessary expenses.  The number ofgeneral and administrative employees at June 30, 2003 and 2002 was 44 and 68,respectively.

 

**PRODUCTDEVELOPMENT EXPENSES.** Product development expenses consistprimarily of compensation and related costs incurred to further enhance our adserving and other technology capabilities. Product development expenses were $0.8 million and $1.3 million for thethree and six month periods ended June 30, 2003, respectively, and $1.1 millionand $2.4

 

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million for the three and six month periodsended June 30, 2002, respectively.  As apercentage of revenue, the expense decreased from 10.4% to 6.2% for the threemonth periods ended June 30, 2002 and 2003, respectively, and from 11.5% to5.6% for the six month periods ended June 30, 2002 and 2003, respectively.  This decrease is due to our successfulrationalization efforts and reduction of discretionary expenses.  Also, the expense decreased as the costsrelated to developing our Open Advertiser (OAD) product are being capitalized.  We capitalized approximately $0.1 millionand $0.4 million in the three and six month periods ended June 30, 2003,respectively.  General release of OpenAdvertiser occurred in June 2003.  Thenumber of employees included in product development decreased from 51 at June30, 2002 to 32 at June 30, 2003.

 

**AMORTIZATIONOF INTANGIBLE ASSETS.** Amortization of intangible assets were $0.7million and $1.3 million for the three and six month periods ended June 30,2003, respectively, and $0.5 million and $1.0 million for the three and sixmonth periods ended June 30, 2002, respectively.  The increase is due to the amortization of acquired technologyrelated to the Now Marketing acquisition in September 2002 and the InsightFirst acquisition in January 2003.

 

**STOCK-BASEDCOMPENSATION**. Stock-based compensation was $0.1 million and $0.2million for the three and six month periods ended June 30, 2003, respectively,and $0.1 million and $0.4 million for the three and six month periods endedJune 30, 2002, respectively.  Theexpense for the six months ended June 30, 2003 consist of $67,000 in salary forcertain employees who elected to received stock instead of cash, $32,000 instock given as bonuses to certain employees and $95,000 in amortization ofdeferred compensation for restricted shares issued to certain employees.  The expense for the six months ended June30, 2002 consists of $0.2 million in salary for certain employees who electedto receive stock instead of cash,  $0.1million in amortization of deferred compensation for restricted shares issuedto certain employees and $0.1 million in amortization of deferred compensationfrom acquisitions.

 

**GAIN ONSALE OF NON-CORE ASSETS, NET. **The $0.3million gain for the six months ended June 30, 2002 includes a $1.1 milliongain related to the sale of Exactis in May 2001, offset by a $0.8 million losson the sale of certain assets related to our US e-mail management product.  As part of the sale ofExactis, there were approximately $1.5 million in deferred gains related to anescrow balance and $1.75 million in deferred gains related to prepaid serviceamounts.  The gains were recognized asthe escrow balance was released and the prepaid services were utilized.  During the first quarter of 2002, we agreedto pay Experian, the acquirer of Exactis, $0.75 million of the escrow balance, withthe remainder paid to the Company immediately. Therefore, $0.75 million of the deferred gain was recognized and $0.75million was reversed against the escrow balance.  During the six month period ended June 30, 2002, we usedapproximately $0.2 million in Exactis services and recorded the relatedgain.  The $0.1 million remaining amountof the gain related to the reversal of unnecessary accruals related to Exactis.

 

**INTERESTEXPENSE, NET**. Interest expense, net includes interest incomefrom our cash and cash equivalents and short-term investments and interestexpense, net related to our long term debt and capital lease obligations.  Interest expense was $0.1 million and $0.2million for the three and six month periods ended June 30, 2003, respectively.

 

**OTHEREXPENSE**.  Other expense includes $1.2 million in legal fees andother expenses related to patent litigation offset by $0.4 million in incomerelated to the settlement of liabilities of disposed businesses onfavorable terms.

 

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**DIVIDENDSON PREFERRED STOCK**.  The SeriesA and Series C preferred stock, issued during the third quarter of 2002 andsecond quarter of 2003, respectively, accrue and cumulate dividends at a rateof 6% per year, compounded monthly, payable when, as and if declared by ourBoard of Directors.  The dividends startaccruing in the month following original issuance.

 

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

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

Since our inception we have financed ouroperations through equity financings and long-term debt.  During 2003, we have increased our liquidityprimarily through the receipt of $6.8 million in net proceeds from issuances ofpreferred stock.  Approximately $1.5million of the proceeds was used in the retirement of the three promissorynotes held by PubliGroupe.  Theremaining net proceeds will be used for general corporate purposes.  In the first half of 2002, we enhanced ourliquidity through $3.0 million in long-term debt financing from PubliGroupe, arelated party, and $2.3 million in proceeds from the sale of non-coreassets.  The proceeds of the 2002 debtfinancing and proceeds from the sale of investments were used to financerestructuring and sustain operations, and previously accrued restructuringcharges.  We used approximately $3.6million and $8.7 million of cash in operating activities during the six monthsended June 30, 2003 and 2002, respectively, generally as a result of our netoperating losses, adjusted for certain non-cash items included in our operatingresults as well as changes in various components of working capital.  Approximately $110,000 was received forearn-outs related to the sale of a former subsidiary.

 

Net cash used by investing activities wasapproximately $0.7 million in the first half of 2003 versus net cash of $2.2million provided by investing activities in 2002.  During 2003, we paid $150,000 as part of the acquisition ofInsight First, Inc., $0.5 million for capital expenditures, includingcapitalized software, and $50,000 as an investment in iPromotions, Inc.  During 2002, cash provided by investingactivities related to proceeds received from the sale of our non-core assets.

 

The Company has various employment agreementswith employees in the U.S., the majority of which are for one year with anautomatic renewal.  The potentialobligation under these contracts is approximately $1.6 million for 2003including 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 years’ 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 theminimum notice period as mandated by local law.  The contracts, or if no expressed provision is included in thecontract, local law, also require severance for involuntary terminations rangingfrom one to six months.  As of

 

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August 1, 2003, there were approximately 63employees in Europe whose annualized base salaries were approximately $4.4million.

 

As of June 30, 2003, we had approximately$0.5 million remaining of cash outlay obligations relating to restructuring andexit costs.  These amounts consistprimarily of office closing costs, which we expect to settle by December 2003.

 

At June 30, 2003, we had material commitmentsrelated to operating leases for office space and facility leases for our adserving systems.  Although we have nomaterial commitments for capital expenditures, we anticipate that our capitalexpenditures will be a use of cash consistent with the levels of our operationsand depend on numerous factors, including market demand for our services, thecapital required to maintain our technology, and the resources we devote tomarketing and selling our services.  Tothe extent we encounter additional opportunities to raise cash, we may selladditional equity securities, which would result in significant furtherdilution of our common stockholders. Stockholders may experience extreme dilution due to both our currentstock price and the significant amount of financing we may raise.  These securities may have rights senior tothose of holders of our common stock and, in the case of preferred stock, mayhave liquidation preference and participation rights that could diminish oreliminate the proceeds available to our common stockholders, if any, upon asale of the Company. We do not have any contractual restrictions on our abilityto incur debt.  Any indebtedness couldcontain covenants which would restrict our operations.

 

We believe that our existing cash and cashequivalents will be sufficient to meet our anticipated cash needs for workingcapital and capital expenditures for at least the next 12 months.

 

MARKET FOR COMPANY’S COMMON EQUITY

 

We have not declared or paidany dividends on our capital stock since our inception and do not anticipatepaying dividends in the foreseeable future. Our current policy is to retainearnings, if any, to finance the expansion of our business. The future paymentof dividends will depend on the results of operations, financial condition,capital expenditure plans, status of our preferred stock, and other factorsthat we deem relevant and will be at the sole discretion of our Board ofDirectors.

 

Since our initial publicoffering on August 13, 1998 until June 2002, our common stock traded on theNASDAQ National Market under the symbol “TFSM.”  In June 2002, we transferred our common stock to the NASDAQSmallCap Market.

 

**RISK FACTORS**

 

RISKS RELATED TO 24/7 REALMEDIA, INC.

 

WE ANTICIPATE CONTINUEDLOSSES AND WE MAY NEVER BE PROFITABLE.

 

We have not achievedprofitability in any period and we may not be able to achieve or sustainprofitability in the future.  Weincurred net losses of $4.8 million and $7.9 million for the six month periodsended June 30, 2003 and 2002, respectively. Each of our predecessors had net losses in every year of theiroperation.  We may incur operatinglosses for the foreseeable future.

 

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Even if we do achieveprofitability, we may not sustain or increase profitability on a quarterly orannual basis in the future.

 

WE MAY NEED TO RAISEADDITIONAL FUNDS TO CONTINUE OPERATIONS.

 

While management believesthe Company’s current financial resources are sufficient to fund our operationsfor the balance of 2003, an unforeseen reduction in our revenues, an impairmentof our receivables, or an increase in expenses or capital expenditures mayrequire us to raise additional funds to continue operations.  To the extent we encounter additionalopportunities to raise cash, we may sell additional equity or debt securities,which would result in further dilution of our stockholders.  Stockholders may experience extreme dilutiondue to our current stock price and the amount of financing we may need to raiseand these securities may have rights senior to those of holders of our commonstock.  We do not have any contractualrestrictions on our ability to incur debt. Any indebtedness could contain covenants, which may restrict ouroperating flexibility.

 

We have limited access tothe capital markets to raise capital. The capital markets have been unpredictable in the past, especially forunprofitable companies such as ours.  Inaddition, it is difficult to raise capital in the current marketconditions.  The amount of capital thata company such as ours is able to raise often depends on variables that arebeyond our control, such as the share price of our stock and its tradingvolume.  As a result, there is noguarantee that efforts to secure financing on terms attractive to us will besuccessful, or that we will be able to secure additional financing on anyterms.  Due to our operating losses, itmay be difficult to obtain debt financing. If we are able to consummate a financing arrangement, there is no guaranteethat the amount raised will be sufficient to meet our future needs.  If adequate funds are not available onacceptable terms, or at all, our business, results of operation, financialcondition and continued viability will be materially and adversely affected.

 

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

 

We have a limited operatinghistory.  You must consider the risks,expenses and difficulties typically encountered by companies with limitedoperating histories, particularly companies in new and rapidly expanding marketssuch as Internet advertising.  Theserisks include our ability to:

 

•                  develop new relationshipsand maintain existing relationships with our Web sites, advertisers, and otherthird parties;

 

•                  continue to develop andupgrade our technology;

 

•                  respond to competitive developments;

 

•                  implementand improveoperational, financial and management information systems;

 

•                  adapt to industryconsolidation; and

 

•                  attract, retain and motivatequalified employees.

 

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At times in the past and incertain segments, our revenues have grown significantly.  Our limited operating history makesprediction of future revenue growth difficult. Accurate predictions of future revenue growth are also difficult becauseof the rapid changes in our markets and the possible need by us to sell assetsto fund operations.  Accordingly,investors should not rely on past revenue growth rates as a prediction offuture revenue growth.

 

OUR FUTURE REVENUES ANDRESULTS OF OPERATIONS MAY BE DIFFICULT TO FORECAST AND RESULTS IN PRIOR PERIODSMAY NOT BE INDICATIVE OF FUTURE RESULTS.

 

Our results of operationshave fluctuated and may continue to fluctuate significantly in the future as aresult of a variety of factors, many of which are beyond our control. These factorsinclude:

 

•                  the addition of new or lossof existing clients;

 

•                  changes in fees paid byadvertisers and direct marketers or other clients;

 

•                  changes in service feespayable by us to owners of Web sites or e-mail lists, or ad serving feespayable by us to third parties;

 

•                  the demand by advertisers,Web publishers and direct marketers for our advertising solutions;

 

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

 

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

 

•                  changes in governmentalregulation of the Internet; and

 

•                  generaleconomicconditions.

 

Our future revenues andresults of operations may be difficult to forecast due to the abovefactors.  In addition, our expenselevels are based in large part on our investment plans and estimates of futurerevenues.  Any increased expenses mayprecede or may not be followed by increased revenues, as we may be unable to,or may elect not to, adjust spending in a timely manner to compensate for anyunexpected revenue shortfall.  As aresult, we believe that period-to-period comparisons of our results ofoperations may not be meaningful.  Youshould not rely on past periods as indicators of future performance.  In future periods, our results of operationsmay fall below the expectations of securities analysts and investors, whichcould adversely affect the trading price of our common stock.

 

WE DISCLOSE PRO FORMA INFORMATION.

 

We prepare and release quarterly unauditedfinancial statements prepared in accordance with generally accepted accountingprinciples (“GAAP”).  We also discloseand discuss certain pro forma and other non-GAAP information in the relatedearnings release and investor conference call, including EBITDA which isderived from pro forma, non-GAAP financial measures.  This pro forma financial information excludes or may excludecertain special, non cash and/or non-recurring charges and other costs.  We believe the disclosure of the pro formafinancial information helps investors more meaningfully evaluate the results ofour ongoing operations.  However, weurge investors to

 

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carefully review the GAAP financialinformation included as part of our Quarterly Reports on Form 10-Q, our AnnualReports on Form 10-K, and our quarterly earnings releases, and to compare theGAAP financial information with the pro forma financial results disclosed inour quarterly earnings releases and investor calls.

 

RECENTLY ENACTED AND PROPOSED CHANGES INSECURITIES LAWS AND REGULATIONS ARE LIKELY TO INCREASE OUR COSTS.

 

The Sarbanes-Oxley Act of 2002 that becamelaw in July 2002 requires changes in some of our corporate governance andsecurities disclosure or compliance practices. That Act also requires the SEC to promulgate new rules on a variety ofsubjects, in addition to rule proposals already made, and NASDAQ has proposedrevisions to its requirements for companies that are NASDAQ-listed.  We expect these developments to increase ourlegal compliance costs.  We expect thesedevelopments to make it more difficult and more expensive for us to obtaindirector and officer liability insurance, and we may be required to acceptreduced coverage or incur substantially higher costs to obtain coverage.  These developments could make it moredifficult for us to attract and retain qualified members of our board ofdirectors, or qualified executive officers. We are presently evaluating and monitoring regulatory developments andcannot estimate the timing or magnitude of additional costs we may incur as aresult.

 

OUR BUSINESS MAY SUFFER IFWE ARE UNABLE TO SUCCESSFULLY IMPLEMENT OUR BUSINESS MODEL.

 

A significant part of ourbusiness model is to generate revenue by providing interactive marketingsolutions to advertisers, ad agencies and Web publishers.  The profit potential for this business modelis unproven.  To be successful, bothInternet advertising and our solutions will need to achieve broad marketacceptance by advertisers, ad agencies and Web publishers.  Our ability to generate significant revenuefrom advertisers will depend, in part, on our ability to contract with Webpublishers that have Web sites with adequate available ad space inventory.  Further, these Web sites must generatesufficient user traffic with demographic characteristics attractive to ouradvertisers.  The intense competition amongInternet advertising sellers has led to the creation of a number of pricing alternativesfor Internet advertising.  Thesealternatives make it difficult for us to project future levels of advertisingrevenue and applicable gross margin that can be sustained by us or the Internetadvertising industry in general.

 

Intensive marketing andsales efforts may be necessary to educate prospective advertisers regarding theuses and benefits of, and to generate demand for, our products and services,including our newer products and services such as Website Results, OpenAdvertiser and Open Insight. Enterprises may be reluctant or slow to adopt a new approach that mayreplace, limit or compete with their existing direct marketing systems.  In addition, since online direct marketingis 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 meet the demands ofthese clients.  Acceptance of our newsolutions will depend on the continued emergence of Internet commerce,communication and advertising, and demand for its solutions.  We cannot assure you that demand for its newsolutions will emerge or become sustainable.

 

WE HAVE GROWN OUR BUSINESSTHROUGH ACQUISITION.

 

We were formed in February1998 to consolidate three Internet advertising companies and have sinceacquired eighteen more companies.  Incombining these entities, we have faced risks and

 

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continue to face risks of integratingand improving our financial and management controls, ad serving technology,reporting systems and procedures, and expanding, training and managing our workforce.  This process of integration maytake a significant period of time and will require the dedication of managementand other resources, which may distract management’s attention from our otheroperations.  We may continue pursuingselective acquisitions of businesses, technologies and product lines as a keycomponent of our growth strategy.  Anyfuture acquisition or investment may result in the use of significant amountsof cash, potentially dilutive issuances of equity securities, incurrence ofdebt and amortization expenses related to intangible assets. In addition,acquisitions involve numerous risks, including:

 

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

 

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

 

•                  the availability offavorable acquisition financing for future acquisitions; and

 

•                  the potential loss of keyemployees of any acquired business.

 

Our inability tosuccessfully integrate any acquired company could adversely affect ourbusiness.

 

WE COULD BE ADVERSELY AFFECTED BY ANIMPAIRMENT OF A SIGNIFICANT AMOUNT OF GOODWILL AND INTANGIBLE ASSETS ON OURBALANCE SHEET.

 

In the course of our operating history, wehave acquired and disposed of 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 goodwilland/or intangible assets was recorded because the fair value of the net assetsacquired was less than the purchase price. We may not realize the full value ofthe goodwill and/or intangible assets. As such, we evaluate on at least 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 potion as a charge to our earnings.

 

To improve our operatingperformance, we may determine to acquire other assets or businessescomplementary to our business and, as a result, we may record additionalgoodwill and/or intangible assets in the future.  The possible write-off of the goodwill and/or intangible assetscould negatively impact our future earnings. We will also be required to allocate a portion of the purchase price ofany acquisition to the value of any intangible assets that meet the criteriaspecified in the Statement of Financial Accounting Standards No. 141, “BusinessCombinations,” such as marketing, customer or contract-based intangibles.  The amount allocated to these intangibleassets could be amortized over a fairly short period.  As a result, our earnings and the market price of our commonstock could be negatively affected.

 

THE SUCCESS OF OUR 24/7 WEBSITE RESULTSOPERATIONS DEPEND ON A SMALL NUMBER OF SEARCH ENGINE AFFILIATES, THE LOSS OF ASINGLE SEARCH ENGINE AFFILIATE COULD RESULT IN A SUBSTANTIAL DECREASE IN OUR24/7 WEBSITE RESULTS REVENUE.

 

We have generated a significant portion ofour 24/7 Website Results revenue from relationships with a small number ofsearch engines, including Inktomi, Google, Alta Vista, MyGeek,

 

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Overture, and AskJeeves.  We expect that a small number of searchengine affiliates will continue to generate a majority or more of our 24/7Website Results revenue for the foreseeable future.  Due to recent changes at Inktomi, following its acquisition byYahoo!, the revenue we generate from this relationship has declined recentlyand our contract expired in May 2003. The interruption or loss of any of our primary search enginerelationships could cause a significant decrease in 24/7 Website Resultsrevenue.  As a result of consolidationamong search engines, and other search marketing companies, we could lose oneof more of our affiliates or face increased competition from affiliates thatinternally develop or acquire capabilities similar to our service.  In addition, as our search engineaffiliates’ operations continue to evolve, we may be required to adjust ourbusiness strategy to maintain relationships with our affiliates which couldhave a material adverse effect on our 24/7 Website Results revenue.

 

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

 

Our success depends, to asignificant extent, upon our senior management and key sales and technicalpersonnel, particularly David J. Moore, Chief Executive Officer.  The loss of the services of one or more ofthese persons could materially and adversely affect our ability to develop ourbusiness.  Our success also depends onour ability to attract and retain qualified technical, sales and marketing,customer support, financial and accounting, and managerial personnel.  We cannot be certain that we will be able toretain our key personnel or that we can attract, integrate or retain otherhighly qualified personnel in the future. We have experienced in the past, and may continue to experience in thefuture, difficulty in hiring and retaining candidates with appropriatequalifications, especially in sales and marketing positions.

 

OUR CUSTOMERS AND PARTNERSMAY EXPERIENCE ADVERSE BUSINESS CONDITIONS THAT COULD ADVERSELY AFFECT OURBUSINESS.

 

As a result of unfavorableconditions in the public equity markets, some of our customers may havedifficulty raising sufficient capital to support their long-termoperations.  As a result, thesecustomers have reduced their spending on Internet advertising, which hasmaterially and adversely affected our business, financial condition and resultsof operations.  In addition, from timeto time, we have entered into strategic business relationships with othercompanies, the nature of which varies, but generally in the context of customerrelationships.  These companies mayexperience similar adverse business conditions that may render them unable tomeet our expectations for the strategic business relationship or to fulfilltheir contractual obligations to us. Such an event could have a material adverse impact on our business,financial condition and results of operations.

 

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

 

OAS is our proprietary nextgeneration ad serving technology that is intended to serve as our sole adserving solution.  We must, among otherthings, ensure that this technology will function efficiently at high volumes,interact properly with our database, offer the functionality demanded by ourcustomers and assimilate our sales and reporting functions.  This development effort could failtechnologically or could take more time than expected.  Customers may become dissatisfied by anysystem failure that interrupts our ability to provide our services to them,including failures affecting our ability to deliver advertisements withoutsignificant delay to the viewer.  Sustainedor repeated system failures would reduce the attractiveness of our solutions toadvertisers, ad agencies and Web publishers and result in contractterminations, fee rebates and make goods,

 

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thereby reducingrevenue.  Slower response time or systemfailures may also result from straining the capacity of our deployed softwareor hardware due to an increase in the volume of advertising delivered throughour servers.  To the extent that we donot effectively address any capacity constraints or system failures, ourbusiness, results of operations and financial condition could be materially andadversely affected.

 

WE MIGHT EXPERIENCE SIGNIFICANT DEFECTS INOUR PRODUCTS.

 

Software products frequently contain errorsor failures, especially when first introduced or when new versions arereleased.  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 producterrors or design flaws would slow the adoption of our products and cause damageto our reputation, which would seriously 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 THIRDPARTIES.

 

Some of our products, including one or moremodules for our OAS platform, contain software licensed from thirdparties.  Some of these licenses may notbe available to us in the future or on terms that are acceptable or allow ourproducts to remain competitive.  Ourinability to use any of this third party software could result in shipmentdelays, delays in the development of future products or enhancements ofexisting products, or other disruptions in our business, which could materiallyand adversely affect our business, financial condition and operating results.

 

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

 

We have limited backupsystems and have experienced system failures and electrical outages from timeto time in the past, which have disrupted our operations.  We have a limited disaster recovery plan inthe event of damage from fire, floods, typhoons, earthquakes, power loss,telecommunications failures, break-ins and similar events.  Our operations are dependent on our abilityto protect our computer systems against these unexpected adverse events.   If any of the foregoing occurs, we mayexperience a complete system shutdown.  Any business interruption insurance that we carry is unlikely to besufficient to compensate us for loss of business in the event of a significantcatastrophe.

 

In addition, interruptionsin our services could result from the failure of our telecommunications providersto provide the necessary data communications capacity in the time frame werequire.  Our OAS technology resides oncomputer systems located in our data centers housed by Exodus Communications inthe United States and Level3 Communications in Europe.  These systems’ continuing and uninterruptedperformance is critical to our success. Despite precautions that we have taken, unanticipated problems affectingour systems have from time to time in the past caused, and in the future couldcause, interruptions in the delivery of our solutions.  Our business, results of operations andfinancial condition could be materially and adversely affected by any damage orfailure that interrupts or delays our operations.  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.

 

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Although we believe we carryproperty insurance with adequate coverage limits, our coverage may not beadequate to compensate us for all losses, particularly with respect to loss ofbusiness and reputation, that may occur.

 

In addition, terrorist acts or acts of warmay cause damage to our employees, facilities, clients, our clients’ customers,and vendors, which could significantly impact our revenues, costs and expensesand financial position.  The potentialfor future terrorist attacks, the national and international responses toterrorist attacks or perceived threats to national security, and other acts ofwar or hostility have created many economic and political uncertainties thatcould adversely affect our business and results of operations in ways thatcannot be presently predicted.  We arepredominantly uninsured for losses and interruptions caused by terrorist actsand acts of war.

 

OUR REVENUES ARE SUBJECT TOSEASONAL FLUCTUATIONS.

 

We believe that our revenuesare subject to seasonal fluctuations because advertisers generally place feweradvertisements during the first and third calendar quarters of each year anddirect marketers mail substantially more marketing materials in the thirdquarter each year.  Furthermore,Internet user traffic typically drops during the summer months, which reducesthe number of advertisements to sell and deliver.  Expenditures by advertisers and direct marketers tend to vary incycles that reflect overall economic conditions as well as budgeting and buyingpatterns.  Our revenue could bematerially reduced by a decline in the economic prospects of advertisers,direct marketers or the economy in general, which could alter current orprospective advertisers’ spending priorities or budget cycles or extend oursales cycle.  Due to such risks, youshould not rely on quarter-to-quarter comparisons of our results of operationsas an indicator of our future results.

 

# OURINTERNATIONAL OPERATIONS MAY POSE LEGAL AND CULTURAL CHALLENGES.

 

We have operations in a number ofinternational markets, including Canada and Europe.  To date, we have limited experience in marketing, selling anddistributing our solutions internationally. International operations are subject to other risks, including changesin regulatory requirements, reduced protection for intellectual property rightsin some countries, potentially adverse tax consequences, general import/exportrestrictions relating to encryption technology and/or privacy, difficulties andcosts of staffing and managing foreign operations, political and economicinstability, fluctuations in currency exchange rates; and seasonal reductionsin business activity during the summer months in Europe and certain other partsof the world.

 

OUR NET OPERATING LOSSCARRYFORWARDS MAY BE LIMITED.

 

Due to the “change inownership” provisions of the Internal Revenue Code, the availability of 24/7Real Media’s net operating loss and credit carryforwards may be subject to anannual limitation against taxable income in future periods, which couldsubstantially limit the eventual utilization of these carryforwards.

 

RISKS RELATED TO THE MARKETFOR OUR COMMON STOCK.

 

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

 

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As of August 12, 2003, therewere 79.1 million shares of our common stock outstanding.  We also have an aggregate of 97 millionshares of common stock that may be sold into the market in the future includingapproximately 18.7 million shares of our common stock issuable upon exercise ofoptions, 68.7 million shares of our common stock issuable upon conversion ofour outstanding preferred stock, and 9.6 million common stock 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 cannotpredict the effect, if any, that future sales of shares of our common stockinto the market, or the availability of shares of common stock for future sale,will have on the market price of our common stock. Sales of substantial amountsof common stock (including shares issued upon the exercise of stock options orconversion of shares of Preferred Stock), or the perception that such salescould occur, may materially and adversely affect prevailing market prices forour common stock.

 

THE MARKET PRICE OF OUR SECURITIES MAY BEVERY VOLATILE.

 

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

 

WE MAY IMPLEMENT A REVERSE STOCK SPLIT OF OURCOMMON STOCK.

 

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

 

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The effect of any reverse stock split uponthe market price of our common stock cannot be predicted, and the history ofreverse stock splits for companies in similar circumstances is varied.  The trading price of our common stock maynot rise in exact proportion to the reduction in the number of shares of ourcommon stock outstanding as a result of the reverse stock split and there maynot be a sustained increase in the trading prices of our common stock aftergiving effect to the reverse stock split. Moreover, the trading price may not remain above the thresholds requiredby the NASDAQ Stock Market and we may not be able to continue to meet the othercontinued listing requirements of the NASDAQ Stock Market.

 

THE POWER OF OUR BOARD OF DIRECTORS TODESIGNATE AND ISSUE SHARES OF  STOCKCOULD HAVE AN ADVERSE EFFECT ON HOLDERS OF OUR COMMON STOCK.

 

We are authorized to issue up to 350,000,000shares of common stock which may be issued by our board of directors for suchconsideration as they may consider sufficient without seeking stockholderapproval. The issuance of additional shares of common stock in the future willreduce the proportionate ownership and voting power of current stockholders.

 

Our Articles of Incorporation also authorizeus to issue up to 10,000,000 shares of preferred stock, the rights andpreferences of which may be designated by our board of directors. These designationsmay be made without stockholder approval. The designation and issuance ofpreferred stock in the future could create additional securities which wouldhave dividend and liquidation preferences prior in right to the outstandingshares of common stock. These

provisions could also impede a non-negotiatedchange in control.

 

SUNRA AND PUBLIGROUPECOLLECTIVELY HOLD A SUBSTANTIAL PORTION OF THE TOTAL OUTSTANDING VOTINGPOWER OF 24/7 REAL MEDIA AND WILL LIKELY BE ABLE TO INFLUENCE CERTAIN APPROVALMATTERS AND PREVENT A CHANGE OF CONTROL.

 

Sunra Capital Holdings Ltd.and affiliated parties are currently the beneficial owner of 42.5 millionshares of our common stock.  PubliGroupe USA Holdings is thebeneficial owner of 12.5 million shares of our common stock and has enteredinto an agreement to vote on all matters in accordance with therecommendations of our Board of Directors.  Additionally, theterms of the Series A Preferred Stock, owned principally by Sunra, containcertain protective provisions that provide such holders an effective vetoright over certain corporate matters.

 

Based on their votingpower, Sunra and PubliGroupe may effectively be able to determine the outcomeof all matters requiring stockholder approval, including the election ofdirectors, amendment of our charter and approval of significant corporatetransactions, and will likely be in a position to prevent a changein control of 24/7 Real Media even if the other stockholders were in favorof the transaction.

 

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

 

In addition, under certaincircumstances, upon the sale, liquidation or dissolution of the Company, ourSeries A and Series C preferred stockholders maybe entitled to receive anaggregate liquidation preference of $15.2 million, before our commonstockholders received any

 

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payment.  After receipt of this payment, the preferredstockholders may also have the right to participate in receiving proceedspayable to the common stockholders on an as-converted basis.  As result, in the event of a sale,liquidation or dissolution of the Company, including one in which the totalproceeds represent a premium to the then prevailing price per share of ourcommon stock, our common stockholders may experience substantial dilution inthe amount payable to them, and if total proceeds are less than or equal to theliquidation preference, then our common stockholders will not receive anyproceeds.

 

WE DO NOT INTEND TO PAY FUTURE CASHDIVIDENDS.

 

We currently do notanticipate paying cash dividends on our common stock at any time in the nearfuture. We may never pay cash dividends or distributions 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, and any other factors that the Board ofDirectors decides is relevant.

 

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

 

Some of the provisions ofour certificate of incorporation, our bylaws and Delaware law could, togetheror separately:

 

•                  discourage potentialacquisition proposals;

 

•                  delay or prevent a change incontrol;

 

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

 

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

 

RISKS RELATED TO OURINDUSTRY.

 

OUR FAILURE TO SUCCESSFULLYCOMPETE MAY HINDER OUR GROWTH.

 

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

 

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

 

•                  changing demands regardingcustomer service and support;

 

•                  shifts in sales andmarketing efforts by us and our competitors; and

 

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

 

Many of our competitors havelonger operating histories, greater name recognition, larger customer bases andsignificantly greater financial, technical and marketing resources thanours.   In addition, current andpotential competitors have established or may establish cooperativerelationships among themselves or with third parties to increase the ability oftheir products or services to address the needs of our prospectiveclients.  We cannot be certain that wewill be able to successfully compete against current or futurecompetitors.  In addition, the Internetmust compete for a share of advertisers’ total budgets with traditionaladvertising media, such as television, radio, cable and print, as well ascontent aggregation companies and other companies that facilitate Internetadvertising.  To the extent that theInternet is perceived to be a limited or ineffective advertising or directmarketing medium, advertisers and direct marketers may be reluctant to devote asignificant portion of their advertising budgets to Internet marketing, whichcould limit the growth of Internet marketing.

 

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

 

The Internet as a marketingmedium has not been in existence for a sufficient period of time to demonstrateits effectiveness.  Our business wouldbe adversely affected if the Internet advertising continues to remain soft orfails to develop in the near future. There are currently no widely accepted standards to measure theeffectiveness of Internet marketing other than clickthrough rates, whichgenerally have been declining.  Wecannot be certain that such standards will develop to sufficiently supportInternet marketing as a significant advertising medium.  Actual or perceived ineffectiveness ofonline marketing in general, or inaccurate measurements or database informationin particular, could limit the long-term growth of online advertising and causeour revenue levels to decline.

 

WE MAY BE UNABLE TO PROMOTE AND MAINTAIN OURBRANDS.

 

We believe that establishing and maintainingthe brand identities of our products and services is a critical aspect ofattracting and expanding a large client base. Promotion and enhancement of our brands will depend largely on oursuccess in continuing to provide high quality service.  If businesses do not perceive our existingservices to be of high quality, or if we introduce new services or enter intonew business ventures that are not favorably received by businesses, we willrisk diluting our brand identities and decreasing their attractiveness toexisting and potential customers.

 

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

 

PRIVACY CONCERNS MAY PREVENTUS FROM COLLECTING USER DATA.

 

Growing concerns about theuse of “cookies” and data collection may limit our ability to develop userprofiles.  Web sites typically placesmall files of information commonly known as “cookies”

 

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on a user’s hard drive,generally without the user’s knowledge or consent.  Cookie information is passed to the Web site through the Internetuser’s browser software.  Our OAStechnology targets advertising to users through the use of identifying data, or“cookies” and other non-personally-identifying information.  OAS enables the use of cookies to delivertargeted advertising and to limit the frequency with which an advertisement isshown to the 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 their hard drive at any time.  Some Internet commentators and privacyadvocates have suggested limiting or eliminating the use of cookies.  Any reduction or limitation in the use ofcookies could limit the effectiveness of our sales and marketing efforts andimpair our targeting capabilities. Microsoft Corporation has changed the design and instrumentation of itsWeb browser in such a way as to give users the option to accept or reject thirdparty cookies.  Giving users the optionto decline such cookies could result in a reduction of the number of Internetusers we are capable of profiling anonymously. Such changes also could adversely affect our ability to determine thereach of advertising campaigns sold and delivered by us and the frequency withwhich users of sites in the 24/7 Network see the same advertisement.

 

If the use or effectivenessof cookies is limited, we would likely have to switch to other technology thatwould allow us to gather demographic and behavioral information.  While such technology currently exists, itis substantially less effective than cookies. Replacement of cookies could require significant reengineering time andresources, might not be completed in time to avoid negative consequences to ourbusiness, financial condition or results of operations, and might not becommercially feasible.

 

CHANGES IN LAWS ANDSTANDARDS RELATING TO DATA COLLECTION AND USE PRACTICES AND THE PRIVACY OFINTERNET USERS AND OTHER INDIVIDUALS COULD HARM OUR BUSINESS.

 

The U.S. federal and variousstate governments have recently proposed limitations on the collection and useof information regarding Internet users. In October 1998, the European Union adopted a directive that may limitour collection and use of information regarding Internet users in Europe.  The effectiveness of our OAS technologycould be limited by any regulation limiting the collection or use ofinformation regarding Internet users. 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 information about individuals has led toself-regulation of these practices by the Internet advertising and directmarketing industry and to increased federal and state regulation.  The Network Advertising Initiative, or NAI, ofwhich 24/7 Real Media is a member along with other Internet advertisingcompanies, has developed self-regulatory principles for online preferencemarketing.  We are also subject tovarious federal and state regulations concerning the collection, distributionand use of information regarding individuals. These laws include the Children’s Online Privacy Protection Act, andstate 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. Although our compliance with the NAI’s guidelines and applicable federaland state laws and regulations has not had a material adverse effect on us, wecannot assure you that additional, more burdensome federal or state laws orregulations, including antitrust and consumer privacy laws, will not be enactedor applied to us or our clients, which could materially and adversely affectour business, financial condition and results of operations.

 

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

 

Laws and regulationsdirectly applicable to Internet communications, commerce and advertising arebecoming more prevalent, and new laws and regulations are under considerationby the United States Congress and state legislatures.  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 or governments of foreign countries mightattempt to regulate our transmissions or levy sales or other taxes relating toour activities.  The European Union hasenacted its own privacy regulations that may result in limits on the collectionand use of certain user information by us. The laws governing the Internet, however, remain largely unsettled, evenin areas where there has been some legislative action.  It may take years to determine whether andhow existing laws such as those governing intellectual property, privacy, libeland taxation apply to the Internet and Internet advertising.  In addition, the growth and development ofInternet commerce may prompt calls for more stringent consumer protection laws,both in the United States and abroad, that may impose additional burdens oncompanies conducting business over the Internet.  Our business, results of operations and financial condition couldbe materially and adversely affected by the adoption or modification of laws orregulations relating to the Internet.

 

OUR NETWORK OPERATIONS MAY BE VULNERABLE TOHACKING, VIRUSES AND OTHER DISRUPTIONS, WHICH MAY MAKE OUR PRODUCTS AND SERVICESLESS ATTRACTIVE AND RELIABLE.

 

Internet usage could decline if anywell-publicized compromise of security occurs. “Hacking” involves efforts to gain unauthorized access to information orsystems or to cause intentional malfunctions or loss or corruption of data,software, hardware or other computer equipment.  Hackers, if successful, could misappropriate proprietaryinformation or cause disruptions in our service.  We may be required to expend capital and other resources toprotect our Web site against hackers. We cannot assure you that any measures wemay take will be effective.  Inaddition, the inadvertent transmission of computer viruses could expose us to amaterial risk of loss or litigation and possible liability, as well asmaterially damage our reputation and decrease our user traffic.

 

DEPENDENCE ON PROPRIETARYRIGHTS AND RISK OF INFRINGEMENT.

 

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

 

We generally enter intoconfidentiality or license agreements with our employees, consultants andcorporate partners, and generally control access to and distribution of ourtechnologies, documentation and other proprietary information.  Despite our efforts to protect ourproprietary

 

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rights from unauthorized useor disclosure, parties may attempt to disclose, obtain or use our solutions ortechnologies.  We cannot assure you thatthe steps we have taken will prevent misappropriation of our solutions ortechnologies, particularly in foreign countries where laws or law enforcementpractices may not protect our proprietary rights as fully as in the UnitedStates.

 

We have licensed, and we maylicense in the future, elements of our trademarks, trade dress and similarproprietary rights to third parties. While we attempt to ensure that the quality of our brand is maintainedby these business partners, such partners may take actions that couldmaterially and adversely affect the value of our proprietary rights or ourreputation.  We cannot assure you thatany of our proprietary rights will be of value in the future since thevalidity, enforceability and scope of protection of certain proprietary rightsin Internet-related industries is uncertain and still evolving.

 

We may be subject to claimsof alleged infringement of the trademarks and other intellectual propertyrights of third parties by us or the Web publishers with Web sites in the 24/7Network.  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 we prevail, such litigation could betime-consuming and expensive to defend, and could result in the diversion ofour time and attention, any of which could materially and adversely affect ourbusiness, results of operations and financial condition.  Any claims or litigation from third partiesmay also result 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 litigationwhich may be unavailable on commercially reasonable terms.

 

In addition to our ongoinglitigation against, aQuantive, from time to time, we may selectively pursueclaims of infringement of our patents and other intellectual property rights bythird parties.  Such claims and anyresultant litigation present the risk that a court could determine, eitherpreliminarily or finally, that some of our patent or other intellectualproperty rights are not valid.  Inaddition, even if we prevail, such litigation could be time-consuming and expensiveto pursue, and could result in the diversion of our time and attention, any ofwhich could materially and adversely affect our business, results of operationsand financial condition.

 

INTELLECTUAL PROPERTYLIABILITY.

 

We may be liable for contentavailable or posted on the Web sites of our publishers.  We may be liable to third parties forcontent in the advertising we serve if the music, artwork, text or othercontent involved violates the copyright, trademark or other intellectualproperty rights of such third parties or if the content is defamatory.  Any claims or counterclaims could be timeconsuming, result in costly litigation or divert management’s attention.

 

RISKS ASSOCIATED WITHTECHNOLOGICAL CHANGE.

 

The Internet and Internetadvertising markets are characterized by rapidly changing technologies,evolving industry standards, frequent new product and service introductions,and changing customer demands.  Ourfuture success will depend on our ability to adapt to rapidly changingtechnologies and to enhance existing solutions and develop and introduce avariety of new solutions to address our customers’ changing demands.  We may experience difficulties that coulddelay or prevent the successful design, development, introduction or marketingof our solutions.  In addition, our newsolutions or enhancements must meet the requirements of our current andprospective customers and must achieve significant market acceptance.  Material delays in

 

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introducing new solutionsand enhancements may cause customers to forego purchases of our solutions andpurchase those of our competitors.

 

ITEM3.  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK

 

INTEREST RATE RISK

 

The primary objective of our investmentactivities is to preserve capital.  Cashand cash equivalents are investments with original maturities of three monthsor less.  Therefore, changes in themarket’s interest rates do not affect the value of the investments as recordedby 24/7 Real Media.  The following tablepresents the amounts of our financial instruments that are subject to interestrate risk by expected maturity and average interest rates as of June 30, 2003(in thousands):

 
|                      |   | **2003** |   | **2004** |   | **2005** |   | **2006** |   | **Thereafter** |   | **TOTAL** |   |
|---------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------------|--------|-----------|--------|
| Cash and cash equivalents |   | $        | 9,120  |     | $      | —   |   | $        | — |           | $      | —    |   | $ | — |   | $ | 9,120 |   |
| Average interest rate     |   | 0.80     | %      |     |   |     |   |     |   |           |   | 0.80      | %      |
|                           |        |          |        |          |        |          |        |          |        |                |        |           |        |  |  |  |  |  |  |

 

We did not hold any derivative financialinstruments as of June 30, 2003.

 

FOREIGN CURRENCY RISK

 

Wetransact business in a variety of foreign countries and are thus subject toexposure from adverse movements in foreign currency exchange rates.  This exposure is primarily related torevenue and operating expenses denominated in European currencies.  The effect of foreign exchange ratefluctuations for the three and six month periods ended June 30, 2003 and 2002were not material.  We do not usederivative financial instruments to limit our foreign currency riskexposure.  As of June 30, 2003, we had$1.8 million in cash and cash equivalents denominated in foreign currencies.

 

ITEM 4.  CONTROLS AND PROCEDURES

 

Within the 90 days prior to the date of this report, the Company’sChief Executive Officer and Chief Financial Officer, evaluated theeffectiveness of the design and operation of our disclosure controls andprocedures.  Based upon this evaluation,the Chief Executive Officer and Chief Financial Officer concluded that thedisclosure controls and procedures are effective in ensuring that informationrequired to be disclosed by the Company in the reports that it files or submitsunder the Securities and Exchange Act of 1934, as amended, is recorded,processed, summarized and reported within the time period specified by theSecurities and Exchange Commission’s rules and forms.

 

Additionally, there were no significant changes in the Company’s internalcontrols that could significantly affect the Company’s disclosure controls andprocedures subsequent to the date of their evaluation, nor were there anysignificant deficiencies or material weaknesses in the Company’s internalcontrols.  As a result, no correctiveactions were required or undertaken.

 

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PART II.  OTHER INFORMATION

 

ITEM1.  LEGAL PROCEEDINGS

 

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

 

On April 19, 2002, aQuantive, Inc. (formerlyAvenue A, 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 ofnon-infringement, to which the Company filed papers in opposition on April 28,2003.  On July 3, 2003, the U.S.Federal Court for the Western District of Washington granted partial summaryjudgment to aQuantive, Inc. and held that, based on the court’s construction ofthe patent’s claims, aQuantive’s Atlas DMT adserving system does not infringethe ‘368 patent.  The Company willappeal the court’s ruling to the Court of Appeals for the Federal Circuit andhas agreed with aQuantive to dismiss the remaining claims in the case toexpedite the appeal.

 

*Beate Uhse*

 

The Company’s German subsidiary Real MediaGermany and Beate Uhse New Medi@ GmbH (“Beate Uhse”) reached a final settlementon their breach of contract claim on July 2, 2003.  Under the terms of the settlement, Real Media Germany retainedapproximately $0.2 million of funds attached from Beate Uhse in January 2002,and remitted approximately $0.2 million to Beate Uhse.  All cash transactions related to thesettlement were completed on July 14, 2003, and all future claims by bothparties related to the subject matter of the lawsuit were extinguished as aresult.

 

*Brian Anderson*

 

On July 5,  2001, BrianAnderson, former Chief Executive of our AwardTrack, Inc.  subsidiary, served us with notice of alawsuit filed in Superior Court for the State of California in and for the County of Santa Cruz, alleging breachof  contract, fraud, intentionalinfliction of emotional distress and breach of fiduciary duty, in connection with the acquisition of AwardTrack andsubsequent  events.  The Companyhas removed the  lawsuit to federalcourt in California and has moved to dismiss the complaint  in its entirety; this motion was granted inpart, with leave to remand, and  deniedin part.  The plaintiff has subsequently refiled the complaint and the Company has filed acounterclaim.

 

*Chinadotcom Corp.*

 

On February  19, 2003, theCompany filed a complaint against Chinadotcom Corporation for  breach of contract, unjust enrichment,breach of duty of good faith and fair dealing, and promissory estoppel arising out of a certain equityexchange  agreement dated August 16,2000 between the Company and Chinadotcom, seeking to enforce our right toexchange our stake in 24/7 Asia Ltd. for 1.8 million shares ofChinadotcom.  Chinadotcom filed a motionseeking to compel arbitration of the matter, which the court  granted on May 12, 2003.  We intend tofile an

 

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arbitration claim relating to both the equity exchange  agreement and other claims that we may haveagainst Chinadotcom.

 

Chinadotcom  recently filed anaction in court in Hong Kong against David Moore, our Chief  Executive Officer, alleging, among otherthings, breach of fiduciary duty by  Mr.Moore in connection with his serving as a director of Chinadotcom and its  subsidiary, 24/7 Media Asia Ltd. The  Company will indemnify Mr. Mooreand assume his defense.  We believe that the charges are completely  without merit and that the action wasbrought solely in retaliation against the Company for asserting its rights in the matter discussed above.

 

On July 22, 2003,Chinadotcom filed an arbitration claim asserting certain breaches of contractin connection with an agreement relating to 24/7 Media Ltd. entered intobetween the parties as of June 30, 2000.  The claim seeks damages that it states total $24 million.  The Company intends to file an answer andcounterclaim in the matter and to vigorously assert a defense.  We do not believe that this matter will havea material adverse effect on our financial condition or results of operations.

 

ITEM2.  CHANGES INSECURITIES AND USE OF PROCEEDS

 

*Series CPreferred Stock*

 

As of June 6, 2003, the Company completed aprivate placement of approximately $7.18 million of Series C-1 NonvotingConvertible Redeemable Preferred Stock, together with related Common Stockwarrants, to several investment funds and a limited number of individualinvestors, including members of the Company’s management.  The issuance of the Company’s Series C-1Preferred Stock was conducted in two tranches in a private placement pursuantto Section 4(2) of the Securities Act of 1933, as amended.  All outstanding shares of the Series C-1Preferred Stock were converted into shares of Series C Voting ConvertiblePreferred Stock upon the approval of the Company’s stockholders on July 29,2003.  The Series C Preferred Stock isconvertible into, and the associated warrants are exerciseable for, shares ofCommon Stock at a conversion price, or exercise price, as the case may be, of$0.24158 per share.

 

ITEM3.  DEFAULTS UPONSENIOR SECURITIES

 

None.

 

ITEM4.  SUBMISSION OFMATTERS TO A VOTE OF SECURITIES HOLDERS

 

None.

 

ITEM5.  OTHER INFORMATION

 

None.

 

ITEM6.  EXHIBITS ANDREPORTS ON FORM 8-K

 

(a)                                  Exhibits.

 
| 4.1 |   | Certification of Designation  of Series C Convertible Preferred Stock* |
|-----|--------|------------------------------------------------------------------------|

 

 

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|   | 4.2    |                                                                                                                                                                | Certification of  Designation of Series C-1 Convertible Preferred Stock*                                                                                                |   |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   |   |                                                                                                                                                                |                                                                                                                                                                    |   |
|   | 10.1   |                                                                                                                                                                | Letter Agreement, dated  May 23, 2003, by and among the Company, Real Media, Inc. and PubliGroups.*                                                                     |   |
|   |   |                                                                                                                                                                |                                                                                                                                                                    |   |
|   | 10.2   |                                                                                                                                                                | Form of Series C-1  Preferred Stock and Common Stock Warrants Purchase Agreement.*                                                                                      |   |
|   |   |                                                                                                                                                                |                                                                                                                                                                    |   |
|   | 10.3   |                                                                                                                                                                | Form of Warrant to  purchase Common Stock to be issued to be Investors.*                                                                                                |   |
|   |   |                                                                                                                                                                |                                                                                                                                                                    |   |
|   | 10.4   |                                                                                                                                                                | Form of Investor Rights  Agreement.*                                                                                                                                    |   |
|   |   |                                                                                                                                                                |                                                                                                                                                                    |   |
|   | 10.5   |                                                                                                                                                                | Form of Voting Rights  Agreement.*                                                                                                                                      |   |
|   |   |                                                                                                                                                                |                                                                                                                                                                    |   |
|   | 31.1   |                                                                                                                                                                | Certification of Chief  Executive Officer of the Company required by Rule 13A-14(A)  or Rule 15d-14(A) of the Exchange Act.                                   |   |
|   |   |                                                                                                                                                                |                                                                                                                                                                    |   |
|   | 31.2   |                                                                                                                                                                | Certification of Chief  Financial Officer of the Company required by Rule 13A-14(A)  or Rule 15d-14(A) of the Exchange Act.                                   |   |
|   |   |                                                                                                                                                                |                                                                                                                                                                    |   |
|   | 32.1   |                                                                                                                                                                | Certification of the Chief  Executive Officer of the Company pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |   |
|   |   |                                                                                                                                                                |                                                                                                                                                                    |   |
|   | 32.2   |                                                                                                                                                                | Certification of the Chief  Financial Officer of the Company pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |   |
|   |   |                                                                                                                                                                |                                                                                                                                                                    |   |
| *      |   | Each of the Exhibits  listed above was filed as an exhibit to the Company’s Report on Form 8-K dated  June 18, 2003 which is incorporated by reference herein. |
|        |        |                                                                                                                                                                     |                                                                                                                                                                         |        |  |

 

(b)                                 Reports on Form 8-K.

 

Report on Form 8-K datedJune 18, 2003 (file no. 0-29768).  Thereport contained information regarding the conversion of indebtedness toPubliGroupe USA Holdings, Inc. and private placement of Series C-1 NonvotingConvertible Redeemable Preferred Stock.

 

Report on Form 8-K datedJune 18, 2003 (file no. 0-29768).  Thereport contained our issuance of a press release announcing that the staff ofNASDAQ have advised the Company that the Company has evidenced compliance withthe bid price and feerequirements, and all other requirements, necessary for continued listing onThe NASDAQ SmallCap Market.

 

ITEM 7.  SIGNATURES

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 

24/7 Real Media, Inc.

Date: August 14, 2003

 

 
|   | By:    | /s/ David J. Moore                      |   |
|--------|--------|-----------------------------------------|--------|
|   |   | David  J. Moore                         |
|   |   | *Chairman and Chief  Executive Officer* |
|   |   |
|   | By:    | /s/ Norman M. Blashka                   |   |
|   |   | Norman  M. Blashka                      |
|   |   | *EVP and Chief Financial  Officer*      |
|        |        |                                         |        |  |

 

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