**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**ý********    ****QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended March 31, 2005**

 

**or**

 

**o****        ****TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition period from                                  to                                  **

 

**Commission file number: 1-14355**

 

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

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

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

 

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

(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

 

**(212) 231-7100**

(REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)

 

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed bySection 13 or 15 (d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. YES ý NO o

 

Indicateby check mark whether the registrant is an accelerated filer Indicate by checkmark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act). YES ý NO o

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date.

 
| **CLASS**                               | ** ** | **OUTSTANDING AT APRIL 30, 2005** |
|-----------------------------------------|------------|-----------------------------------|
| Common  Stock, par value $.01 per share |       | 44,923,212 Shares                 |

 

 

----

 

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

**March 31, 2005**

**FORM 10-Q**

**INDEX**

 
| Part I. Financial  Information                                                                              |   |   |
|-------------------------------------------------------------------------------------------------------------|--------|--------|
| Item 1.  Consolidated Financial Statements                                                                  |   |   |
| Consolidated Balance Sheets  as of March 31, 2005 (unaudited) and December 31, 2004                         |   |   |
| Consolidated  Statements of Operations for the three months ended  March 31, 2005 and 2004 (unaudited) |   |   |
| Consolidated  Statements of Cash Flows for the three months ended  March 31, 2005 and 2004 (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                                                                                           |   |   |
| Signatures                                                                                                  |   |   |

 

Open AdStream® isa registered trademark of 24/7 Real Media, Inc. and Open AdSystemTM, OpenAdvertiserTM, Insight XETM, Insight ACTTM and Decide DNATM are pendingtrademarks of 24/7 Real Media, Inc. All other brand names ortrademarks appearing herein are the property of their respective holders.

 

2

----

 

PARTI. FINANCIAL INFORMATION

 

ITEM1. CONSOLIDATED FINANCIAL STATEMENTS

 

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

**CONSOLIDATED BALANCE SHEETS**

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

 
| ** **                                                                                                                                                               | ** ** | **March 31,**   | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|------------------|------------|
| ** **                                                                                                                                                               | ** ** | **2005**        | ** ** | **2004**         | ** ** |
| ** **                                                                                                                                                               | ** ** | **(unaudited)** | ** ** | ** **       | ** ** |
| **ASSETS**                                                                                                                                                               | ** ** | ** **      | ** ** | ** **       | ** ** |
| Current assets:                                                                                                                                                          |       |            |       |             |       |
| Cash and cash equivalents                                                                                                                                                |       | $               | 30,047     |             | $          | 27,690 |   |
| Short-term investments                                                                                                                                                   |       | 2,640           |       | 3,876            |       |
| Accounts receivable, less allowances of  $2,053 and $1,727, respectively                                                                                                 |       | 27,595          |       | 28,224           |       |
| Prepaid expenses and other current assets                                                                                                                                |       | 3,400           |       | 2,710            |       |
|                                                                                                                                                                     |       |            |       |             |       |
| Total current assets                                                                                                                                                     |       | 63,682          |       | 62,500           |       |
|                                                                                                                                                                     |       |            |       |             |       |
| Property and equipment, net                                                                                                                                              |       | 5,835           |       | 4,783            |       |
| Goodwill                                                                                                                                                                 |       | 34,573          |       | 34,573           |       |
| Intangible assets, net                                                                                                                                                   |       | 11,894          |       | 12,676           |       |
| Other assets                                                                                                                                                             |       | 7,040           |       | 6,866            |       |
|                                                                                                                                                                     |       |            |       |             |       |
| Total assets                                                                                                                                                             |       | $               | 123,024    |             | $          | 121,398 |   |
|                                                                                                                                                                     |       |            |       |             |       |
| **LIABILITIES  AND STOCKHOLDERS' EQUITY**                                                                                                                                |       |            |       |             |       |
| Current liabilities:                                                                                                                                                     |       |            |       |             |       |
| Accounts payable                                                                                                                                                         |       | $               | 13,021     |             | $          | 16,425 |   |
| Accrued liabilities                                                                                                                                                 |       | 16,691          |       | 11,808           |       |
| Deferred revenue                                                                                                                                                         |       | 3,040           |       | 3,222            |       |
| Subordinated convertible debentures, 2%,  due 2006                                                                                                                       |       | 7,500           |       | 7,500            |       |
|                                                                                                                                                                     |       |            |       |             |       |
| Total current liabilities                                                                                                                                                |       | 40,252          |       | 38,955           |       |
|                                                                                                                                                                     |       |            |       |             |       |
| Subordinated convertible debentures, 2%,  due 2006                                                                                                                       |       | 6,584           |       | 6,431            |       |
| Warrant liability                                                                                                                                                        |       | 366             |       | 516              |       |
| Other long-term liabilities                                                                                                                                              |       | 343             |       | 228              |       |
|                                                                                                                                                                     |       |            |       |             |       |
| Total liabilities                                                                                                                                                        |       | 47,545          |       | 46,130           |       |
|                                                                                                                                                                     |       |            |       |             |       |
| Commitments and contingencies                                                                                                                                            |       |            |       |             |       |
|                                                                                                                                                                     |       |            |       |             |       |
| Stockholders’ equity:                                                                                                                                               |       |            |       |             |       |
| Preferred stock; $.01 par value; 10,000,000  shares authorized, 78,000 and 78,000 shares issued and outstanding,  respectively (liquidation preference of $10 per share) |       | 1               |       | 1                |       |
| Common stock; $.01 par value; 350,000,000  shares authorized; 44,904,689 and 44,797,067 shares issued and outstanding, respectively                                      |       | 449             |       | 448              |       |
| Additional paid-in capital                                                                                                                                               |       | 1,174,436       |       | 1,173,765        |       |
| Deferred stock-based compensation                                                                                                                                        |       | (11             | )          | (17              | )          |
| Accumulated other comprehensive income                                                                                                                                   |       | 1,402           |       | 1,463            |       |
| Accumulated deficit                                                                                                                                                      |       | (1,100,798      | )          | (1,100,392       | )          |
| Total stockholders’ equity                                                                                                                                          |       | 75,479          |       | 75,268           |       |
|                                                                                                                                                                     |       |            |       |             |       |
| Total liabilities and stockholders’ equity                                                                                                                          |       | $               | 123,024    |             | $          | 121,398 |   |

 

See accompanying notes to unaudited interimconsolidated financial statements.

 

3

----

 

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

**CONSOLIDATED STATEMENTS OF OPERATIONS**

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

 
| ** **                                                                        | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                        | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| ** **                                                                        | ** ** | **(unaudited)**                  | ** ** | **(unaudited)** | ** ** |
| Revenues:                                                                         |       |                             |       |   |   |
| Media                                                                             |       | $                                | 14,229     |   | $ | 10,023 |   |
| Search                                                                            |       | 9,622                            |       | 3,016 |   |
| Technology                                                                        |       | 5,219                            |       | 4,342 |   |
| Total revenues                                                                    |       | 29,070                           |       | 17,381 |   |
|                                                                              |       |                             |       |   |   |
| Cost of revenues:                                                                 |       |                             |       |   |   |
| Media                                                                             |       | 9,627                            |       | 6,983 |   |
| Search                                                                            |       | 6,632                            |       | 2,458 |   |
| Technology                                                                        |       | 992                              |       | 822 |   |
| Total cost of revenues                                                            |       | 17,251                           |       | 10,263 |   |
|                                                                              |       |                             |       |   |   |
| Gross profit                                                                      |       | 11,819                           |       | 7,118 |   |
|                                                                              |       |                             |       |   |   |
| Operating expenses:                                                               |       |                             |       |   |   |
| Sales and marketing                                                               |       | 5,290                            |       | 3,316 |   |
| General and administrative                                                        |       | 4,584                            |       | 2,982 |   |
| Product development                                                               |       | 1,242                            |       | 1,051 |   |
| Amortization of intangible assets and  deferred financing costs                   |       | 1,140                            |       | 788 |   |
| Stock-based compensation (a)                                                      |       | 513                              |       | 199 |   |
| Restructuring costs                                                               |       | 973                              |       | — |   |
|                                                                              |       |                             |       |   |   |
| Total operating expenses                                                          |       | 13,742                           |       | 8,336 |   |
|                                                                              |       |                             |       |   |   |
| Loss from operations                                                              |       | (1,923                           | )          | (1,218 | ) |
|                                                                              |       |                             |       |   |   |
| Interest expense, net                                                             |       | (88                              | )          | (182 | ) |
| Change in fair value of warrant liability                                         |       | 150                              |       | 928 |   |
| Recovery of investments                                                           |       | 2,100                            |       | — |   |
| Impairment of investments                                                         |       | (588                             | )          | — |   |
| Other income (expense), net                                                       |       | (46                              | )          | 180 |   |
|                                                                              |       |                             |       |   |   |
| Loss before provision for income taxes                                            |       | (395                             | )          | (292 | ) |
|                                                                              |       |                             |       |   |   |
| Provision for income taxes                                                        |       | (11                              | )          | (100 | ) |
|                                                                              |       |                             |       |   |   |
| Net loss                                                                          |       | $                                | (406       | ) | $ | (392 | ) |
|                                                                              |       |                             |       |   |   |
| Dividends on preferred stock                                                      |       | (12                              | )          | (118 | ) |
|                                                                              |       |                             |       |   |   |
| Net loss attributable to common  stockholders                                     |       | $                                | (418       | ) | $ | (510 | ) |
|                                                                              |       |                             |       |   |   |
| Basic and diluted net loss per share  attributable to common stockholders         |       | $                                | (0.01      | ) | $ | (0.02 | ) |
|                                                                              |       |                             |       |   |   |
| Weighted average shares outstanding used in  basic and diluted net loss per share |       | 44,831,154                       |       | 25,618,029 |   |

 

----

| (a)  Stock-based compensation charges are excluded from the following operating  expense categories: |
|------------------------------------------------------------------------------------------------------|

 
| Cost of revenues           |   | $   | 8      |   | $      | — |   |
|----------------------------|--------|-----|--------|--------|--------|--------|--------|
| Sales and marketing        |   | 120 |   | 24     |   |
| General and administrative |   | 335 |   | 172    |   |
| Product development        |   | 50  |   | 3      |   |
|                       |   | $   | 513    |   | $      | 199    |   |

 

See accompanying notes to unaudited interimconsolidated financial statements.

 

4

----

 

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands)**

 
| ** **                                                                                    | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                    | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| ** **                                                                                    | ** ** | **(unaudited)**                  | ** ** | **(unaudited)** | ** ** |
| Cash flows from operating activities:                                                         |       |                             |       |   |   |
| Net loss                                                                                      |       | $                                | (406       | ) | $ | (392 | ) |
| Adjustments to reconcile net loss to net  cash provided by (used in) operating activities:    |       |                             |       |   |   |
| Depreciation and amortization                                                                 |       | 598                              |       | 488 |   |
| Provision for doubtful accounts and sales  reserves                                           |       | 604                              |       | 175 |   |
| Amortization of intangible assets and  deferred financing costs                               |       | 1,140                            |       | 788 |   |
| Amortization of warrants                                                                      |       | 152                              |       | 153 |   |
| Non-cash compensation                                                                         |       | 513                              |       | 199 |   |
| Accrued interest on notes payable                                                             |       | 75                               |       | 75 |   |
| Change in fair value of warrant liability                                                     |       | (150                             | )          | (928 | ) |
| Recovery of investments                                                                       |       | (2,100                           | )          | — |   |
| Impairment of investments                                                                     |       | 588                              |       | — |   |
| Changes in operating assets and  liabilities, net of effect of acquisitions and dispositions: |       |                             |       |   |   |
| Accounts receivable                                                                           |       | 25                               |       | (478 | ) |
| Prepaid assets and other current assets                                                       |       | (690                             | )          | (31 | ) |
| Other assets                                                                                  |       | (532                             | )          | (4,553 | ) |
| Accounts payable and accrued liabilities                                                      |       | 2,126                            |       | 3,015 |   |
| Deferred revenue                                                                              |       | (182                             | )          | 62 |   |
|                                                                                          |       |                             |       |   |   |
| Net cash provided by (used in) operating  activities                                          |       | 1,761                            |       | (1,427 | ) |
|                                                                                          |       |                             |       |   |   |
| Cash flows from investing activities:                                                         |       |                             |       |   |   |
| Recovery of investments                                                                       |       | 2,100                            |       | — |   |
| Proceeds from sale / maturities of  short-term investments                                    |       | 648                              |       | — |   |
| Capital expenditures, including capitalized  software                                         |       | (2,150                           | )          | (345 | ) |
| Cash paid for acquisitions, net                                                               |       | —                           |       | (1,574 | ) |
|                                                                                          |       |                             |       |   |   |
| Net cash provided by (used in) investing  activities                                          |       | 598                              |       | (1,919 | ) |
|                                                                                          |       |                             |       |   |   |
| Cash flows from financing activities:                                                         |       |                             |       |   |   |
| Proceeds from issuance of common stock, net                                                   |       | —                           |       | 33,840 |   |
| Proceeds from exercise of stock options                                                       |       | 71                               |       | 545 |   |
| Payment of capital lease obligations                                                          |       | (12                              | )          | (12 | ) |
|                                                                                          |       |                             |       |   |   |
| Net cash provided by financing activities                                                     |       | 59                               |       | 34,373 |   |
|                                                                                          |       |                             |       |   |   |
| Net change in cash and cash equivalents                                                       |       | 2,418                            |       | 31,027 |   |
| Effect of foreign currency on cash                                                            |       | (61                              | )          | 157 |   |
| Cash and cash equivalents at beginning of  year                                               |       | 27,690                           |       | 21,645 |   |
|                                                                                          |       |                             |       |   |   |
| Cash and cash equivalents at end of period                                                    |       | $                                | 30,047     |   | $ | 52,829 |   |

 

See accompanying notes to unaudited interimconsolidated financial statements.

 

5

----

 

**NOTE 1 – ORAGANIZATION AND NATURE OF OPERATIONS**

 

24/7 Real Media, Inc. (the “Company”) together with itssubsidiaries provides advertising services and software solutions for theonline advertising needs of Web publishers and advertisers, includingadvertising sales, search engine marketing services, online advertisementserving, analytics and audience management. As of March 31, 2005, the Companyprincipally operated in North America, Europe, South Korea and Australia andprovided the following products and services:

 

*Media*, collectivelymarketed as the 24/7 Web Alliance, a global alliance of Web sites representedby the Company, through which advertisers can place campaign orders directlywith the Company.

 

*Search*primarilyconsisting of full budget management services, including paid-inclusion serviceand pay-per-click bid management, optimization services and search engine andconsulting services, including natural search engine optimization servicesdesigned to help advertisers promote their Web site in or in association withrelevant search results displayed by the Company’s partner search engines andto optimize their search marketing budgets.

 

*Technology*primarilyconsisting of Open AdStream and Open Advertiser Internet advertisement deliveryand management software and services, the Insight XE web analytics and audiencemanagement software and services and the Insight ACT behavioral targetingservice. The Company licenses software products to customers that are hostedlocally and provides services from software hosted centrally on its servers asan application service provider.

 

**NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

#### (a) Basis of Presentation

####  

Theaccompanying consolidated financial statements include the accounts of theCompany and its majority-owned and controlled subsidiaries from theirrespective dates of acquisition. The interest of shareholders other thanthose of the Company is recorded as minority interest in the accompanyingconsolidated statements of operations and consolidated balance sheets. Whenlosses applicable to minority interest holders in a subsidiary exceed theminority interest in the equity capital of the subsidiary, these losses areincluded in the Company’s results, as the minority interest holder has noobligation to provide further financing to the subsidiary. The Company does nothave significant minority interest holders. All significant intercompanytransactions and balances have been eliminated in consolidation.

 

Theaccompanying interim consolidated financial statements are unaudited. In theCompany’s opinion, the unaudited consolidated financial statements have beenprepared on the same basis as the annual consolidated financial statements andreflect all adjustments, which include only normal recurring adjustments,necessary to present fairly the financial position and the results of theoperations and cash flows of the Company for the interim periods presented. Thefinancial statements, financial data and other information disclosed in thesenotes to the consolidated results are not necessarily indicative of the resultsexpected for the full fiscal year or any future period.

 

6

----

 

Theaccompanying consolidated financial statements should be read in conjunctionwith the audited consolidated financial statements for the year ended December31, 2004. Certain information and footnote disclosures normally included infinancial statements prepared in accordance with accounting principlesgenerally accepted in the United States of America have been condensed oromitted pursuant to the Securities and Exchange Commission’s rules andregulations.

 

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

######  

The preparation of consolidated financial statementsin accordance with accounting principles generally accepted in the UnitedStates of America requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities and the disclosure ofcontingent assets and liabilities at the date of the consolidated financialstatements and the reported amounts of revenues and expenses during thereporting period. Actual results could differ from those estimates. On anongoing basis, the Company evaluates its estimates, including those related torevenue recognition, accruals, allowance for doubtful accounts, fair value ofacquired intangible assets and goodwill, useful lives of intangible assets andproperty and equipment, among others. The Company bases its estimates onhistorical experience and on various other assumptions that are believed to bereasonable, the results of which form the basis for making judgments about thecarrying values of assets and liabilities.

 

###### (c) Cash and CashEquivalents

######  

The Company considers all highly liquid securities, with originalmaturities of three months or less, to be cash equivalents. Cash and cashequivalents consist principally of money market accounts.

 

The Company maintains letters of credit, secured by cash, related toits office leases. Letters of credit with maturities of one year or less areclassified as other current assets and letters of credit with maturitiesgreater than one year are classified as other assets on the consolidatedbalance sheets.

 

(d) Investments

 

Investments consist of securities with stated maturities of threemonths or more and marketable securities consisting of registered corporateequity securities. The Company classifies the marketable securities asavailable-for-sale in accordance with Statement of Financial AccountingStandards (“SFAS”) No. 115, *Accounting for CertainInvestments in Debt and Equity Securities*. Available-for-salesecurities are carried at fair value, with the unrealized gains or losses, netof tax, reported as a separate component of stockholders’ equity. Realizedgains and losses and the cost of available-for-sale securities sold arecomputed on the basis of the specific identification method. Realized gains andlosses and declines in value judged to be other-than-temporary, are included inimpairment of investments.

 

Investmentsin non-marketable equity securities of companies in which the Company owns lessthan 20% of a company’s stock and does not have the ability to exercisesignificant influence are accounted for on the cost basis. On an ongoing basis,the Company assesses the need to record impairment losses on investments andrecords such losses when the impairment is determined to beother-than-temporary.

 

7

----

 

(e) Accounts Receivable

 

Accounts receivable are recorded at the invoiced amount net ofallowance for doubtful accounts and sales allowance. The Company does notrequire collateral. The Company maintains an allowance for doubtful accounts toreserve for potentially uncollectible receivables and a sales allowance toreserve for potential credits issued to customers. The allowances are estimatescalculated based on an analysis of current business and economic risks,customer credit-worthiness, specific identifiable risks such as bankruptcies,terminations or discontinued customers, or other factors that may indicate apotential loss.

 

As a normal part of the business, the Company has receivables that areinvoiced in the month following the completion of the earnings process. Allunbilled receivables are billed within 30 days after each month-end.

 

(f) Concentration of Credit Risk

 

Financial instruments that potentially subject the Company toconcentrations of credit risk consist principally of cash equivalents, accountsreceivable and debentures. The fair value of cash equivalents and accountsreceivable instruments approximate their financial statement amount because ofthe short-term maturity of these instruments. The fair value of the debenturesapproximates their financial statement carrying value based on interest ratesfor similar borrowing.

 

At times, cash may exceed the federally insured limits. In addition,the majority of the Company’s cash is managed by one financial institution.

 

(g) Significant Customers and Suppliers

 

No single customer accounted for greater than 10% ofnet revenues for the three month periods ended March 31, 2005 and 2004.

 

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

 

On a geographic basis, the Company may also experience significantconcentration among our customers or partners. The Company examines thisconcentration on a country-by-country basis.

 

(h) Property and Equipment; Capitalized Software

 

Property and equipment are recorded at cost and are depreciated usingthe straight-line method over the shorter of the estimated useful lives of therelated assets, generally three to five years, or the lease term.

 

In accordance with Statement of Position (“SOP”) No. 98-1, *Accounting for the Costs of Computer SoftwareDeveloped or Obtained for Internal Use*, software development costs 

 

8

----

 

incurred during the applicationdevelopment stage are capitalized. Costs incurred during the preliminaryproject and post implementation stages of an internal use software project areexpensed as incurred. The capitalized cost of internal use software is chargedover the estimated useful life of two to three years.

 

As required by SFAS No. 86, *Accountingfor the Costs of Computer Software To Be Sold, Leased, or Otherwise Marketed*,the Company requires certain product development costs to be capitalized when aproduct’s technological feasibility has been established by completion of aworking model of the product and ending when a product is available for generalrelease to customers. Capitalized software is depreciated using the greater ofthe amount computed using (a) the ratio that current gross revenues for aproduct bears to the total of current and anticipated future gross revenue forthat product or (b) the straight-line method over the remaining estimatedeconomic life of the software, generally four years.

 

(i)Business Combinations

 

TheCompany’s acquisitions are accounted for as purchase business combinations inaccordance with SFAS No. 141, *BusinessCombinations*, and SFAS No. 142, *Goodwilland Other Intangible Assets*. The Company allocates thepurchase price to tangible and intangible assets and records as goodwill theexcess of the purchase price over the fair value of the identifiable net assetsacquired.  Intangible assets includetrademarks, customer relationships, acquired technology and covenants not tocompete. Such intangible assets are amortized on a straight-line basis overtheir estimated useful lives, which are generally four to seven years.

 

(j)Impairment of Long-Lived Assets

 

Long-lived assets, including property and equipment, goodwill and otherintangible assets are reviewed for impairment whenever events or changes incircumstances indicate that the carrying amount may not be fully recoverable.Conditions that would necessitate an impairment assessment include asignificant decline in the observable market value of an asset, a significantchange in the extent or manner in which an asset is used, or a significantadverse change that would indicate that the carrying amount of an asset orgroup of assets is not recoverable. The Company assesses impairment inaccordance with the requirements of SFAS No. 144, *Accounting for the Impairment or Disposal of Long-Lived Assets*.The Company assesses the impairment of goodwill and intangible assets inaccordance with the provisions of SFAS No. 142, *Goodwill and Other Intangible Assets*. The Company determinesthe recoverability of the assets by comparing the carrying amount of the assetsto net future cash flows that the asset is expected to generate. The impairmentrecognized is the amount by which the carrying amount exceeds the fair marketvalue of the asset.

 

(k)Revenue Recognition; Cost of Revenues; Deferred Revenue

 

*Media*

 

Media revenues are generated by delivering advertisingimpressions for a fixed fee to third-party Web sites. Agreements are primarilyshort-term and revenues are recognized as services are delivered provided thatno significant Company obligations remain outstanding and collection of theresulting receivable is probable. The Company becomes obligated to makepayments to third-party Web sites which have contracted with the Company, inthe period the advertising impressions are delivered. Such expenses areclassified as cost of revenues in the accompanying consolidated statements ofoperations.

 

9

----

 

*Search*

 

Search revenues are derived from attracting clicks on client advertisersWeb listings in search results. 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. The Company becomes obligated to make payments tosearch engine distribution partners, which have contracted with the Company, inthe period the clicks occur. Such expenses are classified as cost of revenuesin the accompanying consolidated statements of operations.

 

In specific circumstances, when the Company provides search marketingservices as an agent for a fixed commission, or otherwise in transactionsin which it does not have principal risk and reward, the Company recognizesrevenue on a net basis.

 

*Technology*

 

Technology revenues are derived primarily from licensing of oursoftware, hosted advertisement serving, and software maintenance and technicalsupport services. Revenue from software licensing agreements is recognized inaccordance with SOP No. 97-2, *SoftwareRevenue Recognition*, and Staff Accounting Bulletin (“SAB”) No. 104, *Revenue Recognition*, upon delivery of thesoftware, which is generally when the software is made available for download,there is persuasive evidence of an arrangement, collection is reasonablyassured, the fee is fixed or determinable, and vendor-specific objectiveevidence exists to allocate the total fees to all elements of the arrangement.Contracts that bundle the software license with maintenance and technicalsupport are recognized ratably over the contract term. Revenue fromadvertisement serving is recognized upon delivery. Revenue from softwaremaintenance and technical support contracts is recognized ratably over the termof the agreement, which typically does not exceed one year.

 

Expenses from Technology revenues are primarily payroll costs incurredto deliver and support the software, hosting, bandwidth and license fees paidto third-party software vendors. These expenses are classified as cost ofrevenues in the accompanying consolidated statements of operations.

 

*Deferred Revenue*

 

Revenues that are billed or collected in advance of services beingcompleted are deferred until the conclusion of the period of the service forwhich the advance billing or collection relates. Deferred revenues are includedon the consolidated balance sheets as a current liability until the service isperformed and then recognized in the period in which the service is completed.The Company’s deferred revenues primarily consist of billings in advance forsoftware license subscriptions and software maintenance and technical supportservices.

 

(l)Stock-Based Compensation

 

The Company accounts for stock-based employee compensation arrangementsin accordance with provisions of Accounting Principles Board (“APB”) OpinionNo. 25, “*Accounting for Stock Issued to Employees*,”and Financial Accounting Standards Board (“FASB”) interpretation No. 44, “*Accounting for Certain Transactions Involving Stock Compensation—aninterpretation of APB Opinion No. 25*,” and complies with thedisclosure provisions of SFAS No. 123, 

 

10

----

 

“*Accounting for Stock-Based Compensation*”and SFAS No. 148, “*Accounting for Stock-BasedCompensation—Transition and Disclosure*.” 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 moreprominent and more frequent disclosures in both interim and annual financialstatements about the method of accounting for stock-based compensation and theeffect of the method used on reported results. We adopted the disclosureprovisions of SFAS No. 148 as of December 31, 2002 and continue toapply the measurement provisions of APB No. 25.

 

Had the Company determined compensation cost based on the fair value atthe grant date for its stock options under SFAS No. 123, the Company’s net losswould have been adjusted to the pro forma amounts indicated below:

 
| ** **                                                                                                                           | ** ** | **For The Three Months Ended March 31,**     | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                                                           | ** ** | **2005**                                     | ** ** | **2004** | ** ** |
| ** **                                                                                                                           | ** ** | **(in thousands, except per share amounts)** | ** ** |
| Net loss:                                                                                                                            |       |                                         |       |   |   |
| As reported                                                                                                                          |       | $                                            | (406       | ) | $ | (392 | ) |
| Deduct: Total stock-based employee  compensation expense determined under fair-value-based method for all awards,  net of tax effect |       | 1,488                                        |       | 1,768 |   |
| Pro forma                                                                                                                            |       | $                                            | (1,894     | ) | $ | (2,160 | ) |
| Net loss per share:                                                                                                                  |       |                                         |       |   |   |
| As reported                                                                                                                          |       | $                                            | (0.01      | ) | $ | (0.02 | ) |
| Pro forma                                                                                                                            |       | (0.04                                        | )          | (0.09 | ) |

 

Theper share weighted-average fair value of stock options granted during the threemonth periods ended March 31, 2005 and 2004 is $2.50 and $4.63, respectively,on the date of grant using the Black-Scholes method with the following weightedaverage assumptions:

 
| ** **               | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|
|                     |       |     |       |     |       |
| Expected dividend yield  |       | 0        | %          | 0        | %          |
| Risk-free interest rate  |       | 3.05     | %          | 2.23     | %          |
| Expected life (in years) |       | 2.5      |       | 2.5      |       |
| Volatility               |       | 103      | %          | 131      | %          |

 

TheCompany accounts for non-employee stock-based awards in which goods or servicesare the consideration received for the equity instruments issued based on thefair value of the equity instruments issued in accordance with the guidanceprovided in the consensus opinion of the Emerging Issues Task Force (“EITF”) inconnection with EITF Issue 96-18 (“EITF 96-18”), *AccountingFor Equity Instruments That Are Issued To Other Than Employees For Acquiring,or in Conjunction With Selling Goods or Services*.

 

InDecember 2004, the FASB issued the revised SFAS No. 123, *Share-Based Payment* (“SFAS 123R”), whichaddresses the accounting for share-based payment transactions in which theCompany obtains employee services in exchange for (a) equity instrumentsof the Company or (b) liabilities that are based on the fair value of theCompany’s equity instruments or that may be settled by the issuance of suchequity instruments. Under SFAS 123R, the Company is now required to reportexpensing of stock options and other equity awards issued to employees anddirectors as of the first interim or annual reporting period beginning after June 15,2005. However, the Securities and Exchange Commission (“SEC”) amended thecompliance dates to the next fiscal year after June 15, 2005 (January 1,2006 for the Company) rather than the next reporting period.

 

SFAS123R applies to all awards granted or modified after the effective date. Inaddition, compensation cost for the unvested portion of previously grantedawards that remain outstanding on the effective date shall be recognized on orafter the effective date, as the related services are rendered, based on theawards’ grant-date fair value as previously calculated for the pro-formadisclosure under SFAS 123.

 

TheCompany expects that upon the adoption of SFAS 123R it will apply the modifiedprospective application transition method, as permitted by the statement. Undersuch transition method, upon the adoption of SFAS 123R, the Company’s financialstatements for periods prior to the effective date of the statement will not berestated.

 

(m)Restructuring Estimates

 

Restructuringactivities are accounted for in accordance with SFAS No. 146, *Accounting For Costs Associated with Exit or Disposal Activities*.Restructuring-related liabilities include 

 

11

----

 

estimates for, among other things, involuntary terminations ofemployees and disposition of lease obligations. Key variables in determiningsuch estimates include timing of sublease rentals, estimates of sublease rentalpayment amounts and tenant improvement costs, and estimates for brokerage andother related costs. The Company periodically evaluates and, if necessary,adjusts the estimates based on currently available information.

 

(n)Warrant Liability

 

Warrantliability is presented in accordance with EITF 00-19, *Accounting for Derivative Financial InstrumentsIndexed To, And Potentially Settled In, a Company’s Own Stock*. EITF00-19 requires freestanding contracts that are settled in a Company’s ownstock, including common stock warrants, to be designated as an equityinstrument, asset or liability. Under the provisions of EITF 00-19, a contractdesignated as an asset or a liability must be carried at fair value untilexercised or expired, with any changes in fair value recorded in the results ofoperations. A contract designated as an equity instrument must be includedwithin equity, and no fair value adjustments are required. The classificationof a contract should be reviewed at each balance sheet date.

 

(o) Basic and Diluted Net Loss Per Share

 

Netloss per share is presented in accordance with the provisions of SFASNo. 128, *Earnings Per Share*(“EPS”). Basic EPS excludes dilution for potentially dilutive securities and iscomputed by dividing income or loss available to common shareholders by theweighted average number of common shares outstanding for the period. DilutedEPS reflects the potential dilution that could occur if securities or othercontracts to issue common stock were exercised or converted into common stockand resulted in the issuance of common stock. Potential common shares consistof incremental common shares issuable upon the exercise of stock options andwarrants and the vesting of restricted stock (using the treasury stock method)and the conversion of subordinated convertible debentures and preferred stock(using the if-converted method).

 

Dilutednet loss 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 the three month periods endedMarch 31, 2005 and 2004 does not include the effects of options topurchase 8.3 million and 4.9 million shares of common stock, respectively;approximately 7,000 shares and 65,000 shares of unvested restricted stock,respectively; 0.6 million and 6.8 million shares of preferred stock,respectively; 0.6 million common stock warrants in 2005 and 2004; and1.7 million shares of common stock in 2005 and 2004 related to thesubordinated convertible debentures, on an “as if” converted basis, as theeffect of their inclusion is anti-dilutive during each period.

 

**NOTE 3 - ACQUISITIONS AND UNAUDITED PRO FORMA SUMMARY**

 

(a)          Acquisition of Decide Holdings Pty Limited (“Decide”)

 

On August 19, 2004, theCompany completed its acquisition of Decide, a leading provider of searchengine marketing in Australia and Europe. The acquisition combined our globalaudience and Decide’s search technology to allow the Company to create a morerelevant, comprehensive and higher quality search offering. Pursuant to theacquisition agreements, the Company acquired all of the outstanding shares ofDecide for $15.0 million in cash, approximately 4.5 million shares of itscommon stock, valued at $12.6 million, and approximately $1.1 million intransaction fees. 

 

12

----

 

Additionally, the Company isrequired to pay up to an additional $2.5 million in cash and issue $7.5 millionin shares of common stock (up to a maximum of 2.3 million shares) to theselling shareholders of Decide if Decide achieves certain performance targets.

 

Thepurchase price in excess of fair value of net tangible liabilities assumed of$28.8 million has been allocated as follows: $20.0 million to goodwill and $8.8million to intangible assets.

 

Ofthe $8.8 million of intangible assets, $1.1 million was assigned to trademarksthat are not subject to amortization. The remaining $7.7 million of intangibleassets have a weighted-average useful life of approximately five years. Theintangible assets that make up that amount include acquired technology of $6.6million (five year weighted-average useful life), customer relationships of$1.0 million (five year weighted-average useful life) and non-competeagreements of $0.1 million (two year weighted-average useful life).

 

The$20.0 million of goodwill was assigned to the Search segment and of thatamount, none is deductible for tax purposes.

 

Thenet tangible liabilities assumed consist of the following:

 
| **Asset / Liability**     | ** ** | **Amount** | ** ** |
|---------------------------|------------|------------|------------|
|                      |       |       |       |
| Cash and cash equivalents |       | $          | 305        |   |
| Other current assets      |       | 1,692      |       |
| Fixed assets              |       | 616        |       |
| Other assets              |       | 180        |       |
| Accrued liabilities       |       | (2,838     | )          |
| Long-term liabilities     |       | (21        | )          |
|                      |       | $          | (66        | ) |

 

(b)         Acquisition of Real Media Korea (“RMK”)

 

On January 6, 2004, the Company completed its acquisition of RMK,a leader in interactive marketing in the Republic of South Korea, by acquiringthe approximately 90.4% of the outstanding shares of RMK that the Company didnot already own. The Company believes that the combined assets will further itsposition as a global leader in interactive marketing. The Company paid totalconsideration of $20.1 million in exchange for the RMK shares, whichconsisted of $5.0 million in cash, approximately 2.1 million sharesof the Company’s common stock valued at $14.6 million and approximately$0.5 million in transaction costs. Approximately 0.9% of the outstandingshares of RMK are held in an employee stock union established under Korean law.The employee shareholders agreed to transfer their RMK shares to the Companyupon vesting in accordance with the terms and conditions of the stock union andKorean law. For accounting purposes, the effective date of the acquisition isJanuary 1, 2004. There was no material activity between the effective dateand the acquisition date. In 2005, the Company changed the name of RMK to 24/7Real Media, Inc.

 

The purchase price in excess of fair value of net tangible assetsacquired of $16.1 million has been allocated as follows: $11.9 million togoodwill and $4.2 million to intangible assets.

 

Ofthe $4.2 million of intangible assets, $0.7 million was assigned to trademarksthat are not subject to amortization. The remaining $3.5 million of intangibleassets have a weighted-average 

 

13

----

 

usefullife of approximately six years. The intangible assets that make up that amountinclude acquired technology of $0.5 million (six year weighted-average usefullife), customer relationships of $2.4 million (seven year weighted-averageuseful life) and a non-compete agreement of $0.6 million (five yearweighted-average useful life).

 

The$11.9 million of goodwill was assigned to the Media and Technology segments inthe amounts of $11.2 million and $0.7 million, respectively. Of that totalamount, none is deductible for tax purposes.

 

The net tangible assets acquired consist of the following:

 
| **Asset/ Liability**      | ** ** | **Amount** | ** ** |
|---------------------------|------------|------------|------------|
|                      |       |       |       |
| Cash and cash equivalents |       | $          | 3,469      |   |
| Other current assets      |       | 5,151      |       |
| Fixed assets              |       | 170        |       |
| Non-current assets        |       | 384        |       |
| Accrued liabilities       |       | (5,159     | )          |
|                      |       | $          | 4,015      |   |

 

(c) Unaudited Pro Forma Summary

 

The results of operations of Decide and RMK have beenincluded in the Company’s consolidated statements of operations since thecompletion of the acquisitions. The following unaudited pro forma informationpresents a summary of the results of operations of the Company assuming theacquisitions of Decide and RMK at the beginning of each period presented:

 
|                                                                       |   | **For Three Months Ended March 31,**     |   |
|----------------------------------------------------------------------------|--------|------------------------------------------|--------|
|                                                                       |   | **2004**                                 |   |
|                                                                       |   | **(in thousands except per share data)** |   |
|                                                                       |   |                                     |   |
| Total revenue                                                              |   | $                                        | 21,103 |   |
| Net loss attributable to common stockholders                               |   | (491                                     | )      |
| Basic and diluted net loss attributable to  common stockholders per share  |   | $                                        | (0.02  | ) |
| Weighted average common shares used in net  loss per share calculation (1) |   | 30,222,518                               |   |

 

----

(1) Theweighted average shares used to compute pro forma basic and diluted net lossper share for the three month periods ended March 31, 2004 includes the 4.5million and 2.1 million shares of common stock issued for Decide and RMK,respectively, as if the shares were issued at the beginning of each periodpresented.

 

The pro forma summary is not necessary indicative ofthe operating results that would have been achieved had the transactions beenin effect as of the beginning of the periods presented and should not beconstrued as being representative of future results.

 

14

----

 

**NOTE 4 – BALANCE SHEET COMPONENTS**

 

(a) Short-termInvestments

 

Short-term investments as of March 31, 2005 and December 31, 2004consisted of $1.4 million and $2.0 million in certificate of deposits withoriginal maturities greater than three months from the balance sheet date,respectively, and $1.2 million and $1.8 million in available-for-salesecurities, respectively. Total realized loss, based on an other-than-temporarydecline in the market value of the securities, was $0.6 million for the threemonth period ended March 31, 2005.

 

(b)Property and Equipment

 

Asof March 31, 2005 and December 31, 2004, property and equipment includedcapitalized software of $0.3 million and $0.4 million, respectively.Approximately $0.1 million was amortized during the three month period endedMarch 31, 2005.

 

(c)Goodwill

 

The$34.6 million in goodwill as of March 31, 2005 and December 31, 2004related $20.0 million to Decide, $12.0 million to RMK,$1.1 million to 24/7 Canada (formerly ClickThrough), $1.1 million toReal Media and $0.4 million to 24/7 Search (formerly Website Results).

 

(d)Intangible Assets, Net

 

The$11.9 million in intangible assets, net as of March 31, 2005 related $7.8million to Decide, $3.5 million to RMK and $0.6 million to Real Media. The $12.7 million in intangible assets,net as of December 31, 2004 related $8.2 million to Decide,$3.7 million to RMK and $0.8 million to Real Media.

 

**NOTE 5 – RESTRUCTURING**

 

Duringthe first quarter of 2005, the Company recorded a restructuring charge of $1.0 million relatingto its former New York headquarters.

 

The following sets forth theactivities in the Company’s restructuring reserve for the three month periodended March 31, 2005, which is included in accrued liabilities in theconsolidated balance sheet (in thousands):

 
| ** **                     | ** ** | **Beginning  Balance** | ** ** | **Current Year  Provision** | ** ** | **Current Year  Utilization** | ** ** | **Ending Balance** | ** ** |
|--------------------------------|------------|------------------------|------------|-----------------------------|------------|-------------------------------|------------|--------------------|------------|
| Employee  termination benefits |       | $                      | 369        |                        | $          | —                        |       | $                  | 238        |   | $ | 131 |   |
| Office closing costs           |       | 529                    |       | 973                         |       | (57                           | )          | 1,559              |       |
|                           |       | $                      | 898        |                        | $          | 973                           |       | $                  | 181        |   | $ | 1,690 |   |

 

15

----

 

**NOTE 6 - 2%SUBORDINATED CONVERTIBLE DEBENTURES**

 

On September 26, 2003, the Company completed theplacement to an institutional accredited investor of $15.0 million ofsubordinated convertible debentures due September 2006 (“Debentures”). TheDebentures are convertible into shares of the Company’s common stock at $8.75per share. Interest on the Debentures at the rate of 2% is due semi-annuallystarting in January 2004. The investor also acquired a five-year warrant(the “Warrants”) to purchase 0.4 million shares of the Company’s common stockat $9.5685 per share.

 

The maturity date of the Debentures is subject toextension, and the conversion price is subject to adjustment, on the terms andconditions set forth in the Debentures. In addition, the Company may elect topay the principal of and interest on the Debentures in shares of its commonstock rather than cash. If the Company elects to pay the principal amount dueunder the Debentures at maturity in shares of its common stock, rather than incash, the maturity date conversion price will be equal to 90% of the average ofthe daily volume-weighted average prices of the Company’s common stock on theNasdaq SmallCap Market for the fifteen consecutive trading days immediatelypreceding the maturity date. If the Company elects to make interest paymentsdue under the Debentures in shares of its common stock, rather than in cash,the interest conversion price will be equal to 90% of the average of the dailyvolume-weighted average prices of the Company’s common stock on the NasdaqSmallCap Market for the five consecutive trading days immediately preceding theinterest payment date. Interest expense on the debentures amounted toapproximately $0.1 million for each of the three month periods ended March 31,2005 and 2004.

 

Additionally, if the specific conditions set forth inthe Debentures are satisfied, the Company may require the holder to convert theDebentures into shares of the Company’s common stock, at the conversion ratethen in effect, or the Company may prepay the Debentures prior to the maturitydate, for an amount in cash equal to 150% of the amount prepaid. In addition,if at any time on or after the second anniversary of the initial issuance date,the weighted average price of the common stock is less than $8.75 on any fiveconsecutive trading days after such second anniversary, the holder shall havethe right, in its sole discretion, to require that the Company redeem up to$7.5 million principal amount of these Debentures in cash, which are being classifiedas short-term debt on the consolidated balance sheet.  The redemption right constitutes an embeddedderivative. The value of this embedded derivative at March 31, 2005 isimmaterial to the financial position of the Company. The Company reviews the valueof the derivative on a quarterly basis, in accordance with SFAS No. 149, *Amendment of Statement 133 on DerivativeInstruments and Hedging Activities*.

 

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

 

16

----

 

In connection with the issuance of the Debentures andWarrants, the Company incurred placement agent fees, legal fees and otherexpenses of approximately $1.2 million to be paid in cash. In addition tothe placement fees, the Company issued warrants to the placement agent. Thewarrants to purchase 86,000 shares of common stock at an exercise price of$10.068 are in the same form and on the same terms and conditions as theWarrants issued to the investor. The Company included the value of thewarrants, $0.4 million, using the factors above, and the cash placementfees of $1.2 million in other assets on the consolidated balance sheet.Collectively, the debt issuance costs of $1.6 million are being amortized overthree years, the initial term of the Debentures. For each of the three monthperiods ended March 31, 2005 and 2004, approximately $0.1 million of thedeferred financing costs are included in amortization expense.

 

**NOTE 7 -****EQUITY INSTRUMENTS**

 

(a) Preferred Stock

 

 The Company’s preferred stock accrue andcumulate dividends at a rate of 6% per year, compounded monthly, payable when,as and if declared by the Company’s Board of Directors. Accordingly, theaccrued dividends are reflected as “Preferred stock dividends” on theconsolidated statements of operations. Accrued dividends must be paid beforeany dividends may be declared or paid on the common stock, and shall be paid asan increase in the liquidation preference of the preferred stock payable upon asale, merger, liquidation, dissolution or winding up of the Company. Accruedbut unpaid dividends are cancelled upon conversion of the preferred stock. Asof March 31, 2005, there are approximately $0.1 million of accruedbut unpaid dividends.

 

(b) Common Stock

 

*Additional Paid-in Capital*

 

*During thethree month period ended March 31, 2005, the Company’s additional paid-incapital increased by $0.7 million primarily due to $0.6 million in otherstock-based compensation to be issued to employees and $0.1 million fromexercise of stock options.*

* *

**NOTE 8 - STOCK INCENTIVE PLANS**

 

*In January 2005,the Company entered into agreements to grant 1.7 million shares of restrictedstock to certain employees. Approximately 1.0 million will be granted andvested annually over a three year vesting period contingent upon employmentwith the company on the date of vesting. Approximately 0.7 million will begranted and vest contingent upon the attainment of a performance milestone ofthe Company’s stock, which is outside the control of the Company. Inaccordance with APB 25, no expense related to the restricted stock is recordeduntil the resolution of the contingency. If the Company’s stockprice reaches the milestone, the Company would incur approximately $6.7 millionin stock-based compensation related to the restricted shares.*

 

17

----

 

For the three month period ended March 31, 2005, the Company granted3.9 million stock options under the 2002 Stock Incentive Plan to employees atexercise prices based on the fair market value of the Company’s common stock atthe respective dates of grant.

 

On January 1, 2005, in accordance with the terms of the 2002 StockIncentive Plan, shares reserved for issuance under the Plan were increased by0.6 million.

 

**NOTE 9 –RECOVERY OF INVESTMENTS**

 

In January 2005, the Company received $2.1 million as a return ofinvestment in Bidland. The return of investment was a result of the settlementof pending litigation between Bidland and Telefonica S.A. and the subsequentliquidation of Bidland. A portion of the settlement proceeds have been retainedby Bidland until all tax issues are resolved at which time any remaining proceedswill be distributed. The Company does not expect future distributions, if any,to be material. In 2000, Bidland ceased operations and, accordingly, theCompany recorded an impairment charge related to the cost-based investment.

 

**NOTE 10 -****SUPPLEMENTAL CASH FLOWINFORMATION**

 

TheCompany capitalized approximately $0.5 million of property and equipmentreceived but unpaid for as of March 31, 2005.

 

For the three month periodsended March 31, 2005 and 2004, the amount of cash paid for interest was$0.2 million and $0.1 million, respectively.

 

**NOTE 11 – SEGMENTS**

 

TheCompany’s business is comprised of three reportable segments: Media, Search andTechnology. As the result of the Company’s acquisition of Decide in August 2004,the Company is reporting Search as a separate segment from Media. The Companymeasures segments based on segment income (loss) from operations. The Companyadjusted prior period segment disclosures to conform to the currentpresentation. The summarized segment information at and for the threemonths ended March 31, 2005 and 2004, is as follows (in thousands):

 
| ** **                                                     | ** ** | **Media**          | ** ** | **Search** | ** ** | **Technology** | ** ** | **Total** | ** ** |
|----------------------------------------------------------------|------------|--------------------|------------|------------|------------|----------------|------------|-----------|------------|
| ** **                                                     | ** ** | **(in thousands)** | ** ** |
| **Three Month Period Ended March 31, 2005**               |       |               |       |       |       |           |       |      |       |
| Revenues                                                       |       | $                  | 14,229     |       | $          | 9,622          |       | $         | 5,219      |   | $ | 29,070 |   |
| Depreciation                                                   |       | 125                |       | 174        |       | 299            |       | 598       |       |
| Amortization of intangible assets and deferred financing costs |       | 495                |       | 395        |       | 250            |       | 1,140     |       |
| Stock-based compensation                                       |       | 129                |       | 178        |       | 206            |       | 513       |       |
| Restructuring                                                  |       | 252                |       | 228        |       | 493            |       | 973       |       |
| Segment income (loss) from operations                          |       | (274               | )          | (1,209     | )          | (440           | )          | (1,923    | )          |
|                                                           |       |               |       |       |       |           |       |      |       |
| **Three Month Period Ended March 31, 2004**               |       |               |       |       |       |           |       |      |       |
| Revenues                                                       |       | $                  | 10,023     |       | $          | 3,016          |       | $         | 4,342      |   | $ | 17,381 |   |
| Depreciation                                                   |       | 201                |       | 54         |       | 233            |       | 488       |       |
| Amortization of intangible assets and deferred financing costs |       | 243                |       | 216        |       | 329            |       | 788       |       |
| Stock-based compensation                                       |       | 191                |       | 8          |       | —         |       | 199       |       |
| Segment loss from operations                                   |       | (401               | )          | (755       | )          | (62            | )          | (1,218    | )          |
|                                                           |       |               |       |       |       |           |       |      |       |
| **Total assets:**                                              |       |               |       |       |       |           |       |      |       |
| March 31, 2005                                            |       | $                  | 71,296     |       | $          | 41,223         |       | $         | 10,505     |   | $ | 123,024 |   |
| December 31,  2004                                        |       | 72,910             |       | 36,849     |       | 11,639         |       | 121,398   |       |

 
| ** **                                               | ** ** | **United   States** | ** ** | **United   Kingdom** | ** ** | **South   Korea** | ** ** | **Other -  International** | ** ** | **Total** | ** ** |
|----------------------------------------------------------|------------|---------------------|------------|----------------------|------------|-------------------|------------|----------------------------|------------|-----------|------------|
| ** **                                               | ** ** | **(in thousands)**  | ** ** |
|                                                     |       |                |       |                 |       |              |       |                       |       |      |       |
| Revenues for the three months ended  March 31, 2005 |       | $                   | 13,868     |                 | $          | 6,131             |       | $                          | 2,359      |      | $          | 6,712 |   | $ | 29,070 |   |
| Long-lived assets as of March 31, 2005              |       | 12,601              |       | 328                  |       | 16,325            |       | 30,088                     |       | 59,342    |       |
|                                                     |       |                |       |                 |       |              |       |                       |       |      |       |
| Revenues for the three months ended  March 31, 2004 |       | $                   | 8,423      |                 | $          | 3,280             |       | $                          | 3,152      |      | $          | 2,526 |   | $ | 17,381 |   |
| Long-lived assets as of December 31,  2004          |       | 11,603              |       | 351                  |       | 16,512            |       | 30,432                     |       | 58,898    |       |
|                                                     |       |                |       |                 |       |              |       |                       |       |      |       |

 

18

----

 

**NOTE 12 - COMMITMENTS AND CONTINGENCIES**

 

(a) Commitments

 

*Lycos, Inc. Services Agreements*

 

On February 11, 2004, the Company entered into a five-yeararrangement with Lycos, Inc. (“Lycos”), including an advertising servicesagreement to provide media sales, a technology services agreement to provideadvertisement serving and analytics technology services to Lycos’ U.S. Webproperties, and a transition services agreement to transition personnel andother services to the Company. The Company and Lycos amended the advertisingservices agreement and the technology services agreement on December 7,2004 and, as amended, Lycos effectively may terminate the media servicesagreement on January 1, 2007.

 

The amended media services agreement provides that Lycos will have theexclusive right to sell advertising, and for the billing and collection of alladvertising, on Wired.com and Quote.com, on July 1, 2005 and January 1,2006, respectively.  On or prior to the respectivetransition dates, the Company will identify twenty advertising accounts (“24/7Accounts”) to which it has sold advertising on Wired.Com and Quote.com.

 

Theagreement provides that Lycos will pay the Company transition commissions basedon advertising sales revenue minus bad debt (“net advertising sales revenue”)as follows:

 

•                  35% of net advertising sales revenuegenerated from the 24/7 Accounts on Wired.com for each of July and August 2005,payable on or prior to October 15, 2005, provided that the transitioncommission is capped at 35% of the average monthly gross revenues generatedfrom the 24/7 Accounts during the period from January 1, 2005 to June 30,2005;

 

•                  17.5% of net advertising sales revenue generatedfrom the 24/7 Accounts on Wired.com for each of September and October 2005,payable on or prior to December 15, 2005, provided that the transitioncommission is capped at 17.5% the average monthly gross revenues generated fromthe 24/7 Accounts during the period from January 1, 2005 to June 30,2005;

 

•                  35% of net advertising sales revenuegenerated from the 24/7 Accounts on Quote.com for each of January and February 2006,payable on or prior to April 15, 2006, provided that the transitioncommission is capped at 35% of the average monthly gross revenues generatedfrom the 24/7 Accounts during the period from July 1, 2005 to December 31,2005; and

 

•                  17.5% of net advertising sales revenuegenerated from the 24/7 Accounts on Quote.com for each of March and April 2006,payable on or prior to June 15, 2006, provided that the transitioncommission is capped at 17.5% of the average monthly gross revenues generatedfrom the 24/7 Accounts during the period from July 1, 2005 to December 31,2005.

 

Theamended media services agreement reconciled past royalty payments and requiresthe Company to pay quarterly royalties for advertising inventory made availableby Lycos as follows:

 

19

----

 

•                  Inception through December 31, 2004:$6.2 million, which was paid in installments of $5.7 million in 2004and $0.5 million in February 2005.

 

•                  January 1, 2005 through March 31,2005: 65% of net advertising sales revenue;

 

•                  April 1, 2005 through June 30,2005: 65% of the greater of (i) net advertising sales revenue generatedduring the period and (ii) the minimum cost-per-thousand (“CPM”) revenuefor such period;

 

•                  July 1, 2005 through December 31,2005: 62.5% of the greater of (i) net advertising sales revenue generatedduring the period and (ii) the minimum CPM revenue for such period;

 

•                  January 1, 2006 through the expirationor termination of the media services agreement: 62.5% of net advertising salesrevenue.

 

Pursuant to the media services agreement minimum CPMrevenue is determined on a quarterly basis by multiplying Lycos’ projectedadvertisement impression level for that quarter by specific CPM prices foradvertising inventory in specific category and unit types.

 

Inaddition to the royalties, the Company paid Lycos a $4.5 milliontransition fee which the Company recorded as an other asset and is amortizingthe fee over the term of the agreement of five years. Amortization related tothe transition fee was $0.2 million for each of the three month periods ended March 31,2005 and 2004. In accordance with SFAS 144, the Company periodicallyevaluates the recoverability of this asset.

 

*Acquisition Earn-Out Payments*

 

TheCompany has contingent obligations related to our acquisitions of Decide.Decide stockholders may receive up to an additional $10.0 million, in acombination of cash and common stock, subject to achievement of earn-outtargets relating to Decide’s operating performance in 2005.

 

*Indemnifications*

 

Whilethe Company has various indemnification obligations included in contracts inthe normal course of business, these indemnities do not represent significantcommitments or contingent liabilities of the indebtedness of others.Accordingly, the Company has not recorded a liability related toindemnification provisions.

 

(b) Litigation

 

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

 

20

----

 

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

 

This report includes forward-looking statements withinthe meaning of the Private Securities Litigation Reform Act of 1995. This Actprovides a “safe harbor” for forward-looking statements to encourage companiesto provide prospective information about themselves so long as they identifythese statements as forward looking and provide meaningful cautionarystatements identifying important factors that could cause actual results todiffer from the projected results. All statements other than statements ofhistorical fact, including statements regarding industry prospects and futureresults of operations or financial position, made in this Quarterly Report areforward looking. We use words such as “anticipates,” “believes,” “expects,” “future”and “intends” and similar expressions to identify forward-looking statements.Forward-looking statements reflect management’s current expectations, plans orprojections and are inherently uncertain. Our actual results may differsignificantly from management’s expectations, plans or projections. Readers arecautioned not to place undue reliance on these forward-looking statements,which speak only as of the date hereof. Certain risks and uncertainties thatcould cause our actual results to differ significantly from management’sexpectations are described in the section entitled “Factors that CouldAffect Future Results” and elsewhere in this Quarterly Report. We undertake noobligation to publicly release any revisions to these forward-lookingstatements that may be made to reflect events or circumstances after the datehereof or to reflect the occurrence of unanticipated events. Readers are urged,however, to review the risk factors set forth in reports that we file from timeto time with the Securities and Exchange Commission. Unless the contextrequires otherwise in this Quarterly Report the terms “24/7 Real Media,” the “Company,”“we,” “us” and “our” refer to 24/7 Real Media, Inc. and its subsidiaries,and references to “24/7 Search” refer to 24/7 Search, Inc., formerly 24/7Website Results, Inc., and Decide Holdings Pty Limited, each a whollyowned subsidiary of 24/7 Real Media, Inc.

 

### **GENERAL**

 

24/7 Real Media is apioneer in the Internet industry, providing online advertising and searchmarketing strategies since 1995. We have three distinct lines ofbusiness, Media, Search and Technology, and operate in over a dozen countries.Our 24/7 Media business helps advertisers increase their reach throughsophisticated targeting and a network of more than 800 Web sites.  24/7 Search enables marketers to maximizetheir search engine marketing spend and achieve optimum return on investment.Finally, our 24/7 Technology business develops and licenses our powerfultechnology, which serves as the underlying engine for everything we do.

 

We operate inthree business segments: Media, Search and Technology.

 

*Media*

 

We selladvertising space for Web publishers through the 24/7 Web Alliance, a networkof Web sites with brand names, quality content and global reach. Web publishersjoin the 24/7 Web Alliance to increase advertising revenues from the availableadvertising space on their Web sites. We solicit advertisers seeking onlinestrategies to target audiences, build their brands and generate customerresponse. Advertisers purchase space through the 24/7 Web Alliance to make onepurchase across several Web sites and to increase the return on theiradvertising spending. We also use targeting technology to best selectadvertising space made available in the 24/7 Web Alliance and to improve theperformance of under-utilized advertising space for Web publishers.

 

21

----

 

We generate Mediarevenue from fees paid by client advertisers for advertising space. Wetypically sell advertising space on a cost-per-thousand-impressions (“CPM”)basis, enabling a client advertiser to pay a fee based on the number of timesits advertisement is viewed. We typically count an advertising impression eachtime a user’s Web browser requests our computer servers to transmit anadvertisement. We may charge higher CPMs to advertisers that purchase ouradvanced targeting solutions, such as our behavioral targeting solution, incomparison to those that purchase advertising space that requires less advancedtargeting.

 

We pay Webpublishers included in the 24/7 Web Alliance a royalty for their advertisingspace. The royalty generally does not exceed 65% of the gross advertisingrevenue we generate from a Web publisher’s advertising space, but may be moreif a Web publisher’s advertising space is viewed by a larger or better qualityaudience, among other factors.

 

On a very limitedbasis, we have generated revenue from e-mail advertisements and marketing.

 

*Search*

 

We provide searchmarketing services that connect advertisers with consumers using search enginesto find information, products and services. We leverage our relationships andunderstanding of search engine algorithms to help advertisers optimize theirWeb pages and achieve better placement in algorithmic search engines. Wealso create Web site listings for advertisers and submit their listings intothe databases of pay-for-placement (“P4P”) and paid-inclusion (“PI”) searchengine platforms. We help advertisers determine the keywords most relevant totheir products and services and use advanced technology to manage keywordbidding simultaneously across P4P search platforms. Our technology showsadvertisers which keywords lead users from search engines to their Web sitesand helps them optimize advertising spending to convert click-throughs intosales.

 

We generate Search revenue primarily from cost-per-click (“CPC”) feespaid by client advertisers when search engine users click-through to their Websites as a result of Web site listings submitted by us into search enginedatabases. To a lesser extent, we also generate revenue from fees paid by advertisersfor consulting services and search engine optimization services and from feespaid by search engines that employ us to optimize the relevancy of Web sitelistings and report on advertising campaigns for their advertisers. We developdirect relationships with P4P and algorithmic search engines in order toenhance the services we provide to our client advertisers. We refer to searchengines we work with as search engine distribution partners.

 

*Technology*

 

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

 

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

 

22

----

 

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

 

*Open Advertiser Service.* Wecharge service fees to advertisers and agencies for operating our OpenAdvertiser (“OAD”) advertisement serving software centrally from our servers.Our service is determined by multiplying the CPM by the number of advertisingimpressions delivered. Service fees typically are billed monthly.  The service fee may vary based on theforecasted number of advertising impressions a Web publisher will serve usingour software, the use of advanced software modules and the term, among otherfactors. In the fourth quarter of 2004, we made the strategic decision tointegrate OAD functionalities into OAS. As a result, we expect OAD servicerevenue to decline.

 

*Insight XE Software and Service.*  OurInsight XE solution offers Web publishers active campaign reporting andmarketing intelligence and helps advertisers measure, analyze and manage onlineaudiences. We charge service fees to Web publishers for operating our OASsoftware centrally our servers. Our service fee is determined by multiplying anagreed CPM by the number of page views measured by our Insight XEsoftware.

 

*Insight ACT Software.* Our Insight ACT software, whichrequires our OAS and Insight XE software solutions, enables Web publishers toidentify and target segments of their audiences based on user activity. Wegenerate revenue from Insight Act on the same basis as the associated OAS andInsight XE arrangements. As of March 31, 2005, we have not generatedsignificant revenue from Insight ACT.

 

Toa lesser extent, we generate revenue by providing professional services chargedat an hourly rate and from fees paid by Web publishers for trafficking theiradvertisements. Trafficking advertisements refers to entering advertisementcreative material and campaign specifications into our OAS software.

 

# **RESULTS OFOPERATIONS**

#  

### The following table comparesthe results of operations for the three month period ended March 31, 2005to the results of operations for the three month period ended March 31,2004 (in thousands):

 

23

----

 
| ** **                                                      | ** ** | **Three Months Ended March 31,** | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------|------------|---------------------------------------|------------|------------|------------|
| ** **                                                      | ** ** | **2005**                              | ** ** | **2004**   | ** ** | **$ Var** | ** ** |
|                                                            |       |                                  |       |       |       |   |   |
| Revenues:                                                       |       |                                  |       |       |       |   |   |
| Media                                                           |       | $                                     | 14,229     |       | $          | 10,023 |   | $ | 4,206 |   |
| Search                                                          |       | 9,622                                 |       | 3,016      |       | 6,606 |   |
| Technology                                                      |       | 5,219                                 |       | 4,342      |       | 877 |   |
| Total revenues                                                  |       | 29,070                                |       | 17,381     |       | 11,689 |   |
|                                                            |       |                                  |       |       |       |   |   |
| Cost of revenues:                                               |       |                                  |       |       |       |   |   |
| Media                                                           |       | 9,627                                 |       | 6,983      |       | 2,644 |   |
| Search                                                          |       | 6,632                                 |       | 2,458      |       | 4,174 |   |
| Technology                                                      |       | 992                                   |       | 822        |       | 170 |   |
| Total cost of revenues                                          |       | 17,251                                |       | 10,263     |       | 6,988 |   |
|                                                            |       |                                  |       |       |       |   |   |
| Gross profit                                                    |       | 11,819                                |       | 7,118      |       | 4,701 |   |
|                                                            |       |                                  |       |       |       |   |   |
| Operating expenses:                                             |       |                                  |       |       |       |   |   |
| Sales and marketing                                             |       | 5,290                                 |       | 3,316      |       | 1,974 |   |
| General and administrative                                      |       | 4,584                                 |       | 2,982      |       | 1,602 |   |
| Product development                                             |       | 1,242                                 |       | 1,051      |       | 191 |   |
| Amortization of intangible assets and  deferred financing costs |       | 1,140                                 |       | 788        |       | 352 |   |
| Stock-based compensation                                        |       | 513                                   |       | 199        |       | 314 |   |
| Restructuring costs                                             |       | 973                                   |       | —     |       | 973 |   |
|                                                            |       |                                  |       |       |       |   |   |
| Total operating expenses                                        |       | 13,742                                |       | 8,336      |       | 5,406 |   |
|                                                            |       |                                  |       |       |       |   |   |
| Loss from operations                                            |       | (1,923                                | )          | (1,218     | )          | (705 | ) |
|                                                            |       |                                  |       |       |       |   |   |
| Interest expense, net                                           |       | (88                                   | )          | (182       | )          | 94 |   |
| Change in fair value of warrant liability                       |       | 150                                   |       | 928        |       | (778 | ) |
| Recovery of investments                                         |       | 2,100                                 |       | —     |       | 2,100 |   |
| Impairment of investments                                       |       | (588                                  | )          | —     |       | (588 | ) |
| Other income (expense), net                                     |       | (46                                   | )          | 180        |       | (226 | ) |
|                                                            |       |                                  |       |       |       |   |   |
| Loss before provision for income taxes                          |       | (395                                  | )          | (292       | )          | (103 | ) |
|                                                            |       |                                  |       |       |       |   |   |
| Provision for income taxes                                      |       | (11                                   | )          | (100       | )          | 89 |   |
|                                                            |       |                                  |       |       |       |   |   |
| Net loss                                                        |       | $                                     | (406       | )          | $          | (392 | ) | $ | (14 | ) |
|                                                            |       |                                  |       |       |       |   |   |
| Dividends on preferred stock                                    |       | (12                                   | )          | (118       | )          | 106 |   |
|                                                            |       |                                  |       |       |       |   |   |
| Net loss attributable to common  stockholders                   |       | $                                     | (418       | )          | $          | (510 | ) | $ | 92 |   |

 

 

**Revenues; Cost of Revenues and Gross Profit**

** **

*Media*

 

*Revenue*. We generateMedia revenue primarily from our 24/7 Web Alliance. 24/7 Web Alliance revenuewas $14.0 million for the three month period ended March 31, 2005 ascompared to $9.7 million for the three month period ended March 31, 2004,an increase of 44.0%. The increase is primarily related to an increase inadvertising impressions sold. The number of advertising impressions deliveredthrough the 24/7 Web Alliance increased from approximately 9.6 billion in 2004to 16.9 billion in 2005.

 

24

----

 

*Cost Of Revenues*.****Mediacost of revenues consisted primarily of fees paid to Web publishers in our 24/7Web Alliance. Cost of revenues also included advertisement serving costs, whichis an intercompany charge from the Technology segment based on a fixed CPM.

 

*Gross Profit*.**Gross profit marginsfor Media were 32.3% in 2005 and 30.3% in 2004. The increase reflects a shiftin where advertising inventory is sold to larger Web sites, such as Lycos,which generally receives a higher royalty rate. Advertisement serving costswere $0.4 million for 2005 and $0.3 million for 2004, representing 4.5% and4.3% of total Media cost of revenues, respectively.

 

*Search*

 

*Revenue*. Search revenue was $9.6 million for the three month period ended March 31,2005 as compared to $3.0 million for the three month period ended March 31,2004, an increase of 219.0%. The increase primarily reflects the addition ofnew advertiser accounts from the acquisition of Decide in August 2004 andfrom an increased number of clicks delivered to our client advertisersas a result of growth in the businesses of our search engine distributionpartners. We also believe the foregoing factors, combined with our salesefforts and improved operational controls, have contributed to an increase inthe average revenue per account.

 

*Cost Of Revenues*. Search cost of revenues consisted primarilyof fees paid to our search engine distribution partners, which are calculatedas a percentage of revenues for algorithmic search engines and a fixed CPC forpay-for-placement search engines. Search cost of revenues also included hostingand bandwidth charges associated with the infrastructure.

 

*Gross Profit*. Grossprofit margins for Search were 31.1% in 2005 and 18.5% in 2004. The increasewas due to a change in product mix primarily as a result of the addition ofhigh margin optimization services for both advertisers and search enginedistribution partners acquired with Decide.  In addition, growth inP4P search engine services relative to the higher margin PI campaigns alsodecreased the overall gross margin percentage. The gross marginpercentage on PI campaigns remained consistent and the gross marginpercentage on P4P campaigns has been improved due to enhanced optimization.

 

*Technology*

 

*Revenue*.****Technology revenue was$5.2 million for the three month period ended March 31, 2005, as comparedto $4.3 million for the three month period ended March 31, 2004, anincrease of 20.2%. The increase primarily reflects expanded usage by customersof Open AdStream Central and usage by new customers. In particular, OpenAdStream Central delivered 41.7 billion paid impressions in the three monthperiod ended March 31, 2005, up from 17.9 billion in the three monthperiod ended March 31, 2004.

 

*Cost of Revenues*.Technology cost of revenues consisted of costs for hosting, bandwidth,third-party license and support fees, support and maintenance of theinfrastructure, including salaries and benefits of related technical personnel.The cost of revenues is offset by fees charged to our Media segment foradvertisement serving.

 

*Gross Profit*. Grossprofit margins for Technology remained consistent at approximately 81.0% in thethree month periods ended March 31, 2005 and 2004, respectively. TheCompany has been able to leverage the existing cost base over higher revenues.

 

25

----

 

**Sales and Marketing Expenses**

 

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

 

Salesand marketing expenses were $5.3 million for the three month period ended March 31,2005 and $3.3 million for the three month period ended March 31, 2004. Theincrease was primarily due to additional personnel-related costs and anincrease in marketing activities. Sales and marketing expenses decreased as a percentage of revenue from19.1% for the three month period ended March 31, 2004 to 18.2% for thethree month period ended March 31, 2005, as we were able to gain operatingleverage. The number of employees included in sales and marketing increasedfrom 133 at March 31, 2004 to 194 at March 31, 2005.

 

**General and Administrative Expenses**

 

Generaland administrative expenses consisted primarily of compensation andrelated expenses for executive and administrative personnel; costs related toleasing, maintaining and operating our facilities and systems; insurance; baddebts; fees for professional services; fees associated with the reporting andother obligations of a public company; depreciation and other general andadministrative services. Feesfor professional services included payments to external lawyers, accountants,and other professionals in connection with operating our business, complianceand evaluating and pursuing new opportunities.

 

Generaland administrative expenses were $4.6 million for the three month period ended March 31,2005 and $3.0 million for the three month period ended March 31, 2004. Theincrease was due primarily to an increase in employee headcount from 47 at March 31,2004 to 59 at March 31, 2005 and increased compliance costs. As apercentage of revenue, the expenses decreased from 17.2% to 15.8% for the threemonth periods ended March 31, 2004 and 2005, respectively, showingincreased leverage of these expenses over a larger revenue base.

 

**Product Development Expenses**

 

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

 

Productdevelopment expenses were $1.2 million and $1.1 million for the three monthperiods ended March 31, 2005 and 2004, respectively. The number ofemployees included in product development increased from 41 at March 31,2004 to 47 at March 31, 2005.

 

**Amortization of Intangible Assets and Deferred FinancingCosts**

 

Amortizationexpense relates to intangible assets acquired with 24/7 Search in August 2000,Real Media in October 2001, Insight First in January 2003, RMK in January 2004and Decide in August 2004; deferred financing costs associated with thesubordinated convertible debenture offering in September 2003; and thetransition payment to Lycos in February 2004.

 

Amortizationexpense was $1.1 million and $0.8 million for the three month periods ended March 31,2005 and 2004, respectively. For the three months ended March 31, 2005,amortization

 

26

----

 

expenserelated $0.6 million to acquired technology, $0.2 million to other intangibleassets, $0.1 million to deferred financing costs and $0.2 million to thetransition payment to Lycos. For the three months ended March 31, 2004,amortization expense related $0.5 million to acquired technology, $0.1 millionto other intangible assets, $0.1 million to deferred financing costs and $0.1million to the transition payment to Lycos.

 

**Stock-Based Compensation**

 

Stock-basedcompensation was $0.5 million and $0.2 million for the three month periodsended March 31, 2005 and 2004, respectively. The expense for the threemonth period ended March 31, 2005 related to the amortization of deferredcompensation for restricted shares to be issued to certain employees. Theexpense for the three month period ended March 31, 2004 consisted of $0.1 millionin discretionary incentives paid in stock and $0.1 million in amortizationof deferred compensation for restricted shares issued to certain employees.

 

**Restructuring Costs**

 

Duringthe three month period ended March 31, 2005, we recorded a restructuring charge of $1.0 million relatingto our former New York headquarters.

 

**Interest Expense, Net**

 

Interestexpense, net relates to our long-term debt and capital lease obligations offsetby interest income related to our cash and cash equivalents. Interest expense,net was $0.1 million and $0.2 million for the three month periods ended March 31,2005 and 2004, respectively. Interest expense in both periods primarily relatedto subordinated convertible debentures issued on September 26, 2003 ofwhich a portion of the interest incurred relates to a cash payment due and aportion related to the amortization of warrants issued with the debentures.Interest expense in both periods was offset by interest income from cash inovernight deposits and money market accounts.

 

**Change In Fair Value Of Warrant Liability**

 

Ourliability relates to warrants outstanding from our preferred stock andsubordinated convertible debenture offerings and is adjusted to fair value atthe end of each reporting period. The $0.2 million gain for the three monthperiod ended March 31, 2005 is due to a decrease in the fair value of thewarrants outstanding which reduced the corresponding liability. The decrease inthe fair value was primarily due to the lower fair market value of our stockcompared to when the warrants were issued.

 

**Recovery of Investments**

 

InJanuary 2005, we received $2.1 million as a return of investment inBidland. The return of investment was a result of the settlement of pendinglitigation between Bidland and Telefonica S.A and the subsequent liquidation ofBidland. A portion of the settlement proceeds have been retained by Bidlanduntil all tax issues are resolved at which time any remaining proceeds will bedistributed. We do not expect future distributions, if any, to be material. In2000, Bidland ceased operations and, accordingly, we recorded an impairmentcharge related to the cost-based investment.

 

27

----

 

**Impairment Of Investments**

 

Duringthe first quarter of 2005, we wrote down our available-for-sale investment inchinadotcom and recognized an impairment charge of approximately$0.6 million for other-than-temporary declines in the value of theinvestment.

 

**Other Income (Expense), Net**

 

Otherincome (expense), net in 2005 primarily relate to legal fees associated with aformer subsidiary that was shut down. The amount in 2004 primarily related toamounts recovered from a former subsidiary that was shut down.

 

**Dividends On Preferred Stock**

 

### Our preferred stock accrueand accumulate dividends at a rate of 6% per year, compounded monthly, payablewhen, as and if declared by our Board of Directors. All accrued dividends mustbe paid before any dividends may be declared or paid on the common stock, andshall be paid as an increase in the liquidation preference of the preferredstock payable upon a sale, merger, liquidation, dissolution or winding up ofthe Company. Accrued but unpaid dividends cancel upon conversion of thepreferred stock.

###  

**LIQUIDITY AND CAPITAL RESOURCES**

 

Cashflows for the three month periods ended March 31, 2005 and 2004 were asfollows (in thousands):

 
| ** **                                           | ** ** | **For the Three Months Ended March 31,** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                           | ** ** | **2005**                                      | ** ** | **2004** | ** ** |
| Net cash provided by (used in) operating  activities |       | $                                             | 1,761      |   | $ | (1,427 | ) |
| Net cash provided by (used in) investing  activities |       | $                                             | 598        |   | $ | (1,919 | ) |
| Net cash provided by financing activities            |       | $                                             | 59         |   | $ | 34,373 |   |

 

Sinceour inception we have financed our operations through equity financings andlong-term debt. Net cash provided by operating activities was $1.8 millionduring the first quarter of 2005. We used approximately $1.4 million of cash inoperating activities during the first quarter of 2004. Cash provided by (usedin) operating activities is generally as a result of our net operating losses,adjusted for certain non-cash items included in our operating results as wellas changes in various components of working capital, particularly accounts receivable. Wegenerally pay our search engine distribution partners and some of ourWeb sites in advance of receiving payments from our customers.

 

Netcash provided by investing activities was approximately $0.6 million during thefirst quarter of 2005. Investing activities in 2005 consisted of $0.6 millionof proceeds from sale and maturities of short-term investments and $2.1 millionfrom the recovery of an investment offset by $2.1 million in capitalexpenditures for operational purposes. Net cash used in investing activitieswas approximately $1.9 million during the first quarter of 2004. Investingactivities during the first quarter of 2004 related $1.6 million to theacquisition of RMK and $0.3 million to capital expenditures for generaloperational purposes.

 

28

----

 

Financingactivities provided $59,000 and $34.4 million in the three month periods ended March 31,2005 and 2004, respectively. Financing activities in 2005 related to proceedsfrom exercise of common stock options. Financing activities in 2004 primarilyrelated to proceeds from our secondary offering of common stock and theexercise of stock options.

 

On September 26, 2003, we completed the placement to aninstitutional accredited investor of $15.0 million of subordinatedconvertible debentures due September 2006 (“Debentures”). If at any timeon or after September 26, 2005, the second anniversary of the initialissuance date, the weighted average price of our common stock is less than$8.75 on any five consecutive trading days after such second anniversary, theholder has the right, in its sole discretion, to require that we redeem up to$7.5 million principal amount of the Debentures in cash. Management believesthe holder may exercise its right to require redemption. Management believesexisting cash and investments will be sufficient to meet the obligation toredeem should the holder exercise its right.

 

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

 

**OFF-BALANCE SHEET ARRANGEMENTS**

 

We did not have any relationships with unconsolidated entities orfinancial partnerships, such as entities often referred to as structuredfinance or special purpose entities, which would have been established for thepurpose of facilitating off-balance sheet financial arrangements or othercontractually narrow or limited purposes at March 31, 2005. Accordingly,we are not materially exposed to any financing, liquidity, market or creditrisk that could arise if we had engaged in such relationships.

 

**CRITICAL ACCOUNTING POLICIES**

 

Ourconsolidated financial statements are prepared in conformity with accountingprinciples generally accepted in the United States of America. As such, we arerequired to make certain estimates, judgments and assumptions that managementbelieves are reasonable based upon the information available. These estimates,judgments and assumptions affect the 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.

 

Thesignificant accounting policies which we believe are the most critical to aidin fully understanding and evaluating the reported consolidated financialresults include the following:

 

29

----

 

***Revenue Recognition; Cost of Revenues***

*** ***

*Media*

 

Our Media revenues are generated from fees paid by client advertisersfor advertising impressions. We typically offer advertisers a pricing modelbased on CPM, which enables client advertisers to pay a fee based on the numberof times its advertisement is viewed. Agreements are primarily short-term andrevenues are recognized as services are delivered provided that no significantobligations remain outstanding and collection of the resulting receivable isprobable. We become obligated to make royalty payments to Web sites that havecontracted with us, in the period the advertising impressions or e-mails aredelivered. Such expenses are classified as cost of revenues in the consolidatedstatements of operations.

 

*Search*

 

We generate revenue from our Search segment primarily from fees paid byclient advertisers when users click-through to their Web sites as a result ofour submission of their Web site listings into search engines databases. To alesser extent, we also generate revenue from fees paid by search engines thatemploy us to optimize the submission of Web site listings and report onadvertising campaigns for their advertisers. Agreements are primarilyshort-term and revenues are recognized as services are delivered provided thatno significant obligations remain outstanding and collection of the resultingreceivable is probable. We become obligated to make payments to search enginedistribution partners, which have contracted us, in the period the clicks aredelivered. Such expenses are classified as cost of revenues in the consolidatedstatements of operations. In specific circumstances, when we provide searchmarketing services as an agent for a fixed commission or otherwise intransactions in which we do not have principal risk and reward, we recognizerevenue on a net basis.

 

*Technology*

 

Our Technology revenues are derived primarily from licensing oursoftware, hosted advertisement serving, and software maintenance and technicalsupport services. Revenue from software licensing agreements is recognized inaccordance with Statements of Position (“SOP”) No. 97-2, *Software Revenue Recognition*, and StaffAccounting Bulletin (“SAB”) No. 104, *RevenueRecognition*, upon delivery of the software, which is generally whenthe software is made available for download, there is persuasive evidence of anarrangement, collection is reasonably assured, the fee is fixed ordeterminable, and vendor-specific objective evidence exists to allocate thetotal fees to all elements of the arrangement. Contracts that bundle thesoftware license with software maintenance and technical support are recognizedratably over the contract term. Revenue from advertisement serving isrecognized upon delivery. Revenue from software maintenance and technicalsupport contracts is recognized ratably over the life of the agreement, whichtypically does not exceed one year.

 

Expenses related to our Technology revenues are primarily payroll costsincurred to deliver and support the software, hosting, bandwidth and licensefees paid to third-party software vendors. These expenses are classified ascost of revenues in the consolidated statements of operations.

 

30

----

 

*Deferred Revenue*

 

Revenues that are billed or collected in advance of services beingcompleted are deferred until the conclusion of the period of the service forwhich the advance billing or collection relates. Deferred revenues are includedon the consolidated balance sheets as a current liability until the service isperformed and then recognized in the period in which the service is completed.Our deferred revenues primarily consist of billings in advance for softwarelicense subscriptions and software maintenance and technical support services.

 

**Allowance for Doubtful Accounts; Sales Allowance**

 

We maintain an allowance for doubtful accounts to reserve forpotentially uncollectible receivables and a sales allowance to reserve forpotential credits issued to customers. The allowances are estimates calculatedbased on an analysis of current business and economic risks, customercredit-worthiness, specific identifiable risks such as bankruptcies,terminations or discontinued customers, or other factors that may indicate apotential loss.

 

**Valuation of Goodwill, Intangible Assets andLong-Lived Assets**

 

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

 

Goodwill and intangible assets are reviewed for impairment wheneverevents or changes in circumstances indicate that the carrying amount may not befully recoverable. Conditions that would necessitate an impairment assessmentinclude a significant decline in the observable market value of an asset, asignificant change in the extent or manner in which an asset is used, or asignificant adverse change that would indicate that the carrying amount of anasset or group of assets is not recoverable. For long-lived assets to be heldand used, the Company recognizes an impairment loss only if its carrying amountis not recoverable through its undiscounted cash flows and measures theimpairment loss based on the difference between the carrying amount and fairvalue. Long-lived assets held for sale are reported at the lower of cost orfair value less costs to sell.

 

**Business Combinations**

 

Ouracquisitions are accounted for as purchase business combinations in accordancewith SFAS No. 141, *BusinessCombinations*, and SFAS No. 142, *Goodwill and Other Intangible Assets*. We allocate thepurchase price of tangible and intangible assets, and record as goodwill, theexcess of purchase price over the fair value of the identifiable net assetsacquired. Intangible assets include trademarks, customer relationships,acquired technology and covenants not to compete. Such intangible assets areamortized on a straight-line basis over their estimated useful lives, which aregenerally four to seven years.

 

**Contingencies and Litigation**

 

We evaluate contingent liabilities including threatened or pendinglitigation in accordance with SFAS No. 5, *Accountingfor Contingencies*, and record accruals when the outcome of thesematters is deemed probable and the liability is reasonably estimable. We makethese assessments

 

31

----

 

based on the facts and circumstances and in some instances based inpart on the advice of outside legal counsel.

 

**Restructuring Activities**

 

Restructuring activities are accounted for in accordance with SFAS No. 146,*Accounting for Costs Associated with Exit orDisposal Activities*. Restructuring-related liabilities includeestimates for, among other things, involuntary terminations of employees anddisposition of lease obligations. Key variables in determining such estimatesinclude timing of sublease rentals, estimates of sublease rental paymentamounts and tenant improvement costs, and estimates for brokerage and otherrelated costs. The Company periodically evaluates and, if necessary, adjuststhe estimates based on currently available information.

 

**Short-Term Investments**

 

SFAS115, *Accounting for Certain Investments inDebt and Equity Securities*, and Securities and Exchange Commission (“SEC”)Staff Accounting Bulletin (“SAB”) 59, *Accountingfor Non-current Marketable**Equity Securities*, provide guidance on determining when aninvestment is other-than-temporarily impaired. Investments are reviewedquarterly for indicators of other-than-temporary impairment. This determinationrequires significant judgment. In making this judgment, we evaluate, amongother factors, the duration and extent to which the fair value of an investmentis less than its cost; the financial health of the investee; and our intent andability to hold the investment. Investments with an indicator are furtherevaluated to determine the likelihood of a significant adverse effect on thefair value and amount of the impairment as necessary. If market, industryand/or investee conditions deteriorate, we may incur future impairments.

 

**MARKET FOR COMPANY’S COMMON EQUITY**

 

We have not declared orpaid any 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. In addition, oursubordinated convertible debentures restrict our ability to pay cash dividendson our capital stock. The future payment of dividends will depend on theresults of operations, financial condition, capital expenditure plans and otherfactors that we deem relevant and will be at the sole discretion of our Boardof Directors.

 

Since our initial publicoffering on August 13, 1998 until June 2002, our common stock tradedon the NASDAQ National Market under the symbol “TFSM.”  In June 2002, we transferred our commonstock to the NASDAQ SmallCap Market, where it currently trades under that samesymbol.

 

32

----

 

**FACTORS THAT COULD AFFECT FUTURE RESULTS**

 

Becauseof the following factors, as well as other variables affecting our operatingresults, past financial performance may not be a reliable indicator of futureperformance, and historical trends should not be used to anticipate results ortrends in future periods.

 

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

 

WEHAVE A HISTORY OF LOSSES AND MAY NEVER ACHIEVE PROFITABILITY.

 

We have not achieved profitability in accordance with generallyaccepted accounting principles, or GAAP, in any reporting period in ourhistory, except as the result of non-recurring gains, and we may not be able toachieve or sustain profitability in the future. We incurred net losses of $0.4million for each of the three month periods ended March 31, 2005 and 2004.We may incur net losses for the foreseeable future. Even if we do achieveprofitability, we may not sustain profitability on a consistent basis in thefuture.

 

WE HAVE SUBSTANTIAL DEBT, AND WE MAY NOT GENERATE SUFFICIENT CASHFLOW TO MEET OUR DEBT SERVICE AND REPAYMENT OBLIGATIONS.

 

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

 

33

----

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

WE MAY BE UNABLE TO RAISE THE FUNDS NECESSARY TO REPAY ORREFINANCE OUR INDEBTEDNESS. THE ISSUANCE OF STOCK UPON REDEMPTION OF OURSUBORDINATED CONVERTIBLE DEBENTURES MAY SUBSTANTIALLY DILUTE THE INTERESTSOF OTHER SECURITY HOLDERS.

 

We are obligated to make semi-annual interest payments on January 1and July 1 of each year and the entire principal face amount of thedebentures is due and payable on September 26, 2006. We may elect to payinterest in cash, in shares of our common stock or in additional debentures. Wemay elect to repay the principal amount of the debentures in cash or in sharesof our common stock. If we so elect, payment in shares shall be based upon 90%of the average of the volume weighted average price of our common stock on theprincipal market as reported by Bloomberg Financial L.P. during the fivetrading days immediately prior to the interest payment date, in the case of aninterest payment, or during the 15 trading days immediately prior to thematurity date, in the case of the repayment of the principal amount of thedebentures.    Stockholders couldexperience substantial dilution resulting from our election to pay thesemi-annual accrued interest due in common stock or repay the principal amountin common stock.  In addition, if, at anytime after September 26, 2005, the price of our common stock does notexceed the conversion price ($8.75 per share of our common stock) of thedebentures for any five trading days we may be required to immediatelyrepurchase $7.5 million in principal amount of the debentures in cash.

 

If we repay any principal in cash we may need additional capital tofund this obligation. Our ability to arrange financing and the cost of thisfinancing will depend upon many factors, including: general economic andcapital market conditions generally, and in particular the non-investment gradedebt market; credit availability from banks or other lenders; investorconfidence in our industry generally and our company specifically; andprovisions of tax and securities law

 

34

----

 

that are conducive to raising capital. If we need additional funds andare unable to raise them, our inability to raise them will have an adverseeffect on our operations. If we decide to raise additional funds by incurringdebt, we may become subject to additional or more restrictive financialcovenants and ratios.

 

WE MAY NEED TO RAISE ADDITIONAL FUNDS TO CONTINUE OPERATIONS.

 

An unforeseen reduction in our revenues, an unexpected impairment ofour receivables, or an unbudgeted increase in expenses or capital expendituresmay require us to raise additional funds to continue operations. To the extentwe encounter additional opportunities to raise cash, we may sell additionalequity or debt securities, which would result in further dilution of ourstockholders. Stockholders may experience extreme dilution due to our currentstock price and the amount of financing we may need to raise and thesesecurities may have rights senior to those of holders of our common stock.Access to the capital markets has been unpredictable in the past, especiallyfor unprofitable companies such as ours. The amount of capital that a companysuch as ours is able to raise often depends on variables that are beyond ourcontrol, such as the share price of our stock and its trading volume. As aresult, efforts to secure financing on terms attractive to us may not besuccessful, and we may not be able to secure additional financing on any terms.

 

OUR ACQUISITIONS, WHICH HAVE BEEN CRITICAL TO OUR GROWTH, MAY NOTBE SUCCESSFUL AND COULD AFFECT OUR ABILITY TO PROJECT RESULTS.

 

We were formed in February 1998 to consolidate three Internetadvertising companies and have since acquired many other companies. We maycontinue pursuing selective acquisitions of businesses, technologies andproduct lines as a key component of our growth strategy. If we acquireadditional companies, we will continue to face risks of integrating andimproving our financial and management controls, advertisement servingtechnology, reporting systems and procedures, and expanding, training andmanaging our work force. This process of integration may take a significantperiod of time and will require the dedication of management and otherresources, which may distract management’s attention from our other operations.Any future acquisition or investment may result in the use of significantamounts of cash, potentially dilutive issuances of equity securities,incurrence of debt and amortization expenses related to intangible assets. Inaddition, acquisitions involve numerous risks, including:

 

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

 

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

 

•                  the availabilityof favorable acquisition financing for future acquisitions; and

 

•                  the potentialloss of key senior managers or employees of any acquired business.

 

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

 

35

----

 

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

 

At times in the past and in certain segments, our revenues have grownsignificantly and also have decreased during certain periods and in certainsegments. Accurate predictions of future revenues are difficult because of therapid changes in our markets.

 

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

 

•                  the addition ofnew or loss of existing clients;

 

•                  changes in feespaid by advertisers or other clients;

 

•                  changes inroyalties payable by us to owners of Web sites;

 

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

 

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

 

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

 

•                  seasonality,which generally results in lower revenue for the Company in the first and thirdquarter of each year;

 

•                  changes inresults of operations brought about by newly acquired businesses, which may beexceedingly difficult to predict due to management’s lack of history with suchbusinesses;

 

•                  changes ingovernmental regulation of the Internet; and

 

•                  general economicconditions.

 

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

 

OUR TECHNOLOGY SOLUTIONS MAY NOT FUNCTION AS DESIGNED AND MAY CAUSEBUSINESS DISRUPTION.

 

Open AdSystem is our proprietary advertisement serving technology thatserves as our sole advertisement serving solution. We have developed a varietyof products to work on or with this platform. Some of these products, such asInsight ACT has only recently been made widely available. We must, among otherthings, ensure that the technology will function efficiently at high volumes,interact properly with our database, offer the functionality demanded by our

 

36

----

 

customers and assimilate our sales and reporting functions. We mustfurther complete development of our beta products. This development effortcould fail technologically or could take more time than expected. Customers maybecome dissatisfied by any system failure that interrupts our ability toprovide our services to them, including failures affecting our ability todeliver advertisements or report on advertisement delivery without significantdelay. Sustained or repeated system failures would reduce the attractiveness ofour solutions to advertisers, advertising agencies and Web publishers andresult in contract terminations, fee rebates and make-goods, thereby reducingour revenue. Our Media Solutions business utilizes our Open AdSystemtechnology, and thus any performance issues with Open AdSystem will also impactMedia Solutions. Slower response time or system failures may also result fromstraining the capacity of our deployed software or hardware due to an increasein the volume of advertising delivered through our servers. To the extent thatwe do not effectively address any capacity constraints or system failures, ourbusiness, results of operations and financial condition could be materially andadversely affected.

 

OUR REVENUE COULD DECLINE IF WE FAIL TO EFFECTIVELY MANAGE ADVERTISINGINVENTORY MADE AVAILABLE TO US AND OUR GROWTH COULD BE IMPEDED IF WE FAIL TOACQUIRE ACCESS TO NEW ADVERTISING INVENTORY.

 

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

 

WE COULD LOSE CUSTOMERS OR ADVERTISING INVENTORY IF WE FAIL TO MEASUREIMPRESSIONS, CLICKS AND ACTIONS ON ADVERTISEMENTS IN A MANNER THAT ISACCEPTABLE TO OUR ADVERTISERS AND WEB PUBLISHERS.

 

We earn advertising revenue and make payments to Web publishers basedon the number of impressions, clicks and actions from advertisements deliveredon our network. Advertisers’ and Web publishers’ willingness to use ourservices and join our network will depend on the extent to which they perceiveour measurements of clicks to be accurate and reliable. Advertisers and Webpublishers often maintain their own technologies and methodologies for countingclicks, and from time to time we have had to resolve differences between our measurementsand theirs. Further,

 

37

----

 

search advertisers are paying closer attention to allegations of clickfraud in the industry generally and have become more willing to inquire aboutor challenge click counts related to search marketing services.  Any significant dispute over the propermeasurement of clicks or other user responses to advertisements could cause usto lose customers or advertising inventory.

 

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

 

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

 

OUR NET OPERATING LOSS CARRYFORWARDS MAY BE LIMITED.

 

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

 

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

 

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

 

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

 

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

 

38

----

 

We have generated the majority of our global search revenue from clicksoriginating on Google and Overture, which is a subsidiary of Yahoo!, throughrelationships in many countries in which we operate. We expect that thesesearch engines will continue to generate a majority or more of our 24/7 Searchrevenue for the foreseeable future. The interruption or loss of ourrelationship with Google or Overture would cause a significant decrease insearch revenue. As a result of consolidation among search engines, and othersearch marketing companies, we could lose one of more of our clients or faceincreased competition from clients that internally develop or acquirecapabilities similar to our service. In addition, as our search engine clients’operations continue to evolve, we may be required to adjust our businessstrategy to maintain relationships with our clients, which could have amaterial adverse effect on our search revenue.

 

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

 

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

 

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

 

Our success depends, to a significant extent, upon our seniormanagement and key sales and technical personnel, particularly our ChiefExecutive Officer.  The loss of the servicesof one or more of these persons could materially and adversely affect ourability to develop our business.  Oursuccess also depends on our ability to attract and retain qualified technical,sales and marketing, customer support, financial and accounting, and managerialpersonnel.  We may be unable to retainour key personnel or attract, integrate or retain other highly qualifiedpersonnel in the future.  We haveexperienced in the past, and may continue to experience in the future,difficulty in hiring and retaining candidates with appropriate qualifications,especially in sales and marketing positions.

 

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

 

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

 

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

 

39

----

 

In addition, interruptions in our services could result from thefailure of our telecommunications providers to provide the necessary datacommunications capacity in the time frame we require. Our Open AdSystemtechnology resides on computer systems located in our data centers housed by Savvisin the United States and Level 3 Communications in Europe. These systems’continuing and uninterrupted performance is critical to our success, as asubstantial portion of the revenue depend on the continuing availability ofthese systems. Despite precautions that we have taken, unanticipated problemsaffecting our systems have from time to time in the past caused, and in thefuture could cause, interruptions in the delivery of our solutions. Ourbusiness, results of operations and financial condition could be materially andadversely affected by any damage or failure that interrupts or delays ouroperations. To improve the performance and to prevent disruption of ourservices, we may have to make substantial investments to deploy additionalservers or one or more copies of our Web sites to mirror our online resources.Although we believe we carry property insurance with adequate coverage limits,our coverage may not be adequate to compensate us for all losses, particularlywith respect to loss of business and reputation, that may occur.

 

In addition, terrorist acts or acts of war may cause damage to ouremployees, facilities, clients, our clients’ customers and vendors, which couldsignificantly impact our revenues, costs and expenses and financial position.The potential for future terrorist attacks, the national and internationalresponses to terrorist attacks or perceived threats to national security, andother acts of war or hostility have created many economic and politicaluncertainties that could adversely affect our business and results ofoperations in ways that cannot be presently predicted. We are predominantlyuninsured for losses and interruptions caused by terrorist acts and acts ofwar.

 

OUR NETWORK OPERATIONS MAY BE VULNERABLE TO HACKING, VIRUSES ANDOTHER DISRUPTIONS, WHICH MAY MAKE OUR PRODUCTS AND SERVICES LESSATTRACTIVE AND RELIABLE.

 

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

 

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

 

Our success and ability to compete are substantially dependent on ourinternally developed technologies and trademarks, which we protect through acombination of patent, copyright, trade secret and trademark law. We havereceived two patents in the United States, and have filed and intend to fileadditional patent applications in the United States. In addition, we apply toregister our trademarks in the United States and internationally. Our patentapplications and trademark applications may not be approved. Even if they areapproved, such patents or trademarks may be successfully challenged by othersor invalidated. If our trademark registrations are not approved

 

40

----

 

because third parties own such trademarks, our use of such trademarkswill be restricted unless we enter into arrangements with such third partiesthat may be unavailable on commercially reasonable terms.

 

We generally enter into confidentiality or license agreements with ouremployees, consultants and corporate partners, and generally control access toand distribution of our technologies, documentation and other proprietaryinformation. Despite our efforts to protect our proprietary rights from unauthorizeduse or disclosure, parties may attempt to disclose, obtain or use our solutionsor technologies. The steps we have taken may not prevent misappropriation ofour solutions or technologies, particularly in many foreign countries in whichwe operate, where laws or law enforcement practices may not protect ourproprietary rights as fully as in the United States.

 

We have from time to time licensed, and we may license in the future,elements of our trademarks, trade dress and similar proprietary rights to thirdparties. 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. The value of our proprietary rights could decline in the futuresince the validity, enforceability and scope of protection of certainproprietary rights in Internet-related industries is uncertain and stillevolving.

 

We have, from time to time, been, and may in the future be, subject toclaims of alleged infringement of the trademarks and other intellectualproperty rights of third parties by us or the Web publishers with Web sites inthe 24/7 Network, or by customers who employ our Technology solutions, whom wemay be required, or may elect, to indemnify against such claims. Such claimsand any resultant litigation could subject us to significant liability fordamages and could result in the invalidation of our proprietary rights. Inaddition, even if we prevail, such litigation could be time-consuming andexpensive to defend, and could result in the diversion of our time andattention, any of which could materially and adversely affect our business,results of operations and financial condition. Any claims or litigation fromthird parties may also result in limitations on our ability to use thetrademarks and other intellectual property subject to such claims or litigationunless we enter into arrangements with the third parties responsible for suchclaims or litigation, which may be unavailable on commercially reasonableterms.

 

From time to time, we may selectively pursue claims of infringement ofour patents and other intellectual property rights by third parties. Suchclaims and any resultant litigation present the risk that a court coulddetermine, either preliminarily or finally, that some of our patents or otherintellectual property rights are not valid, which may make it difficult to sellour technology solutions and may lead to a loss of and an inability to generatelicensing revenue from our patents. In addition, even if we prevail, suchlitigation could be time-consuming and expensive to pursue, and could result inthe diversion of our time and attention, any of which could materially andadversely affect our business, results of operations and financial condition.

 

OUR INTERNATIONAL OPERATIONS FACE LEGAL AND CULTURAL CHALLENGES.

 

We have operations in a number of international markets, includingAsia, Canada and Europe, and we currently derive more than half our revenuefrom non-U.S. markets. To date, we have limited experience in marketing,selling and distributing our solutions internationally. Internationaloperations are subject to other risks, including:

 

•                  changes inregulatory requirements;

 

41

----

 

•                  reducedprotection for intellectual property rights in some countries;

 

•                  potentiallyadverse tax consequences;

 

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

 

•                  difficulties andcosts of staffing and managing foreign operations;

 

•                  political andeconomic instability;

 

•                  fluctuations incurrency exchange rates; and

 

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

 

**RISKS RELATED TO THE MARKET FOR OUR COMMONSTOCK.**

 

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

 

As of March 31, 2005, there were approximately 44.9 million sharesof our common stock outstanding. As of that date, we also had an aggregate ofapproximately 13.0 million shares of common stock that may be sold intothe market in the future, including approximately 8.3 million shares ofour common stock issuable upon exercise of options, 0.8 million shares ofour common stock issuable upon conversion of our outstanding preferred stockand exercise of the related warrants, 1.7 million shares of our common stockupon vesting of restricted shares issued, and 2.2 million shares of ourcommon stock issuable upon conversion of the debentures and exercise of therelated warrants. In addition, if we undertake an additional acquisitions orfinancing involving securities convertible into shares of our common stock, theaggregate number of shares into which those securities are convertible willfurther increase our overhang.

 

We cannot predict the effect, if any, that future sales of shares ofour common stock into the market, or the availability of shares of common stockfor future sale, will have on the market price of our common stock. Sales ofsubstantial amounts of common stock (including shares issued upon the exerciseof stock options or conversion of shares of preferred stock), or the perceptionthat such sales could occur, may materially and adversely affect prevailingmarket prices for our common stock.

 

OUR SHARE PRICE MAY BE VOLATILE AND COULD DECLINE SUBSTANTIALLY.

 

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

 

42

----

 

resources, which could materially and adversely affect our business,financial condition and results of operations.

 

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

 

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

 

We also believe that one or more unaffiliated groups have purchasedsignificant quantities of our common stock.

 

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

 

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

 

•                  discouragepotential acquisition proposals;

 

•                  delay or preventa change in control;

 

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

 

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

 

WE DO NOT INTEND TO PAY FUTURE CASH DIVIDENDS.

 

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

 

**RISKS RELATED TO OUR INDUSTRY**

 

OUR FAILURE TO COMPETE SUCCESSFULLY MAY HINDER OUR GROWTH.

 

43

----

 

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

 

•                  the developmentof new online advertising media and methods;

 

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

 

•                  changing demandsregarding customer service and support;

 

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

 

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

 

Some of our competitors have longer operating histories, greater namerecognition, larger customer bases and significantly greater financial,technical and marketing resources than ours. In addition, current and potentialcompetitors have established or may establish cooperative relationships amongthemselves or with third parties to increase the ability of their products orservices to address the needs of our prospective clients.  In addition, most online advertisingcompanies are seeking to broaden their business models, so that companies thatdo not currently compete directly with us may decide to compete more directlywith us in the future. We may be unable to compete successfully against currentor future competitors.

 

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

 

Laws and regulations directly applicable to Internet communications,commerce and advertising are becoming more prevalent, and new laws andregulations are under consideration by the United States Congress and statelegislatures. Any legislation enacted or restrictions arising from current orfuture government investigations or policy could dampen the growth in use ofthe Internet generally and decrease the acceptance of the Internet as acommunications, commercial and advertising medium. State governments orgovernments of foreign countries might attempt to regulate our transmissions orlevy sales or other taxes relating to our activities. The laws governing theInternet, however, remain largely unsettled, even in areas where there has beensome legislative action. It may take years to determine whether and howexisting laws such as those governing intellectual property, privacy, libel andtaxation apply to the Internet and Internet advertising. In addition, thegrowth and development of Internet commerce may prompt calls for more stringentconsumer protection laws, both in the United States and abroad, that may imposeadditional burdens on companies conducting business over the Internet. Ourbusiness, results of operations and financial condition could be materially andadversely affected by the adoption or modification of laws or regulationsrelating to the Internet.

 

CHANGES IN LAWS AND STANDARDS RELATING TO DATA COLLECTION AND USEPRACTICES AND THE PRIVACY OF INTERNET USERS, OR RELATED LITIGATION, COULD HARMOUR BUSINESS.

 

44

----

 

The U.S. federal and various state governments have recently proposedlimitations on the collection and use of information regarding Internet users.In 2004 and 2005, the U.S. Congress proposed several new pieces of legislationthat would limit the use of technologies deemed to be “spyware”, which somebills have defined to include cookies, Web beacons and javascript, which arerequired by our products and services. The effectiveness of our Open AdSystemproducts and services could be significantly limited by federal and stateregulations limiting the collection or use of information regarding Internetusers. Since many of the proposed federal and state laws or regulations arebeing developed, we cannot yet determine the impact these regulations may haveon its business. In addition, growing public concern about privacy and thecollection, distribution and use of personal information has led toself-regulation of these practices by the Internet advertising and direct marketingindustry and to increased federal and state regulation.  Lastly, a number of civil actions have beenbrought by federal and state authorities against companies alleged to havedistributed “spyware” without proper consent of users. The Network AdvertisingInitiative, of which we are a member, has developed self-regulatory principlesfor online preference marketing. We are also subject to various federal andstate regulations concerning the collection, distribution and use of personalinformation. These laws include the Children’s Online Privacy Protection Act,and state laws that limit or preclude the use of voter registration and driverslicense information, as well as other laws that govern the collection and useof consumer credit information. While we monitor legislative initiatives, inthe event that more onerous federal or state laws or regulations are enacted orapplied to us or our clients, our business, financial condition and results ofoperations could be materially and adversely affected.

 

PRIVACY CONCERNS MAY PREVENT US FROM COLLECTING USER DATA.

 

Growing concerns about the use of cookies and data collection may limitour ability to develop user profiles. Web sites typically place small files ofinformation, commonly known as “cookies”, on a user’s hard drive, generallywithout the user’s knowledge or consent. Cookie information is passed to theWeb site through the Internet user’s browser software. Our Open AdSystemtechnology targets advertising to users through the use of cookies and othernon-personally-identifying information. Open AdSystem enables the use ofcookies to deliver targeted advertising and to limit the frequency with whichan advertisement is shown to a user. Most currently available Internet browsersallow users to modify their browser settings to prevent cookies from beingstored on their hard drive, and a small minority of users are currentlychoosing to do so. Users can also delete cookies from their hard drive ormodify them at any time. Some Internet commentators and privacy advocates havesuggested limiting or eliminating the use of cookies. Any reduction orlimitation in the use of cookies could limit the effectiveness of our sales andmarketing efforts and impair our targeting capabilities. Microsoft Corporationhas changed the design and instrumentation of its Web browser in such a way asto give users the option to accept or reject third party cookies. Giving usersthe option to decline such cookies could result in a reduction of the number ofInternet users that we can profile anonymously. Such changes also couldadversely affect our ability to determine the reach of advertising campaignssold and delivered by us and the frequency with which users of sites in the24/7 Network see the same advertisement.

 

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

 

45

----

 

WE FACE RISKS ASSOCIATED WITH TECHNOLOGICAL CHANGE.

 

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

 

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

 

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK

 

**INTEREST RATE RISK**

 

The primary objective of our investment activities is to preservecapital. Cash and cash equivalents are investments with original maturities ofthree months or less. Therefore, changes in the market’s interest rates do notaffect the value of the investments as recorded by 24/7 Real Media. Thefollowing table presents the amounts of our financial instruments that are subjectto interest rate risk by expected maturity and average interest rates as of March 31,2005 (in thousands):

 
| ** **                | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| Cash and cash equivalents |       | $        | 30,047     |     | $          | —   |       | $              | —     |      | $          | — |   | $ | 30,047 |   |
| Average interest rate     |       | 2.38     | %          |     |       |     |       |           |       | 2.38      | %          |
|                      |       |     |       |     |       |     |       |           |       |      |       |
| Loan payable              |       | $        | 7,500      |     | $          | 7,500    |       | $              | —     |      | $          | — |   | $ | 15,000 |   |
| Loan payable              |       | 2.00     | %          | 2.00     | %          |     |       |           |       | 2.00      | %          |

 

The 2% subordinated convertible debentures due 2006 contain a provisionthat gives the holder the ability to call a portion of the note upon thesatisfaction of a trading price condition. This condition constitutes anembedded derivative. The value of this embedded derivative at March 31,2005 is immaterial to our financial position. We review the value of thederivative on a quarterly basis, in accordance with SFAS No. 149, *Amendment of Statement 133 on Derivative Instrumentsand Hedging Activities*. At March 31, 2005, we did not hold anyother derivative financial instruments.

 

46

----

 

**FOREIGNCURRENCY RISK**

 

We transactbusiness in a variety of foreign countries and are thus subject to exposurefrom adverse movements in foreign currency exchange rates. This exposure isprimarily related to revenue and operating expenses. The effect of foreignexchange rate fluctuations for the three month periods ended March 31,2005 and 2004 were not material. We do not use derivative financial instrumentsto limit our foreign currency risk exposure. At March 31, 2005, we had$6.7 million in cash and cash equivalents denominated in foreigncurrencies.

 

ITEM 4.CONTROLS AND PROCEDURES

 

*Evaluation of Controls and Procedures*

 

As of the end of the period covered by this Form 10-Q, anevaluation of the effectiveness of the design and operation of our disclosure controlsand procedures was carried out by us under the supervision and with theparticipation of our management, including our Chief Executive Officer andChief Financial Officer. Based on that conclusion, our Chief Executive Officerand Chief Financial Officer concluded that our disclosure controls andprocedures have been designed and are being operated in a manner that providesreasonable assurance that the information required to be disclosed in ourExchange Act reports is recorded, processed, summarized and reported within thetime periods specified in the SEC’s rules and forms, and that suchinformation is accumulated and communicated to our management, including ourChief Executive Officer and Chief Financial Officer, as appropriate, to allowtimely decisions regarding required disclosure. In designing and evaluating thedisclosure controls and procedures, our management recognizes that any controlsand procedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives, and ourmanagement necessarily is required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures.

 

In 2004, as a complement to our existing overall program of internal control,we initiated a company-wide review of our internal control over financialreporting as part of the process for compliance with Section 404 of theSarbanes-Oxley Act of 2002. As a result of the review, we have madeimprovements to the design and effectiveness of our internal control throughthe quarter ended March 31, 2005.  We anticipate that improvementswill continue to be made.

 

*Changes in Internal Control*

 

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

 

47

----

 

PART II. OTHER INFORMATION

 

ITEM 1.  LEGAL PROCEEDINGS

 

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

 

ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS

 

None.

 

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4.   SUBMISSIONOF MATTERS TO A VOTE OF SECURITIES HOLDERS

 

None.

 

ITEM 5.  OTHER INFORMATION

 

None.

 

ITEM 6.  EXHIBITS

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

 

----

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

 

----

 

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. |
|-------------------------|-----------------------|
|                    | *(Registrant)*        |
|                    |                  |
|                    |                  |
| Date: May 10, 2005 | By:                   | /s/ DAVID J. MOORE |   |
|                    |                  |   David J. Moore |
| * *                | * *              | *  Chairman  and Chief Executive Officer* |
| * *                | * *              | *  (Principal  Executive Officer)* |

 

----