SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarter ended September 30, 2003

Commission File No. 0-21935

Modem Media, Inc.

(Exact name of registrant as specified in its charter)

DELAWARE	06-1464807
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

230 East Avenue

Norwalk, CT 06855

(203) 299-7000

(Address of principal executive offices and zip code)

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

There were 26,302,852 shares of the Registrant’s Common Stock, $0.001 par value, issued and outstanding as of November 3, 2003.

TABLE OF CONTENTS

		Page
SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS AND RISK FACTORS		2
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited)
	Consolidated Balance Sheets as of September 30, 2003 and December 31, 2002	3
	Consolidated Statements of Operations for the three and nine months ended September 30, 2003 and 2002	4
	Consolidated Statements of Cash Flows for the nine months ended September 30, 2003 and 2002	5
	Notes to Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	19
Item 4.	Controls and Procedures	19
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	20
Item 4.	Submission of Matters to a Vote of Security Holders	21
Item 5.	Other Information	21
Item 6.	Exhibits and Reports on Form 8-K	21
	Signatures	22

1

SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS AND RISK FACTORS

This document includes forward-looking statements within the meaning of Section 21E(i)(1) of the Securities and Exchange Act of 1934, as amended. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results to be materially different from any future results expressed or implied by these statements. Such factors include, among other things, the following:

• our history of operating losses,

• our ability to generate new demand for our services from new and existing clients,

• the scope and timing of new assignments and client initiatives,

• the allocation of resources to new business development,

• spending levels and budget constraints of our clients,

• our dependence on a limited number of clients,

• the variability of our operating results,

• our ability to accurately estimate costs in fixed-fee engagements,

• our ability to attract and retain qualified professionals,

• the ability of CentrPort to meet their obligations under its real estate lease, of which we are guarantor,

• our ability to sub-lease our unoccupied office space,

• the ability of our sub-tenants to continue to meet their obligations under our sub-lease agreements for parts of our San Francisco office space,

• our need and ability to manage the level of our staff and capacity in the future,

• our ability to manage third party vendors for the benefit of our clients,

• the use of a significant portion of our cash on hand if we implement any additional cost reduction programs,

• the potential decrease in our cash balance if we experience a material decrease in demand for our media purchasing services,

• the potential future impairment of our goodwill,

• our dependence on key management staff,

• exclusivity arrangements with clients that may limit our ability to provide services to others,

• pricing pressure for our services,

• our ability to integrate acquired companies, if any,

• utilization and recoverability of our deferred tax assets,

• the timing of collections from our clients,

• our ability to manage future growth,

• our ability to respond to rapid technological change,

• our dependence on the future growth of the internet and the market for our services,

• our change of our financial and operational information system,

• the long-term effects of the global recession,

• changes in government regulation, including regulation of privacy and spam issues,

• the volatility of the price of our stock,

• the concentrated ownership of our stock, and

• the effect of terrorist activities and military actions.

In light of these and other uncertainties, the forward-looking statements included in this document should not be regarded as a representation by us that our plans and objectives would be achieved.

2

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

MODEM MEDIA, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)

(unaudited)

	September 30, 2003			December 31, 2002
ASSETS
Current assets:
Cash and cash equivalents	$	53,275		$	49,312
Accounts receivable, net of bad debt reserve of $224 and $281, respectively		8,156			11,947
Unbilled revenues		1,517			909
Deferred income taxes		4,309			2,511
Prepaid expenses and other current assets		1,588			2,058
Total current assets		68,845			66,737
Noncurrent assets:
Property and equipment, net		7,516			8,687
Goodwill		43,156			43,156
Deferred income taxes		13,533			17,804
Other assets		3,297			3,413
Total noncurrent assets		67,502			73,060
Total assets	$	136,347		$	139,797
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	891		$	2,338
Pre-billed media		10,466			12,301
Deferred revenues		2,338			2,344
Accrued restructuring		3,130			3,141
Accrued expenses and other current liabilities		6,860			8,663
Total current liabilities		23,685			28,787
Noncurrent liabilities:
Accrued restructuring		13,091			16,387
Other liabilities		1,013			1,209
Stockholders’ equity:
Common stock, $.001 par value—145,000,000 shares authorized, 26,424,569 and 26,188,475 issued, respectively		26			26
Preferred stock, $.001 par value—5,000,000 shares authorized, none issued and outstanding		—			—
Paid-in capital		192,888			191,720
Deferred compensation		(268	)		—
Accumulated deficit		(92,480	)		(96,812	)
Treasury stock, 264,522 and 219,422 shares of common stock, respectively, at cost		(1,351	)		(1,251	)
Accumulated other comprehensive loss		(257	)		(269	)
Total stockholders’ equity		98,558			93,414
Total liabilities and stockholders’ equity	$	136,347		$	139,797

The accompanying notes are an integral part of these consolidated financial statements.

3

MODEM MEDIA, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2003			2002			2003			2002
										(Restated)
Revenues	$	14,630		$	17,811		$	44,575		$	55,153
Cost of revenues		7,221			9,075			21,826			28,198
Gross profit		7,409			8,736			22,749			26,955
Operating expenses:
Selling, general and administrative		4,338			4,771			14,099			17,097
Restructuring and other charges (credits), net		(1,111	)		—			(1,111	)		7,942
Depreciation and amortization		612			1,078			2,413			3,592
Total operating expenses		3,839			5,849			15,401			28,631
Operating income (loss)		3,570			2,887			7,348			(1,676	)
Gain on sale of CentrPort stock		—			—			—			2,317
Interest income		129			186			420			565
Other income (expense), net		(171	)		180			(513	)		(71	)
Income from continuing operations before income taxes		3,528			3,253			7,255			1,135
Provision for income taxes		1,466			1,143			2,923			611
Income from continuing operations		2,062			2,110			4,332			524
Discontinued operations:
Operating loss		—			(224	)		—			(4,762	)
Provision (benefit) for income taxes		—			140			—			(5,375	)
Income (loss) from discontinued operations		—			(364	)		—			613
Income before cumulative effect of accounting change		2,062			1,746			4,332			1,137
Cumulative effect of accounting change		—			—			—			(3,391	)
Net income (loss)	$	2,062		$	1,746		$	4,332		$	(2,254	)
Basic per share data:
Income from continuing operations	$	0.08		$	0.08		$	0.17		$	0.02
Income (loss) from discontinued operations		—			(0.01	)		—			0.02
Income before cumulative effect of accounting change		0.08			0.07			0.17			0.04
Cumulative effect of accounting change		—			—			—			(0.13	)
Net income (loss)	$	0.08		$	0.07		$	0.17		$	(0.09	)
Diluted per share data:
Income from continuing operations	$	0.08		$	0.08		$	0.16		$	0.02
Income (loss) from discontinued operations		—			(0.01	)		—			0.02
Income before cumulative effect of accounting change		0.08			0.07			0.16			0.04
Cumulative effect of accounting change		—			—			—			(0.13	)
Net income (loss)	$	0.08		$	0.07		$	0.16		$	(0.09	)
Weighted-average number of common shares outstanding:
Basic		26,044			25,964			25,990			25,930
Diluted		26,667			26,105			26,330			26,164

The accompanying notes are an integral part of these consolidated financial statements.

4

MODEM MEDIA, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(unaudited)

	Nine Months Ended September 30,
	2003			2002
				(Restated)
Cash flows from operating activities:
Net income (loss)	$	4,332		$	(2,254	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		2,413			3,838
Non-cash restructuring and other charges		—			3,696
Gain from the sale of CentrPort stock		—			(2,317	)
Cumulative effect of accounting change — goodwill impairment		—			3,391
Non-cash income taxes		2,473			(5,055	)
Provision for doubtful accounts		—			(178	)
Amortization of deferred compensation		159			—
Changes in assets and liabilities:
Accounts receivable		3,791			6,626
Unbilled revenues		(608	)		(1,757	)
Prepaid expenses and other assets		(38	)		801
Accounts payable, accrued expenses and other liabilities		(3,158	)		(6,561	)
Pre-billed media		(1,834	)		(893	)
Deferred revenues		(6	)		(1,952	)
Accrued restructuring		(3,307	)		6,228
Net cash provided by operating activities		4,217			3,613
Cash flows from investing activities:
Purchases of property and equipment		(1,241	)		(175	)
Collection of notes receivable		624			69
Net cash used in investing activities		(617	)		(106	)
Cash flows from financing activities:
Purchases of treasury stock		(100	)		(19	)
Payments of notes payable and capital lease obligations		(294	)		(775	)
Exercises of stock options and purchases under employee stock purchase plan		742			496
Net cash provided by (used in) financing activities		348			(298	)
Effect of exchange rates on cash and cash equivalents		15			(193	)
Net increase in cash and cash equivalents		3,963			3,016
Cash and cash equivalents, beginning of the period		49,312			40,995
Cash and cash equivalents, end of the period	$	53,275		$	44,011

The accompanying notes are an integral part of these consolidated financial statements.

5

MODEM MEDIA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. Basis of Presentation and Summary of Significant Accounting Policies

Nature of Operations—Modem Media, Inc. (the “Company”) is an interactive marketing strategy and services firm. The Company is a marketing partner to some of the world’s leading companies and uses digital marketing and technologies to help its clients realize greater value from their most vital asset—their customers. The Company leverages its experience in marketing and business strategy, marketing programs, creative design and technology development to address the unique business objectives, challenges and opportunities of each of its client companies. Headquartered in Norwalk, Connecticut, the Company maintains offices in San Francisco, London and São Paulo.

Basis of Presentation—The accompanying unaudited consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to make the information presented not misleading. The consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the Company’s financial position and results of operations. The operating results for the three and nine months ended September 30, 2003 and 2002 are not necessarily indicative of the results to be expected for any other interim period or any future year. These consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.

Discontinued Operations—In the third quarter of 2002, the operations of the Company’s offices in Toronto, Munich and Hong Kong ceased. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, as adopted by the Company on January 1, 2002, the results of these operations have been reclassified and are separately presented for all reporting periods as discontinued operations. A restructuring charge related to these activities was recorded in second quarter of 2002 and is included within operating loss from discontinued operations.

Principles of Consolidation—The accompanying consolidated financial statements include all of the accounts of the Company and its subsidiaries. All significant intercompany transactions have been eliminated in consolidation.

Use of Estimates—The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

Reclassifications—Certain reclassifications have been made in the prior period consolidated financial statements to conform to the current period presentation.

Revenue Recognition—The Company recognizes revenues as services are rendered in accordance with SEC Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements (“SAB No. 101”). A majority of its revenues are derived from fixed-bid and retainer-based assignments. Unbilled revenues represent labor costs incurred and estimated earnings in excess of billings and production and other client-reimbursable out-of-pocket costs incurred in excess of billings. Amounts billed to clients in excess of revenues recognized to date are classified as deferred revenues. The Company’s clients hire it on a fixed-bid, retainer or time-and-materials basis. The Company reassesses its estimated costs on fixed-bid engagements periodically and, as needed, for specific engagements. Losses are accrued to the extent that costs incurred and anticipated costs to complete engagements exceed total anticipated billings. Provisions for losses on uncompleted fixed-bid contracts, if any, are recognized in the period in which such losses are determined. The cost of online media and email campaigns purchased by the Company for its clients is not included in revenue because the Company acts as an agent on behalf of its clients.

In accordance with Emerging Issue Task Force (“EITF”) Issue No. 01-14, Income Statement Characterization of Reimbursements Received for Out-Of-Pocket Expenses Incurred (“EITF 01-14”), the Company reports reimbursable pass-through expenses as a component of revenues and cost of revenues. This component of revenue was less than 3% of total revenues for all periods presented.

6

MODEM MEDIA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Business Concentrations and Credit Risk—The Company’s services have been provided primarily to a limited number of clients located worldwide in a variety of industries. The Company had revenues from three clients representing 26%, 14% and 13% of revenues for the three months ended September 30, 2003, and revenues from three clients representing 24%, 18% and 11% of revenues for the nine months ended September 30, 2003. The Company had revenues from four clients representing 21%, 20%, 12% and 11% of revenues for the three months ended September 30, 2002. The Company had revenues from three clients representing 18%, 15% and 11% of revenues for the nine months ended September 30, 2002. The Company generally does not require its clients to provide collateral. Additionally, the Company is subject to a concentration of credit risk with respect to its accounts receivable. The Company had four clients accounting for 18%, 17%, 13% and 11% of total gross accounts receivable as of September 30, 2003. The Company had three clients accounting for 38%, 18% and 14% of total gross accounts receivable as of December 31, 2002.

Income Taxes—The Company accounts for income taxes under the liability method in accordance with SFAS No. 109, Accounting for Income Taxes. In accordance with such standard, the provision for income taxes includes deferred income taxes resulting from items reported in different periods for income tax and financial statement purposes. Deferred income tax assets and liabilities represent the expected future tax consequences of the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. The effects of changes in tax rates on deferred income tax assets and liabilities are recognized in the period that includes the enactment date.

Stock-Based Compensation—The Company follows the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 encourages, but does not require, companies to record compensation expense for stock-based employee compensation plans at fair value. The Company has elected to continue to account for stock-based compensation to employees using the intrinsic value method presented in Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees and related interpretations. Accordingly, the compensation cost of stock options is measured as the excess, if any, of the quoted market price of the Company’s stock at the date of grant over the exercise price and is charged to operations either when earned or over the vesting period. Income tax benefits attributable to stock options exercised are credited to paid-in capital.

If compensation expense for stock options awarded under the Company’s plans were to have been determined in accordance with SFAS No. 123, the Company’s pro forma net income (loss) and pro forma net income (loss) per share would have been as follows:

	Three Months Ended September 30,		Nine Months Ended September 30,
	2003	2002	2003	2002
				(Restated)
	(in thousands, except per share data)		(in thousands, except per share data)
Net income (loss) as reported	$2,062	$1,746	$4,332	$(2,254	)
Stock–based compensation recorded, net of tax	32	—	96	—
Sub total	2,094	1,746	4,428	(2,254	)
Stock-based compensation expense determined     under SFAS 123, net of tax	651	1,061	1,966	3,561
Pro forma net income (loss)	$1,443	$   685	$2,462	$(5,815	)
Net income (loss) per share:
Basic income (loss) per share, as reported	$  0.08	$  0.07	$  0.17	$  (0.09	)
Basic income (loss) per share, pro forma	$  0.06	$  0.03	$  0.09	$  (0.22	)
Diluted income (loss) per share, as reported	$  0.08	$  0.07	$  0.16	$  (0.09	)
Diluted income (loss) per share, pro forma	$  0.05	$  0.03	$  0.09	$  (0.22	)

The effects of applying SFAS No. 123 in the pro forma net income (loss) disclosures above are not likely to be representative of the effects on pro forma disclosures of future years.

During the first quarter of 2003, as a partial payment under the Company’s management incentive plan, the Company issued approximately 244,000 options to purchase its common stock to certain management employees at an exercise price of $0.58 per share. The Company recorded deferred compensation expense of approximately $0.4 million relating to these options, which represents the difference between the exercise price and the fair market value of the Company’s common stock on the date of grant. This balance will be amortized on a straight-line basis over the vesting period, which ends on December 31, 2004. The Company has amortized approximately $0.05 million and $0.16 million of deferred compensation during the three and nine months ended September 30, 2003, respectively.

7

MODEM MEDIA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Cash and Cash Equivalents—The Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents. Although cash balances are maintained in high quality financial institutions, the balances at times exceed insurable amounts.

Property and Equipment—Property and equipment are stated at cost and are depreciated principally using the straight-line method over their estimated useful lives of three to five years for computers and software, and five to seven years for furniture and other. Purchased software and third-party costs incurred to develop software for internal use are capitalized and amortized principally over three years. Leasehold improvements are amortized over the lesser of their estimated useful lives or the remaining lease term.

Goodwill—Goodwill represents acquisition costs in excess of the fair value of net assets acquired. In July 2001, the FASB issued SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for using the purchase method of accounting. Under SFAS No. 142, goodwill is no longer amortized but is reviewed for impairment annually, as well as when a triggering event indicates impairment may have occurred. This statement eliminated goodwill amortization upon adoption and required an initial assessment for goodwill impairment within six months of adoption and at least annually thereafter. The Company adopted this pronouncement on January 1, 2002. The goodwill test for impairment consists of a two-step process that begins with an estimation of the fair value of the reporting unit. The first step of the process is a screen for potential impairment and the second step measures the amount of impairment, if any. SFAS No. 142 required an entity to complete the first step of the transitional goodwill impairment test within six months of adopting the statement. The Company performed the required transitional fair value impairment test on its goodwill as of January 1, 2002. As a result of completing this test, the Company determined that the goodwill associated with its Munich operation was fully impaired as of January 1, 2002. Accordingly, the Company recorded a goodwill impairment charge of $3.4 million as a cumulative effect of an accounting change retroactive to January 1, 2002. There was no income tax benefit associated with this charge because the Company believed it was not likely that future taxable income in Germany would be sufficient to realize the related income tax benefit.

Net Income Per Share—In accordance with SFAS No. 128, Earnings Per Share, basic net income per share is computed using the weighted-average number of common shares outstanding during each period. Diluted net income per share gives effect to all potentially dilutive securities that were outstanding during each period. For the three months ended September 30, 2003 and 2002, outstanding options to purchase shares of common stock of approximately 1.9 million and 6.0 million, respectively, were not included in the computation of diluted net income per share because to do so would have an antidilutive effect for the periods presented. For the nine months ended September 30, 2003 and 2002, outstanding options of approximately 4.6 million and 5.2 million, respectively, were likewise excluded. The following table details the computation of basic and diluted earnings per share for continuing operations:

	Three Months Ended September 30,		Nine Months Ended September 30,
	2003	2002	2003	2002
	(in thousands, except per share amounts)		(in thousands, except per share amounts)
Income from continuing operations	$  2,062	$  2,110	$  4,332	$     524
Weighted average common shares outstanding—basic	26,044	25,964	25,990	25,930
Assumed conversion of dilutive securities	623	141	340	234
Weighted average common shares outstanding—diluted	26,667	26,105	26,330	26,164
Basic earnings per share for income from continuing operations	$    0.08	$    0.08	$    0.17	$    0.02
Diluted earnings per share for income from continuing operations	$    0.08	$    0.08	$    0.16	$    0.02

Fair Value of Financial Instruments—The carrying values of the Company’s assets and liabilities approximate fair value because of the short maturities of these financial instruments.

Foreign Currency Translation—The Company’s financial statements were prepared in accordance with the requirements of SFAS No. 52, Foreign Currency Translation. Under this method, net foreign currency transaction gains and losses are included in the accompanying consolidated statements of operations.

8

MODEM MEDIA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Comprehensive Income—The Company reflects its comprehensive income such as unrealized gains and losses on the Company’s foreign currency translation adjustments and available-for-sale securities as a separate component of stockholders’ equity as required by SFAS No. 130, Reporting Comprehensive Income. The Company has not recorded the tax effects related to the currency translation adjustments because such adjustments relate to indefinite investments in international subsidiaries. Comprehensive income (loss) consists of net income (loss) and foreign currency translation adjustments. Comprehensive income was $2.1 million and $2.0 million for the three months ended September 30, 2003 and 2002, respectively. Comprehensive income (loss) was $4.3 million and $(1.4) million for the nine months ended September 30, 2003 and 2002, respectively.

Recently Issued Accounting Pronouncements

In March 2003, the EITF published Issue No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables,” (“EITF 00-21”). This issue addresses certain aspects of the accounting by a vendor for arrangements under which it performs multiple revenue-generating activities and how to determine whether such an arrangement involving multiple deliverables contains more than one unit of accounting for purposes of revenue recognition. The guidance is effective for revenue arrangements that the Company entered into in fiscal periods beginning after June 15, 2003. Accordingly, the Company adopted EITF 00-21 on July 1, 2003 and the Company has determined that the adoption of this statement did not have a material effect on its consolidated financial statements or disclosures.

In April 2003, the FASB issued Statement No. 149, “Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities,” (“Statement No. 149”). Statement No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities.” Statement No. 149 is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003 and is to be applied prospectively. The Company does not use derivative instruments, and therefore, the adoption of Statement No. 149 did not have a material impact on its consolidated financial statements.

NOTE 2. Discontinued Operations and Restatement of Prior Period Financial Results

In the third quarter of 2002, the operations of the Company’s offices in Toronto, Munich and Hong Kong ceased. In accordance with SFAS No. 144, the results of these operations have been reclassified and are separately presented for all reporting periods as discontinued operations. Revenue for discontinued operations for the three and nine months ended September 30, 2002 was $0.3 million and $2.4 million, respectively.

In connection with the reclassification of the results of these operations, the Company also noted certain errors within accrued liabilities associated with its continuing operations that were generated in prior periods. Therefore, the Company has restated its historical results to adjust for these items. The impact of these adjustments served to decrease selling, general and administrative expenses and the loss from continuing operations before income taxes by approximately $0.1 million in the first quarter of 2002. The correction for these items had no impact on the timing or amount of the Company’s revenue or cash flow. The impact of the restatement on the net loss for the nine months ended September 30, 2002 is as follows:

	Nine Months Ended September 30, 2002
	(in thousands, except per share amounts)
	As Previously Reported			As Restated
Net loss	$	(2,329	)	$	(2,254	)
Basic and diluted net loss per share	$	(0.09	)	$	(0.09	)

NOTE 3. Restructuring and Other Charges (Credits), Net

Continuing Operations

The Company initiated a series of restructuring actions in 2002 to align capacity with both revenue and the demand from its clients. These actions were completed in the third and fourth quarters of 2002 and included staff reductions and a reduction in office space in the Company’s U.S. and London offices. In October 2003 the Company entered into a sub-lease arrangement with a third party for part of the Company’s San Francisco office space. Accordingly, $1.1 million of the previously established restructuring accrual was reversed in the third quarter of 2003.

9

MODEM MEDIA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Discontinued Operations

Due to the decline in client demand, the Company decided in the second quarter of 2002 to close its offices in Toronto, Munich and Hong Kong, ceasing operations in the third quarter of 2002.

The accruals established by the Company in respect to both continuing and discontinued operations, and activities related thereto, are summarized as follows:

	Balances at December 31, 2002		Charges (Credits)			Cash Uses			Other			Balances at September 30, 2003
	(In thousands)
Facilities	$	19,192	$	(1,111	)	$	(2,569	)	$	319		$	15,831
Severance		114		—			(66	)		(12	)		36
Other exit costs		222		—			(46	)		178			354
Total	$	19,528	$	(1,111	)	$	(2,681	)	$	485			16,221
Less: current portion													3,130
Long-term portion												$	13,091

Included in “other” within the facilities category is $0.4 million in interest expense and $0.1 million of the impact of foreign currency translation adjustments and is partially offset by a reclass of $0.2 million from “facilities” to “other exit costs” to better reflect the remaining restructure accrual.

NOTE 4. CentrPort Transactions

In conjunction with the CentrPort Transactions, described in detail in Note 3 to the Company’s 2002 Consolidated Financial Statements, the Company designated CentrPort as a preferred vendor and committed to resell at least $5.0 million of CentrPort’s products and services during 2001 pursuant to a value added reseller agreement (“CentrPort Commitment”). Based primarily on the uncertain nature of the Company’s ability to meet this CentrPort Commitment, the Company deferred its gain of $4.1 million on the CentrPort Preferred Stock Sale. The original agreement provided that, if the CentrPort Commitment was not met, the Company was to remit the value of the shortfall to CentrPort in either CentrPort common stock from the Company’s holdings pursuant to a contractual per share fixed value, or in cash, at the Company’s election. As of December 31, 2001, the Company had sold $2.7 million in CentrPort products and services applicable to the CentrPort Commitment. As a result, the Company recognized $1.7 million in the fourth quarter of 2001 of the $4.1 million deferred gain that was recorded as of December 31, 2000. The remaining balance of the deferred gain on the Company’s balance sheet was equal to $2.3 million as of December 31, 2001. In February 2002, the Company, CentrPort and the CentrPort Investors were party to agreements which amended various conditions and commitments including the extinguishment of the Company’s CentrPort Commitment to sell further CentrPort products and services, the extinguishment of the Company’s obligation to pay the value of the shortfall in either cash or CentrPort common stock and the extension of the Company’s $2.5 million note receivable due from the CentrPort Investors to it until December 31, 2002, which was subsequently satisfied. Accordingly, the Company recognized the remaining deferred gain of $2.3 million in the first quarter of 2002.

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MODEM MEDIA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The Company is guarantor for CentrPort’s obligations under its lease for office space at 450 Post Road East, Westport, Connecticut for 16,900 square feet, which expires on June 30, 2010, subject to renewal. As of September 30, 2003, the aggregate remaining base rent and estimated operating expenses due under this lease was $5.8 million, subject to adjustment in accordance with the terms of the lease. This balance will be reduced by approximately $0.8 million per year through June 30, 2010. The lease provides that once 50% of the original lease term has expired, which will occur in July 2005, this guaranty may be replaced with an irrevocable letter of credit in favor of the landlord in an amount not to exceed the remaining base rent. Upon expiration of 50% of the lease term, CentrPort is required to obtain such a letter of credit. Additionally, CentrPort has agreed to cooperate with the Company to secure the Company’s release from its guaranty prior to that time, if possible. In the event that CentrPort were to default on its lease obligation, the Company would be liable for the aggregate remaining base rent and operating expenses at the time of default by CentrPort. In the event of a default, the Company would take all appropriate action to be reimbursed for this liability. Based on the Company’s understanding of CentrPort’s overall business conditions and financial viability, no provision has been recorded for this potential liability.

NOTE 5. Legal Proceedings

Beginning in August 2001, a number of substantially identical class action complaints alleging violations of the federal securities laws were filed in the United States District Court for the Southern District of New York naming as defendants Modem Media, Inc., certain of its officers (G.M. O’Connell, Chairman, Steven Roberts, former Chief Financial Officer, and, in certain actions, Robert C. Allen II, Board member, a Managing Director and former President), and certain named underwriters of its initial public offering (FleetBoston Robertson Stephens, Inc., BankBoston Robertson Stephens, Inc., Bear Stearns & Co., Inc., Nationsbanc Montgomery Securities and Banc of America Securities LLC) (the “Underwriters”). The complaints have since been consolidated into a single action, and a consolidated amended complaint was filed on April 24, 2002. The amended complaint alleges, among other things, that the underwriters of the Company’s initial public offering violated the securities laws by failing to disclose certain alleged compensation arrangements (such as undisclosed commissions or stock stabilization practices) in the offering’s registration statement and by engaging in manipulative practices to artificially inflate the price of Modem Media stock in the after-market subsequent to the IPO. The Modem Media defendants are named in the amended complaint pursuant to Section 11 of the Securities Act of 1933, and Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 on the basis of an alleged failure to disclose the Underwriters’ alleged compensation arrangements and manipulative practices. The complaint seeks unspecified damages. Similar complaints have been filed against over 300 other issuers that have had initial public offerings since 1998 and all such actions have been included in a single coordinated proceeding.

On June 30, 2003, a committee of our Board of Directors conditionally approved a proposed partial settlement with the plaintiffs in this matter. The settlement would provide, among other things, a release of Modem Media, Inc. and of the individual defendants for the conduct alleged in the action to be wrongful in the amended complaint. The Company would agree to undertake other responsibilities under the partial settlement, including agreeing to assign away, not assert, or release certain potential claims it may have against its Underwriters. Any direct financial impact of the proposed settlement is expected to be borne by the Company’s insurers. The committee agreed to approve the settlement subject to a number of conditions, including the participation of a substantial number of other issuer defendants in the proposed settlement, the consent of the Company’s insurers to the settlement, and the completion of acceptable final settlement documentation. Furthermore, the settlement is subject to a hearing on fairness and approval by the court overseeing the IPO Litigation. The settlement is partial because the Underwriters are not party to the settlement. We understand that a majority of the other issuer defendants in the consolidated actions have also conditionally approved the proposed settlement.

If the settlement is not finalized, the Company will continue to defend these actions vigorously. However, due to the inherent uncertainties of litigation, the Company cannot accurately predict the ultimate outcome of the litigation if the litigation is not settled. Any unfavorable outcome of this litigation could have an adverse impact on the Company’s business, financial condition and results of operations.

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MODEM MEDIA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

In August 2001, the Company’s subsidiary, Modem Media Canada, Inc. (“Modem Media Canada”), brought suit against City Core Properties, Ltd. (“Landlord”) in Ontario Supreme Court for breach of an office lease on the basis that the Landlord did not complete the building into which Modem Media Canada was to move (the “Space”). Modem Media Canada is claiming approximately $1.2 million in damages. The Landlord has counter-sued the Company, Modem Media Canada and certain of its officers and directors for breach of lease and is seeking damages in the amount of approximately $16.0 million. The Space was repossessed by a mortgage holder and has been sold to an unrelated third party. The Company is currently in discovery for this litigation. The Company believes that there is no basis for the counterclaims, it has meritorious defenses to the counterclaims and the Company intends to defend this action vigorously. Based on this belief, the Company believes that the resolution of these matters will not have a material adverse effect on its business, financial condition and results of operations.

From time to time, the Company becomes involved in various routine legal proceedings in the ordinary course of its business. Other than as noted above, the Company believes that the outcome of pending legal proceedings and unasserted claims in the aggregate will not have a material adverse effect on its business, financial condition and results of operations.

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

Overview

Founded in 1987, Modem Media is an interactive marketing strategy and services firm. We are a marketing partner to some of the world’s leading companies, including Delta Air Lines, General Motors, Michelin, IBM, Hewlett Packard, Sprint and Kraft. We define interactive marketing as the use of any interactive channel to reach and serve any target customer with the intention of generating measurable value, both to that customer and to the marketer. These “channels” include web sites and other internet applications, wireless applications, electronic mail, online marketing, advertising, promotions and other emerging communication channels. We use interactive marketing to help our clients realize greater value from their most vital asset—their customers. We approach this goal through the following business basics:

• We add profitable new customers for our clients, through brand awareness, demand generation, lead generation and customer acquisition initiatives,

• We increase our clients’ sales from current customers, through loyalty, retention, cross-sell and up-sell initiatives and through digital services and experiences that expand the breadth, depth and lifetime value of customer relationships, and

• We improve our clients’ marketing productivity, by migrating high cost sales, service and communication activities online and optimizing the cost and impact of activities that already are executed online.

We provide marketing and business strategy, marketing programs, creative design and technology development to address the unique business objectives, challenges and opportunities of each of our client companies. We tailor solutions across integrated service offerings that include the following:

Marketing Insights, Strategy and Planning

We help our clients discover and mine untapped opportunities to create revenue, reduce costs and capture the full value potential of their customers. This work begins and ends with our clients’ customers by understanding their needs and preferences, assessing their value to the client’s business, prioritizing customer segments and defining pragmatic strategies to realize value potential. Our planning teams guide clients on topics as wide-ranging as digital branding, technology architecture and planning and media partnership strategy.

Marketing Platform Design and Development

We design and build marketing platforms that enable our clients to create, manage and grow profitable relationships with their customers. These platforms include web sites and wireless applications, intranets and extranets that support our clients’ needs in communications, commerce and customer care. Our marketing platform teams bring expertise in both the creative and technical aspects of digital platform design including user interface and experience design, information architecture, application development, content management, personalization systems and marketing automation tools.

Marketing Program Design and Execution

We conceive, create and distribute the marketing programs that turn our clients’ prospects into customers. We test, track and optimize digital experiences to achieve each client’s marketing goals most effectively and efficiently. This work entails the development of innovative marketing ideas and data analysis. Our marketing program teams bring expertise in creative design and execution, marketing plan development, media services, as well as database marketing, management and analysis.

Headquartered in Norwalk, Connecticut, we also maintain offices in San Francisco, London and São Paulo.

Application of Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenue and expenses during a reporting period. Actual results can differ from those estimates and it is possible that the differences could be material.

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We believe the following accounting policies are critical to the understanding of the more significant judgments and estimates used in the preparation of our consolidated financial statements:

• revenue recognition,

• allowance for doubtful accounts,

• accounting for restructuring liabilities,

• accounting for income taxes,

• valuation of long-lived assets, investments and goodwill, and

• lease guarantees.

Revenue Recognition

We recognize revenues as services are rendered in accordance with SEC Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements (“SAB No. 101”). A majority of our revenues are derived from fixed-bid and retainer-based assignments. Unbilled revenues represent labor costs incurred and estimated earnings in excess of billings and production and other client-reimbursable out-of-pocket costs incurred in excess of billings. Amounts billed to clients in excess of revenues recognized to date are classified as deferred revenues. Our clients hire us on a fixed-bid, retainer or time-and-materials basis. We reassess our estimated costs on fixed-bid engagements periodically and, as needed for specific engagements, losses are accrued to the extent that costs incurred and anticipated costs to complete engagements exceed total anticipated billings. Provisions for losses on uncompleted fixed-bid contracts, if any, are recognized in the period in which such losses are determined. Out-of-pocket and other pass-through expenses are recognized as revenue in the period incurred. The cost of online media and email campaigns purchased by us for our clients is not included in revenue because we act as an agent on behalf of our clients.

Allowance for Doubtful Accounts

We assess the required amount of allowance for doubtful accounts based on past experience and the review of the aging and analysis of specific accounts.

Accounting for Restructuring Liabilities

Restructuring charges include the costs associated with our restructuring actions taken in the periods presented. Charges were recorded at the time the decision was made and plans were approved to restructure operations. The charges consisted of actual and estimated costs that were incremental to our ongoing operations and were incurred to close offices, reduce excess office facilities and equipment, and terminate employees. The liability for the excess office facilities is equal to the present value of the future minimum lease payments under contractual obligations offset by estimated future sublease payments. In determining the estimates for the excess office facilities, we evaluated our potential to sublease our excess office space and our ability to renegotiate various leases at more favorable terms and in some instances obtain relief through relocation of office space. These sublease estimates, which were made in connection with our real estate advisers, are based on current and projected conditions in the real estate and economic markets in which we have excess office space. If our assumptions about future events are more or less favorable than those we have projected, we may be required to adjust existing accrued restructuring liabilities associated with this excess office space.

We continue to pursue potential sublease opportunities in all of these markets. We have recently experienced some interest in our London office space and we will be pursuing this interest in the fourth quarter of 2003. Should we be able to sublease this office space, or any of our other office space, we would reverse the appropriate portion of the existing restructuring accrual related to this facility at such time.

Accounting for Income Taxes

We follow the provisions of SFAS No. 109, Accounting for Income Taxes. As part of the process of preparing our consolidated financial statements, we are required to estimate an income tax provision for each of the jurisdictions in which we operate. This process involves estimating the actual current tax provision or benefit together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We then assess the likelihood that deferred tax assets will be recovered from future taxable income and, to the extent it is determined that recovery is not likely, a valuation allowance is established. Significant management judgment is required in determining the provision or benefit for income taxes and the amount of valuation allowance that would be required. Historically, we have not taken benefits for losses generated by most of our foreign entities and accordingly have recorded a valuation allowance against their deferred tax assets. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to establish an additional valuation allowance that could materially impact our financial condition and results of operations.

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At September 30, 2003 deferred tax assets were $17.8 million, net of a $1.3 million valuation allowance. The net deferred tax assets of $17.8 million represents net operating loss carry forwards and deductible temporary differences, which are more likely than not to be utilized in the future. We considered all of the available evidence in evaluating the recoverability of our deferred tax assets; however, a change in circumstances, including expectations as to our projected future taxable income, may have a material impact on the recoverability of deferred tax assets and on future operating results.

Valuation of Long-lived Assets, Investments and Goodwill

We have a significant amount of long-lived assets, including fixed assets, goodwill and investments. We periodically evaluate the realizability of all of our long-lived assets. Future events could cause us to conclude that impairment exists and that the asset values associated with a given operation have become impaired. Any resulting impairment loss could have a material impact on our financial condition and results of operations.

We performed our annual goodwill impairment test during the fourth quarter of 2002 and determined that the goodwill was not impaired. We will continue to perform a goodwill impairment test annually, as well as when a triggering event indicates impairment may have occurred. We will perform our next annual goodwill impairment test during the fourth quarter of 2003. If our projections of future cash flows are lower than the current estimates, we may be required to recognize an impairment charge up to the carrying value of the goodwill of $43.2 million.

Lease Guarantee

We are the guarantor for CentrPort’s obligations under its lease for office space at 450 Post Road East, Westport, Connecticut, for 16,900 square feet, which expires on June 30, 2010, subject to renewal. As of September 30, 2003, the aggregate remaining base rent and estimated operating expenses due under this lease was $5.8 million, subject to adjustment in accordance with the terms of the lease. This balance will be reduced by approximately $0.8 million per year through June 30, 2010. The lease provides that once 50% of the original lease term has expired, which will occur in July 2005, this guaranty may be replaced with an irrevocable letter of credit in favor of the landlord in an amount not to exceed the remaining base rent. Upon expiration of 50% of the lease term, CentrPort is required to obtain such a letter of credit. Additionally, CentrPort has agreed to cooperate with us to secure our release from our guaranty prior to that time, if possible. In the event that CentrPort were to default on its lease obligation, we would be liable for the aggregate remaining base rent and operating expenses at the time of default by CentrPort. In the event of a default, we would take all appropriate action to be reimbursed for this liability. Based on our understanding of CentrPort’s overall business conditions and financial viability, no provision has been recorded for this potential liability.

Historical Results of Operations

Clients hire us on a fixed-fee, retainer or time-and-materials basis. A majority of our revenues are derived from fixed-fee engagements. We recognize revenues as services are rendered in accordance with SAB No. 101. We reassess our estimated costs on fixed-fee engagements periodically and, as needed for specific engagements, losses are accrued to the extent that costs incurred and anticipated costs to complete engagements exceed anticipated billings. Provisions for losses on uncompleted fixed-fee contracts, if any, are recognized in the period in which such losses are determined. The cost of online media and email campaigns purchased by us for our clients is not included in revenue because we act as an agent on behalf of our clients.

Our results of operations and our business depend on our relationships with a limited number of large clients with which we generally do not have long-term contracts. Our clients generally have the right to terminate their relationships with us without penalty and with relatively short or no notice. Once an engagement is completed, we cannot be assured that a client will engage us for further services. As a result, a client that generates substantial revenue for us in one period may not be a substantial source of revenue in a subsequent period. The termination of our business relationships with any of our significant clients, or a material reduction in the use of our services by any of our significant clients, could adversely affect our future financial performance.

Our ten largest clients accounted for 91% and 90% of consolidated revenues for the three months ended September 30, 2003 and 2002, respectively, and 88% and 87% of consolidated revenues for the nine months ended September 30, 2003 and 2002, respectively. Three clients individually accounted for 26%, 14% and 13% of our revenues in the three months ended September 30, 2003. Three clients accounted for 24%, 18% and 11% of our revenues in the nine months ended September 30, 2003. Four clients individually accounted for 21%, 20%, 12% and 11% of our revenues in the three months ended September 30, 2002. Three clients accounted for 18%, 15% and 11% of our revenues in the nine months ended September 30, 2002. We expect a relatively high level of client concentration to continue which may not necessarily involve the same clients from period to period.

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Cost of revenues consists of salaries, employee benefits and incentive compensation for our professional services staff, costs for temporary staff that we use to provide professional services and certain other direct costs. Selling, general and administrative expenses consist of salaries, employee benefits and incentive compensation of sales and marketing, new business development, administrative and other non-billed employees, certain other marketing costs, office rent, utilities, professional and consulting fees, travel, telephone and other related expenses.

Three Months Ended September 30, 2003 Compared to Three Months Ended September 30, 2002

Revenues. Revenues decreased $3.2 million, or 18%, to $14.6 million for the three months ended September 30, 2003 from $17.8 million for the three months ended September 30, 2002. This decline in revenues was primarily attributable to a decrease in total billed hours, partially offset by an increase in average revenue per billed hour. This decline in total billed hours was attributable to a decrease in demand for our services due to the continued overall reduction in marketing spending from most of our significant clients.

Cost of Revenues. Cost of revenues decreased $1.9 million, or 20%, to $7.2 million for the three months ended September 30, 2003 from $9.1 million for the three months ended September 30, 2002. This decrease in cost of revenues was primarily due to a reduction in employee compensation and related expenses principally caused by a reduction in staff and to the use of consultants. This decrease was mainly in line with the reduced demand for our services.

Gross Profit. Gross profit margin increased to 51% of revenues for the three months ended September 30, 2003 from 49% for the three months ended September 30, 2002. This increase was primarily due to an increase in the average revenue per billed hour, as a result of a favorable improvement in the billed rates for several significant engagements and from the completion of certain lower margin projects during 2002. This increase in gross profit margin was partially offset by lower utilization (billed hours divided by total capacity hours of billed employees) of 70% for the three months ended September 30, 2003 versus 83% for the same period in 2002.

Selling, General and Administrative. Selling, general and administrative expenses decreased $0.5 million, or 9%, to $4.3 million for the three months ended September 30, 2003 from $4.8 million for the three months ended September 30, 2002. The decrease in selling, general and administrative expenses were primarily due to a reduction in employee compensation and related expenses mainly caused by a reduction in staff. In addition, facilities-related expenses decreased due to the restructuring actions taken in 2002. The decrease was partially offset by the absence of a benefit of $0.5 million from the favorable settlement during the third quarter of 2002 of previously accrued liabilities.

Restructuring and Other Charges (Credits), Net. Restructuring and other charges (credits), net, of $(1.1) million for the three months ended September 30, 2003 represent the reversal of previously recorded restructuring charges as a result of sub-letting office space within our San Francisco office. There were no restructuring and other charges (credits), net, for the three months ended September 30, 2002. Restructuring and other charges (credits), net, consists of facilities charges, severance costs and other office related costs.

Depreciation and Amortization. Depreciation and amortization decreased $0.5 million to $0.6 million for the three months ended September 30, 2003 from $1.1 million for the three months ended September 30, 2002. The decrease in depreciation and amortization was attributable to the write-off of certain property and equipment in 2002 and to certain assets becoming fully depreciated during the last quarter of 2002 and the first half of 2003.

Interest Income. Interest income decreased by $0.1 million to $0.1 million for the three months ended September 30, 2003 from $0.2 million for the three months ended September 30, 2002. This decrease was primarily attributable to the decrease in average interest rates for the three months ended September 30, 2003 compared to the same period in 2002.

Other Income (Expense), Net. Other expense, net, increased $0.4 million to $0.2 million for the three months ended September 30, 2003 from income of $0.2 million for the three months ended September 30, 2002. Other expense increased primarily as a result of the absence of a benefit of $0.4 million from the favorable settlement during the third quarter of 2002 of previously accrued liabilities, partially offset by a decrease in interest expense of $0.1 million.

Provision for Income Taxes. The provision for income taxes for the three months ended September 30, 2003 was $1.5 million compared to $1.1 million for the three months ended September 30, 2002. The effective income tax provision rate was 42% for the three months ended September 30, 2003 compared to 35% for the three months ended September 30, 2002. We provide for income taxes in the jurisdictions in which we pay income taxes at the statutory rates in effect in each jurisdiction, adjusted for differences in providing for income taxes between financial reporting and income tax purposes. The effective tax rates differ from the federal statutory rates due to the impact of state taxes, non-deductible items and changes in the valuation allowances recorded against losses generated by certain foreign entities.

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Nine Months Ended September 30, 2003 Compared to Nine Months Ended September 30, 2002

Revenues. Revenues decreased $10.6 million, or 19%, to $44.6 million for the nine months ended September 30, 2003 from $55.2 million for the nine months ended September 30, 2002. This decline in revenues was primarily attributable to a decrease in total billed hours, partially offset by an increase in average revenue per billed hour. This decline in total billed hours was attributable to a decrease in demand for our services due to the continued overall reduction in marketing spending from most of our significant clients.

Cost of Revenues. Cost of revenues decreased $6.3 million, or 23%, to $21.9 million for the nine months ended September 30, 2003 from $28.2 million for the nine months ended September 30, 2002. This decrease in cost of revenues was primarily due to a reduction in employee compensation and related expenses mainly caused by a reduction in staff.

Gross Profit. Gross profit margin increased to 51% of revenues for the nine months ended September 30, 2003 from 49% for the nine months ended September 30, 2002. This increase was primarily due to an increase in the average revenue per billed hour, as a result of a favorable improvement in the billed rates for several significant engagements and from the completion of certain lower margin projects during 2002. This increase in gross profit margin was partially offset by lower utilization (billed hours divided by total capacity hours of billed employees) of 72% for the nine months ended September 30, 2003 versus 78% for the same period in 2002.

Selling, General and Administrative. Selling, general and administrative expenses decreased $3.0 million, or 18%, to $14.1 million for the nine months ended September 30, 2003 from $17.1 million for the nine months ended September 30, 2002. The decrease in selling, general and administrative expenses were mainly due to a reduction in employee compensation and related expenses principally caused by a reduction in staff. In addition, facilities-related expenses decreased due to the restructuring actions taken in 2002. The decrease was partially offset by the absence of a benefit of $0.5 million from the favorable settlement during the third quarter of 2002 of previously accrued liabilities.

Restructuring and Other Charges (Credits), Net. Restructuring and other charges (credits), net, of $(1.1) million for the nine months ended September 30, 2003 represent the reversal of previously recorded restructuring charges as a result of sub-letting of certain office space within our San Francisco office. Restructuring and other charges (credits), net, of $7.9 million for the nine months ended September 30, 2002 include costs related to office leases for our excess facilities, fixed asset dispositions and severance costs related to the reduction of staff across multiple offices.

Depreciation and Amortization. Depreciation and amortization decreased $1.2 million, or 33%, to $2.4 million for the nine months ended September 30, 2003 from $3.6 million for the nine months ended September 30, 2002. The decrease in depreciation and amortization was attributable to the restructuring actions taken in 2002, which included the write-off of certain property and equipment, and to certain assets becoming fully depreciated during 2002 and 2003.

Interest Income. Interest income decreased by $0.2 million to $0.4 million for the nine months ended September 30, 2003 from $0.6 million for the nine months ended September 30, 2002. This decrease was primarily attributable to the decrease in average interest rates for the nine months ended September 30, 2003 compared to the same period in 2002.

Other Expense, Net. Other expense, net increased $0.4 million to $0.5 million for the nine months ended September 30, 2003 from $0.1 million for the nine months ended September 30, 2002. Other expense increased primarily due to the absence of a $0.4 million benefit from the favorable settlement during the third quarter of 2002 of previously accrued liabilities.

Provision for Income Taxes. The provision for income taxes for the nine months ended September 30, 2003 was $2.9 million compared to $0.6 million for the nine months ended September 30, 2002. The effective income tax provision rate was 40% for the nine months ended September 30, 2003 compared to 54% for the nine months ended September 30, 2002. We provide for income taxes in the jurisdictions in which we pay income taxes at the statutory rates in effect in each jurisdiction, adjusted for differences in providing for income taxes between financial reporting and income tax purposes. The effective tax rate differs from the federal statutory rate due to the impact of state taxes, non-deductible items and changes in the valuation allowances recorded against losses generated by certain foreign entities.

Cumulative Effect of Accounting Change. In accordance with SFAS No. 142, we performed the required transitional impairment test on our goodwill as of January 1, 2002. As a result of completing this test, we determined that the goodwill associated with our Munich operation was fully impaired as of January 1, 2002. Accordingly, we recorded a goodwill impairment charge of $3.4 million as a cumulative effect of an accounting change retroactive to January 1, 2002. There was no income tax benefit associated with this charge since we believed it was more likely than not that future taxable income in Munich, Germany would not be sufficient to realize the related income tax benefit.

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Liquidity and Capital Resources

We historically have financed our operations primarily from funds generated from operations. Net cash provided by operating activities was $4.2 million and $3.6 million for the nine months ended September 30, 2003 and 2002, respectively.

Net cash used in investing activities was $0.6 million for the nine months ended September 30, 2003 compared to $0.1 million for the nine months ended September 30, 2002. During the first nine months of 2003, we invested $1.2 million in capital expenditures. In addition, during the first nine months of 2003 we collected $0.6 million of notes receivable.

Net cash provided by (used in) financing activities was $0.3 million for the nine months ended September 30, 2003 compared to $(0.3) million for the nine months ended September 30, 2002. Our primary use of cash from financing activities during the nine months ended September 30, 2003 and 2002 were repayments of debt and capital lease obligations of $0.3 million and $0.8 million, respectively, and the purchase of treasury stock for $0.1 million and $0.02 million, respectively. Offsetting these items for the nine months ended September 30, 2003 and 2002 were proceeds from the exercise of employee stock options and purchases under the employee stock purchase plan of $0.7 million and $0.5 million, respectively.

We are the guarantor for CentrPort’s obligations under its lease for office space at 450 Post Road East, Westport, Connecticut, for 16,900 square feet, which expires on June 30, 2010, subject to renewal. As of September 30, 2003, the aggregate remaining base rent and estimated operating expenses due under this lease was $5.8 million, subject to adjustment in accordance with the terms of the lease. This balance will be reduced by approximately $0.8 million per year through June 30, 2010. The lease provides that once 50% of the original lease term has expired, which will occur in July 2005, this guaranty may be replaced with an irrevocable letter of credit in favor of the landlord in an amount not to exceed the remaining base rent. Upon expiration of 50% of the lease term, CentrPort is required to obtain such a letter of credit. Additionally, CentrPort has agreed to cooperate with us to secure our release from our guaranty prior to that time, if possible. In the event that CentrPort were to default on its lease obligation, we would be liable for the aggregate remaining base rent and operating expenses at the time of default by CentrPort. In the event of a default, we would take all appropriate action to be reimbursed for this liability. Based on our understanding of CentrPort’s overall business conditions and financial viability, no provision has been recorded for this potential liability.

In October 2002, we established a program to repurchase over an eighteen month period up to $5.0 million of our common stock. The timing and amount of purchases will be dependent upon a number of factors, including the price and availability of our common stock, general market conditions and other uses of funds. The program may be discontinued at any time. During the first nine months of 2003, we repurchased 45,100 shares of common stock at an average price of $2.19 per share for a total cost of $0.1 million under this program. In aggregate we have purchased 57,790 shares of common stock at an average price of $2.25 per share for a total cost of $0.1 million as of September 30, 2003.

Recently Issued Accounting Pronouncements

In March 2003, the EITF published Issue No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables,” (“EITF 00-21”). This issue addresses certain aspects of the accounting by a vendor for arrangements under which it performs multiple revenue-generating activities and how to determine whether such an arrangement involving multiple deliverables contains more than one unit of accounting for purposes of revenue recognition. The guidance is effective for revenue arrangements that we entered into in fiscal periods beginning after June 15, 2003. Accordingly, we adopted EITF 00-21 on July 1, 2003 and we have determined that the adoption of this statement did not have a material effect on our consolidated financial statements and disclosures.

In April 2003, the FASB issued Statement No. 149, “Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities,” (“Statement No. 149”). Statement No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities.” Statement No. 149 is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003 and is to be applied prospectively. We do not use derivative instruments, and therefore, the adoption of Statement No. 149 did not have a material impact on our consolidated financial statements.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our consolidated financial statements are denominated in U.S. dollars. For the three months ended September 30, 2003 and 2002, we derived 12% and 18%, respectively, of our revenues from operations outside of the U.S. For the nine months ended September 30, 2003 and 2002, we derived 13% and 20%, respectively, of our revenues from operations outside of the U.S. We face foreign currency risks primarily as a result of the revenues that we receive from services delivered through our foreign subsidiaries. These subsidiaries incur most of their expenses in the local currency. Accordingly, our foreign subsidiaries use the local currency as their functional currency. We are also exposed to foreign exchange rate fluctuations with respect to the British Pound and Brazilian Real as the financial results of foreign subsidiaries are translated into U.S. dollars for consolidation. As exchange rates vary, these results when translated may vary from expectations and adversely impact net income (loss) and operating performance. The effect of foreign exchange rate fluctuation for the three months and nine months ended September 30, 2003 and 2002 was not material. Currently, we do not hedge foreign currency transactions into U.S. dollars because we believe that, over time, the cost of a hedging program will outweigh any benefit of greater predictability in our U.S. dollar-denominated results. However, we would from time to time reconsider the issue of whether a foreign currency-hedging program would be beneficial to our operations.

We are exposed to interest rate risk primarily through our investments in cash equivalents and short-term investments. Our investment policy calls for investment in short-term, low risk instruments. We have limited our exposure to interest rate risk by investing in securities with maturities of one year or less.

ITEM 4. CONTROLS AND PROCEDURES

We conducted an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in ensuring that material information required to be disclosed by us in the reports that we file and submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

During the quarter ended September 30, 2003, there has not occurred any change in our internal controls over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Beginning in August 2001, a number of substantially identical class action complaints alleging violations of the federal securities laws were filed in the United States District Court for the Southern District of New York naming as defendants Modem Media, Inc., certain of our officers (G.M. O’Connell, Chairman, Steven Roberts, former Chief Financial Officer, and, in certain actions, Robert C. Allen II, Board member, a Managing Director and former President), and certain named underwriters of our initial public offering (FleetBoston Robertson Stephens, Inc., BankBoston Robertson Stephens, Inc., Bear Stearns & Co., Inc., Nationsbanc Montgomery Securities and Banc of America Securities LLC) (the “Underwriters”). The complaints have since been consolidated into a single action, and a consolidated amended complaint was filed on April 24, 2002. The amended complaint alleges, among other things, that the underwriters of our initial public offering violated the securities laws by failing to disclose certain alleged compensation arrangements (such as undisclosed commissions or stock stabilization practices) in the offering’s registration statement and by engaging in manipulative practices to artificially inflate the price of Modem Media stock in the after-market subsequent to the IPO. The Modem Media defendants are named in the amended complaint pursuant to Section 11 of the Securities Act of 1933, and Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 on the basis of an alleged failure to disclose the Underwriters’ alleged compensation arrangements and manipulative practices. The complaint seeks unspecified damages. Similar complaints have been filed against over 300 other issuers that have had initial public offerings since 1998 and all such actions have been included in a single coordinated proceeding.

On June 30, 2003, a committee of our Board of Directors conditionally approved a proposed partial settlement with the plaintiffs in this matter. The settlement would provide, among other things, a release of Modem Media, Inc. and of the individual defendants for the conduct alleged in the action to be wrongful in the amended complaint. We would agree to undertake other responsibilities under the partial settlement, including agreeing to assign away, not assert, or release certain potential claims we may have against our underwriters. Any direct financial impact of the proposed settlement is expected to be borne by our insurers. The committee agreed to approve the settlement subject to a number of conditions, including the participation of a substantial number of other issuer defendants in the proposed settlement, the consent of our insurers to the settlement, and the completion of acceptable final settlement documentation. Furthermore, the settlement is subject to a hearing on fairness and approval by the Court overseeing the IPO Litigations. The settlement is partial because the Underwriters are not party to the settlement. We understand that a majority of the other issuer defendants in the consolidated actions have also conditionally approved the proposed settlement.

If the settlement is not finalized, we will continue to defend these actions vigorously. However, due to the inherent uncertainties of litigation, we cannot accurately predict the ultimate outcome of the litigation if the litigation is not settled. Any unfavorable outcome of this litigation could have an adverse impact on our business, financial condition and results of operations.

In August 2001, our subsidiary, Modem Media Canada, Inc. (“Modem Media Canada”), brought suit against City Core Properties, Ltd. (“Landlord”) in Ontario Supreme Court for breach of an office lease on the basis that the Landlord did not complete the building into which Modem Media Canada was to move (the “Space”). Modem Media Canada is claiming approximately $1.2 million in damages. The Landlord has counter-sued us, Modem Media Canada and certain of our officers and directors for breach of lease and is seeking damages in the amount of approximately $16.0 million. The Space was repossessed by a mortgage holder and has been sold to an unrelated third party. We are currently in discovery for this litigation. We believe that there is no basis for the counterclaims, we have meritorious defenses to the counterclaims and we intend to defend this action vigorously. Based on this belief, we believe that the resolution of these matters will not have a material adverse effect on our business, financial condition and results of operations.

From time to time, we become involved in various routine legal proceedings in the ordinary course of our business. Other than as noted above, we believe that the outcome of pending legal proceedings and unasserted claims in the aggregate will not have a material adverse effect on our business, financial condition and results of operations.

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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

ITEM 5. OTHER INFORMATION

In accordance with Section 10A(i)(2) of the Securities Exchange Act of 1934, since the end of the second quarter of 2003, our Audit Committee has approved additional engagements of PricewaterhouseCoopers LLP, our independent auditors, to perform the following:

(a) non-audit services: evaluate our design of our internal controls that are required by section 404 of the Sarbanes-Oxley Act; and

(b) audit related services: audit our 401(K) employee benefit plan for the years ended December 31, 2002 and December 31, 2003.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

Exhibit No.	Description
31.1	Certification of Marc C. Particelli, President and Chief Executive Officer of Modem Media, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Frank J. Connolly, Jr., Chief Financial Officer of Modem Media, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32	Certification of Marc C. Particelli, President and Chief Executive Officer and Frank J. Connolly, Jr., Chief Financial Officer of Modem Media, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(b) Reports on Form 8-K

We filed a Form 8-K, dated August 5, 2003, reporting in Item 7, Item 9 and Item 12 that we issued a press release reporting our results of operations for the second quarter ended June 30, 2003 and guidance as to future results of operations.

We filed a Form 8-K, dated November 5, 2003, reporting in Item 7, Item 9 and Item 12 that we issued a press release reporting our results of operations for the third quarter ended September 30, 2003 and guidance as to future results of operations.

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SIGNATURES

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

Date: November 12, 2003	MODEM MEDIA, INC.
	By	/s/ FRANK J. CONNOLLY, JR.
		Frank J. Connolly, Jr. Chief Financial Officer (Principal Financial Officer)
	By	/s/ BRIAN J. DICK
		Brian J. Dick Vice President, Controller (Principal Accounting Officer)

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