-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FOVuJKN2cfEuGOemk1UjwR33WHlSnjwsPgxOnIsZQuRpva3fzsAEimvWMyygWnzl cbdQ33qSWORi/igag/JSPQ== 0000912057-02-020873.txt : 20020515 0000912057-02-020873.hdr.sgml : 20020515 20020515172657 ACCESSION NUMBER: 0000912057-02-020873 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20020331 FILED AS OF DATE: 20020515 FILER: COMPANY DATA: COMPANY CONFORMED NAME: 24/7 MEDIA INC CENTRAL INDEX KEY: 0001062195 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-ADVERTISING [7310] IRS NUMBER: 133995672 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-29768 FILM NUMBER: 02653925 BUSINESS ADDRESS: STREET 1: 1250 BROADWAY STREET 2: 27TH FLOOR CITY: NEW YORK STATE: NY ZIP: 10001 BUSINESS PHONE: 2122317100 MAIL ADDRESS: STREET 1: 1250 BROADWAY CITY: NEW YORK STATE: NY ZIP: 10001 10-Q 1 a2080196z10-q.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark one) /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2002 or / / TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 0-29768 24/7 Real Media, Inc. (Exact name of registrant as specified in its charter) DELAWARE 13-3995672 (STATE OR OTHER JURISDICTION OF (IRS EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 7319 (STANDARD INDUSTRIAL CLASSIFICATION CODE) 1250 BROADWAY, NEW YORK, NY 10001 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) (212) 231-7100 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) Indicate by check mark whether the registrant 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 / / APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. CLASS OUTSTANDING AT May 13, 2002 Common Stock, par value $.01 per share 50,707,670 Shares 24/7 REAL MEDIA, INC. MARCH 31, 2002 FORM 10-Q INDEX Part I. Financial Information Item 1. Consolidated Financial Statements Consolidated Balance Sheets as of March 31, 2002 (unaudited) and December 31, 2001..................... 2 Consolidated Statements of Operations for the three months ended March 31, 2002 and 2001 (unaudited)............................................................ 3 Consolidated Statements of Cash Flows for the three months ended March 31, 2002 and 2001 (unaudited)............................................................. 4 Notes to Unaudited Interim Consolidated Financial Statements........................................... 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......................................................................................... 16 Item 3. Quantitative and Qualitative Disclosure about Market Risk..................................... 24 Part II. Other Information Item 1. Legal Proceedings............................................................................. 38 Item 2. Changes in Securities and Use of Proceeds..................................................... 38 Item 3. Defaults Upon Senior Securities............................................................... 38 Item 4. Submission of Matters to a Vote of Security Holders........................................... 38 Item 5. Other Information............................................................................. 38 Item 6. Exhibits and Reports on Form 8-K.............................................................. 38 Item 7. Signatures.................................................................................... 38
1 24/7 REAL MEDIA, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
March 31, December 31, 2002 2001 ------------ --------------- (unaudited) (notes 1 and 3) ASSETS Current assets: Cash and cash equivalents........................................ $ 4,668 $ 6,974 Restricted cash.................................................. - 1,500 Accounts receivable, less allowances of $2,269 and $2,493, respectively............................................ 8,820 9,623 Net current assets of discontinued operation..................... - 738 Receivable from related party.................................... 600 - Prepaid expenses and other current assets........................ 2,252 1,931 ------------ --------------- Total current assets........................................... 16,340 20,766 Property and equipment, net........................................ 5,217 6,308 Intangible assets, net............................................. 13,979 14,518 Net long-term assets of discontinued operation..................... - 1,700 Receivable from related party...................................... - 600 Other assets....................................................... 2,332 1,452 ------------ --------------- Total assets $ 37,868 $ 45,344 ============ =============== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable................................................. $ 7,947 $ 8,781 Accrued liabilities.............................................. 13,495 16,306 Current installments of obligations under capital leases......... 47 42 Deferred revenue................................................. 2,134 2,422 Deferred gain on sale of subsidiary.............................. 684 2,308 ------------ --------------- Total current liabilities...................................... 24,307 29,859 Obligations under capital leases, excluding current installments... 97 112 Loan payable - related party....................................... 6,000 4,500 Minority interest.................................................. 21 21 Commitments and contingencies Stockholders' equity: Preferred stock, $.01 par value; 10,000,000 shares authorized and no shares issued and outstanding............................ - - Common stock, $.01 par value; 140,000,000 shares authorized; 50,220,440 and 49,532,127 shares issued and outstanding, respectively.................................................... 502 495 Additional paid-in capital....................................... 1,070,528 1,070,403 Deferred stock compensation...................................... (531) (670) Accumulated other comprehensive loss............................. (77) (62) Accumulated deficit.............................................. (1,062,979) (1,059,314) ------------ --------------- Total stockholders' equity..................................... 7,443 10,852 ------------ --------------- Total liabilities and stockholders' equity..................... $ 37,868 $ 45,344 ============ ===============
See accompanying notes to unaudited interim consolidated financial statements. 2 24/7 REAL MEDIA, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXPECT SHARE AND PER SHARE DATA)
Three months ended March 31, ---------------------------- 2002 2001 ------------- ------------ (unaudited) (unaudited) Revenues: Integrated media solutions.......................................$ 7,516 $ 12,360 Technology solutions............................................. 3,235 5,248 ------------- ------------ Total revenues................................................. 10,751 17,608 ------------- ------------ Cost of revenues: Integrated media solutions....................................... 5,236 9,827 Technology solutions (exclusive of $7 in 2002 reported below as stock-based compensation)..................... 852 1,241 ------------- ------------ Total cost of revenues.......................................... 6,088 11,068 ------------- ------------ Gross profit.................................................... 4,663 6,540 ------------- ------------ Operating expenses: Sales and marketing (exclusive of $41 and $358, respectively, reported below as stock-based compensation)....... 3,044 8,015 General and administrative (exclusive of $186 and $711, respectively, reported below as stock-based compensation)....... 3,970 12,210 Product technology (exclusive of $36 and ($53), respectively, reported below as stock-based compensation)....... 1,338 4,986 Amortization of goodwill and intangible assets................... 542 6,944 Stock-based compensation......................................... 270 1,016 Restructuring costs.............................................. - 347 Gain on sale of assets, net...................................... (874) - Impairment of intangible assets.................................. - 35,547 ------------- ------------ Total operating expenses....................................... 8,290 69,065 ------------- ------------ Loss from operations........................................... (3,627) (62,525) Interest income (expense), net..................................... (38) 345 Gain on sale of investments, net................................... - 3,998 Impairment of investments.......................................... - (3,089) ------------- ------------ Loss from continuing operations.................................... (3,665) (61,271) Loss from discontinued operations.................................. - (17,416) ------------- ------------ Net loss...........................................................$ (3,665) $ (78,687) ============= ============ Loss per common share - basic and diluted Loss from continuing operations....................................$ (0.07) $ (1.43) Loss from discontinued operations.................................. - (0.41) ------------- ------------ Net loss...........................................................$ (0.07) $ (1.84) ============= ============ Weighted average shares outstanding................................ 49,873,034 42,691,843 ============= ============
See accompanying notes to unaudited interim consolidated financial statements. 3 24/7 REAL MEDIA, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
Three Months Ended March 31, ---------------------------- 2002 2001 ------------- ------------ (unaudited) (unaudited) Cash flows from operating activities: Net loss......................................................... $ (3,665) $ (78,687) Adjustments to reconcile net loss to net cash used in operating activities: Loss from discontinued operation................................. - 17,416 Depreciation and amortization.................................... 1,041 4,084 Provision for doubtful accounts and sales reserves............... 388 472 Amortization of goodwill and other intangible assets............. 542 6,944 Non-cash compensation............................................ 270 1,016 Gain on sale of investments, net................................. - (3,998) Gain on sale of non-core assets, net............................. (874) - Loss on disposal of fixed assets................................. 80 625 Warrants issued for services..................................... - 100 Impairment of investments........................................ - 3,089 Impairment of intangible assets.................................. - 35,547 Changes in operating assets and liabilities, net of effect of acquisitions and dispositions: Accounts receivable............................................ 415 12,027 Prepaid assets and other current assets........................ (21) (649) Other assets................................................... 795 802 Accounts payable and accrued liabilities....................... (3,745) (13,315) Deferred revenue............................................... (288) (1,282) ------------- ------------ Net cash used in operating activities........................ (5,062) (15,809) ------------- ------------ Cash flows from investing activities: Proceeds from sale of investments................................ - 6,113 Capital expenditures, including capitalized software............. (32) (159) ------------- ------------ Net cash (used in) provided by investing activities.......... (32) 5,954 ------------- ------------ Cash flows from financing activities: Proceeds from issuance of note payable........................... 1,500 - Proceeds from exercise of stock options.......................... - 36 Payment of capital lease obligations............................. (10) (9) Proceeds from sale of non core assets............................ 1,272 - ------------- ------------ Net cash provided by financing activities.................... 2,762 27 ------------- ------------ Net change in cash and cash equivalents...................... (2,332) (9,828) Effect of foreign currency on cash............................... 26 228 Cash used by discontinued operations............................. - (5,529) Cash and cash equivalents at beginning of period................. 6,974 25,653 ------------- ------------ Cash and cash equivalents at end of period....................... $ 4,668 $ 10,524 ============= ============
See accompanying notes to unaudited interim consolidated financial statements. 4 (1) SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES SUMMARY OF OPERATIONS AND GOING CONCERN On November 9, 2001, the Company amended its Certificate of Incorporation to change its name from 24/7 Media, Inc. to 24/7 Real Media, Inc ("24/7 Real Media" or the "Company"). 24/7 Real Media together with its subsidiaries is a provider of marketing solutions to the digital advertising industry including Web publishers, online advertisers, advertising agencies, e-marketers and e-commerce merchants. In October 2001, through the merger with Real Media, the Company has expanded its operations into Europe. The Company operates in two principal lines of business: Integrated Media Solutions and Technology Solutions. - Integrated Media Solutions connects advertisers to audiences via Web-based advertising including banner ads, sponsorships, targeted search traffic delivery, and promotions as well as serves as a list broker for permission-based email lists. - Technology Solutions, through Open Adstream, its propriety technology, provides advertising delivery and management. The Company's business is characterized by rapid technological change, new product development and evolving industry standards. Inherent in the Company's business are various risks and uncertainties, including its limited operating history, unproven business model and the limited history of commerce and advertising on the Internet. The Company's success may depend, in part, upon the continued expansion of the Internet as a communications medium, prospective product development efforts and the acceptance of the Company's solutions by the marketplace. The Company's independent public accountants have included a "going concern" explanatory paragraph in their audit report accompanying the 2001 consolidated financial statements which have been prepared assuming that the Company will continue as a going concern. The explanatory paragraph states that the Company's recurring losses from operations since inception and working capital deficiency raise substantial doubt about the Company's ability to continue as a going concern and that the consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. ORGANIZATION AND BASIS OF PRESENTATION PRINCIPLES OF CONSOLIDATION The Company's consolidated financial statements as of March 31, 2002 and December 31, 2001 and for the three months ended March 31, 2002 and 2001 include the accounts of the Company and its majority-owned and controlled subsidiaries from their respective dates of acquisition (see note 2). When losses applicable to minority interest holders in a subsidiary exceed the minority interest in the equity capital of the subsidiary, these losses are included in the Company's results, as the minority interest holder has no obligation to provide further financing to the subsidiary. All significant intercompany transactions and balances have been eliminated in consolidation. INTERIM RESULTS The consolidated financial statements as of March 31, 2002 and for the three months ended March 31, 2002 and 2001 have been prepared by 24/7 Real Media and are unaudited. In the Company's opinion, the unaudited consolidated financial statements have been prepared on the same basis as the annual consolidated financial statements and reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly the financial position as of March 31, 2002 and the results of the Company's operations and cash flows for the interim periods ended March 31, 2002 and 2001. The financial data and other information disclosed in these notes to the consolidated results for the three months ended March 31, 2002 and 2001 are not necessarily indicative of the results to be expected for any subsequent quarter or the entire fiscal year ending December 31, 2002. 5 Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the Securities and Exchange Commission's rules and regulations. It is suggested that these unaudited consolidated financial statements be read in conjunction with our audited consolidated financial statements and notes thereto for the year ended December 31, 2001 as included in the Company's report on Form 10-K. CASH AND CASH EQUIVALENTS The Company considers all highly liquid securities, with original maturities of three months or less, to be cash equivalents. Cash and cash equivalents consisted principally of money market accounts. UNBILLED RECEIVABLES At March 31, 2002 and December 31, 2001, accounts receivable included approximately $2.8 million and $2.4 million, respectively, of earned but unbilled receivables, which are a normal part of the Company's business. The terms of the related advertising contracts typically require billing at the end of each month. All unbilled receivables as of March 31, 2002 have been subsequently billed. COMPREHENSIVE LOSS Total comprehensive loss for the three month periods ended March 31, 2002 and 2001 was $(3.7) million and $(82.1) million, respectively. Comprehensive loss resulted primarily from net losses of $(3.7) million and $(78.7) million, respectively, as well as a change in unrealized gains (losses)(net of tax), of marketable securities of $0 and $(3.6) million, respectively, and foreign currency translation adjustments of $0 and $0.2 million, respectively. The net change in unrealized gains (losses) of $3.6 million for the three months ended March 31, 2001 is comprised of net unrealized holding losses arising during the period of $5.1 million related to chinadotcom, a reclassification adjustment of $4.0 million for net gains of the sale of investments in marketable securities and a reclassification adjustment of $2.5 million for other-than-temporary losses related to available-for-sale securities of Network Commerce and i3Mobile. LOSS PER SHARE Loss per share is presented in accordance with the provisions of Statement of Financial Accounting Standards No. 128, Earnings Per Share ("EPS"). Basic EPS excludes dilution for potentially dilutive securities and is computed by dividing income or loss available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock and resulted in the issuance of common stock. Diluted net loss per share is equal to basic net loss per share since all potentially dilutive securities are anti-dilutive for each of the periods presented. Diluted net loss per common share for the three months ended March 31, 2002 and 2001 does not include the effects of options to purchase 8.3 million and 11.9 million shares of common stock, respectively; 4.0 million and 2.8 million common stock warrants; and 0.1 million and 0.3 million shares of unvested restricted stock, respectively, on an "as if" converted basis, as the effect of their inclusion is anti-dilutive during each period. RECLASSIFICATIONS Certain reclassifications have been made to prior year consolidated financial statements to conform to current year's presentation. 6 (2) BUSINESS COMBINATIONS ACQUISITION OF REAL MEDIA On October 30, 2001, the Company entered into a merger agreement with Real Media, Inc. ("Real Media"), a privately-held Delaware Corporation. Pursuant to the Agreement and Plan of Merger, the Company acquired all the outstanding common and preferred shares of Real Media in a merger transaction whereby an indirect subsidiary of the Company was merged with and into Real Media, in exchange for approximately 8.2 million shares valued at $2.2 million of the Company's common stock, equal to 19.9 percent of the Company common stock prior to the merger. The total purchase price of $6.7 million also included acquisition and transaction costs of $0.9 million and assumption of $3.6 million in net liabilities. The merger created cost reductions for the combined Company, one of which was to focus on Real Media's proprietary Open AdStream technology ("OAS") and abandon the Company's existing technology, 24/7 Connect. Other cost reductions were achieved through the elimination of redundant personnel, renegotiating affiliate contracts with low split rates on the Real Media network, renegotiation of supplier contracts at better rates due to increased volume and the consolidation of numerous offices. The Company also adopted a new name "24/7 Real Media, Inc." to capitalize on the Real Media and 24/7 brand names. The purchase price in excess of the value of net liabilities acquired of $6.7 million has been allocated $3.5 million to acquired technology, $0.5 million to tradename and $2.7 million to goodwill. The acquired technology and tradename are being amortized over the expected period of benefit of four years. The acquisition was accounted for as a purchase business combination in accordance with Statement of Financial Accounting Standards Board 141, "Business Combinations" and Statement of Financial Accounting Standards Board 142, "Goodwill and Other Intangible Assets". Accordingly, goodwill was not amortized. The Company also guaranteed a Promissory Note for $4.5 million issued by Publigroupe USA Holding, Inc. ("Publigroupe"), former principal shareholder of Real Media, as of the acquisition date, which was to be used primarily to finance Real Media's restructuring plan. The note bears interest at 4.5% and principal and interest are due on October 30, 2006. The restructuring plan provides for office closings of $0.2 million, workforce reduction of approximately 120 employees for $3.1 million and other related obligations of $1.2 million (see note 9). Publigroupe also promised to provide additional funding in the form of three-year notes of $1.5 million which was received in January 2002 and $1.5 million based on the Company achieving certain target operating results for the three months ended March 31, 2002, which was received on May 13, 2002. In addition, certain key executives had clauses in their Real Media employment agreements that called for transactional bonuses to be paid in the case of a change in control. These bonuses of $0.5 million were assumed as part of the acquisition and were paid in November 2001. The net liabilities acquired consist of the following:
ASSET/LIABILITY AMOUNT --------------- -------- Cash ........................................................$ 6,343 Accounts receivable ......................................... 6,405 Fixed assets ................................................ 2,248 Receivable--Publigroupe ..................................... 600 Other assets ................................................ 1,411 Accounts payable and accrued liabilities .................... (13,870) Deferred revenue ............................................ (2,249) Note payable--Publigroupe ................................... (4,500) -------- $ (3,612) ========
The following unaudited pro forma consolidated amounts give effect to the Company's acquisition of Real Media accounted for by the purchase method of accounting as if it had occurred at the beginning of the period by consolidating the results of operations of the acquired entity for the three month period ended March 31, 2001. 7 The unaudited pro forma consolidated statements of operations are not necessarily indicative of the operating results that would have been achieved had the transactions been in effect as of the beginning of the periods presented and should not be construed as being representative of future operating results.
THREE MONTHS ENDED MARCH 31, 2001 ------------------------------- (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) Total revenues.........................................................$ 25,401 ------------------------------- Loss from continuing operations........................................ (67,460) Loss from discontinued operations...................................... (17,416) ------------------------------- Net loss...............................................................$ (84,876) =============================== Basic and diluted loss per share Loss from continuing operations........................................$ (1.33) Loss from discontinued operations...................................... (0.34) ------------------------------- Net loss...............................................................$ (1.67) =============================== Weighted average shares used in net loss per share calculation (1)................................ 50,908,711 ===============================
(1) The weighted average shares used to compute pro forma basic and diluted net loss per share for the period ended March 31, 2001 includes the 8,216,868 shares issued for Real Media as if the shares were issued on January 1, 2001. (3) DISCONTINUED OPERATIONS EUROPE On August 6, 2001, the Company, determined that it would cease funding its European subsidiaries and communicated that to 24/7 Europe NV's management team and Board of directors. Management of 24/7 Europe advised the Company that 24/7 Europe NV was insolvent and shut down all operations in the third quarter of 2001. During the second quarter of 2001, the Company had reduced the carrying value of the net assets of the European operations to zero. The write down included $12.3 million in impairment charges related to goodwill and other intangible assets, which was included within discontinued operations in the second quarter of 2001 statement of operations. IMAKE In accordance with SFAS 144, operations meeting the definition of a component of an entity are treated as discontinued operations when sold. On January 22, 2002, the Company completed the sale of its wholly owned subsidiary, IMAKE Software & Services, Inc, to Schaszberger Corporation, the previous owner and officer of IMAKE. Under the terms of the sale, the purchase price payable by the buyer was approximately $6.5 million for the stock of IMAKE of which $2.0 million was in the form of a 6% four year secured note, approximately $500,000 in cash consideration, a potential earnout of up to $4 million over the next three years based on gross revenue as defined in the agreement and Series A preferred stock of Schaszberger Corp which as of the closing date represented 19.9% of the buyer. The Note secured by certain assets of IMAKE is guaranteed by Schaszberger Corporation. In the event that the earnout is not met within the three year period, the Company is entitled to receive a $1.00 Warrant for common stock equivalent to the difference between $3.0 million and actual earn out paid to date. The shares to be received is based on a third party outside valuation of the Buyer at December 31, 2005 and a ratio set forth in the agreement. The consideration paid to the Company was determined as a result of negotiations between the buyer and the 8 Company. The Company has discounted the note receivable and recorded the net present value of the earnout based on its estimates of projected revenues and reflected $0.5 million and $1.5 million, respectively. In January, the Company received the upfront cash consideration of $0.5 million and has been receiving the monthly earnout payments as scheduled. As of March 31, 2002, there are approximately $0.3 million in prepaid expenses and other current assets and $1.7 million in other assets related to IMAKE on the consolidated balance sheet. The consolidated financial statements of the Company have been restated to reflect the disposition of the international segment and the sale of the IMAKE subsidiary as a discontinued operation in accordance with SFAS 144 and APB Opinion No. 30. Accordingly, revenues, costs and expenses, assets, liabilities, and cash flows of Europe and IMAKE have been excluded from the respective captions in the Consolidated Statements of Operations, Consolidated Balance Sheets and Consolidated Statements of Cash Flows, and have been reported through the date of disposition as "Loss from discontinued operations," "Net assets of discontinued operations," and "Net cash used by discontinued operations," for all periods presented. Summarized financial information for the discontinued operations is as follows (in thousands): STATEMENT OF OPERATIONS DATA
THREE MONTHS ENDED MARCH 31, 2001 ------------------ Revenue.......................................... $ 7,669 Net loss......................................... 17,416
BALANCE SHEET DATA
DECEMBER 31, 2001 --------------- Net current assets of discontinued operation................ $ 738 Net total assets of discontinued operation.................. $ 2,438
(4) DISPOSAL OF NON-CORE ASSETS On May 23, 2001, the Company completed the sale of Exactis to Direct Marketing Technologies, Inc., a subsidiary of Experian Marketing Solutions, Inc. ("Experian"). The purchase price was $15.25 million of which $1.5 million was deposited into escrow until August 2002 as security for the Company's indemnification obligations under the Stock Purchase Agreement and $1.75 million was retained as a prepayment for future services that are to be purchased by the Company from Experian pursuant to a services agreement that expires on December 31, 2002. During the second quarter of 2001, the $1.5 million in escrow and $1.75 million prepayment had been reflected as deferred gain on sale of non-core assets on the consolidated balance sheet. In September 2001, the Company received a letter from Experian alleging that the Company made certain misrepresentations and omissions in connection with the Stock Purchase Agreement relating to the sale of Exactis. On March 27, 2002, the Company and Experian reached a settlement agreement whereby the Company authorized the escrow agent to release $750,000 to Experian, and Experian authorized the escrow agent to release the remaining balance of approximately $780,000 to the Company. On March 28, 2002, the funds were released to the Company. Upon release of the escrow balance, the Company recognized $750,000 of the deferred gain related to the sale as gain on sale of non-core assets in the 2002 statement of operations and $30,000 as interest income. During the quarter ended March 31, 2002, the Company was billed approximately $124,000 in services which have been reflected as cost of revenues and gain on sale of non core assets in the statement of operations. Through March 31, 2002, the sale has resulted in a cumulative loss of $3.5 million, not including the 9 remainder of the aforementioned deferred gains of $0.7 million. The Company has reflected the remaining $0.7 million of prepaid services in prepaid and other current assets on the consolidated balance sheet. (5) INTANGIBLE ASSETS, NET The Company performs on-going business reviews and, based on quantitative and qualitative measures, assesses the need to record impairment losses on long-lived assets used in operations when impairment indicators are present. Where impairment indicators were identified, the Company determined the amount of the impairment charge by comparing the carrying values of goodwill and other long-lived assets to their fair values. Through August 2000, the Company completed numerous acquisitions that were financed principally with shares of the Company's common stock and were valued based on the price of the common stock at that time. Starting with the fourth quarter of 2000, the Company reevaluated the carrying value of its businesses on a quarterly basis. The revaluation was triggered by the continued decline in the Internet advertising and marketing sectors throughout 2000 and 2001. In addition, each of these entities have experienced declines in operating and financial metrics over several quarters, primarily due to the continued weak overall demand of on-line advertising and marketing services, in comparison to the metrics forecasted at the time of their respective acquisitions. These factors significantly impacted current projected revenue generated from these businesses. The Company's evaluation of impairment was also based on achievement of the unit's business plan objectives and milestones, the fair value of each business unit relative to its carrying value, the financial condition and prospects of each business unit and other relevant factors. The business plan objectives and milestones that were considered included, among others, those related to financial performance, such as achievement of planned financial results, and other non-financial milestones such as successful deployment of technology or launching of new products and the loss of key employees. The impairment analysis also considered when these properties were acquired and that the intangible assets recorded at the time of acquisition were being amortized over useful lives of 2 - 4 years. The amount of the impairment charge was determined by comparing the carrying value of goodwill and other long-lived assets to fair value at each respective period end. Where impairment was indicated, the Company determined the fair value of its business units based on a market approach, which included an analysis of market price multiples of companies engaged in similar businesses. To the extent that market comparables were not available, the Company used discounted cash flows in determining the value. The market price multiples are selected and applied to the business based on the relative performance, future prospects and risk profile of the business in comparison to the guideline companies. The methodology used to test for and measure the amount of the impairment charge was based on the same methodology used during the initial acquisition valuations. As a result, during the Company's review of the value and periods of amortization of both goodwill and certain other intangibles it was determined that the carrying value of goodwill and certain other intangible assets were not recoverable. The other intangible assets that were determined to be impaired related to the decline in fair market value of acquired technology, a significant reduction in the acquired customer bases and turnover of workforce which was in place at the time of the acquisition of these companies. As a result, the Company determined that the fair value of goodwill and other intangible assets attributable to several of its operating units were less than their recorded carrying values. Accordingly, the Company recognized $35.5 million in impairment charges to adjust the carrying values in 2001 - $20.1 million related to Mail, $10.9 million related to WSR and $4.5 million related to Exactis. The impairment factors evaluated may change in subsequent periods, given that the Company's business operates in a highly volatile business environment. This could result in significant additional impairment charges in the future. As of March 31, 2002, the goodwill and other intangibles, net was $14.0 million: $6.6 million related to Real Media, $3.8 million related to Mail, $2.5 million related to WSR and $1.1 million related to ClickThrough. 10
March 31, December 31, Estimated 2002 2001 Useful Lives --------------- -------------- ------------ (in thousands) UNAMORTIZED INTANGIBLE ASSETS Goodwill.................................................. $ 8,321 $ 7,901 AMORTIZED INTANGIBLE ASSETS WITH FINITE LIVES Technology................................................ 6,004 6,001 4 Assembled workforce (1)................................... - 730 2 Trademark................................................. 500 500 4 --------------- -------------- 6,504 7,231 Less accumulated amortization............................. (846) (614) --------------- -------------- 5,658 6,617 --------------- -------------- Total $ 13,979 $ 14,518 =============== ==============
(1) In connection with the adoption of SFAS 142, on January 12, 2002, the Company reclassified $420 in net book value associated with its assembled workforce to goodwill. Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards Board No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142") and Statement of Financial Accounting Standards Board No. 144, "Accounting for the Impairment or Disposal of Long-Lived Asset ("SFAS 144"). SFAS 142 eliminates the amortization of goodwill and indefinite-lived intangible assets, addresses the amortization of intangible assets with finite lives and addresses impairment testing and recognition for goodwill and intangible assets. SFAS 144 establishes a single model for the impairment of long-lived assets and broadens the presentation of discontinued operations to include more disposal transactions on a prospective basis (see notes 3 and 13). In accordance with SFAS 144, no impairment charges resulted from the required impairment evaluations. The Company assesses goodwill for impairment annually unless events occur that require more frequent reviews. Long-lived assets, including amortizable intangibles, are tested for impairment if impairment triggers occur. Discounted cash flow analyses are used to assess nonamortizable intangible impairment while undiscounted cash flow analyses are used to assess long-lived asset impairment. If an assessment indicates impairment, the impaired asset is written down to its fair market value based on the best information available. Estimated fair market value is generally measured with discounted estimated future cash flows. Considerable management judgment is necessary to estimate undiscounted and discounted future cash flows. Assumptions used for these cash flows are consistent with internal forecasts. The Company will have an external valuation performed on its goodwill by June 30, 2002 and impairment that arise, if any, will be reflected as a cumulative effect of change in accounting principle as of January 1, 2002. The amortization expense and net loss for the periods ended March 31, 2002 and 2001 had SFAS 142 been applied for both periods is as follows: 11
2002 2001 -------- --------- Loss from continuing operations(1).............................. $ (3,665) $ (61,271) Add back: goodwill amortization................................. - 3,811 -------- --------- Adjusted loss from continuing operations...................... (3,665) (57,460) Loss from discontinued operations............................... - (17,416) -------- --------- Adjusted net loss............................................. $ (3,665) $ (74,876) ======== ========= Basic and diluted net loss per share: Loss from continuing operations................................. $ (0.07) $ (1.43) Add back: goodwill amortization................................. - 0.09 -------- --------- Adjusted loss from continuing operations...................... (0.07) (1.34) Loss from discontinued operations............................... - (0.41) -------- --------- Adjusted net loss per share................................... $ (0.07) $ (1.75) ======== ========= (1) Includes $35.5 million of goodwill impairment charges recorded in the three month period ended March 31, 2001.
(6) INVESTMENTS The fair value of the available-for-sale marketable securities is based on the quoted market values reported on NASDAQ. As of September 30, 2001, the Company has sold all of its marketable and cost based securities. During the three months ended March 31, 2001, the Company sold approximately 1.1 million shares of chinadotcom stock at prices ranging from $2.38 to $7.69 per share. The shares had a cost basis of $1.5 million, which resulted in a gain of approximately $4.5 million. The Company also sold a portion of its investments in Network Commerce and i3Mobile, which resulted in proceeds of $0.6 million and a loss of approximately $0.5 million. The Company's net gain on the sale of these investments are included in "Gain on sale of investments, net" within other income (expense) in the Company consolidated statement of operations. During the first quarter of 2001, the Company wrote down certain of its investments and recognized impairment charges of approximately $3.1 million for other-than-temporary declines in value of certain investments. The Company's management made an assessment of the carrying value of its cost-based investments and determined that they were in excess of their carrying values due to the significance and duration of the decline in valuations of comparable companies operating in the Internet and technology sectors. The write down of cost based investments was $0.6 million related to Media-Asia. The Company's management also recognized that the decline in value of its available-for-sale investments in Network Commerce and i3Moble were other-than-temporary and recorded an impairment of $2.3 million and $0.2 million, respectively. These impairment charges are included in "Impairment of investments" within other income (expense) in the Company's 2001 consolidated statement of operations. (7) COMMON STOCK During the first quarter of 2002, approximately 52 employees including members of senior management agreed to receive between 5-20% of their compensation in the form of the Company's common stock in lieu of cash. As a result, approximately 682,000 shares, with a fair market value of $0.2 million, were issued by March 31, 2002. These shares were issued out of the Company's 2001 Equity Compensation Plan ("2001 Equity Plan"). On March 23, 2001, the Company issued 710,000 shares of common stock to employees of the Company for meeting the earn-out provisions in the WSR merger agreement, as amended. The related compensation expense of approximately $0.2 million is reflected as stock based compensation expense in the 12 consolidated statements of operations. Substantially all of these shares were returned as part of the settlement with the former principal stockholders on September 25, 2001. On May 23, 2000, the Company offered certain members of management the option of exchanging their January 1, 2000 option grants for restricted stock in a ratio of one share for three options. As a result, the Company cancelled 832,500 options and issued approximately 285,000 shares of restricted stock to these employees of the Company, which vest over a period of three to four years. Such grants resulted in a deferred compensation expense of approximately $4.5 million, which is being amortized over the vesting period of those shares. For the three month periods ended March 31, 2002 and 2001, 7,000 and 120,000 shares, respectively, were granted to employees according to their vesting schedule. (8) STOCK INCENTIVE PLAN For the three month period ended March 31, 2002, the Company granted approximately 6.4 million stock options under the 1998 Stock Incentive Plan and 1.5 million stock options under the 2001 Stock Incentive Plan for Non-officers to employees at exercise prices based on the fair market value of the Company's common stock at the respective dates of grant. On January 1, 2002, in accordance in the terms of the Plan, shares available under the Plan were increased by 1,485,230. (9) RESTRUCTURING CHARGES During the first quarter 2001, restructuring charges of approximately $0.3 million were recorded by the Company in accordance with the provisions of EITF 94-3, and Staff Accounting Bulletin No. 100. The Company's restructuring initiatives were to reduce employee headcount by the involuntary termination of approximately 100 employees. The following sets forth the activities in the Company's restructuring reserve for the three months ended March 31, 2002, which is included in accrued expenses in the consolidated balance sheet (in thousands):
Beginning Current year Current year Ending Balance provision utilization Balance ------------ -------------- ------------- ------------ Employee termination benefits...... $ 2,489 $ - $ 1,504 $ 985 Office closing costs............... 266 - 129 137 Other exit costs................... 1,512 - 225 1,287 ------------ -------------- ------------- ------------ $ 4,267 $ - $ 1,858 $ 2,409 ============ ============== ============= ============
(10) SEGMENT INFORMATION On October 30, 2001, the Company merged with Real Media. As a result of this merger and the restructuring performed by both companies, the Company has changed how it operates its businesses and views its reportable segments. Based on these operational changes the consolidated financial statements presented have been restated to reflect these new reportable segments. The Company's business is currently comprised of two reportable segments: integrated media solutions and technology solutions. The integrated media solutions segment generates the majority of its revenues by delivering advertisements and promotions to affiliated Web sites, search engine traffic delivery and marketing services to target online users compiled by list management. The technology solutions segment generates revenue by providing third party ad serving, email delivery service bureau, broadband software solutions and technology services. The Company's management reviews corporate assets and overhead expenses for each segment. 13 The summarized segment information as of and for the three months ended March 31, 2002 and 2001, is as follows:
THREE MONTHS ENDED MARCH 31, 2002 THREE MONTHS ENDED MARCH 31, 2001 ----------------------------------- ---------------------------------- INTEGRATED INTEGRATED MEDIA TECHNOLOGY MEDIA TECHNOLOGY SOLUTIONS SOLUTIONS TOTAL SOLUTIONS SOLUTIONS TOTAL ------------ ----------- ---------- ----------- ----------- ---------- (IN THOUSANDS) Revenues......................... $ 7,516 $ 3,235 $ 10,751 $ 12,360 $ 5,248 $ 17,608 Segment loss from operations..... (3,551) (76) (3,627) (55,968) (6,557) (62,525) Amortization of goodwill and intangibles............... 292 250 542 6,290 654 6,944 Stock-based compensation (1)..... 37 - 270 471 (112) 1,016 Restructuring costs.............. - - - 174 173 347 Gain on sale of assets, net...... 874 - 874 - - - Impairment of intangible assets.. - - - 31,046 4,501 35,547 Total assets: March 31, 2002................ 25,125 12,743 37,868 December 31, 2001(2).......... 29,936 12,970 42,906
(1) Not included in the segment columns are stock based compensation of $233,000 and $657,000 for the periods ended March 31, 2002 and 2001, respectively, related to corporate employees. (2) Not included above at December 31, 2001 are $2.4 million in assets related to discontinued operations. Geographical information is as follows:
US INTERNATIONAL TOTAL ------------- ------------- ------------ (IN THOUSANDS) THREE MONTHS ENDED MARCH 31, 2002 Revenues ................................... $ 7,549 $ 3,202 $ 10,751 Long-lived assets .......................... 12,578 8,950 21,528 THREE MONTHS ENDED MARCH 31, 2001 Revenues ................................... $ 16,077 $ 1,531 $ 17,608 Long-lived assets at December 31, 2001 ..... 14,877 8,001 22,878
Not included above at December 31, 2001 are $1.7 million in long-lived assets related to discontinued operations. (11) SUPPLEMENTAL CASH FLOW INFORMATION The amount of cash paid for interest was $4,000 for both the three month periods ended March 31, 2002 and 2001. (12) RELATED PARTY LOAN PAYABLE In conjunction with the merger with Real Media, the Company also guaranteed a Promissory Note for $4.5 million issued by Publigroupe as of the acquisition date, which was to be used in accordance with Real Media's restructuring plan and in payment of transactional bonuses. The restructuring plan provides for office closings, workforce reduction and other related obligations (see note 9 for details). The note bears interest at 4.5% and principal and interest are due on October 30, 2006. In addition, in accordance with the Real Media purchase agreement in January 2002, the Company received cash of $1.5 million and signed a promissory note bearing interest at 6%, with interest and principal due in January 2006. Based on the Company achieving certain target operating results for the three months ended March 31, 2002 it received another $1.5 million in the form of a 6% three year promissory note on May 13, 2002. 14 RECEIVABLE FROM RELATED PARTY As of March 31, 2002, the Company has a $0.6 million receivable from a wholly owned subsidiary of Publigroupe, a principal stockholder. (13) SUBSEQUENT EVENTS STOCK BASED COMPENSATION During the second quarter of 2002, approximately 19 employees including members of senior management agreed to receive between 5-20% of their compensation in the form of the Company's common stock in lieu of cash. As a result, approximately 274,000 shares will be issued by July 31, 2002. SALE OF CERTAIN EMAIL ASSETS On May 3, 2002, the Company completed the sale of certain assets related to its Email management product, including customer contracts, certain intangibles and employee relationships, to 24/7 Mail, Inc., a wholly owned subsidiary of Naviant, Inc. The Company adopted the provisions of SFAS 144 on January 1, 2002. Under the terms of the sale, the purchase price payable is up to $4.5 million. The purchase price is comprised of (i) $1.0 million that was paid at closing; (ii) $1.0 million in the form of a non-interest bearing installment note with $350,000 due in ninety days, $350,000 due in one hundred and eighty days and $300,000 due in two hundred seventy days from closing; (iii) an earn-out payable quarterly over the next 45 months, based on 5% of Net Revenue (as defined in the Asset Purchase Agreement), with minimum payments of $600,000 and a maximum of $2.0 million. Lastly, pursuant to a $500,000 non-interest bearing installment note, half of which is payable on each of April 30, 2004 and April 30, 2005, Naviant has the option either to (i) issue to the Company a number of shares currently comprising 19.9% of 24/7 Mail, Inc., or (ii) pay the Company cash in lieu of the shares. The consideration paid to the Company was determined as a result of arms-length negotiations between the buyer and the Company. ISSUANCE OF STOCK FOR BONUSES In April 2002, the Company issued 416,784 shares, valued at $0.1 million, for 2001 bonuses as reported in the Company's 10-K and accrued as of December 31, 2001, principally to the CEO. 2002 EQUITY COMPENSATION PLAN On April 22, 2002, the Board approved the 24/7 Real Media, Inc. 2002 Equity Compensation Plan to enable the Company to offer and issue to certain employees, former employees, advisors and consultants of the Company and its affiliates its common stock in payment of amounts owed to such employees and third parties. The aggregate number of shares of common stock that may be issued pursuant to the 2002 Equity Compensation Plan shall not exceed 3,000,000 shares. The Company may from time to time issue to employees, former employees, advisors and consultants to the Company or its affiliates shares of its common stock in payment or exchange for or in settlement or compromise of amounts due by the Company to such persons for goods sold and delivered or to be delivered or services rendered or to be rendered. Shares of the Company's common stock issued pursuant to the 2002 Equity Compensation Plan will be issued at a price per share of not less than eighty-five percent (85%) of the fair market value per share on the date of issuance and on such other terms and conditions as determined by the Company. The Chief Executive Officer of the Company is authorized to issue shares pursuant to and in accordance with the terms of the 2002 Equity Compensation Plan, provided that all issuances shall be co-authorized by at least one of the President, any Executive Vice President, the Chief Financial Officer or the General Counsel. The plan may be amended at any time by the Company. 15 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE TERMS "WE" AND "OUR COMPANY" MEAN 24/7 Real Media, OUR SUBSIDIARIES AND EACH OF OUR PREDECESSOR ENTITIES. FORWARD-LOOKING STATEMENTS This report includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and we are including this statement for purposes of complying with these safe harbor provisions. We have based these forward-looking statements on our current expectations and projections about future events. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions, including those set forth under "--Risk Factors" below. Words such as "expect", "anticipate", "intend", "plan", "believe", "estimate" and variations of such words and similar expressions are intended to identify such forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this report might not occur. GENERAL 24/7 Real Media provides marketing solutions to the digital advertising industry. Through its comprehensive suite of online marketing and technologies services, 24/7 Real Media connects media buyers and media sellers across multiple digital platforms and works closely with individual clients to develop a comprehensive, customized, value-enhancing solution. Our business is organized into two principal lines of business: - Integrated Media Solutions: 24/7 Real Media connects advertisers to high-quality audiences through four products: (i) the 24/7 Network of marquee branded Web sites and prestigious niche Web sites; (ii) one of the largest permission based email databases; (iii) a comprehensive promotions suite; and (iv) a leading search engine results listings service. - Technology Solutions: OpenAdstream, our proprietary advertising delivery and management technology suite was developed by Real Media, which was subsequently acquired by 24/7 Media on October 30, 2001. 24/7 Real Media also partners with other companies to offer complementary plug-ins and modules. Through a global sales force and account management team, both local and centrally-served solutions are offered to Web sites, ad networks, ad agencies, and advertisers. On May 3, 2002, we sold certain assets of our email management product to 24/7 Mail, Inc., a wholly owned subsidiary of Naviant. Going forward the Company will no longer recognize revenue from managed lists. The sale combines 24/7 Mail which already has one of the largest and broadest permission email databases, with Naviant, a leading collector of opt-in consumer data and an industry leader in permission-based email marketing. Under the terms of the agreement, we will still act as brokers for email campaigns. We will recognize as revenue only the commission due to us as a broker. CRITICAL ACCOUNTING POLICIES Financial Reporting Release No. 60, which was recently released by the Securities and Exchange Commission (SEC), requires all companies to include a discussion of critical accounting policies or methods used in the preparation of financial statements. Note 1 of the Notes to the Consolidated Financial Statements includes a summary of the significant accounting policies and methods used by the Company. In addition, Financial Reporting Release No. 61 was recently released by the SEC to require all companies to include a discussion to address, among other things, liquidity, off balance sheet arrangements, contractual obligations and commercial commitments. 16 GENERAL The consolidated financial statements of the Company are prepared in conformity with accounting principles generally accepted in the United States of America. As such, the Company is required to make certain estimates, judgments and assumptions that management believes are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. The significant accounting policies which the Company believes are the most critical to aid in fully understanding and evaluating the reported consolidated financial results include the following: REVENUE RECOGNITION INTEGRATED MEDIA SOLUTIONS Our network revenues are derived principally from short-term advertising agreements in which we deliver advertising impressions for a fixed fee to third-party Web sites comprising our Network. Our email related revenues were derived principally from short-term delivery based agreements in which we deliver advertisements to email lists for advertisers and Web sites. Revenues are recognized as services are delivered provided that no significant obligations remain outstanding and collection of the resulting receivable is probable. Service revenue is derived from driving traffic to a client website or the delivery of email messages for clients both of which are recognized upon delivery. On May 3, 2002 the Company sold its email business and starting in May 2002 we will only recognize commissions from brokerage sales as revenue. Third party Web sites that register Web pages with our network and display advertising banners on those pages are commonly referred to as "Affiliated Web sites." These third party Web sites are not "related party" relationships or transactions as defined in Statement of Financial Accounting Standards No. 57, "Related Party Disclosures." We pay Affiliated Web sites a fee for providing advertising space to our network. We also have agreements with various list owners in which we service its advertisers and other customers through the use of these lists. We become obligated to make payments to Affiliated Web sites, which have contracted to be part of our network, and list owners in the period the advertising impressions or emails are delivered. Such expenses are classified as cost of revenues in the consolidated statements of operations. TECHNOLOGY SOLUTIONS Our technology revenues are derived from licensing of our ad serving software and related maintenance and support contracts. In addition, we derived revenue from our broadband and professional services subsidiary, IMAKE, which was sold in January, 2002; and our email service bureau subsidiary, Exactis, and our third party ad serving subsidiary, Sabela, both of which were sold in May of 2001. Revenue from software licensing agreements is recognized in accordance with Statements of Position ("SOP") 97-2, "Software Revenue Recognition," and Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" upon delivery of the software, which is generally when customers begin utilizing the software, there is pervasive evidence of an arrangement, collection is reasonably assured, the fee is fixed or determinable, and vendor-specific objective evidence exists to allocate the total fees to all elements of the arrangement. Revenue related to the central ad serving product is recognized based on monthly usage fees. Revenue from software maintenance and support services is recognized ratably over the life of the maintenance agreements, which typically do not exceed one year. Maintenance revenue invoiced in advance of the related services is recorded as deferred revenue. Expense from our licensing, maintenance and support revenues are primarily payroll costs incurred to deliver, modify and support the software. These expenses are classified as cost of revenues in the accompanying consolidated statements of operations. ACCOUNTS RECEIVABLE We perform ongoing credit evaluations of our customers and adjust credit limits based upon payment history and the customer's current credit worthiness, as determined by a review of their current credit information. We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon historical experience and any specific customer collection issues that have been identified. While such credit losses have historically been within our expectations and the provisions 17 established, we cannot guarantee that we will continue to experience the same credit loss rates that have been experienced in the past. IMPAIRMENT OF LONG-LIVED ASSETS We assess the need to record impairment losses on long-lived assets, including fixed assets, goodwill and other intangible assets, to be held and used in operations whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, we estimate the undiscounted future cash flows to result from the use of the asset and its ultimate disposition. If the sum of the undiscounted cash flows is less than the carrying value, we recognize an impairment loss, measured as the amount by which the carrying value exceeds the fair value of the asset. Assets to be disposed of are carried at their lower of carrying value or fair value less costs to sell. On an on-going basis, management reviews the value and period of amortization or depreciation of long-lived assets, including goodwill and other intangible assets. During this review, we reevaluate the significant assumptions used in determining the original cost of long-lived assets. Although the assumptions may vary from transaction to transaction, they generally include revenue growth, operating results, cash flows and other indicators of value. Management then determines whether there has been an impairment of the value of long-lived assets based upon events or circumstances, which have occurred since acquisition. The impairment policy is consistently applied in evaluating impairment for each of our wholly owned subsidiaries and investments. The impairment factors evaluated by us may change in subsequent periods, given that our business operates in a highly volatile business environment. This could result in significant additional impairment charges in the future. RESULTS OF OPERATIONS FACTORS AFFECTING COMPARABILITY OF 2002 TO 2001 On October 30, 2001, we acquired Real Media. The merger created cost synergies for our combined company, one of which was to focus on Real Media's proprietary Open Adstream technology and abandon our existing ad serving technology, 24/7 Connect. The transition of the network business onto the Open Adstream platform began in December 2001 and was completed in February 2002 resulting in the elimination of redundant personnel and operating costs associated with the two ad serving platforms, Open Adstream and 24/7 Connect. Throughout 2001, in accordance with our business plan, we divested or discontinued many of our non-core assets, including: - In May 2001, we completed the sale of certain technology assets and intellectual property of Sabela and completed the shut down of Sabela operations on June 30, 2001. - In May 2001, we completed the sale of Exactis, our email service bureau. - In August 2001, the operations of 24/7 Europe were shut down, which have been restated in our consolidated financial statements to reflect the disposition of this international segment. - In January 2002, we completed the sale of our IMAKE subsidiary. The financial statements of prior periods have been restated to reflect the disposition of IMAKE. The decline in 2002 revenue attributed to the disposition of these non-core assets was approximately $5.3 million as there was no revenue related to these entities in the first quarter of 2002. The decline does not include $7.7 million for 2001, related to Europe and IMAKE, which are shown as part of discontinued operations in the 2001 consolidated statement of operations. As a result of our cost-cutting and divestiture efforts, which began in November 2000 through December 31, 2001, we reduced our headcount by approximately 1,000 and closed several offices, both domestic and foreign. The core elements of our business that remain are: - Open Adstream ad serving technology, with one of the largest installed base of any ad serving solution in the world; - The 24/7 Network, one of the largest branded ad networks online; - 24/7 iPromotions, one of the most innovative online promotions and sweepstakes services; and - 24/7 Website Results, a leading traffic driving and keyword monetizing solution. 18 In addition, in May 2002, we completed the sale of certain assets related to our email management product, which had $1.3 million in revenue for the three months ended March 31, 2002. Starting in May 2002, we will no longer generate revenue from the sale of managed email lists. We will recognize only the commissions due to us from being a broker. RESULTS OF OPERATIONS REVENUES INTEGRATED MEDIA SOLUTIONS. Our Integrated Media Solutions revenues decreased $4.8 million, or 39.2% to $7.5 million for the three month period ended March 31, 2002 from $12.4 million for the three month period ended March 31, 2001. The decrease in revenue was due to a dramatic decrease in advertising dollars spent as the economy continued to deteriorate through-out the end of the first quarter of 2002 as a result of the economic recession. Online advertising was especially hard hit due to the collapse of other Internet companies, which were a significant portion of our customer base and as the advertising dollars available went toward traditional media. The declines in revenue were partially offset by our merger with Real Media on October 30, 2001. The US Email management product, which was sold on May 3, 2002 accounted for $1.3 million and $3.3 million for the periods ended March 31, 2002 and 2001, respectively. Our second quarter results will include only one month's revenue contribution from the US Email management product. TECHNOLOGY SOLUTIONS. Our Technology Solutions revenue decreased $2.0 million, or 38.4% to $3.2 million for the three month period ended March 31, 2002 from $5.2 million three month period ended March 31, 2001. The periods are not comparable as the revenue in 2002 is derived solely from operations that were acquired with Real Media on October 30, 2001, while the revenue in 2001 relates to operations that have been sold, including Exactis.com and Sabela. COST OF REVENUE AND GROSS PROFIT INTEGRATED MEDIA SOLUTIONS COST OF REVENUES AND GROSS PROFIT. The cost of revenues consists primarily of fees paid to affiliated Web sites, which are calculated as a percentage of revenues resulting from ads delivered on our Network; list providers and traffic providers; depreciation of our 24/7 Connect ad serving system (in 2001) and internet access costs. In 2002, cost associated with ad serving is accounted for in our Technology Solutions segment cost of revenues and an allocation based on usage is reflected in the Integrated Media Solutions cost of revenues, making these costs variable versus fixed as they were under 24/7 Connect. Gross margin increased from 20.5% in 2001 to 30.3% in 2002. The increase is due to lower adserving costs as the operations in 2001 could not support the fixed costs of 24/7 Connect which adversely affected the gross margin. Excluding the Email management product in the US, the margins increased from 15.3% for the three month period ended March 31, 2001 to 28.3% for the three month period ended March 31, 2002. TECHNOLOGY SOLUTIONS COST OF REVENUES AND GROSS PROFIT. The cost of technology revenues consists of the cost of equipment and broadband for our third party adserving solutions and payroll costs to deliver, modify and support software offset by the portion allocated to integrated media solutions for adserving. Gross margin decreased from 76.4% for the period ended March 31, 2001 to 73.7% for the period ended March 31, 2001. As noted above, the periods are not comparable as the segment is comprised of completely different operations. OPERATING EXPENSES. Each of sales and marketing, general and administrative and product technology expenses decreased significantly in the three month period ended March 31, 2002 compared to the three month period ended March 31, 2001 as a result of our restructuring activities, the decisions to and exit Latin America and the sale of Sabela and Exactis. The disposal of these divisions resulted in a decrease of the above expenses by 66.9% or $16.9 million from prior year. SALES AND MARKETING EXPENSES. Sales and marketing expenses consist primarily of sales force salaries and commissions, advertising expenditures and costs of trade shows, conventions and marketing materials. Sales and marketing expenses decreased as a percentage of revenue from 45.5% for the period ended 19 March 31, 2001 to 28.3% for the period ended March 31, 2002. This decrease is due to our successful rationalization efforts and reduction of discretionary expenses. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses consist primarily of compensation, facilities expenses and other overhead expenses incurred to support the business. General and administrative expenses decreased as a percentage of revenue from 69.3% for the period ended March 31, 2001 to 36.9% for the period ended March 31, 2002. The significant decrease is due to our rationalization efforts both in eliminating headcount, office space and unnecessary expenses. PRODUCT TECHNOLOGY EXPENSES. Product technology expenses consist primarily of compensation and related costs incurred to further enhance our ad serving and other technology capabilities. Product technology expenses decreased as a percentage of revenue from 28.3% for the period ended March 31, 2002 to 12.4% for the period ended March 31, 2001. The decrease is due to the sale of Exactis on whose technology we spent significant dollars and our focus on OAS which requires less enhancements than did 24/7 Connect. AMORTIZATION OF GOODWILL AND INTANGIBLES. Amortization of goodwill and intangibles was $0.5 million for the period ended March 31, 2002 and $7.0 million for the period ended March 31, 2001. The decrease is due to impairment charges taken during 2001 for Exactis, Sabela, AwardTrack, iPromotions, ConsumerNet and Website Results. The sale of Exactis in May 2001 and the adoption of FAS 142 which states that goodwill is no longer amortized also contributed to the decline. Had we not adopted FAS 142, the amortization related to goodwill and other intangibles would have been approximately $1.1 million higher than reported under FAS 142. STOCK-BASED COMPENSATION. Stock based compensation of $0.3 million for the period ended March 31, 2002 consists of $0.2 million in salary for certain employees who elected to receive stock instead of cash and $0.1 million in amortization of deferred compensation for restricted shares issued to certain employees. The $1.0 million for period ended March 31, 2001 consists of a $0.7 million in amortization of deferred compensation for restricted shares issued to certain employees, $0.1 million in amortization of deferred compensation from acquisitions and $0.2 million in stock to be given as bonuses to certain employees. RESTRUCTURING COSTS. During the period ended March 31, 2001 a restructuring charge of approximately $0.3 million was recorded related to the reduction of employee headcount. This restructuring involved the involuntary termination of approximately 100 employees. GAIN ON SALE OF ASSETS, NET. The $0.9 million gain for the period ended March 31, 2002 relates to the sale of Exactis. As part of the sale, there were approximately $1.5 million in deferred gains related to an escrow balance and $1.75 million in deferred gains related to prepaid service amounts. The gains are recognized as the escrow balance is released and the prepaid services are utilized. During the first quarter of 2002, we agreed to pay Experian, the acquirer of Exactis, $750,000 of the escrow balance, with the remainder released to the Company immediately. Therefore, $750,000 of the previous gain was recognized and $750,000 reversed. The remaining amount of the gain relates to the use of prepaid services. IMPAIRMENT OF INTANGIBLE ASSETS. We perform on-going business reviews and, based on quantitative and qualitative measures, assess the need to record impairment losses on long-lived assets used in operations when impairment indicators are present. Where impairment indicators were identified, we determined the amount of the impairment charge by comparing the carrying values of goodwill and other long-lived assets to their fair values. Through August 2000, we completed numerous acquisitions that were financed principally with shares of our common stock and were valued based on the price of the common stock at that time. Starting with the fourth quarter of 2000, we reevaluated the carrying value of our businesses on a quarterly basis. The revaluation was triggered by the continued decline in the Internet advertising and marketing sectors throughout 2000 and 2001. In addition, each of these entities have experienced declines in operating and financial metrics over several quarters, primarily due to the continued weak overall demand of on-line advertising and marketing services, in comparison to the metrics forecasted at the time of their respective acquisitions. These factors significantly 20 impacted current projected revenue generated from these businesses. Our evaluation of impairment was also based on achievement of the unit's business plan objectives and milestones, the fair value of each business unit relative to its carrying value, the financial condition and prospects of each business unit and other relevant factors. The business plan objectives and milestones that were considered included, among others, those related to financial performance, such as achievement of planned financial results, and other non-financial milestones such as successful deployment of technology or launching of new products and the loss of key employees. The impairment analysis also considered when these properties were acquired and that the intangible assets recorded at the time of acquisition were being amortized over useful lives of 2 - 4 years. The amount of the impairment charge was determined by comparing the carrying value of goodwill and other long-lived assets to fair value at each respective period end. Where impairment was indicated, we determined the fair value of its business units based on a market approach, which included an analysis of market price multiples of companies engaged in similar businesses. To the extent that market comparables were not available, we used discounted cash flows in determining the value. The market price multiples are selected and applied to the business based on the relative performance, future prospects and risk profile of the business in comparison to the guideline companies. The methodology used to test for and measure the amount of the impairment charge was based on the same methodology used during the initial acquisition valuations. As a result, during our review of the value and periods of amortization of both goodwill and certain other intangibles it was determined that the carrying value of goodwill and certain other intangible assets were not recoverable. The other intangible assets that were determined to be impaired related to the decline in fair market value of acquired technology, a significant reduction in the acquired customer bases and turnover of workforce which was in place at the time of the acquisition of these companies. As a result, we determined that the fair value of goodwill and other intangible assets attributable to several of its operating units were less than their recorded carrying values. Accordingly, we recognized $35.5 million in impairment charges to adjust the carrying values in 2001 - $20.1 million related to Mail, $10.9 million related to WSR and $4.5 million related to Exactis. The impairment factors evaluated may change in subsequent periods, given that our business operates in a highly volatile business environment. This could result in significant additional impairment charges in the future. INTEREST INCOME (EXPENSE), NET. Interest income, net primarily includes interest income from our cash and cash equivalents and short-term investments and interest expense related to our capital lease obligations. Interest income, net was approximately zero for the period ended March 31, 2002 and $0.3 million for the period ended March 31, 2001. The decrease was due to the addition of debt as the related interest expense offset any interest income. GAIN ON SALE OF INVESTMENTS. The gain on sale of investments was $4.0 million for the period ended March 31, 2001. This gain relates to the sale of the Company's remaining available-for-sale securities. IMPAIRMENT OF INVESTMENTS. During 2001, the Company wrote down certain of its investments and recognized impairment charges of approximately $3.1 million for other-than-temporary declines in value. Management made an assessment of the carrying value of our cost-based investments and determined that they were in excess of their carrying values due to the significance and duration of the decline in valuations of comparable companies operating in the Internet and technology sectors. The write down of cost based investments was $0.6 million related to Media-Asia. Management also recognized that the decline in value of our available-for-sale investments in Network Commerce and i3Mobile were other-than-temporary and recorded an impairment of $2.3 million and $0.2 million, respectively. LOSS FROM DISCONTINUED OPERATIONS. On August 6, 2001, the Company determined that it would cease funding to its European subsidiaries and communicated that to 24/7 Europe NV's Board of directors. Management of 24/7 Europe has shut down all operations. 21 On January 22, 2002 we completed the sale of our wholly owned subsidiary, IMAKE. In accordance with FAS 144, we accounted for the operations of this component as a discontinued operation. All revenue, cost and expenses related to these discontinued businesses are included in this line for the current period and prior periods have been reclassified to reflect this presentation. LIQUIDITY AND CAPITAL RESOURCES At March 31, 2002, we had cash and cash equivalents of $4.7 million versus $7.0 million at December 31, 2001. Cash and cash equivalents are comprised of highly liquid short term investments with maturities of three months or less. In the first quarter of 2002, we generated much of our liquidity through $1.5 million in debt financing from a related party. In 2001, we generated a portion of our liquidity through monetization of our investments primarily in chinadotcom common stock; which generated approximately $6.1 million in proceeds. The debt financing and proceeds from the sale of investments were used to finance restructurings and sustain operations during periods of declining revenues. We used approximately $5.1 million and $15.8 million of cash in operating activities during 2002 and 2001, respectively, generally as a result of our net operating losses, adjusted for certain non-cash items such as amortization of goodwill and other intangible assets and gains on sales of investments, gain on sale of non-core assets, impairment of investments and intangibles and non-cash related equity transactions and restructuring and exit costs, and also significant decreases in accounts receivable and prepaid and other current assets which were partially offset by decreases in accounts payable and accrued expenses and deferred revenue. Net cash provided by (used in) investing activities was approximately $0 million in 2002 versus $6.0 million in 2001. The majority of the cash provided by investing activities during 2001 related to proceeds received from the sale of our investments, primarily chinadotcom. During 2001, as a result of divestitures of non-core assets and numerous restructurings, we had significantly scaled back our capital expenditures. As a result of the merger with Real Media and the decision to consolidate onto the Open Adstream technology platform, we have sufficient equipment and did not budget for a significant amount of capital expenditures in 2002. The Company has various employment agreements with employees, the majority of which are for one year with automatic renewal. The obligation under these contracts is approximately $2.8 million for 2002 including salary and performance based target bonuses. These contracts call for severance in the event of involuntary termination which range in amount from two months to two years' salary. All European employees have employment contracts as required by local law. The majority of these contracts allow for resignation or termination by either party at any time, according to the notice period provisions contained in the employment contracts, or according to the minimum notice period as mandated by local law. The contracts, or if no expressed provision is included in the contract, local law, also require severance for involuntary terminations ranging from one to six months. As of May 1, 2002, there were approximately 77 employees in Europe whose annualized base salaries were approximately $3.1 million. As of March 31, 2002, we had approximately $2.4 million remaining of cash outlay obligations relating to restructuring and exit costs. These amounts consist primarily of severance and rent exit costs which are being paid ratably. We expect to pay the majority of these costs by the end of the third quarter of 2002. Our capital requirements depend on numerous factors, including market demand of our services, the capital required to maintain our technology, and the resources we devote to marketing and selling our services. We have received a report from our independent accountants containing an explanatory paragraph stating that our recurring losses from operations since inception and working capital deficiency raise substantial doubt about our ability to continue as a going concern. Management believes that the support of our vendors, customers, stockholders, and employees, among other, continue to be key factors affecting our future success. Moreover, management's plans to continue as a going concern rely heavily on achieving revenue targets, raising additional financing and controlling our operating expenses. Management believes that 22 significant progress has been made in reducing operating expenses since the Real Media merger. In addition, management is currently exploring a number of strategic alternatives and is also continuing to identify and implement internal actions to improve our liquidity. These alternatives may include selling assets which could result in changes in our business plan. To the extent we encounter additional opportunities to raise cash, we may sell additional equity securities, which would result in further dilution of our stockholders. Stockholders may experience extreme dilution due to both our current stock price and the significant amount of financing we may be required to raise. These securities may have rights senior to those of holders of our common stock. We do not have any contractual restrictions on our ability to incur debt. Any indebtedness could contain covenants, which would restrict our operations. With the acquisition of Real Media, Inc. in October 2001, the Company acquired cash of $6.3 million and a note payable of $4.5 million to Publigroupe, who as a result of the merger is a significant shareholder. The note bears interest at 4.5% and principal and interest are due on October 30, 2006. In addition, in accordance with the Real Media purchase agreement in January 2002, the Company received cash of $1.5 million and signed a promissory note bearing interest at 6%, with interest and principal due in January 2005. The Company achieved certain target operating results for the three months ended March 31, 2002. As a result, we became entitled to and on May 13, 2002, we received another $1.5 million in exchange for a 6% three-year promissory note. These related party notes call for all principal and interest due at maturity. On March 21, 2001, we entered into a common stock purchase agreement with Maya Cove Holdings. The agreement gives us the ability to sell our common stock to Maya pursuant to periodic draw downs once a Registration Statement covering these shares has been declared effective by the SEC. The draw downs would be subject to our ability to continue trading on the Nasdaq, our trading volumes and prices and our ability to comply with securities registration requirements for this type of facility. Based on current market price, we estimate the maximum potential draw down is approximately $2.0 million. To date, the registration statement has not been filed and no amounts have been drawn under this facility. There can be no assurances that it will provide the resources necessary to fund our needs and we are continuing to evaluate other fund raising vehicles. On January 22, 2002, we completed the sale of our wholly owned subsidiary, IMAKE, to Schaszberger Corporation. Under the terms of the sale, the purchase price payable to Schaszberger Corporation payable to us was up to approximately $6.5 million for the stock of IMAKE consisting of $2.0 million in the form of a 6% four year secured note due in January 2006, approximately $0.5 million in cash consideration, and a potential earnout of up to $4.0 million over the next three years based on gross revenue. Additionally, we received Series A preferred stock of Schaszberger Corp which, as of the closing date, represented 19.9% of the buyer. The note is secured by certain assets of IMAKE and is guaranteed by Schaszberger Corporation. We have recorded the consideration received at its estimated fair value of $0.5 million for the note receivable and $1.5 million for the earnout as part of assets held for sale at December 31, 2001. In January 2002, we received the cash consideration of $0.5 million for the note receivable and have received the first monthly earnout payment as scheduled. On May 3, 2002, the Company completed the sale of certain assets related to its email business, including customer contracts, certain intangibles and employee relationships, to 24/7 Mail, Inc., a wholly owned subsidiary of Naviant, Inc. Under the terms of the sale, the purchase price payable is up to $4.5 million. The purchase price is comprised of (i) $1.0 million that was paid at closing; (ii) $1.0 million in the form of a non-interest bearing installment note with $350,000 due in ninety days, $350,000 due in one hundred and eighty days and $300,000 due in two hundred seventy days from closing; (iii) an earn-out payable quarterly over the next 45 months, based on 5% of Net Revenue (as defined in the Asset Purchase Agreement), with minimum payments of $600,000 and a maximum of $2.0 million. Lastly, pursuant to a $500,000 non-interest bearing installment note, half of which is payable on each of April 30, 2004 and April. 30, 2005, Naviant has the option either to (i) issue to the Company a number of shares currently comprising 19.9% of 24/7 Mail, Inc., or (ii) pay the Company cash in lieu of the shares. The consideration paid to the Company was determined as a result of arms-length negotiations between the buyer and the Company. 23 MARKET FOR COMPANY'S COMMON EQUITY The shares of our common stock are currently listed on the Nasdaq national market. Due to the low share price of our common stock, in February 2002, we received a letter from Nasdaq stating that they have determined that we have failed to meet Nasdaq's minimum listing requirements and as a result, our common stock could be delisted as we did not satisfy the minimum $1.00 bid price requirement for at least ten consecutive days by May 15, 2002. As a result, the Company has applied to transition its listing to the Nasdaq SmallCap Market. If such application is accepted by Nasdaq, we will remain listed on Nasdaq SmallCap through at least August 15, 2002, and up to 180 days additional time if our stockholders'equity is at least $5 million at the measurement time. Should our stock price remain consistently below $1.00, we will be deemed to be out of compliance with the Nasdaq requirements and will have to explore certain avenues, including a potential reverse stock split, to increase our stock price above $1.00 and thus regain compliance. There can be no assurance that the Company will be able to maintain its Nasdaq listing in the future. Our failure to meet NASDAQ's maintenance criteria may result in the delisting of our common stock from Nasdaq. In such event, trading, if any, in the securities may then continue to be conducted in the non-NASDAQ over-the-counter market in what are commonly referred to as the electronic bulletin board and the "pink sheets". As a result, an investor may find it more difficult to dispose of or obtain accurate quotations as to the market value of the securities. In addition, we would be subject to a Rule promulgated by the Securities and Exchange Commission that, if we fail to meet criteria set forth in such Rule, imposes various practice requirements on broker-dealers who sell securities governed by the Rule to persons other than established customers and accredited investors. For these types of transactions, the broker-dealer must make a special suitability determination for the purchaser and have received the purchaser's written consent to the transactions prior to sale. Consequently, the Rule may have a materially adverse effect on the ability of broker-dealers to sell the securities, which may materially affect the ability of shareholders to sell the securities in the secondary market. Delisting could make trading our shares more difficult for investors, potentially leading to further declines in share price. It would also make it more difficult for us to raise additional capital. We would also incur additional costs under state blue sky laws to sell equity if we are delisted. ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK Cash and cash equivalents are investments with original maturities of three months or less. Therefore, changes in the market's interest rates do not affect the value of the investments as recorded by 24/7 Real Media. Our accounts receivables are subject, in the normal course of business, to collection risks. We regularly assess these risks and have established policies and business practices to protect against the adverse effects of collection risks. Due to the current economic environment, we believe that we have sufficiently provided for any material losses in this area, however, there can be no assurance that unanticipated material losses may not result. We transact business in various foreign countries. Accordingly, we are subject to exposure from adverse movements in foreign currency exchange rates. This exposure is primarily related to revenue and operating expenses in the United Kingdom and in countries which the currency is the Euro. The effect of foreign exchange rate fluctuations for 2002 and 2001 was not material. We do not use derivative financial instruments to limit our foreign currency risk exposure. Our debt is at fixed rates; therefore, there is no rate risk. 24 RISK FACTORS WE MAY NEED TO RAISE ADDITIONAL FUNDS TO CONTINUE OPERATIONS AND OUR RECURRING OPERATING LOSSES AND WORKING CAPITAL DEFICIENCY RAISE SUBSTANTIAL DOUBT ABOUT OUR ABILITY TO CONTINUE AS A GOING CONCERN. Our current cash may not be sufficient to meet our anticipated operating cash needs for 2002 and there can be no assurance that new funds can be secured when needed. The support of our vendors, customers, stockholders and employees will continue to be key to our future success. There can be no assurance that we will be able to raise additional financing to meet our cash and operational needs or reduce our operating expenses or increase revenues significantly to address this going concern issue. Since our inception, we have incurred significant operating losses and we believe we will continue to incur operating losses for the foreseeable future. We also expect to incur negative cash flows for the foreseeable future as a result of our operating losses. We have received a report from our independent accountants on our December 31, 2001 consolidated financial statements containing an explanatory "going concern" paragraph stating that our recurring losses from operations and working capital deficiency since inception raise substantial doubt about our ability to continue our business as a going concern. Management's plans to continue as a going concern rely heavily on achieving revenue targets, reducing operating expenses and raising additional financing. Management is currently exploring a number of strategic alternatives and is also continuing to identify and implement internal actions to improve our liquidity. These alternatives may include selling assets, which could result in changes in our business plan. To the extent we encounter additional opportunities to raise cash, we may sell additional equity or debt securities. Stockholders may experience extreme dilution due to our current stock price and the significant amount of financing we need to raise and these securities may have rights senior to those of holders of our common stock. We do not have any contractual restrictions on our ability to incur debt. Any indebtedness could contain covenants that restrict our operations. We have limited access to the capital markets to raise capital. The capital markets have been unpredictable in the past, especially for unprofitable companies such as ours. In addition, it is difficult to raise capital in the current market conditions. The amount of capital that a company such as ours is able to raise often depends on variables that are beyond our control, such as the share price of our stock and its trading volume. As a result, there is no guarantee that our efforts to secure financing will be available on terms attractive to us, or at all. Due to our operating losses, it may be difficult to obtain debt financing. If we are able to consummate a financing arrangement, there is no guarantee that the amount raised will be sufficient to meet our future needs. If adequate funds are not available on acceptable terms, or at all, our business, results of operation, financial condition and continued viability will be materially adversely affected. THE LOW PRICE OF OUR COMMON STOCK COULD RESULT IN ITS DELISTING FROM THE NASDAQ NATIONAL MARKET. The shares of our common stock are currently listed on the Nasdaq national market. Due low share price of our common stock, on February 14, 2002, we received a letter from Nasdaq 25 stating that they have determined that we have failed to meet Nasdaq's minimum listing requirements and as a result, our common stock could be delisted as we did not satisfy these requirements by May 15, 2002. As a result, the Company has applied to transition its listing to the Nasdaq SmallCap Market. If such application is accepted by Nasdaq, we will remain listed on Nasdaq SmallCap through at least August 15, 2002, and up to 180 days additional time if our stockholders'equity is at least $5 million at the measurement time. Should our stock price remain consistently below $1.00, we will be deemed to be out of compliance with the Nasdaq requirements and will have to explore certain avenues, including a potential reverse stock split, to increase our stock price above $1.00 and thus regain compliance. There can be no assurance that the Company will be able to maintain its Nasdaq listing in the future. Our failure to meet Nasdaq's maintenance criteria may result in the delisting of our common stock from Nasdaq. In such event, trading, if any, in the securities may then continue to be conducted in the non-NASDAQ over-the-counter market in what are commonly referred to as the electronic bulletin board and the "pink sheets". As a result, an investor may find it more difficult to dispose of or obtain accurate quotations as to the market value of the securities. In addition, we would be subject to a Rule promulgated by the Securities and Exchange Commission that, if we fail to meet criteria set forth in such Rule, imposes various practice requirements on broker-dealers who sell securities governed by the Rule to persons other than established customers and accredited investors. For these types of transactions, the broker-dealer must make a special suitability determination for the purchaser and have received the purchaser's written consent to the transactions prior to sale. Consequently, the Rule may have a materially adverse effect on the ability of broker-dealers to sell the securities, which may materially affect the ability of shareholders to sell the securities in the secondary market. Delisting could make trading our shares more difficult for investors, potentially leading to further declines in share price. It would also make it more difficult for us to raise additional capital. We would also incur additional costs under state blue sky laws to sell equity if we are delisted. HIGH VOLATILITY OF STOCK PRICE. The market price of our common stock has fluctuated in the past and may continue to be volatile. In addition, the stock market has experienced extreme price and volume fluctuations. The market prices of the securities of Internet-related companies have been especially volatile. Investors may be unable to resell their shares of our common stock at or above the purchase price. In the past, following periods of volatility in the market price of a particular company's securities, securities class action litigation has often been brought against that company. Many companies in our industry have been subject to this type of litigation in the past. We may also become involved in this type of litigation. Litigation is often expensive and diverts management's attention and resources, which could materially and adversely affect our business, financial condition and results of operations. REVENUE GROWTH IN PRIOR PERIODS MAY NOT BE INDICATIVE OF FUTURE GROWTH. At times in the past, our revenues have grown significantly, primarily as a result of our numerous acquisitions. Our limited operating history makes prediction of future revenue growth difficult. Accurate predictions of future revenue growth are also difficult because of the rapid 26 changes in our markets and the possible need by us to sell assets to fund operations. Accordingly, investors should not rely on past revenue growth rates as a prediction of future revenue growth. WE HAVE A LIMITED OPERATING HISTORY ON WHICH AN INVESTOR CAN EVALUATE OUR BUSINESS. We have a limited operating history. You must consider the risks, expenses and difficulties typically encountered by companies with limited operating histories, particularly companies in new and rapidly expanding markets such as Internet advertising. These risks include our ability to: - develop new relationships and maintain existing relationships with our Web sites, advertisers, and other third parties; - further develop and upgrade our technology; - respond to competitive developments; - implement and improve operational, financial and management information systems; and - attract, retain and motivate qualified employees. WE ANTICIPATE CONTINUED LOSSES AND WE MAY NEVER BE PROFITABLE. We have not achieved profitability in any period and we may not be able to achieve or sustain profitability in the future. We incurred net losses of $3.7 million and $78.7 million for the three months ended March 31, 2002 and 2001, respectively. Even if we do achieve profitability, we cannot assure you that we can sustain or increase profitability on a quarterly or annual basis in the future. OUR FUTURE REVENUES AND RESULTS OF OPERATIONS MAY BE DIFFICULT TO FORECAST. Our results of operations have fluctuated and may continue to fluctuate significantly in the future as a result of a variety of factors, many of which are beyond our control. These factors include: - the addition of new or loss of existing clients; - changes in fees paid by advertisers and direct marketers or other clients; - changes in service fees payable by us to owners of Web sites or email lists, or ad serving fees payable by us to third parties; - the demand by advertisers, Web publishers and direct marketers for our advertising solutions; - the introduction of new Internet marketing services by us or our competitors; 27 - variations in the levels of capital or operating expenditures and other costs relating to the maintenance or expansion of our operations, including personnel costs; - changes in governmental regulation of the Internet; and - general economic conditions. Our future revenues and results of operations may be difficult to forecast due to the above factors. In addition, our expense levels are based in large part on our investment plans and estimates of future revenues. Any increased expenses may precede or may not be followed by increased revenues, as we may be unable to, or may elect not to, adjust spending in a timely manner to compensate for any unexpected revenue shortfall. As a result, we believe that period-to-period comparisons of our results of operations may not be meaningful. You should not rely on past periods as indicators of future performance. In future periods, our results of operations may fall below the expectations of securities analysts and investors, which could adversely affect the trading price of our common stock. OUR FINANCIAL PERFORMANCE AND REDUCTION OF OUR WORKFORCE MAY AFFECT THE MORALE AND PERFORMANCE OF OUR PERSONNEL. We have incurred significant net losses since our inception. In an effort to reduce our cash expenses, we began to implement certain restructuring initiatives and cost reductions. During 2001, we reduced our workforce by over 1,000 employees. We have also left positions unfilled when employees have left the company. In addition, recent trading levels of our common stock have decreased the value of the stock options granted to employees pursuant to our stock option plan. As a result of these factors, our remaining personnel may seek employment with larger, more stable companies they perceive to have better prospects. Our failure to retain qualified employees to fulfill our current and future needs could impair our future growth and have a material adverse effect on our business. OUR FINANCIAL PERFORMANCE MAY AFFECT OUR ABILITY TO ENTER INTO NEW BUSINESS RELATIONSHIPS AND TO COLLECT REVENUES. The publicity we receive in connection with our financial performance and our measures to remedy this performance generate negative publicity, which may negatively affect our reputation and our business partners' and other market participants' perception of our company. If we are unable to maintain the existing relationships and develop new ones, our revenues and collections could suffer materially. OUR BUSINESS MAY NOT GROW IF THE INTERNET ADVERTISING MARKET DOES NOT CONTINUE TO DEVELOP. The Internet as a marketing medium has not been in existence for a sufficient period of time to demonstrate its effectiveness. Our business would be adversely affected if the Internet advertising continues to remain soft or fails to develop in the near future. There are currently no widely accepted standards to measure the effectiveness of Internet marketing other than clickthrough rates, which generally have been declining. We cannot be certain that such standards will develop to sufficiently support Internet marketing as a significant advertising medium. Actual or perceived ineffectiveness of online marketing in general, or inaccurate measurements or database information in particular, could limit the long-term growth of online advertising and cause our revenue levels to decline. 28 OUR BUSINESS MAY SUFFER IF WE ARE UNABLE TO SUCCESSFULLY IMPLEMENT OUR BUSINESS MODEL A significant part of our business model is to generate revenue by providing interactive marketing solutions to advertisers, ad agencies and Web publishers. The profit potential for this business model is unproven. To be successful, both Internet advertising and our solutions will need to achieve broad market acceptance by advertisers, ad agencies and Web publishers. Our ability to generate significant revenue from advertisers will depend, in part, on our ability to contract with Web publishers that have Web sites with adequate available ad space inventory. Further, these Web sites must generate sufficient user traffic with demographic characteristics attractive to our advertisers. The intense competition among Internet advertising sellers has led to the creation of a number of pricing alternatives for Internet advertising. These alternatives make it difficult for us to project future levels of advertising revenue and applicable gross margin that can be sustained by us or the Internet advertising industry in general. Intensive marketing and sales efforts may be necessary to educate prospective advertisers regarding the uses and benefits of, and to generate demand for, our products and services. Enterprises may be reluctant or slow to adopt a new approach that may replace, limit or compete with their existing direct marketing systems. In addition, since online direct marketing is emerging as a new and distinct business apart from online advertising, potential adopters of online direct marketing services will increasingly demand functionality tailored to their specific requirements. We may be unable to meet the demands of these clients. Acceptance of our new solutions will depend on the continued emergence of Internet commerce, communication and advertising, and demand for its solutions. We cannot assure you that demand for its new solutions will emerge or become sustainable. BANNER ADVERTISING, FROM WHICH WE CURRENTLY DERIVE A SIGNIFICANT PORTION OF OUR REVENUE, MAY NOT BE AN EFFECTIVE ADVERTISING METHOD IN THE FUTURE. A significant portion of our revenues are derived from the delivery of banner advertisements. Online banner advertising has dramatically decreased since the middle of 2000 and has continued to decline throughout 2001 and is expected to continue through the second quarter of 2002, which could have a material adverse effect on our business. If advertisers determine that banner advertising is an ineffective or unattractive advertising medium, we cannot assure you that we will be able to effectively make the transition to any other form of Internet advertising. Also, there are "filter" software programs that limit or prevent advertising from being delivered to a user's computer. The commercial viability of Internet advertising, and our business, results of operations and financial condition, would be materially and adversely affected by Web users' widespread adoption of such software. In addition, many online advertisers have been experiencing financial difficulties, which could materially impact our revenues and our ability to collect our receivables. GROWTH OF OUR BUSINESS DEPENDS ON THE DEVELOPMENT OF ONLINE DIRECT MARKETING. Adoption of online direct marketing, particularly by those entities that have historically relied upon traditional means of direct marketing, such as telemarketing and direct mail, is an important part of our business model. Intensive marketing and sales efforts may be necessary to educate prospective advertisers regarding the uses and benefits of our products and services to 29 generate demand for our direct marketing services. Enterprises may be reluctant or slow to adopt a new approach that may replace, limit, or compete with their existing direct marketing systems. In addition, since online direct marketing is emerging as a new and distinct market apart from online advertising, potential adopters of online direct marketing services will increasingly demand functionality tailored to their specific requirements. We may be unable to meet the demands of our clients. LOSS OF OUR MAJOR WEB SITES WOULD SIGNIFICANTLY REDUCE OUR REVENUES. The 24/7 Network generates a significant portion of our revenues, and we expect that the 24/7 Network will continue to account for a significant portion of our revenue for the foreseeable future. The 24/7 Network consists of a limited number of our Web sites that have contracted for our services under agreements cancelable generally upon a short notice period. We experience turnover from time to time among our Web sites, and we cannot be certain that the Web sites named above will remain associated with us or that such Web sites will not experience a reduction in online traffic on their sites. We cannot assure you that we will be able to replace any departed Web site in a timely and effective manner with a Web site with comparable traffic patterns and user demographics. Our business, results of operations and financial condition would be materially adversely affected by the loss of one or more of the Web sites that account for a significant portion of our revenue from the 24/7 Network. LOSS OF MAJOR CUSTOMERS WOULD REDUCE OUR REVENUES. We generate a significant portion of our revenues from a limited number of customers. We expect that a limited number of these entities may continue to account for a significant percentage of our revenues for the foreseeable future. For the three months ended March 31, 2002, our top ten customers accounted for approximately 22.1% of our total revenues. Customers typically purchase advertising or services under agreements on a short-term basis. Since these contracts are short-term, we will have to negotiate new contracts or renewals in the future that may have terms that are not as favorable to us as the terms of existing contracts. We cannot be certain that current customers will continue to purchase advertising or services from us or that we will be able to attract additional customers successfully, or that customers will make timely payment of amounts due to us. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products or services to address the needs of our prospective clients. Our business, results of operations and financial condition would be materially adversely affected by the loss of one or more of our customers that account for a significant portion of our revenue. WE HAVE GROWN OUR BUSINESS THROUGH ACQUISITION. We were formed in February 1998 to consolidate three Internet advertising companies and have since acquired thirteen more companies. In combining these entities, we have faced risks and continue to face risks of integrating and improving our financial and management controls, ad serving technology, reporting systems and procedures, and expanding, training and managing our work force. This process of integration may take a significant period of time and will require the dedication of management and other resources, which may distract management's attention from our other operations. We may continue pursuing selective acquisitions of businesses, technologies and product lines as a key component of our growth strategy. Any future acquisition or investment may result in the use of significant amounts of cash, potentially dilutive 30 issuances of equity securities, incurrence of debt and amortization expenses related to goodwill and other intangible assets. In addition, acquisitions involve numerous risks, including: - the difficulties in the integration and assimilation of the operations, technologies, products and personnel of an acquired business; - the diversion of management's attention from other business concerns; - the availability of favorable acquisition financing for future acquisitions; and - the potential loss of key employees of any acquired business. Our inability to successfully integrate any acquired company could adversely affect our business. OUR ADVERTISING CUSTOMERS AND THE COMPANIES WITH WHICH WE HAVE STRATEGIC RELATIONSHIPS MAY EXPERIENCE ADVERSE BUSINESS CONDITIONS THAT COULD ADVERSELY AFFECT OUR BUSINESS. As a result of unfavorable conditions in the public equity markets, some of our customers may have difficulty raising sufficient capital to support their long-term operations. As a result, these customers have reduced their spending on Internet advertising, which has materially and adversely affected our business, financial condition and results of operations. In addition, from time to time, we have entered into strategic business relationships with other companies, the nature of which varies, but generally in the context of customer relationships. These companies may experience similar adverse business conditions that may render them unable to meet our expectations for the strategic business relationship or to fulfill their contractual obligations to us. Such an event could have a material adverse impact on our business, financial condition and results of operations. OUR REVENUES ARE SUBJECT TO SEASONAL FLUCTUATIONS. Our revenues are subject to seasonal fluctuations because advertisers generally place fewer advertisements during the first and third calendar quarters of each year and direct marketers mail substantially more marketing materials in the third quarter each year. Internet user traffic typically drops during the summer months, which reduces the number of advertisements to sell and deliver. Expenditures by advertisers and direct marketers tend to vary in cycles that reflect overall economic conditions as well as budgeting and buying patterns. Our revenue could be materially reduced by a decline in the economic prospects of advertisers, direct marketers or the economy in general, which could alter current or prospective advertisers' spending priorities or budget cycles or extend our sales cycle. Due to such risks, you should not rely on quarter-to-quarter comparisons of our results of operations as an indicator of our future results. OUR TECHNOLOGY SOLUTIONS MAY NOT BE SUCCESSFUL AND MAY CAUSE BUSINESS DISRUPTION. Open Adstream is our proprietary next generation ad serving technology that is intended to serve as our sole ad serving solution. We launched Open Adstream Central and Network in mid-2001, and we must, among other things, ensure that this technology will function efficiently at high volumes, interact properly with our database, offer the functionality demanded by our 31 customers and assimilate our sales and reporting functions. This development effort could fail technologically or could take more time than expected. Our Open Adstream technology resides on a computer system located in our data centers housed by Exodus Communications. These systems' continuing and uninterrupted performance is critical to our success. Customers may become dissatisfied by any system failure that interrupts our ability to provide our services to them, including failures affecting our ability to deliver advertisements without significant delay to the viewer. Sustained or repeated system failures would reduce the attractiveness of our solutions to advertisers, ad agencies and Web publishers and result in contract terminations, fee rebates and make goods, thereby reducing revenue. Slower response time or system failures may also result from straining the capacity of our deployed software or hardware due to an increase in the volume of advertising delivered through our servers. To the extent that we do not effectively address any capacity constraints or system failures, our business, results of operations and financial condition could be materially and adversely affected. Our operations are dependent on our ability to protect our computer systems against damage from fire, power loss, water damage, telecommunications failures, vandalism and other malicious acts, and similar unexpected adverse events. In addition, interruptions in our solutions could result from the failure of our telecommunications providers to provide the necessary data communications capacity in the time frame we require. Despite precautions that we have taken, unanticipated problems affecting our systems have from time to time in the past caused, and in the future could cause, interruptions in the delivery of our solutions. Our business, results of operations and financial condition could be materially and adversely affected by any damage or failure that interrupts or delays our operations. OUR FAILURE TO SUCCESSFULLY COMPETE MAY HINDER OUR GROWTH. The markets for Internet advertising and related products and services are intensely competitive and such competition is expected to increase. Our failure to successfully compete may hinder our growth. We believe that our ability to compete depends upon many factors both within and beyond our control, including: - the timing and market acceptance of new products and enhancements of existing services developed by us and our competitors; - changing demands regarding customer service and support; - shifts in sales and marketing efforts by us and our competitors; and - the ease of use, performance, price and reliability of our services and products. Many of our competitors have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical and marketing resources than ours. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products or services to address the needs of our prospective clients. We cannot be certain that we will be able to successfully compete against current or future competitors. In addition, the Internet must compete for a share of advertisers' total budgets with traditional advertising media, such as television, radio, cable and print, as well as content aggregation companies and other companies that facilitate Internet advertising. To the extent that the Internet is perceived to be a limited or ineffective advertising or direct marketing medium, advertisers and direct marketers may be reluctant to devote a significant portion of their advertising budgets to Internet marketing, which could limit the growth of Internet marketing. 32 CHANGES IN LAWS AND STANDARDS RELATING TO DATA COLLECTION AND USE PRACTICES AND THE PRIVACY OF INTERNET USERS AND OTHER INDIVIDUALS COULD HARM OUR BUSINESS. The U.S. federal and various state governments have recently proposed limitations on the collection and use of information regarding Internet users. In October 1998, the European Union adopted a directive that may limit our collection and use of information regarding Internet users in Europe. The effectiveness of our Open Adstream technology could be limited by any regulation limiting the collection or use of information regarding Internet users. Since many of the proposed laws or regulations are just being developed, we cannot yet determine the impact these regulations may have on its business. In addition, growing public concern about privacy and the collection, distribution and use of information about individuals has led to self-regulation of these practices by the Internet advertising and direct marketing industry and to increased federal and state regulation. The Network Advertising Initiative, or NAI, of which 24/7 Real Media is a member along with other Internet advertising companies, has developed self-regulatory principles for online preference marketing. These principles were recently endorsed by the Federal Trade Commission, and are in the process of being adopted by the NAI companies. The Direct Marketing Association, or DMA, the leading trade association of direct marketers, has adopted guidelines regarding the fair use of this information which it recommends participants, such as us, through our services, in the direct marketing industry follow. We are also subject to various federal and state regulations concerning the collection, distribution and use of information regarding individuals. These laws include the Children's Online Privacy Protection Act, and state laws that limit or preclude the use of voter registration and drivers license information, as well as other laws that govern the collection and use of consumer credit information. Although our compliance with the DMA's guidelines and applicable federal and state laws and regulations has not had a material adverse effect on us, we cannot assure you that the DMA will not adopt additional, more burdensome guidelines or that additional, more burdensome federal or state laws or regulations, including antitrust and consumer privacy laws, will not be enacted or applied to us or our clients, which could materially and adversely affect our business, financial condition and results of operations. IF WE LOSE OUR CEO OR OTHER SENIOR MANAGERS OUR BUSINESS WILL BE ADVERSELY EFFECTED. Our success depends, to a significant extent, upon our senior management and key sales and technical personnel, particularly David J. Moore, Chief Executive Officer. The loss of the services of one or more of these persons could materially adversely affect our ability to develop our business. Our success also depends on our ability to attract and retain qualified technical, sales and marketing, customer support, financial and accounting, and managerial personnel. Competition for such personnel in the Internet industry is intense, and we cannot be certain that we will be able to retain our key personnel or that we can attract, integrate or retain other highly qualified personnel in the future. We have experienced 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 INTERNATIONAL OPERATIONS MAY POSE LEGAL AND CULTURAL CHALLENGES. We have operations in a number of international markets, including Canada, Europe and Asia. To date, we have limited experience in marketing, selling and distributing our solutions 33 internationally. International operations are subject to other risks, including changes in regulatory requirements, reduced protection for intellectual property rights in some countries, potentially adverse tax consequences, general import/export restrictions relating to encryption technology and/or privacy, difficulties and costs of staffing and managing foreign operations, political and economic instability, fluctuations in currency exchange rates; and seasonal reductions in business activity during the summer months in Europe and certain other parts of the world. In addition to these factors, due to our minority stake in 24/7 Real Media Korea in Asia, we are relying on our partner to conduct operations, build the network, aggregate Web publishers and coordinate sales and marketing efforts. The success of the 24/7 Network in Asia is directly dependent on the success of our partner and its dedication of sufficient resources to our relationship. DEPENDENCE ON PROPRIETARY RIGHTS AND RISK OF INFRINGEMENT. Our success and ability to compete are substantially dependent on our internally developed technologies and trademarks, which we protect through a combination of patent, copyright, trade secret and trademark law. We have received two patents in the United States, and have filed and intend to file additional patent applications in the United States. In addition, we apply to register our trademarks in the United States and internationally. We cannot assure you that any of our patent applications or trademark applications will be approved. Even if they are approved, such patents or trademarks may be successfully challenged by others or invalidated. If our trademark registrations are not approved because third parties own such trademarks, our use of such trademarks will be restricted unless we enter into arrangements with such third parties that may be unavailable on commercially reasonable terms. We generally enter into confidentiality or license agreements with our employees, consultants and corporate partners, and generally control access to and distribution of our technologies, documentation and other proprietary information. Despite our efforts to protect our proprietary rights from unauthorized use or disclosure, parties may attempt to disclose, obtain or use our solutions or technologies. We cannot assure you that the steps we have taken will prevent misappropriation of our solutions or technologies, particularly in foreign countries where laws or law enforcement practices may not protect our proprietary rights as fully as in the United States. We have licensed, and we may license in the future, elements of our trademarks, trade dress and similar proprietary rights to third parties. While we attempt to ensure that the quality of our brand is maintained by these business partners, such partners may take actions that could materially and adversely affect the value of our proprietary rights or our reputation. We cannot assure you that any of our proprietary rights will be of value in the future since the validity, enforceability and scope of protection of certain proprietary rights in Internet-related industries is uncertain and still evolving. We may be subject to claims of alleged infringement of the trademarks and other intellectual property rights of third parties by us or the Web publishers with Web sites in the 24/7 Network. Such claims and any resultant litigation could subject us to significant liability for damages and could result in the invalidation of our proprietary rights. In addition, even if we prevail, such litigation could be time-consuming and expensive to defend, and could result in the diversion of our time and attention, any of which could materially and adversely affect our business, results of operations and financial condition. Any claims or litigation from third parties may also result in limitations on our ability to use the trademarks and other intellectual property subject to such claims or litigation unless we enter into arrangements with the third parties 34 responsible for such claims or litigation which may be unavailable on commercially reasonable terms. INTELLECTUAL PROPERTY LIABILITY. We may be liable for content available or posted on the Web sites of our publishers. We may be liable to third parties for content in the advertising we serve if the music, artwork, text or other content involved violates the copyright, trademark or other intellectual property rights of such third parties or if the content is defamatory. Any claims or counterclaims could be time consuming, result in costly litigation or divert management's attention. PRIVACY CONCERNS MAY PREVENT US FROM COLLECTING USER DATA. Growing concerns about the use of "cookies" and data collection may limit our ability to develop user profiles. Web sites typically place small files of information commonly known as "cookies" on a user's hard drive, generally without the user's knowledge or consent. Cookie information is passed to the Web site through the Internet user's browser software. Our Open Adstream technology targets advertising to users through the use of identifying data, or "cookies" and other non-personally-identifying information. Open Adstream enables the use of cookies to deliver targeted advertising and to limit the frequency with which an advertisement is shown to the user. Most currently available Internet browsers allow users to modify their browser settings to prevent cookies from being stored on their hard drive, and a small minority of users are currently choosing to do so. Users can also delete cookies from their hard drive at any time. Some Internet commentators and privacy advocates have suggested limiting or eliminating the use of cookies. Any reduction or limitation in the use of cookies could limit the effectiveness of our sales and marketing efforts and impair our targeting capabilities. Recently, Microsoft Corporation changed the design and instrumentation of its Web browser in such a way as to give users the option to accept or reject third party cookies. Giving users the option to decline such cookies could result in a reduction of the number of Internet users we are capable of profiling anonymously. Such changes also could adversely affect our ability to determine the reach of advertising campaigns sold and delivered by us and the frequency with which users of sites in the 24/7 Network see the same advertisement. If the use or effectiveness of cookies is limited, we would likely have to switch to other technology that would allow us to gather demographic and behavioral information. While such technology currently exists, it is substantially less effective than cookies. Replacement of cookies could require significant reengineering time and resources, might not be completed in time to avoid negative consequences to our business, financial condition or results of operations, and might not be commercially feasible. In addition, privacy concerns may cause some Web users to be less likely to visit Web sites that contribute data to our databases. This could have a material adverse effect on our financial condition. In addition, we are developing our database to collect data derived from user activity on our networks and from other sources. We collect and compile information in databases for the product offerings of all our businesses. Individuals or entities may claim in the future, that our collection of this information is illegal. Although we believe that we have the right to use and compile the information in these databases, we cannot assure you that our ability to do so will remain lawful, that any trade secret, copyright or other intellectual property protection will be available for our databases, or that statutory protection that is or becomes available for databases will enhance our rights. In addition, others may claim rights to the information in our databases. Further, pursuant to our contracts with Web publishers using our solutions, we are obligated to keep certain information regarding each Web publisher confidential and, therefore, may be restricted from further using that information in our business. 35 WE MAY HAVE TO CHANGE OUR BUSINESS PLANS BASED UPON CHANGES IN INFORMATION COLLECTION PRACTICES. There has been public debate about how fair information collection practices should be formulated for the online and offline collection, distribution and use of information about a consumer. Some of the discussion has focused on the fair information collection practices that should apply when information about an individual that is collected in the offline environment is associated with information that is collected over the Internet about that individual. We are working with industry groups, such as the NAI and the Online Privacy Alliance, to establish such standards with the U.S. government regarding the merger of online and offline consumer information. We cannot assure you that we will be successful in establishing industry standards acceptable to the U.S. government or the various state governments, or that the standards so established will not require material changes to our business plans. We also cannot assure you that our business plans, or any U.S. industry standards that are established, will either be acceptable to any non-U.S. government or conform to foreign legal and business practices. As a consequence of governmental legislation or regulation or enforcement efforts or evolving standards of fair information collection practices, we may be required to make changes to our products or services in ways that could diminish the effectiveness of the product or service or their attractiveness to potential customers. In addition, given the heightened public discussion about consumer online privacy, we cannot assure you that our products and business practices will gain market acceptance, even if they do conform to industry standards. CHANGES IN GOVERNMENT REGULATION COULD DECREASE OUR REVENUES AND INCREASE OUR COSTS. Laws and regulations directly applicable to Internet communications, commerce and advertising are becoming more prevalent, and new laws and regulations are under consideration by the United States Congress and state legislatures. Any legislation enacted or restrictions arising from current or future government investigations or policy could dampen the growth in use of the Internet generally and decrease the acceptance of the Internet as a communications, commercial and advertising medium. State governments or governments of foreign countries might attempt to regulate our transmissions or levy sales or other taxes relating to our activities. The European Union has enacted its own privacy regulations that may result in limits on the collection and use of certain user information by us. The laws governing the Internet, however, remain largely unsettled, even in areas where there has been some legislative action. It may take years to determine whether and how existing laws such as those governing intellectual property, privacy, libel and taxation apply to the Internet and Internet advertising. In addition, the growth and development of Internet commerce may prompt calls for more stringent consumer protection laws, both in the United States and abroad, that may impose additional burdens on companies conducting business over the Internet. Our business, results of operations and financial condition could be materially and adversely affected by the adoption or modification of laws or regulations relating to the Internet. DEPENDENCE ON THE WEB INFRASTRUCTURE. Our success will depend, in large part, upon the maintenance of the Web infrastructure, such as a reliable network backbone with the necessary speed, data capacity and security, and timely development of enabling products such as high speed modems, for providing reliable Web access and services and improved content. We cannot assure you that the Web infrastructure will continue to effectively support the demands placed on it as the Web continues to experience 36 increased numbers of users, frequency of use or increased bandwidth requirements of users. Even if the necessary infrastructure or technologies are developed, we may have to spend considerable amounts to adapt our solutions accordingly. Furthermore, the Web has experienced a variety of outages and other delays due to damage to portions of its infrastructure. Such outages and delays could impact the clients using our solutions and the level of user traffic on Web sites on our networks. RISKS ASSOCIATED WITH TECHNOLOGICAL CHANGE. The Internet and Internet advertising markets are characterized by rapidly changing technologies, evolving industry standards, frequent new product and service introductions, and changing customer demands. Our future success will depend on our ability to adapt to rapidly changing technologies and to enhance existing solutions and develop and introduce a variety of new solutions to address our customers' changing demands. We may experience difficulties that could delay or prevent the successful design, development, introduction or marketing of our solutions. In addition, our new solutions or enhancements must meet the requirements of our current and prospective customers and must achieve significant market acceptance. Material delays in introducing new solutions and enhancements may cause customers to forego purchases of our solutions and purchase those of our competitors. EFFECTS OF ANTI-TAKEOVER PROVISIONS COULD INHIBIT THE ACQUISITION OF OUR COMPANY. Some of the provisions of our certificate of incorporation, our bylaws and Delaware law could, together or separately: - discourage potential acquisition proposals; - delay or prevent a change in control; - impede the ability of our stockholders to change the composition of our board of directors in any one year; and - limit the price that investors might be willing to pay in the future for shares of our common stock. 37 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS None. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS None. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. None. (b) Reports on Form 8-K. Report on Form 8-K dated February 6, 2002 (file no. 0-29768). The report contained information about the sale of our IMAKE subsidiary. ITEM 7. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. 24/7 Real Media, Inc. Date: May 15, 2002 By: /s/ David J. Moore ---------------------------------------- David J. Moore Chairman and Chief Executive Officer By: /s/ Norman M. Blashka ---------------------------------------- Norman M. Blashka EVP and Chief Financial Officer 38 -----END PRIVACY-ENHANCED MESSAGE-----