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 September 30, 1998
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 1-14355
24/7 Media, Inc.
(Exact name of registrant as specified in its charter)
Delaware 13-3995672
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
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 November 6, 1998
Common Stock, par value $.01 per share 15,482,804 Shares
<PAGE>
24/7 MEDIA, INC.
INDEX
Page No.
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets....................................3
Consolidated Statements of Operations..........................4
Consolidated Statements of Cash Flows..........................6
Consolidated Statements of Stockholders' Equity (Deficit)......7
Notes to Interim Consolidated Financial Statements.............8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ....................................17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................33
Item 2. Changes in Securities and Use of Proceeds.....................33
Item 3. Defaults Upon Senior Securities...............................33
Item 4. Submission of Matters to a Vote of Security Holders...........33
Item 5. Other Information.............................................33
Item 6. Exhibits and Reports on Form 8-K..............................34
Item 7. Signatures....................................................35
2
<PAGE>
24/7 MEDIA, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
(unaudited)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents .................................... $ 42,784,975 $ 93,945
Accounts receivable, net of allowance for doubtful
accounts of $636,840 and $63,723, respectively ........... 6,229,674 176,034
Prepaid expenses and other current assets .................... 328,610 14,936
------------ ------------
Total current assets ....................... 49,343,259 284,915
------------ ------------
Property and equipment, net .................................... 1,474,279 591,337
Goodwill, net .................................................. 11,519,218 --
Deferred offering costs ........................................ -- 110,602
Intangible assets, net ......................................... 23,309 2,711
Deposits ....................................................... 206,094 49,376
------------ ------------
Total assets ............................... $ 62,566,159 $ 1,038,941
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable ............................................. $ 5,128,306 $ 882,696
Accrued liabilities .......................................... 2,726,160 471,205
Current installments of obligations under capital leases ..... 41,960 --
Deferred revenue ............................................. 46,000 96,496
------------ ------------
Total current liabilities .................. 7,942,426 1,450,397
------------ ------------
Senior convertible notes payable-related parties, net of debt
discount of $0 and $158,348, respectively .................... -- 2,316,511
Obligations under capital leases, excluding current installments 42,759 --
Stockholders' equity (deficit):
Convertible preferred stock, $.01 par value; 10,000,000 shares
authorized; 0 and 158,144 shares issued and
outstanding, respectively; with aggregate liquidation
preference of $0 and $4,538,733, respectively .............. -- 1,581
Common stock, $.01 par value; 70,000,000 shares
authorized; 15,482,804 and 1,148,762 shares
issued and outstanding, respectively ....................... 154,828 11,488
Additional paid-in capital ................................... 86,731,261 10,564,382
Deferred stock compensation .................................. (372,922) --
Accumulated deficit .......................................... (31,932,193) (13,305,418)
------------ ------------
Total stockholders' equity (deficit) ....... 54,580,974 (2,727,967)
------------ ------------
Commitments and contingencies
Total liabilities and stockholders' equity
(deficit) ............................. $ 62,566,159 $ 1,038,941
============ ============
</TABLE>
See accompanying notes to interim consolidated financial statements.
3
<PAGE>
24/7 MEDIA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Three months ended September 30,
--------------------------------
1998 1997
---- ----
(unaudited) (unaudited)
<S> <C> <C>
Revenues:
Advertising ............................ $ 5,461,341 $ 315,697
Consulting and license fees ............ 66,000 233,130
------------ -----------
Total revenues ......... 5,527,341 548,827
Cost of revenues ........................... 4,615,542 511,466
------------ -----------
Gross profit ........... 911,799 37,361
------------ -----------
Operating expenses:
Sales and marketing .................... 2,524,284 451,235
General and administrative ............. 2,118,610 682,480
Product development .................... 486,779 438,557
Legal costs in connection with claim ... -- 108,461
Write-off of property and equipment .... -- 756,795
Amortization of goodwill ............... 1,823,927 --
------------ -----------
Total operating expenses 6,953,600 2,437,528
------------ -----------
Loss from operations ... (6,041,801) (2,400,167)
Interest income ............................ 250,403 485
Interest expense, including amortization of
debt discount of $3,870 and $9,910,
respectively ............................ (4,951) (33,620)
------------ -----------
Net loss ............... (5,796,349) (2,433,302)
Cumulative dividends on preferred stock .... (90,607) --
------------ -----------
Net loss attributable to common
stockholders ............................ $ (5,886,956) $(2,433,302)
============ ===========
Net loss per share - basic and diluted ..... $ (0.50) $ (2.25)
============ ===========
Weighted average shares outstanding ........ 11,737,255 1,079,116
============ ===========
</TABLE>
See accompanying notes to interim consolidated financial statements.
4
<PAGE>
24/7 MEDIA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Nine months ended September 30,
--------------------------------
1998 1997
---- ----
(unaudited) (unaudited)
<S> <C> <C>
Revenues:
Advertising ............................... $ 10,198,701 $ 1,059,935
Consulting and license fees ............... 105,178 1,668,963
------------ -----------
Total revenues ............ 10,303,879 2,728,898
Cost of revenues .............................. 8,643,492 1,405,693
------------ -----------
Gross profit .............. 1,660,387 1,323,205
------------ -----------
Operating expenses:
Sales and marketing ....................... 4,806,710 1,475,763
General and administrative ................ 5,207,699 2,194,824
Product development ....................... 1,002,478 1,285,280
Legal costs in connection with claim ...... -- 232,304
Write-off of acquired in-process technology 5,477,281 --
Write-off of property and equipment ....... -- 756,795
Amortization of goodwill .................. 3,630,573 --
------------ -----------
Total operating expenses .. 20,124,741 5,944,966
------------ -----------
Loss from operations ...... (18,464,354) (4,621,761)
Interest income ............................... 326,286 17,060
Interest expense, including amortization of
debt discount of $158,348 and $12,936,
respectively ............................... (212,911) (40,572)
------------ -----------
Net loss .................. (18,350,979) (4,645,273)
Cumulative dividends on preferred stock ....... (275,796) --
------------ -----------
Net loss attributable to common
stockholders ............................... $(18,626,775) $(4,645,273)
============ ===========
Net loss per share - basic and diluted ........ $ (2.45) $ (4.30)
============ ===========
Weighted average shares outstanding ........... 7,610,191 1,079,116
============ ===========
</TABLE>
See accompanying notes to interim consolidated financial statements.
5
<PAGE>
24/7 MEDIA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Nine months ended September 30,
--------------------------------
1998 1997
---- ----
(unaudited) (unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net loss ......................................................... $(18,350,979) $(4,645,273)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization of fixed assets .................... 289,263 291,679
Amortization of debt discount .................................... 158,348 12,936
Write-off property and equipment ................................. -- 756,795
Write-off of in process .......................................... 5,477,281 --
Accrued interest on senior convertible notes-related
parties .......................................................... 14,630 27,636
Imputed interest on note payable-related party ................... 9,000 --
Provision for doubtful accounts .................................. 196,226 27,000
Amortization of intangible assets ................................ 3,630,573 18,000
Non-cash compensation ............................................ 536,318 15,876
Changes in operating assets and liabilities:
Accounts receivable .......................................... (4,414,542) 188,672
Prepaid expenses and other current assets .................... (257,455) 135,874
Deposits ..................................................... (156,718) (271)
Accounts payable ............................................. 2,632,773 841,075
Accrued liabilities .......................................... 921,255 (62,972)
Deferred revenue ............................................. (50,496) (1,331,738)
------------ -----------
Net cash used in operating activities ............ (9,364,523) (3,724,711)
------------ -----------
Cash flows from investing activities:
Increase in intangible assets .................................... (20,598) --
Cash received from acquisition ................................... 168,839 --
Cash paid for acquisition ........................................ (1,627,725) --
Proceeds from sale of property and equipment ..................... -- 22,850
Purchases of property and equipment .............................. (958,035) (34,466)
------------ -----------
Net cash used in investing activities ............ (2,437,519) (11,616)
------------ -----------
Cash flows from financing activities:
Proceeds from issuance of mandatorily
redeemable convertible preferred stock ........................ 10,060,002 --
Deferred offering costs .......................................... (321,126) --
Proceeds from senior convertible notes payable-
related parties ............................................... 150,000 1,625,000
Repayment of notes payable-related parties ....................... (295,945) --
Proceeds from exercise of stock options .......................... 129,148 --
Proceeds from issuance of convertible preferred stock, net ....... -- 500,011
Proceeds from issuance of common stock related
to initial public offering, net .............................. 44,770,993 --
------------ -----------
Net cash provided by financing activities 54,493,072 2,125,011
------------ -----------
Net change in cash and cash equivalents 42,691,030 (1,611,316)
Cash and cash equivalents at beginning of period ..................... 93,945 1,689,395
------------ -----------
Cash and cash equivalents at end of period ........................... $ 42,784,975 $ 78,079
============ ===========
</TABLE>
See accompanying notes to interim consolidated financial statements.
6
<PAGE>
24/7 MEDIA, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
Year Ended December 31, 1997 and Nine Months Ended September 30, 1998
(unaudited)
<TABLE>
<CAPTION>
Convertible
preferred stock Common stock
------------------ -------------------
Shares Amount Shares Amount
------ ------ ------ ------
<S> <C> <C> <C> <C>
Balance as of January 1, 1997 .......................... 140,722 $ 1,407 1,079,116 $ 10,791
Issuance of preferred stock ............................ 17,422 174 -- --
Issuance of common stock to officer .................... -- -- 10,462 105
Issuance of warrants in connection with senior
convertible notes payable-related parties ........... -- -- -- --
Senior convertible notes payable-related parties
converted into common stock ......................... -- -- 59,184 592
Net loss ............................................... -- -- -- --
------- ------- --------- --------
Balance as of December 31, 1997 ........................ 158,144 1,581 1,148,762 11,488
Issuance of warrants in connection with senior
convertible notes payable-related parties ......... -- -- -- --
Issuance of warrants to former officer ................. -- -- -- --
Issuance of warrants to consultant ..................... -- -- -- --
Issuance of common stock for acquired businesses ....... -- -- 5,278,167 52,782
Issuance of stock options to employees ................. -- -- -- --
Issuance of common stock to officer .................... -- -- 56,250 563
Amortization of deferred stock compensation ............ -- -- -- --
Issuance of common stock to consultants ................ -- -- 5,909 59
Offering costs in connection with mandatorily
redeemable convertible preferred stock ............ -- -- -- --
Senior convertible notes payable-related parties
converted into common stock ....................... -- -- 828,036 8,280
Convertible preferred stock converted into
common stock ...................................... (158,144) (1,581) 542,908 5,429
Conversion of warrants into common stock ............... -- -- 191,349 1,913
Imputed interest on loans payable-related parties ...... -- -- -- --
Accrual of cumulative dividends on mandatorily
redeemable convertible preferred stock ............ -- -- -- --
Issuance of common stock in initial public offering, net -- -- 3,550,000 35,500
Conversion of mandatorily redeemable convertible
preferred stock into common stock ................. -- -- 3,807,533 38,075
Exercise of stock options .............................. -- -- 73,890 739
Net loss for the period ................................ -- -- -- --
------- ------- --------- --------
Balance as of September 30, 1998 (unaudited) ........... -- $ -- 15,482,804 $154,828
======= ======= ========== ========
</TABLE>
<TABLE>
<CAPTION>
Additional Deferred Total
paid-in Accumulated stock stockholders'
capital deficit compensation equity (deficit)
------- ------- ------------ ----------------
<S> <C> <C> <C> <C>
Balance as of January 1, 1997 .............................. $ 9,737,594 $ (7,999,590) $ -- $ 1,750,202
Issuance of preferred stock ................................ 499,837 -- -- 500,011
Issuance of common stock to officer ........................ 31,786 -- -- 31,891
Issuance of warrants in connection with senior ............. --
convertible notes payable-related parties ............... 201,000 -- -- 201,000
Senior convertible notes payable-related parties ........... --
converted into common stock ............................. 94,165 -- -- 94,757
Net loss ................................................... -- (5,305,828) -- (5,305,828)
------------ ------------ --------- ------------
Balance as of December 31, 1997 ............................ 10,564,382 (13,305,418) -- (2,727,967)
Issuance of warrants in connection with senior
convertible notes payable-related parties ............. 12,156 -- -- 12,156
Issuance of warrants to former officer ..................... 450,000 -- -- 450,000
Issuance of warrants to consultant ......................... 20,240 -- -- 20,240
Issuance of common stock for acquired businesses ........... 10,768,785 -- -- 10,821,567
Issuance of stock options to employees ..................... 331,500 -- (331,500) --
Issuance of common stock to officer ........................ 89,437 -- (90,000) --
Amortization of deferred stock compensation ................ -- -- 48,578 48,578
Issuance of common stock to consultants .................... 22,441 -- -- 22,500
Offering costs in connection with mandatorily .............. --
redeemable convertible preferred stock ................ (229,105) -- -- (229,105)
Senior convertible notes payable-related parties ...........
converted into common stock ........................... 2,665,614 -- -- 2,673,894
Convertible preferred stock converted into .................
common stock .......................................... (3,848) -- -- --
Conversion of warrants into common stock ................... (1,913) -- -- --
Imputed interest on loans payable-related parties .......... 9,000 -- -- 9,000
Accrual of cumulative dividends on mandatorily .............
redeemable convertible preferred stock ................ -- (275,796) -- (275,796)
Issuance of common stock in initial public offering, net ... 44,735,433 -- -- 44,770,933
Conversion of mandatorily redeemable convertible
preferred stock into common stock ..................... 17,168,730 -- -- 17,206,805
Exercise of stock options .................................. 128,409 -- -- 129,148
Net loss for the period .................................... -- (18,350,979) -- (18,350,979)
------------ ------------ --------- ------------
Balance as of September 30, 1998 (unaudited)............... $ 86,731,261 $(31,932,193) $(372,922) $ 54,580,974
============ ============ ========= ============
</TABLE>
See accompanying notes to interim consolidated financial statements.
7
<PAGE>
24/7 MEDIA, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED
(1) Summary of Operations and Significant Accounting Policies
(a) Summary of Operations and Basis of Presentation
24/7 Media, Inc. (together with its subsidiary, "24/7 Media" or the "Company")
operates networks of Web sites that enable both advertisers and Web publishers
to capitalize on the opportunities presented by Internet advertising, direct
marketing and commerce. The Company generates revenues by delivering
advertisements and promotions to Web sites affiliated with the Company. The
Company's network properties include the 24/7 Network, the CliqNow! network, and
the ContentZone, which are networks of Web sites to which advertisements and
promotions are served.
24/7 Media was incorporated in Delaware on January 23, 1998 as a wholly owned
subsidiary of Interactive Imaginations, Inc. ("Interactive Imaginations"). On
February 25, 1998, pursuant to an Agreement and Plan of Merger dated February 2,
1998, the Company simultaneously consummated the merger of each of Petry
Interactive, Inc. ("Petry") and Advercomm, Inc. ("Advercomm") with and into the
Company (the mergers, together with a concurrent investment of approximately $10
million pursuant to a Securities Purchase Agreement dated February 25, 1998 (the
"Securities Purchase Agreement") by certain third party investors as well as an
existing investor of Interactive Imaginations, the "Initial Merger").
On April 9, 1998, Interactive Imaginations (24/7 Media's then parent) was merged
with and into the Company in a manner similar to a pooling of interests. As a
result, 24/7 Media's historical financial statements and results of operations
for all periods prior to the Initial Merger represent those of Interactive
Imaginations.
On April 13, 1998, the Company completed an Agreement and Plan of Merger to
acquire Intelligent Interactions Corporation ("Intelligent Interactions"). In
this transaction, the Company issued approximately 949,242 shares of common
stock, 3,561,505 shares of mandatorily redeemable convertible preferred stock,
and 265,212, 265,212 and 136,553 Class A, B and C Warrants, respectively, to
purchase common stock at exercise prices of $7.62, $11.42 and $3.81 per share,
respectively, for a total purchase price of $7,670,500. Based upon an
independent appraisal, which takes into account replacement cost of assets,
market multiples and present value of anticipated future after-tax earnings,
approximately $5,477,300 of the purchase price of Intelligent Interactions was
allocated to in-process technology. Because such in-process technology had not
reached the stage of technological feasibility at the acquisition date and had
no alternative future use, this amount was immediately written off by the
Company.
As of June 1, 1998, the Company acquired the CliqNow! network ("CliqNow!") for
$1,295,000 and $3 million of the Company's Series B Mandatorily Redeemable
Convertible Preferred Stock (plus acquisition costs of approximately $96,000)
for a total price of $4,390,800 (the Initial Merger together with the
acquisitions of Intelligent Interactions and CliqNow!, the "Acquisitions"). The
Company issued 3,000 shares of Series B Preferred Stock which converted into
230,415 shares of common stock upon completion of the Company's initial public
offering in August 1998.
8
<PAGE>
(b) Principles of Consolidation
The Company's unaudited consolidated financial statements as of September 30,
1998 and for the three month and nine month periods ended September 30, 1998
include (i) the consolidated accounts of the Company, (ii) Petry and Advercomm
from February 25, 1998, (iii) Intelligent Interactions from April 13, 1998, and
(iv) CliqNow! from June 1, 1998. For the three month and nine month periods
ended September 30, 1997, the Company's historical results of operations only
include the results of Interactive Imaginations. All significant intercompany
transactions and balances have been eliminated in consolidation.
The Acquisitions have been accounted for using the purchase method of
accounting, and accordingly, the purchase price has been allocated to the
tangible and identifiable intangible assets acquired and liabilities assumed on
the basis of their fair values on the acquisition dates. The aggregate purchase
price of the Acquisitions was $19,144,600. Of this, approximately ($987,970) of
the aggregate purchase price was allocated to net tangible liabilities
consisting primarily of cash, accounts receivable, property and equipment,
accounts payable and accrued liabilities. The historical carrying amounts of
such net liabilities approximated their fair values. Approximately $5,477,300 of
the purchase price was allocated to acquired in-process technology and was
immediately written off by the Company. The purchase price in excess of the fair
value of identified tangible and intangible assets and liabilities assumed in
the amount of $14,655,270 was allocated to goodwill and is being amortized over
its estimated useful life of two years from the respective dates of acquisition.
The following unaudited pro forma consolidated amounts give effect to the
Acquisitions as if they had occurred at the beginning of the respective periods,
or date of inception, if later, by consolidating the results of operations of
Petry, Advercomm, Intelligent Interactions and CliqNow! for the three month and
nine month periods ended September 30, 1998 and 1997.
<TABLE>
<CAPTION>
Three months ended September 30, Nine months ended September 30,
-------------------------------- -------------------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Total revenues ............................. $ 5,527,341 $ 1,051,433 $ 12,128,686 $ 3,502,971
Net loss ................................... (5,796,349) (5,882,888) (21,022,208) (13,449,881)
Net loss attributable to common stockholders (5,886,956) (6,019,388) (21,298,004) (13,859,381)
Net loss per share--basic and diluted ...... $ (0.50) $ (1.30) $ (2.45) $ (3.18)
Weighted average shares used in basic and
diluted net loss per share calculation .. 11,737,255 4,652,006 8,688,842 4,363,405
</TABLE>
(c) Interim Results
The consolidated financial statements as of September 30, 1998 and for the three
month and nine month periods ended September 30, 1998 and 1997 have been
prepared by the Company and are unaudited. In the opinion of management, the
unaudited consolidated financial statements have been prepared on the same basis
as the annual financial statements and reflect all adjustments, which include
only normal recurring adjustments, necessary to present fairly the financial
position as of September 30, 1998 and the results of the Company's operations
and its cash flows for the three month and nine month periods ended September
30, 1998 and 1997. The financial data and other information disclosed in these
notes to consolidated financial statements related to these periods are
unaudited. The results for the three month and nine month periods ended
September 30, 1998 are not necessarily indicative of the results to be expected
for any subsequent quarter or the entire fiscal year ending December 31, 1998.
The consolidated balance sheet at December 31, 1997 has been derived from the
audited financial statements at that date.
9
<PAGE>
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 the Company's
audited consolidated financial statements and notes thereto for the year ended
December 31, 1997 as included in the Company's Registration Statement on Form
S-1 filed with the Securities and Exchange Commission in August 1998.
(d) Stock Split
On July 20, 1998, the Company effected a 1-for-4 reverse stock split in
connection with its initial public offering. Accordingly, all references in the
consolidated financial statements to the number of shares and to per share
amounts have been retroactively restated to reflect these changes.
(e) Use of Estimates
The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
(f) Cash and Cash Equivalents
The Company considers all highly liquid securities, with original maturities of
three months or less, to be cash equivalents. Cash equivalents at September 30,
1998 and December 31, 1997 were $41,510,047 and $0, respectively, which
consisted principally of money market funds.
(g) Intangible Assets
Goodwill resulting from the acquisition of Internet advertising businesses is
estimated by management to be primarily associated with the acquired workforce,
contracts and technological know how. As a result of the rapid technological
changes occurring in the Internet industry and the intense competition for
qualified Internet professionals and customers, recorded goodwill is amortized
on a straight-line basis over the estimated period of benefit, which is two
years.
At each balance sheet date, the Company assesses the value of recorded goodwill
for possible impairment based upon a number of factors, including turnover of
the acquired workforce and the undiscounted value of expected future operating
cash flows in relation to each acquired company. To date, the Company has not
recorded any provisions for possible impairment of intangible assets.
(h) Deferred Offering Costs
At December 31, 1997, specific incremental costs directly attributable to the
issuance of mandatorily redeemable convertible preferred stock were deferred.
These costs have been charged against additional paid-in capital as a result of
the Company's issuance of mandatorily redeemable convertible preferred stock
during the three months ended March 31, 1998.
10
<PAGE>
(i) Revenue Recognition
The Company's advertising revenues are derived principally from short-term
advertising agreements in which the Company delivers advertising impressions or
full-page advertisements for a fixed fee to third party Web sites comprising the
24/7 Network, the CliqNow! network and the ContentZone. Revenues from
advertising are recognized in the period the advertising impressions are
delivered, provided that collection of the resulting receivables is probable.
Third party Web sites which register Web pages with the Company's networks and
display advertising banners on those pages are commonly referred to as
"Affiliated Web sites." The Company pays its Affiliated Web sites a service fee
for providing advertising space to the Company's networks. The Company becomes
obligated to make payments to such Affiliated Web sites, which have contracted
with the Company to be part of the Company's networks, in the period the
advertising impressions are delivered. Such expenses are classified as cost of
revenues in the consolidated statements of operations. 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."
The Company's licensing revenue is derived principally from software licensing
fees and fees from maintenance, consulting and support of its software.
Licensing fees are recognized as performance occurs under the terms of the
applicable agreement. Expenses from the Company's licensing revenues are
primarily payroll costs to deliver, modify and support the software. These
expenses are classified in cost of revenues in the consolidated statements of
operations and were not material.
At September 30, 1998 and December 31, 1997, accounts receivable included
approximately $1,493,782 and $56,000, respectively, of unbilled receivables, all
of which have been subsequently billed.
The Company historically traded advertisements on its Web properties in exchange
for advertisements on the Internet sites of other companies or for goods that
were used as prizes for its Riddler game site. Barter and prize revenue and
expenses are recorded at the fair market value of services or products provided
or received, whichever is more determinable in the circumstances. Revenue from
barter transactions is recognized as income when advertisements are delivered on
the Company's Web properties. Barter expense is recognized when the Company's
advertisements are run on other companies' Web sites, which is typically in the
same period when the barter revenue is recognized. The Company expects that
barter and prize revenue will continue to represent an insignificant percentage
of total revenues in the future.
(j) Stock-Based Compensation
The Company accounts for stock-based employee compensation arrangements in
accordance with provisions of APB No. 25, "Accounting for Stock Issued to
Employees," and complies with the disclosure provisions of Statement of
Financial Accounting Standards ("SFAS") 123, "Accounting for Stock-Based
Compensation." Under APB No. 25, compensation cost is recognized based on the
difference, if any, on the date of grant between the fair value of the Company's
stock and the amount an employee must pay to acquire the stock. During the first
six months of 1998, the Company recorded deferred compensation charges of
approximately $422,000. Such amount has been presented as a reduction in
stockholders' equity (deficit) and is being amortized to compensation costs over
the vesting period of the applicable options, which is generally four years.
The Company accounts for non-employee stock-based awards in which goods or
services are the consideration received for the equity instruments issued based
on the fair value of the consideration received or the fair value of the equity
instruments issued, whichever is more reliably measurable.
11
<PAGE>
(k) Loss Per Share
Loss per share is presented in accordance with the provisions of SFAS 128,
Earnings Per Share, and the Securities and Exchange Commission Staff Accounting
Bulletin No. 98. SFAS 128 replaced the presentation of primary and fully diluted
earnings (loss) per share (EPS), with a presentation of basic EPS and diluted
EPS. Under SFAS 128, basic EPS excludes dilution for common stock equivalents
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. Only basic EPS is presented, as
all common stock equivalents are anti-dilutive for each of the periods
presented. Anti-dilutive potential common shares outstanding were and 4,993,984
and 885,419 at September 30, 1998 and 1997, respectively.
Net loss applicable to common stockholders for the three month and nine month
periods ended September 30, 1998 has been increased to give effect to $90,607
and $275,796, respectively, of cumulative dividends on mandatorily redeemable
convertible preferred stock through the date of the August 1998 initial public
offering.
(l) Recent Accounting Pronouncements
The Company adopted the provisions of SFAS 130, "Reporting Comprehensive Income"
in the quarter ended March 31, 1998. SFAS 130 requires the Company to report in
its financial statements, in addition to its net income (loss), comprehensive
income (loss), which includes all changes in equity during a period from
non-owner sources including, as applicable, foreign currency items, minimum
pension liability adjustments and unrealized gains and losses on certain
investments in debt and equity securities. There were no differences between the
Company's comprehensive loss and its net loss as reported.
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use" ("SOP 98-1"). SOP 98-1 provides guidance
for determining whether computer software is internal-use software and on
accounting for the proceeds of computer software originally developed or
obtained for internal use and then subsequently sold to the public. It also
provides guidance on capitalization of the costs incurred for computer software
developed or obtained for internal use. The Company has not yet determined the
impact, if any, of adopting SOP 98-1, which will be effective for the Company's
year ending December 31, 1999.
In June 1997, the FASB issued SFAS 131, "Disclosure about Segments of an
Enterprise and Related Information." SFAS 131 establishes standards for the way
that public business enterprises report information about operating segments. It
also establishes standards for related disclosures about products and services,
geographic areas and major customers. SFAS 131 is effective for fiscal years
beginning after December 15, 1997. The Company has determined that it does not
have any separately reportable business segments.
In June 1998, the FASB issued SFAS 133, "Accounting for Derivative Instruments
and Hedging Activities." SFAS 133 establishes accounting and reporting standards
for derivative instruments, including derivative instruments embedded in other
contracts, and for hedging activities. SFAS 133 is effective for all fiscal
quarters of fiscal years beginning after June 15, 1999. This statement is not
expected to affect the Company, as the Company currently does not have any
derivative instruments or hedging activities.
12
<PAGE>
(m) Reclassifications
Certain reclassifications have been made to the prior year's financial
statements to conform to the current year's presentation.
(2) Balance Sheet Components
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
------------------ -----------------
(unaudited)
<S> <C> <C>
Property and Equipment, Net
Computer equipment $ 1,973,359 $ 972,283
Furniture and fixtures 214,637 -
Leasehold improvements 21,069 -
----------- ---------
2,209,065 972,283
Less accumulated depreciation and amortization (734,786) (380,946)
----------- ---------
$ 1,474,279 $ 591,337
=========== =========
Goodwill, net
Goodwill $15,149,791 $ -
Less accumulated amortization (3,630,573) -
----------- ---------
$11,519,218 $ -
=========== =========
Accrued Liabilities
Professional fees $ 96,983 $ 225,691
Employee commissions, incentives, and expenses 1,425,347 -
Ad management fees 160,639 -
Affiliate royalties 390,303 81,384
Rent and lease obligations 176,019 -
Other 476,870 164,130
----------- ---------
$ 2,726,160 $ 471,205
=========== =========
</TABLE>
(3) Related Party Transactions
On September 30, 1998, the Company settled all of its obligations to Petry Media
Corporation which arose in connection with the Company's acquisition of Petry in
February 1998. In connection therewith, the Company made a lump sum payment in
the amount of $828,500 settling its outstanding loan payable and royalty payable
balances of $183,500 and $217,500, respectively, at September 30, 1998, as well
as any additional obligations in connection with its contingent purchase
obligation to Petry Media Corporation, the total of which was limited to
$1,000,000. Accordingly, the difference between the lump sum payment of $828,500
and the Company's outstanding obligations of $401,000 was attributed to the
contingent purchase obligation which was accounted for as an adjustment of
$427,500 to the Petry purchase price. Such amount is now included as part of
goodwill and will be amortized over its remaining amortization period commencing
October 1, 1998.
13
<PAGE>
(4) Common Stock, Preferred Stock and Warrants
Common Stock
On February 25, 1998, as part of the acquisition of Petry and Advercomm, the
Company issued an aggregate of 4,328,925 shares of common stock.
In February 1998, the Company awarded to the President of the Company 56,250
shares of restricted common stock which were granted at the fair market value of
the Company's common stock of $1.60 per share determined by an independent
appraisal of the Company's common stock in connection with the Initial Merger,
and which vest over a three year period. In connection with this issuance, the
Company is recognizing compensation expense of $90,000 ratably over a three year
period. For the three month and nine month periods ended September 30, 1998, the
Company recognized $7,500 and $17,500 in compensation expense, respectively.
In August 1998, the Company completed an offering of 3,550,000 shares of its
common stock, par value $.01 per share, in an initial public offering at an
offering price of $14.00 per share. Net proceeds to the Company from this
initial public offering totaled $44.8 million, after offering costs of $1.4
million.
Mandatorily Redeemable Convertible Preferred Stock
On February 25, 1998, the Company entered into the Securities Purchase Agreement
for the sale and issuance of 10,060,002 shares of mandatorily redeemable
convertible preferred stock--Series A, par value $.01 per share ("Series A"),
1,320,904 Class A warrants to purchase common stock at an exercise price of
$7.62 per share ("Class A Warrants"), and 1,320,904 Class B warrants to purchase
common stock at an exercise price of $11.42 per share ("Class B Warrants") in a
private placement for total proceeds of $10,060,002.
On April 13, 1998, as part of the acquisition of Intelligent Interactions, the
Company issued 949,242 shares of common stock, 3,561,505 shares of mandatorily
redeemable convertible preferred stock, 265,152 Class A Warrants, 265,152 Class
B Warrants and 136,553 Class C warrants to purchase common stock at an exercise
price of $3.81 per share ("Class C Warrants").
As of June 1, 1998, as part of the acquisition of CliqNow!, the Company issued
3,000 shares of Series B convertible redeemable preferred stock, par value $.01
per share ("Series B").
The Series A and Series B shareholders were entitled to receive, when and as
declared by the Board of Directors out of funds legally available, dividends at
a rate of $0.04 and $60.00 per share per annum, respectively. Such dividends
were cancelled pursuant to the Securities Purchase Agreement effective August
1998 since the Company consummated a qualified initial public offering (as
defined in the Securities Purchase Agreement) prior to January 31, 1999.
Each Series A and Series B share was automatically converted into common shares
at their respective conversion prices simultaneously with the closing of the
initial public offering.
14
<PAGE>
Warrants
On February 24, 1998, Interactive Imaginations and an executive entered into a
separation agreement ("Separation Agreement") pursuant to which the executive's
employment as an executive, but not as a Director, of Interactive Imaginations
was terminated as of February 24, 1998. Interactive Imaginations agreed to issue
to the executive Class C Warrants to purchase up to 625,000 shares of Common
Stock. Accordingly, the Company recorded an expense of $450,000 during the three
month period ended March 31, 1998 in connection with this transaction based upon
an independent valuation of the Class C Warrants. All warrants are exercisable
and have expiration dates generally five years from the date of grant.
(5) 1998 Stock Incentive Plan
On July 20, 1998, the board of directors and stockholders of the Company
approved the 1998 Stock Incentive Plan as amended (the "Plan"). The following is
a summary of the material features of the Plan. This Plan replaced the 1995
Stock Option Plan as Amended.
All employees of and consultants to the Company are eligible under the Plan.
Grants under the Plan shall be determined by the Company's Stock Incentive
Committee. The Plan provides for the grant of any or all of the following types
of awards: (i) stock options, including incentive stock options and
non-qualified stock options; (ii) stock appreciation rights, in tandem with
stock options or free standing; and (iii) restricted stock. In addition, the
Plan provides for the non-discretionary award of stock options to non-employee
directors of the Company.
A maximum of 3,000,000 shares of Common Stock may be issued or used for
reference purposes pursuant to the Plan. The maximum number of shares of Common
Stock subject to each of stock options or stock appreciation rights that may be
granted to any individual under the Plan is 187,500 for each fiscal year during
the term of the Plan. If a stock appreciation right is granted in tandem with a
stock option, it shall be applied against the individual limits for both stock
options and stock appreciation rights, but only once against the maximum number
of shares available under the Plan.
Subsequent to December 31, 1997 through September 30, 1998, the Company granted
a total of 1,071,495 stock options: 477,750 of such were at an exercise price of
$4.00 per share, 300,000 of such were at an exercise price of $6.00 per share,
212,807 of such were assumed as a result of the acquisition of Intelligent
Interactions at exercise prices ranging from $0.16 to $0.48 per share, and
80,938 of such were at exercise prices of $9.00 to $14.00 per share, which were
granted at the fair market value of the underlying common stock at the time of
grant.
The Company has recorded a deferred compensation charge of approximately
$331,500 in the second quarter of 1998 in connection with the grant of
approximately 300,000 stock options to employees at a weighted average exercise
price of $5.74 per share, representing the difference between the deemed fair
value of the Company's Common Stock for accounting purposes and the exercise
price of such options at the date of grant. Such amount is presented as a
reduction of stockholders' equity (deficit) and amortized over the vesting
period of the applicable options, generally over four years. Amortization of
deferred stock compensation is recorded in general and administrative expense in
the consolidated statements of operations.
15
<PAGE>
(6) Supplemental Cash Flow Information
The amount of cash paid for interest was $3,426 and $23,710 for the three months
ended September 30, 1998 and 1997, respectively, and $45,563 and $27,636 for the
nine months ended September 30, 1998 and 1997, respectively.
Non-cash financing activities:
During the nine months ended September 30, 1998, the Company converted all
outstanding shares of convertible preferred stock into an aggregate of 4,350,441
shares of common stock, converted $2,556,250 of senior convertible notes
payable--related parties, plus accrued interest, into 828,036 shares of common
stock, and outstanding warrants were converted into 191,349 shares of common
stock.
During the nine months ended September 30, 1998, the Company issued an aggregate
of 5,278,167 shares of common stock, 3,561,505 Series A shares, 3,000 Series B
shares, 265,212 Class A Warrants, 265,212 Class B Warrants and 136,553 Class C
Warrants in connection with the acquisitions of Petry, Advercomm, Intelligent
Interactions and CliqNow!.
In February 1998, the Company issued warrants to a former executive for $450,000
(see Note 4).
In April 1998, the Company issued 5,909 shares of common stock to a consultant
for $22,500.
16
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion contains forward-looking statements within the meaning
of federal securities law. Such statements can be identified by the use of
forward-looking terminology such as "may," "will," "expect," "anticipate,"
"estimate," "continue" or other similar words. These statements discuss future
expectations, contain projections of results of operations or of financial
condition or state other "forward-looking" information. Although management
believes that the expectations reflected in such forward-looking statements are
based on reasonable assumptions, certain factors such as rapid changes in the
markets in which the Company competes or general economic conditions might cause
a difference between actual results and such forward-looking statements. When
considering such forward-looking statements, prospective investors should
consider the "Risk Factors" and other cautionary statements in this report.
General
The Company enables both advertisers and Web publishers to capitalize on the
many opportunities presented by Internet advertising, direct marketing and
electronic commerce. In particular, 24/7 Media: (i) operates the 24/7 Network, a
network of over 100 high profile Affiliated Web sites to which the Company
delivered an aggregate of over 535 million advertisements in September 1998;
(ii) operates the CliqNow! network, a network of over 85 medium to large-sized
Affiliated Web sites to which the Company delivered an aggregate of over 65
million advertisements in September 1998; (iii) operates the ContentZone, a
network of over 2,000 small to medium-sized Affiliated Web sites to which the
Company delivered an aggregate of over 50 million advertisements in September
1998; (iv) licenses its Adfinity(TM) advertising management system to
independent Web sites to manage and serve high-volume advertising and direct
marketing campaigns; and (v) markets its dbCommerce(TM) software to e-commerce
merchants to enable the delivery of targeted promotions.
The Company is the result of several recent mergers and acquisitions and the
combination of these predecessor entities has resulted in an integrated Internet
advertising company with both media sales and technology expertise. Petry
established the network business model and contributed its network of Web sites
which became the foundation for the 24/7 Network. Advercomm folded several high
profile Web sites into the 24/7 Network, which increased the breadth of content
available on the 24/7 Network and accelerated the Company's ability to organize
its Affiliated Web sites into channels. Interactive Imaginations' ContentZone
provided the Company with the ability to offer advertising solutions for small
to medium-sized Web sites. The acquisition of CliqNow! added a network of medium
to large-sized Web sites to the Company's diverse portfolio of Affiliated Web
sites. Intelligent Interactions provided the Company with ad serving and
targeting technology. Management believes that the combination of these
predecessor entities has enabled the Company to offer advertisers and Web
publishers comprehensive advertising solutions and to pursue its objective of
becoming the leading Internet advertising and direct marketing firm.
The Company sells its products and services through its sales and marketing
staff located in New York, Boston, Chicago, Dallas, Detroit, Los Angeles, San
Francisco, Seattle and the Washington, D.C. area. The Company generates
substantially all of its revenues by delivering advertisements and promotions to
Affiliated Web sites on its networks. Advertisements delivered by the Company
are typically sold pursuant to purchase order agreements with advertisers which
are short-term in nature or subject to cancellation.
17
<PAGE>
The pricing of ads is based on a variety of factors, including the gross dollar
amount spent on the advertising campaign and whether the campaign is delivered
on a specific Web site basis, a channel basis or a run of network basis. The
Company strives to sell 100% of its inventory through the combination of
advertisements sold on a "CPM" basis (the cost to the advertiser to run 1,000
ads) and a "cost-per-action" basis (whereby revenues are generated if the user
responds to the ad with an action, such as an inquiry or a purchase of the
product advertised). The Company has recently started to sell sponsorship
advertising, which involves a greater degree of coordination among the Company,
the advertiser and Affiliated Web sites. These sponsorships are generally priced
based on the length of time that the sponsorship runs, rather than on a CPM
basis.
Advertising revenues are recognized in the period that the advertisement is
delivered, provided that no significant obligations remain. In nearly all cases,
the Company recognizes revenues generated from advertising sales, net of any
commissions paid to advertising agencies on behalf of their clients. The Company
pays its Affiliated Web sites a service fee calculated as a percentage of
revenues generated by advertisements run on the Web site, which amount is
included in cost of revenues. In addition, the Company is generally responsible
for billing and collecting for advertisements delivered to its networks.
Revenues relating to sponsorship advertising are recognized ratably over the
sponsorship period. In addition, the Company generates revenue from licensing
its Adfinity(TM) technology to third party Web publishers. To date, revenue from
licensing Adfinity(TM) to third parties has not comprised a significant
percentage of the Company's total revenues.
The Company expects to generate most of its revenues for the foreseeable future
from advertisements delivered to Affiliated Web sites on its networks. The
Company's strategy is to aggressively recruit Web sites of all sizes for its
networks in order to extend the Company's reach and to provide advertisers with
a broad base of page views and online content. For the three months ended
September 30, 1998, one Affiliated Web site accounted for approximately 13% of
the Company's total advertising revenue and the top ten Web sites accounted for
approximately 40% of the Company's advertising revenue.
24/7 Media delivered an aggregate of over 650 million ad impressions during the
month of September 1998, compared to 440 million ad impressions during the month
of June 1998, an increase of 48 percent. The Company added a number of marquee
Web sites during the third quarter, including Netscape, The New York Post,
SportsNetworks.com, Reuter's Health, and Server.com. According to Media Metrix,
the three 24/7 Media networks reached 44.1%, or more than two out of five, of
all Internet users in September 1998. The Company believes that this reach
figure is among the highest in the Internet advertising industry.
In addition, for the three months ended September 30, 1998, no single advertiser
accounted for over 8% of the Company's total advertising revenue and the top ten
advertisers and ad agencies accounted for approximately 41% of the Company's
advertising revenue.
The Company believes that, due to the Acquisitions, the period-to-period
comparisons of its historical operating results are not meaningful and should
not be relied upon as indicative of future performance. The Company's prospects
should be considered in light of the risks, expenses and difficulties
encountered by companies in the early stages of development, particularly
companies in the rapidly evolving Internet market. Although the Company has
experienced revenue growth in recent periods, it anticipates that it will incur
operating losses for the foreseeable future due to a high level of planned
operating and capital expenditures. In particular, the Company expects to
increase its operating expenses in order to expand its sales and marketing
organization and to enhance its Adfinity(TM) technology.
18
<PAGE>
Pro Forma Results of Operations
Because the Company has a limited operating history, the Company has included
its results of operations on a pro forma basis in order to better understand the
Company's business as a result of the combination of the businesses of Petry,
Advercomm, Interactive Imaginations, Intelligent Interactions and CliqNow!. The
following unaudited pro forma consolidated statements of operations give effect
to the Acquisitions as if they had occurred on January 1, 1997 (or inception, if
later) by consolidating the results of operations of the acquired entities with
the results of operations of 24/7 Media for the three month and nine month
periods ended September 30, 1998 and 1997.
As a result, for pro forma purposes, amortization of goodwill has been
recognized beginning in the first quarter of pro forma 1997 and the one-time
write-off of in-process technology has been excluded. For financial reporting
purposes (i) amortization of goodwill will be recognized over a two year period
from the respective dates of the acquisitions, and (ii) the write-off of
acquired in-process technology of approximately $5.5 million related to the
Intelligent Interactions acquisition has been recognized in the second quarter
of 1998 (the date of acquisition). The Company believes that all necessary
adjustments, consisting of normal recurring adjustments, have been included in
the amounts stated below.
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.
24/7 MEDIA, INC.
PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Three months ended September 30, Nine months ended September 30,
-------------------------------- -------------------------------
1998 1997 1998 1997
---- ---- ---- ----
(unaudited) (unaudited) (unaudited) (unaudited)
<S> <C> <C> <C> <C>
Revenues:
Advertising .......................... $ 5,461,341 $ 806,543 $ 11,935,146 $ 1,813,248
Consulting and license fees .......... 66,000 244,890 193,540 1,689,723
----------- ----------- ------------ ------------
Total revenues ..... 5,527,341 1,051,433 12,128,686 3,502,971
Cost of revenues ....................... 4,615,542 904,284 9,857,914 1,987,964
----------- ----------- ------------ ------------
Gross profit ....... 911,799 147,149 2,270,772 1,515,007
----------- ----------- ------------ ------------
Total operating expenses ............... 6,953,600 5,999,435 17,918,570 14,947,128
----------- ----------- ------------ ------------
Loss from operations (6,041,801) (5,852,286) (15,647,798) (13,432,121)
Net interest income (expense) .......... 245,452 (30,602) 102,871 (17,760)
----------- ----------- ------------ ------------
Net loss ............................... $(5,796,349) $(5,882,888) $(15,544,927) $(13,449,881)
=========== =========== ============ ============
</TABLE>
Revenues
Advertising Revenue. Advertising revenue primarily consists of cash advertising
revenue and also includes barter and prize revenue. The Company's pro forma cash
advertising revenue increased in both the three month and nine month periods
from 1997 to 1998 primarily due to an increase in the number of Web sites on the
24/7 Network and the CliqNow! network, the number of advertisers utilizing the
Company's advertising solutions and the number of advertisements delivered to
the 24/7 Network and the CliqNow! network. Such increase was partially offset by
a decline in pro forma cash advertising revenue
19
<PAGE>
generated by the ContentZone during these periods. The Company expects the 24/7
Network and the CliqNow! network to continue to account for a significant
portion of the Company's total advertising revenue.
Consulting and License Fees. Pro forma consulting and license fees in the first
nine months of 1998 consisted primarily of fees generated from licensing the
Adfinity(TM) system to third parties. Pro forma consulting and license fees
generated through the first nine months of 1997 consisted primarily from an
agreement with SegaSoft, whereby SegaSoft licensed certain software from
Interactive Imaginations. The Company does not expect to realize meaningful
revenues from the SegaSoft license agreement in the future. Although the Company
expects to derive consulting and license fees in the future from the licensing
of Adfinity(TM) and dbCommerce(TM) to third parties, such revenues are not
expected to comprise a significant portion of the Company's total revenues.
Cost of Revenues and Gross Profit. 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 the Company's networks. Cost of revenues also
includes third party ad serving costs, depreciation of the Company's ad serving
system and Internet access costs. The increases in pro forma gross profit from
the three month and nine month periods in 1997 to the three month and nine month
periods in 1998 was caused by (i) the significant growth in advertising revenue
generated by the 24/7 Network and the CliqNow! network, which typically pay
higher fees to Affiliated Web sites, at the same time that advertising revenue
generated by the ContentZone declined; (ii) an increase in third party ad
serving costs related to the growth of the 24/7 Network and the CliqNow!
network; (iii) the cessation of high margin consulting and license fees
generated by the SegaSoft agreement in 1997; and (iv) the temporary increase,
which began late in the first quarter of 1998, in third party ad serving costs
incurred by the Company in connection with the transition of the Company's ad
serving to Adfinity(TM). Until the Company completes the transition to a single
ad serving platform, it expects to incur ad serving costs that are significantly
higher than historical levels. Thereafter, the Company expects gross margins to
increase because third party ad serving fees will no longer be paid.
Operating Expenses. Each of pro forma sales and marketing, general and
administrative and product development expenses increased from the three month
and nine month periods in 1997 to the three month and nine month periods in 1998
as the Company and the companies which it acquired incurred expenses in
connection with the growth of their respective businesses.
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. The Company expects sales and
marketing expenses to increase as it continues to invest in sales and marketing
personnel, expand into new markets and broaden the visibility of the Company.
General and Administrative Expenses. General and administrative expenses consist
primarily of compensation, facilities expenses and other overhead expenses
incurred to support the growth of the business. Beginning in the second quarter
of 1998, the Company's general and administrative expenses increased due to the
additional ad serving personnel required to support Adfinity(TM). In addition,
the Company general and administrative expenses increased due to the increased
levels of expenses to support the Company's current and future growth.
Product Development Expenses. Product development expenses consist primarily of
compensation and related costs incurred to further develop the Company's ad
serving capabilities. The Company believes that continued investment in product
development, particularly for its Adfinity(TM) system, is critical to its
20
<PAGE>
strategy of providing excellent service, and it expects to increase the future
amounts spent on product development.
Other Expenses. Pro forma other expenses in the three month and nine month
periods ended September 30, 1997 included an aggregate of $108,461 and $232,304,
respectively, in legal costs incurred in defending a class-action lawsuit filed
by certain Affiliated Web sites on the ContentZone. The Company's defense of
such lawsuit resulted in a grant of summary judgment in favor of the Company,
but such lawsuit resulted in a diversion of management resources during such
period. In addition, the Company incurred a write-off during 1997 of $756,795 of
property and equipment. The Company recorded pro forma goodwill amortization
expense beginning in the first quarter of 1997 (or date of inception, if later),
which represents the excess purchase price over the fair value of net
liabilities of the acquired businesses of Petry, Advercomm, CliqNow! and
Intelligent Interactions.
Historical Results of Operations
For the three month and nine month periods ended September 30, 1998, 24/7
Media's historical results of operations reflect the Initial Merger as of
February 25, 1998, the acquisition of Intelligent Interactions as of April 13,
1998 and the acquisition of CliqNow! as of June 1, 1998. For the three month and
nine month periods ended September 30, 1997, 24/7 Media's historical results of
operations only include the results of Interactive Imaginations. The Company
does not believe that the historical revenues or expenses as presented below are
accurate indicators of the future performance of the combined Company.
Revenues. Total revenues were $5,527,341 and $10,303,879 for the three month and
nine month periods ended September 30, 1998, respectively, as compared to
$548,827 and $2,728,898 for the three month and nine month periods ended
September 30, 1997, respectively. Such increase was caused primarily by a
significant increase in advertising revenue, offset by a decline in revenues
caused by the cessation of the SegaSoft agreement in 1997.
Cost of Revenues. Cost of revenues was $4,615,542 and $8,643,492 for the three
month and nine month periods ended September 30, 1998, respectively, as compared
to $511,466 and $1,405,693 for the three month and nine month periods ended
September 30, 1997, respectively. Such increases primarily related to increased
payments to Affiliated Web sites and increases in third party ad serving costs
which were caused by growth in advertising revenue and the temporary increase in
costs in connection with the transition to Adfinity(TM). Such increases were
offset by reduced ContentZone ad serving costs.
Operating Expenses. Total operating expenses were $6,953,600 and $20,124,741 for
the three month and nine month periods ended September 30, 1998, respectively,
as compared to $2,437,528 and $5,944,966 for the three month and nine month
periods ended September 30, 1997, respectively. These increases were caused by
(i) higher sales and marketing and general and administrative expenses resulting
from the Acquisitions, (ii) additional operating expenses incurred in
anticipation of future growth, (iii) acquired in-process technology of
approximately $5.5 million from the acquisition of Intelligent Interactions
which was immediately charged to operations in April 1998, and (iv) amortization
of goodwill resulting from the Acquisitions. Such increases were partially
offset in the nine months ended September 30, 1998 by the significant reduction
of product development expense prior to the Company's acquisition of Intelligent
Interactions in April 1998.
The value of the acquired in-process technology was determined using a
combination of a risk-adjusted income approach and an independent valuation. The
acquired in-process technology had not reached the stage of technological
feasibility at the date of acquisition and had no alternative future use.
21
<PAGE>
Liquidity and Capital Resources
Historically, the Company has financed its operations primarily from private
placements of equity and convertible debt securities. Concurrently with the
merger of Petry and Advercomm with and into 24/7 Media, the Company completed a
private placement of preferred stock and warrants which resulted in net proceeds
of $9,830,897. In August 1998, the Company completed an initial public offering
of its common stock pursuant to which the Company realized net proceeds of
approximately $44.8 million. As of September 30, 1998, the Company had cash and
cash equivalents of $42,784,975.
In addition to funding on-going operations, the Company's principal commitments
consist of various obligations under operating and capital leases. Total lease
expenses, excluding rent, were $130,432 and $229,881 for the three month and
nine month periods ended September 30, 1998, respectively, as compared to
$241,841 and $567,855 for the three month and nine month periods ended September
30, 1997, respectively. An operating lease which was initially entered into by
the Company in 1996 requires current quarterly payments of approximately $43,000
and expires in November 1998. During the second and third quarters of 1998, the
Company entered into a series of operating leases for computer equipment and
software related to its Adfinity(TM) system, with a combined fair market value
of $849,488. This operating lease, as amended, requires monthly payments and
expires in November 2000. Total rent expense for currently outstanding leases is
expected to be approximately $90,500 per quarter. During the third quarter of
1998, the Company entered into a capital lease for approximately $85,000
including principal and interest.
At the beginning of the fourth quarter, the Company has ordered additional
computer equipment with a combined fair market value of approximately $600,000.
The Company is in the process of finalizing a leasing arrangement for this
equipment, which it expects to result in additional quarterly payments of
approximately $40,000 during the term of the lease, which may be up to four
years.
Furthermore, the Company expects to incur approximately $1 million in leasehold
improvements prior to moving into additional leased office space at the
Company's headquarters in New York City, and in the aggregate, the Company's
annual lease expense for this office space will be approximately $1.2 million
through 2003. In addition, the Company is in final negotiations with the
landlord for this space to extend the lease to 2008. The Company believes that
the expenses associated with such additional office space will not have a
material effect on the Company's financial position.
Net cash used in operating activities was $9,364,523 for the nine months ended
September 30, 1998 as compared to $3,724,711 for the nine months ended September
30, 1997. Net cash used in operating activities resulted from the Company's net
operating losses, adjusted for certain non-cash items, including: (i) a
significant advance by SegaSoft in late 1996 for revenues that were primarily
recognized during 1997; (ii) the amortization of goodwill in the first nine
months of 1998 related to the Acquisitions. Net cash used in operating
activities also resulted from a high level of accounts receivable and related
accrued liabilities due to the time lag between revenue recognition and receipt
of payments from advertisers. The Company has recently taken steps to improve
the timeliness of its billing procedures such as working with its ad serving
companies to ensure the timely receipt of reports and improving the Company's
internal billing and collection procedures and systems. The Company anticipates
that it will be able to further improve the timeliness of its billing and
collections processes as it completes the transition to a single ad serving
solution, which will enable the Company to produce required reports internally,
thereby enhancing net working capital as a percentage of total revenues.
Net cash used in investing activities was $2,437,519 for the nine months ended
September 30, 1998 as compared to $11,616 for the nine months ended September
30, 1997. Net cash used in investing activities resulted primarily from capital
expenditures relating to computer equipment as well as the cash portion of
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the purchase of CliqNow!. To the extent that the Company purchases significant
ad serving hardware in the future, net cash used in investing activities could
increase.
Net cash provided by financing activities was $54,493,072 for the nine months
ended September 30, 1998 as compared to $2,125,011 for the nine months ended
September 30, 1997. Net cash provided by financing activities for the nine month
periods ended September 30, 1998 and 1997 included issuances of convertible
notes, convertible preferred stock, common stock and warrants. Prior to
September 30, 1998, all of the previously issued convertible notes, convertible
preferred stock and warrants were converted or exercised into common stock,
except for warrants to purchase approximately 3.8 million shares of Common Stock
with exercise prices ranging from $3.81 to $11.42 per share.
No provision for federal or state income taxes has been recorded as the Company
incurred net operating losses for all periods presented. At December 31, 1997,
the Company had approximately $13,394,000 of federal net operating loss
carryforwards available to offset future taxable income; such carryforwards
expire in various years through 2012. As a result of various equity transactions
during 1996, 1997 and 1998, management believes that the Company has undergone
an "ownership change" as defined by section 382 of the Internal Revenue Code.
Accordingly, the utilization of a portion of the net operating loss carryforward
may be limited. Due to this limitation, and the uncertainty regarding the
ultimate utilization of the net operating loss carryforward, no tax benefit for
losses has been recorded by the Company and a valuation allowance has been
recorded for the entire amount of the net deferred tax asset. In addition,
certain events, including any sales by the Company of shares of its stock,
including sales pursuant to the IPO, and/or transfers of a substantial number of
shares of Common Stock by the current stockholders, may partially restrict the
ability of the Company to utilize its net operating loss carryforwards.
The Company believes that its cash and cash equivalent balances as of September
30, 1998 will be sufficient to fund its requirements for working capital and
capital expenditures for at least the next 12 months. To the extent that the
Company encounters unanticipated opportunities, the Company may need to raise
additional funds sooner, in which case the Company may sell additional equity or
debt securities or borrow funds from banks or other financial sources. Sales of
additional equity or convertible debt securities may result in additional
dilution of the Company's stockholders. There is no assurance that the Company
will be able to sell additional equity or debt securities in the future or that
additional financing will be available to the Company when needed on
commercially reasonable terms, or at all.
Year 2000 Compliance
Beginning in the Year 2000, the date fields coded in certain software products
and computer systems will need to accept four digit entries in order to
distinguish 21st century dates from 20th century dates and, as a result, many
companies' software and computer systems may need to be upgraded or replaced in
order to comply with such "Year 2000" requirements. Systems that do not properly
recognize such information could generate erroneous data or cause a system to
fail. Significant uncertainty exists in the software industry concerning the
potential effects associated with such compliance issues.
State of Readiness. The Company has developed a remediation plan for its Year
2000 issue that involves identification, assessment and testing of the equipment
and systems affected.
a) The Company has assessed its information technology (IT) equipment and
systems, which includes its ad servers and ad serving technology.
b) The Company has identified and assessed non-information technology
(non-IT) embedded systems such as building security, voice mail, fire
prevention, climate control and other systems.
c) The Company is analyzing the readiness of significant third party vendors
and suppliers of services.
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The Company's evaluation covers the following phases: (i) identification of all
IT equipment and systems, and non-IT systems; (ii) assessment of repair or
replacement requirements; (iii) repair or replacement; (iv) testing; (v)
implementation; and (vi) creation of contingency plans in the event of Year 2000
failures. The Company's evaluation will be completed in the first quarter of
1999.
The Company's non-information technology systems are not considered by the
Company to be date sensitive to the Year 2000 and, therefore, do not raise Year
2000 issues. The Company has reviewed its internally developed programs, and has
determined that there are no significant Year 2000 issues within the Company's
systems or services. Based on this evaluation, the Company generally believes
that it will be Year 2000 compliant.
Although the Company believes that its internally developed systems are Year
2000 compliant, the Company utilizes third-party equipment and software that may
not be Year 2000 compliant. Failure of such third-party equipment or software to
operate properly with regard to the Year 2000 and thereafter could require the
Company to incur unanticipated expenses to remedy any problems, which could have
a material adverse effect on the Company's business, results of operations and
financial condition. The software and hardware products used by Web publishers
and advertisers using the Company's solutions, software and hardware products
used by the Company's vendors, as well as software and hardware products used to
operate the Internet and certain public utilities, including telecommunications
companies and electric companies, may not be Year 2000 compliant, thereby
disrupting the ability of customers to utilize the Company's solutions. The
Company is currently in the process of evaluating the Year 2000 compliance of
(i) the third-party products used in its internal systems and (ii) the Company's
major vendors.
The Company is currently unable to predict the extent to which the Year 2000
issue will affect its suppliers, or the extent to which it would be vulnerable
to the suppliers' failure to remediate any Year 2000 issues on a timely basis.
The failure of a major supplier subject to the Year 2000 to convert its systems
on a timely basis or a conversion that is incompatible with the Company's
systems could have a material adverse effect on the Company. The Company
anticipates that the evaluation will be completed by the first quarter of 1999.
In addition, the purchasing patterns of advertisers may be affected by Year 2000
issues as companies expend significant resources to correct their current
systems for Year 2000 compliance. These expenditures may result in reduced funds
available for Web advertising or sponsorship of Web services, which could have a
material adverse effect on the Company's business, results of operations and
financial condition.
Costs to address the Company's Year 2000 Issue. To date, the Company has not
incurred any material expenditures in connection with identifying or evaluating
Year 2000 compliance issues. Most of its expenses have related to the
opportunity cost of time spent by employees of the Company evaluating its
software, the current versions of its products, and Year 2000 compliance matters
generally. The Company does not believe that the costs of the evaluation of Year
2000 compliance or to address any of its Year 2000 compliance issues will be
material. However, the impact of the Year 2000 issues cannot be determined at
this time. The failure by certain third parties, particularly public utility
companies and Web publishers, to address their Year 2000 issues on a timely
basis could have a material adverse effect on the Company's business, results of
operations, or financial condition.
There is no assurance that such parties will not suffer a Year 2000 business
disruption, which could have a material adverse effect on the Company's
business, financial condition and results of operations.
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Contingency Plan. The Company has not developed a Year 2000-specific contingency
plan. If Year 2000 compliance issues are discovered, the Company then will
evaluate the need for contingency plans relating to such issues.
The Company intends to actively work with and encourage its suppliers to
minimize the risks of business disruptions resulting from Year 2000 issues and
develop contingency plans where necessary. Such plans may include, but are not
limited to, using alternative suppliers and establishing contingent supply
arrangements. The Company expects to have such plans in place by the second
quarter of 1999.
Risk Factors
This report contains forward-looking statements that are based largely on the
Company's current expectations and that are subject to a number of risks and
uncertainties, including those set forth below. The Company's actual results
could differ materially from the results discussed in "Risk Factors" below,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and elsewhere in this report.
Extremely Limited Operating History; History of Losses; Integration of Acquired
Entities. Because none of the predecessor companies that were combined to form
24/7 Media had an operating history of more than four years, the Company has an
extremely limited operating history upon which an evaluation of the Company can
be based. The Company and its prospects must be considered in light of the
risks, expenses and difficulties encountered by companies with limited operating
histories, particularly companies in the new and rapidly evolving Internet
market. To address these risks, the Company must, among other things,
effectively develop new relationships and maintain existing relationships with
customers, business and technology partners and other third parties; further
develop and upgrade its technology; improve its technical support and service;
respond to competitive developments; implement and improve operational,
financial and managerial information systems; and attract, retain and motivate
qualified personnel. There can be no assurance that the Company will succeed in
addressing such risks and the failure to do so could have a material adverse
effect on the Company's business, results of operations and financial condition.
Although the Company has experienced revenue growth in recent periods, such
growth may not be sustained and is not necessarily indicative of future
operating results. The Company incurred pro forma net losses of $16.9 million
for the year ended December 31, 1997 and $15.5 million for the nine months ended
September 30, 1998. Each of the predecessors of the Company had net losses in
each year since its inception. The Company anticipates that it will incur
operating losses for the foreseeable future due to a high level of planned
operating and capital expenditures. There can be no assurance that operating
losses will not increase in the future or that the Company will ever achieve or
sustain profitability. The Company's business, results of operations and
financial condition may be materially and adversely affected if revenues do not
grow at anticipated rates or if the Company is unable to adjust operating
expenses to appropriate levels for revenue levels achieved.
24/7 Media did not conduct any substantial operations until February 1998. In
February 1998, the Company closed a transaction pursuant to which Petry and
Advercomm were merged into the Company. In April 1998, the Company completed two
transactions pursuant to which Interactive Imaginations was merged into the
Company and Intelligent Interactions became a wholly-owned subsidiary of the
Company. In June 1998, the Company acquired CliqNow! In order to integrate
effectively the previously independent operations, the Company must continue to
integrate and improve its financial and management controls, ad serving
technology, reporting systems and procedures, and expand, train and
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manage its work force. Completion of such 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 other operations of
the Company.
Potential Fluctuations in Quarterly Operating Results; Seasonality. The
Company's results of operations may fluctuate significantly in the future as a
result of a variety of factors, many of which are beyond the Company's control.
These factors include the addition of new or loss of current advertisers or
Affiliated Web sites, changes in fees paid by advertisers, changes in the level
of user traffic and number of available impressions on the Web sites in the
Company's networks, changes in service fees payable by the Company to Web
publishers, the introduction of new Internet advertising services by the Company
or its competitors, variations in the levels of capital expenditures and other
costs relating to the expansion of the Company's operations, and general
economic conditions. Future revenues and results of operations of the Company
may be difficult to forecast due to such factors.
Management believes that its revenues are also subject to seasonal fluctuations
because advertisers generally place fewer advertisements during the first and
third calendar quarters of each year. Additional seasonal patterns in Internet
advertising spending may emerge as the industry matures. Expenditures by
advertisers tend to vary in cycles that reflect overall economic conditions as
well as budgeting and buying patterns. The Company's business could be
materially adversely affected by a decline in the economic prospects of
advertisers or the economy generally, which could alter current or prospective
advertisers' spending priorities or budget cycles or extend the Company's sales
cycle with respect to certain of its advertisers.
The Company's current and future expense levels are based in large part on its
investment plans and estimates of future revenues. In particular, the Company
expects to increase significantly its operating expenses in order to expand its
sales and marketing organization and to enhance its Adfinity(TM) technology. To
the extent that such expenses precede or are not subsequently followed by
increased revenues, the Company's business, results of operations and financial
condition would be materially and adversely affected. The Company may be unable
to, or may elect not to, adjust spending in a timely manner to compensate for
any unexpected revenue shortfall. Therefore, any significant shortfall in
revenues in relation to the Company's expectations would have a material adverse
effect on the Company's business, results of operations and financial condition.
Due to the foregoing factors, 24/7 Media believes that period-to-period
comparisons of its results of operations may not be meaningful and should not be
relied upon as indicators of future performance. Furthermore, it is possible
that in some future periods the Company's results of operations may fall below
the expectations of securities analysts and investors. In such event, the
trading price of the Common Stock would likely be materially and adversely
affected.
Developing Market; Unproven Effectiveness of Web Advertising and Online Direct
Marketing. In the new and rapidly evolving Internet advertising market, demand
and market acceptance for products and services are subject to high levels of
uncertainty, and a significant number of entrants continually seek to penetrate
the market. Since 24/7 Media expects to derive substantially all of its revenues
in the foreseeable future from Internet advertising, the future success of the
Company is highly dependent on the increased use of the Internet as an
advertising medium.
The Internet as an advertising medium has not been in existence for a sufficient
period of time in order to demonstrate its effectiveness as compared with
traditional advertising media. Most of the Company's current or potential
advertising customers have limited or no experience using the Internet as an
advertising medium, have not devoted a significant portion of their advertising
expenditures to Internet
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advertising and may not find Internet advertising to be effective for promoting
their products and services relative to advertising across traditional media.
Companies adopting Internet advertising, particularly those that use traditional
media for advertising, must accept new ways of conducting business and
exchanging information. In addition, most Web publishers have limited or no
experience in generating revenues from the sale of advertising space on their
Web sites. There can be no assurance that the market for Internet advertising
will continue to emerge or be sustainable.
Online advertising must demonstrate a level of effectiveness necessary to
justify a reallocation of resources from traditional forms of advertising to
this developing medium. There are currently no widely accepted standards to
measure the effectiveness of Internet advertising and there can be no assurance
that such standards will develop to support Internet advertising sufficiently as
a significant advertising medium. Advertisers may not accept the Company's or
third-party measurements of impressions on Web sites utilizing the Company's
services or that such measurements will not contain errors. In addition, the
effectiveness of Internet advertising is dependent upon the accuracy of
information contained in the databases used to target advertisements. There can
be no assurance that the information in the Company's database will be accurate
or that advertisers will be willing to have advertisements targeted by any
database containing such potential inaccuracies. Actual or perceived
ineffectiveness of online advertising generally, or accuracy of measurements or
database information in particular, could limit the long-term growth of online
advertising, which would have a material adverse effect on the Company's
business, results of operations and financial condition.
Banner advertising, from which the Company currently derives most of its
revenues, may not be an effective advertising method in the future. There can be
no assurance that any other forms of Internet advertising will be developed or
accepted by the market and if so developed, that the Company would effectively
transition to the marketing and sale of such other forms of online advertising.
Moreover, "filter" software programs that limit advertising from being delivered
to a Web site are currently available. Failure to develop successfully
alternative forms of online advertising or widespread adoption of filter
software could have a material adverse effect upon the Internet advertising
market and 24/7 Media's business, results of operations and financial condition.
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), requires the broad acceptance of a new and
substantially different approach to direct marketing. As with online advertising
and other new markets, intensive marketing and sales efforts may be necessary to
educate prospective advertisers regarding the uses and benefits of the Company's
products and services in order to generate demand for the Company's services.
Enterprises that have already invested substantial resources in other methods of
conducting business may be reluctant or slow to adopt a new approach that may
replace, limit, or compete with their existing 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.
Reliance on a Limited Number of Web Publishers; Dependence on the 24/7 Network.
The Company expects to generate most of its revenues for the foreseeable future
from advertisements delivered to Web sites of a limited number of Web publishers
on the 24/7 Network. The 24/7 Network consists of a limited number of Affiliated
Web sites that have contracted for the Company's services under agreements
cancelable upon a specified notice period. For the nine months ended September
30, 1998 and for the year ended December 31, 1997, approximately 50% and 68%,
respectively, of the 24/7 Network's pro forma advertising revenues were derived
from advertisements on the top ten Affiliated Web sites on the 24/7 Network. The
top ten Web sites for the nine months ended September 30, 1998 included AT&T
WorldNet Service, Netscape Communications, Reuters News Network, Comedy Central,
Encompass,
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Inc., Earthlink Network, Inc., Blizzard Entertainment, The Mining Company,
Meredith Corporation and Reality Online Inc. The top ten Web sites for the year
ended December 31, 1997 included AT&T WorldNet Service, Reuters, USA.NET,
Columbia House, Comedy Central, Reuters-MoneyNet, Maps on Us, Universal Media,
FlashNet Communications and FoxNews Internet. The Company from time to time
experiences turnover in its Affiliated Web sites, and there can be no assurance
that the Web sites named above remain or will remain associated with the
Company. Affiliated Web sites generally measure satisfaction by acceptable
revenue levels, adequate "click-thru rates" (the number of times users click on
an advertisement as a percentage of page views), high levels of customer service
and timely and accurate reporting. There can be no assurance that the Affiliated
Web sites will maintain consistent or increasing levels of traffic over time, or
that the Company would be able to replace any departed Affiliated Web site with
another Web publisher with comparable traffic patterns and user demographics.
The loss or reduction in traffic of such Web sites may cause advertisers or Web
publishers to withdraw from the 24/7 Network, which, in turn, could materially
adversely affect the Company's business, results of operations and financial
condition. The failure of the Company to market its networks successfully or the
failure of Affiliated Web sites to maintain consistent or increasing levels of
traffic would have a material adverse effect on the Company's business, results
of operations and financial condition.
Reliance on a Limited Number of Advertisers and Ad Agencies. The Company's
revenues have been derived from a limited number of advertisers and ad agencies
that purchase space on Affiliated Web sites and the Company expects that a
limited number of these entities may continue to account for a significant
percentage of the Company's revenues for the foreseeable future. For the nine
months ended September 30, 1998 and for the year ended December 31, 1997, the
Company's top ten advertisers and ad agencies accounted for an aggregate of
approximately 41% and 48%, respectively, of the 24/7 Network's pro forma
advertising revenues. Advertisers and ad agencies typically purchase advertising
pursuant to purchase order agreements that run for a limited time. There can be
no assurance that current advertisers and ad agencies will continue to purchase
advertising from the Company or that the Company will be able to attract
additional advertisers and ad agencies successfully. The loss of one or more of
the advertisers or ad agencies that represent a material portion of the revenues
generated on the Company's networks could have a material adverse effect on the
Company's business, results of operations and financial condition. In addition,
the non-payment or late payment of amounts due to the Company from a significant
advertiser or ad agency could have a material adverse effect on the Company's
business, results of operations and financial condition.
Integration of Adfinity(TM) Technology; Dependence on Third Party Technology.
The Company has utilized the advertisement management service from AdForce to
deliver its advertisements to the 24/7 Network. 24/7 Media is in the process of
replacing the AdForce service with the Company's Adfinity(TM) system, which is
expected to become the technology platform for all of the Company's networks.
The Company anticipates that Adfinity(TM) will enable it to deliver targeted
advertisements based on demographic profiles and consumer behavior. There can be
no assurance that the information required to develop user profiles will be
available and, if available, that the utilization of such information will not
be cost prohibitive. The Company's ability to deliver increased value to
advertisers and Web publishers in the future is therefore based, in large part,
on the successful integration of Adfinity(TM) as the technology platform for the
Company's networks. In order to complete the transition to Adfinity(TM), the
Company must, among other things, ensure scalability of the Adfinity(TM) system,
assimilate the Company's current sales and reporting functions into the
Adfinity(TM) model and work with certain existing Affiliated Web sites to re-tag
such Web sites. There can be no assurance that the Company will be able to
complete the integration of Adfinity(TM) on a timely basis. The failure of the
Company to effect a successful transition to Adfinity(TM) could result in a loss
of Affiliated Web sites, a disruption in the Company's ability to deliver
advertisements effectively and a negative impact on its business in general
until Adfinity(TM) or an alternative advertisement management technology is
integrated. If the Company is unable to integrate the
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Adfinity(TM) technology successfully on a timely basis, or if the Adfinity(TM)
technology does not enable the Company to target advertisements effectively
based on demographic profiles and consumer behavior, or if the information to
develop user profiles is not available, the Company's business, results of
operations and financial condition would be materially adversely affected.
Until the integration of Adfinity(TM) is completed, the Company may be dependent
upon AdForce to deliver ads to the 24/7 Network. If the AdForce service becomes
unavailable or if AdForce fails to serve the Company's advertisements
effectively, the Company's business, results of operations and financial
condition would be materially adversely affected. In addition to the delivery of
advertisements, AdForce also produces frequent operational reports for use by
the Company, advertisers and the Affiliated Web sites. However, the AdForce
system requires the Company to employ a significant amount of effort to prepare
information for financial reporting. This causes difficulties in preparing
financial statements and reporting information on a timely basis. The Company is
in the process of upgrading its systems in order to integrate newly developed
and/or purchased modules with its existing systems and with Adfinity(TM) in
order to improve its accounting, control and reporting methods. The Company's
inability to add additional software and hardware or to develop further and
upgrade its existing technologies, systems or network infrastructure may cause
unanticipated delays in delivering its customers' advertisements and providing
timely reporting of accurate financial information.
Competition. The markets for Internet advertising and related products and
services are intensely competitive and such competition is expected to increase.
The Company believes that its ability to compete depends upon many factors both
within and beyond its control, including the timing and market acceptance of new
products and enhancements of existing services developed by the Company and its
competitors; changing demands regarding customer service and support; shifts in
sales and marketing efforts by the Company and its competitors; and the ease of
use, performance, price and reliability of the Company's services and products.
The Company competes with large Web publishers and Web search engine companies,
such as America Online, Excite, GeoCities, Infoseek, Lycos and Yahoo!, for
Internet advertising revenues. Further, the Company's networks compete with a
variety of Internet advertising networks, including DoubleClick and Link
Exchange. In marketing the Company's networks and its Adfinity(TM) service to
Web publishers, the Company also competes with providers of advertisement
software and related services, including NetGravity and Accipiter, a division of
CMG Information Services, Inc. In marketing dbCommerce(TM), the Company competes
with a variety of entities, including BroadVision. The Company also encounters
competition from a number of other sources, including content aggregators,
companies engaged in advertising sales networks, advertising agencies and other
entities that facilitate Internet advertising. Many of the Company's existing
competitors, as well as a number of potential new competitors, have longer
operating histories, greater name recognition, larger customer bases and
significantly greater financial, technical and marketing resources than the
Company. There can be no assurance that the Company will be able to compete
successfully against current or future competitors or that competitive pressures
will not have a material adverse effect on the Company's business, results of
operations and financial condition. In addition, the Internet, in general, and
the Company, specifically, also must compete for a share of advertisers' total
budgets with traditional advertising media, such as television, radio, cable and
print. To the extent that the Internet is perceived to be a limited or
ineffective advertising medium, advertisers may be reluctant to devote a
significant portion of their advertising budgets to Internet advertising, which
could limit the growth of Internet advertising and would have a material adverse
effect on the Company's business, results of operations and financial condition.
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Dependence on Third Party Systems; Risk of System Failure; Capacity Constraints.
A key to the Company's strategy is to generate a high volume of traffic for its
products and services. In particular, the future success of the Company depends
on the performance of Adfinity(TM) and third party service providers. Adfinity's
computer hardware and software is housed at GlobalCenter, Inc., a third party
provider of Internet communication services. Any Adfinity(TM) or third party ad
server system failure, including failures that delay the delivery of
advertisements to Web sites, could reduce customer satisfaction and result in a
material adverse effect on the Company's business, results of operations and
financial condition.
In general, the Company's operations are dependent upon the proper operation of
its own and third party computer systems. Any damage from fire, power loss,
telecommunications failures, vandalism and other malicious acts, and similar
unexpected events could adversely affect 24/7 Media's business, results of
operations and financial condition. In addition, failure of the Company's
telecommunications providers to provide the data communications capacity in the
time frame required by the Company for any reason could cause interruptions in
the services provided by the Company. Despite precautions taken by the Company,
unanticipated problems affecting the Company's computer and telecommunications
systems in the future could cause interruptions in the delivery of the Company's
services. Any damage or failure that interrupts or delays the Company's
operations could have a material adverse effect on the Company's business,
results of operations and financial condition.
Furthermore, large increases in the volume of advertising delivered through the
Company's ad servers could strain the capacity of the software or hardware
deployed by the Company, which could lead to slower response time or system
failures and could have a material adverse effect on the Company's business,
results of operations and financial condition.
Management of Growth; Risks Associated with Acquisitions; Risks of International
Expansion. 24/7 Media has experienced rapid growth and expansion in operations
that have placed a significant strain on the Company's managerial, operational
and financial resources. The Company has grown from approximately 60 employees
on a pro forma basis as of September 30, 1997 to approximately 150 employees as
of September 30, 1998 and expects the number of employees to increase in the
future. In order to successfully compete in the evolving Internet industry, 24/7
Media must continue to improve its financial and management controls, enhance
its reporting systems and procedures, and expand, train and manage its work
force. There can be no assurance that the Company's systems, procedures or
controls will be adequate to support 24/7 Media's expanding operations, or that
management will be able to respond effectively to such growth. The Company's
future results of operations also depend on the expansion of its sales,
marketing and customer support organizations. 24/7 Media's business, results of
operations and financial condition could be materially adversely affected if
growth is not managed effectively.
24/7 Media intends to pursue selective acquisitions of businesses, technologies
and product lines as a key component of its growth strategy. 24/7 Media
regularly seeks to identify and acquire or invest in companies or assets that
will enhance 24/7 Media's revenue growth, operations and profitability. Any
future acquisition or investment may result in the use of significant amounts of
cash, potentially dilutive issuances of equity securities, incurrence of debt
and amortization expenses related to goodwill and other intangible assets, each
of which could materially adversely affect the Company's business, results of
operations or financial condition. In addition, acquisitions involve numerous
risks, including the difficulties in the integration and assimilation of the
operations, technologies, products and personnel of any 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. In the event that an
acquisition does occur, there can be no assurance
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that 24/7 Media will be able to successfully integrate the acquired business,
and the failure to do so could have a material adverse effect on the Company's
results of operations and financial position. See "--Integration of Adfinity(TM)
Technology; Dependence on Third Party Technology."
The Company has entered into a number of international alliances. These
alliances involve certain inherent risks, such as unexpected changes in
regulatory requirements, potentially adverse tax consequences, general export
restrictions and export controls relating to encryption technology, tariffs and
other trade barriers, political instability and fluctuations in currency
exchange rates, and seasonal reductions in business activity. Any of the above
could have a material adverse effect on the success of the Company's future
international initiatives.
Dependence on Key Personnel. The Company's success depends upon its senior
management and its key sales and technical personnel, particularly David J.
Moore, Chief Executive Officer, Jacob I. Friesel, Executive Vice President, and
Yale R. Brown, Executive Vice President. The loss of the services of one or more
of these persons could materially adversely affect 24/7 Media's business,
results of operations and financial condition. 24/7 Media's success also depends
on its 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 there
can be no assurance that the Company will be able to retain its key personnel or
that it can attract, assimilate or retain other highly qualified personnel in
the future. The Company has 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.
Although the Company has not experienced any material impact from the difficulty
in hiring and retaining qualified employees, there can be no assurance that the
Company will not be materially impacted in the future from such hiring
difficulties. The failure by the Company to successfully hire and retain
candidates with appropriate qualifications could have a material adverse effect
on the Company's business, results of operations and financial condition.
Privacy Concerns. The Company's Adfinity(TM) technology collects and utilizes
data derived from user activity on the Company's networks and the Web sites of
independent Web publishers using the Company's services. There can be no
assurance that any trade secret, copyright or other protection will be available
for such data or that others will not claim rights to such data. 24/7 Media must
also keep certain information regarding Web publishers confidential pursuant to
its contracts with Web publishers. Adfinity(TM) enables the use of "cookies," in
addition to other mechanisms, to deliver targeted advertising, to help compile
demographic information, and to limit the frequency with which an advertisement
is shown to the user. Cookies are bits of information keyed to a specific
server, file pathway or directory location that are stored on a user's hard
drive and passed to a Web site's server through the user's browser software.
Cookies are placed on the user's hard drive without the user's knowledge or
consent, but can be removed by the user at any time through the modification of
the user's browser settings. Due to privacy concerns, some Internet
commentators, advocates and governmental bodies have suggested that the use of
cookies be limited or eliminated. In addition, certain currently available
Internet browsers allow a user to delete cookies or prevent cookies from being
stored on the user's hard drive.
Government Regulation. Due to the increasing popularity and use of the Web, a
number of laws and regulations may be adopted regarding user privacy, pricing,
acceptable content, taxation and quality of products and services. Although
there are currently few laws or regulations directly governing access to or
commerce on the Internet, any new legislation could inhibit the growth in use of
the Web and decrease the acceptance of the Web as a communications and
commercial medium, which could have a material adverse effect on the Company's
business, results of operations and financial condition. In addition, the
growing use of the Web has burdened existing telecommunications infrastructure
and has caused interruptions in telephone service. Certain telephone carriers
have petitioned the government to regulate
31
<PAGE>
and impose fees on Internet service providers and online service providers in a
manner similar to long distance telephone carriers. Any such regulations could
affect the costs of communicating on the Web and adversely affect the growth in
use of the Web, which could in turn decrease the demand for the Company's
products or otherwise have a material adverse effect on the Company's business,
results of operations and financial condition. Further, due to the global nature
of the Web, governments of states or foreign countries may attempt to regulate
Internet transmissions or levy sales or other taxes relating to the Company's
activities. There can be no assurance that violations of local laws will not be
alleged by applicable governments, 24/7 Media will not violate such laws or new
laws will not be enacted in the future. Moreover, the applicability to the
Internet of existing laws governing issues such as property ownership, libel and
personal privacy is uncertain. Any of the foregoing developments could have a
material adverse effect on the Company's business, results of operations and
financial condition.
32
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
The Company is not a party to any material legal proceedings.
Item 2. Changes in Securities and Use of Proceeds.
On August 19, 1998, the Company consummated an initial public offering of its
common stock pursuant to a Registration Statement on Form S-1, as amended, File
No. 333-56085. The order of the Securities and Exchange Commission declaring the
Registration Statement effective was dated approximately 5:30 p.m. EDT on August
12, 1998. The offering was managed by Merrill Lynch & Co., Allen & Company
Incorporated and J.P. Morgan & Co. Net proceeds to the Company from this initial
public offering totaled $44.8 million, after offering costs of $1.4 million.
None of the expenses incurred in the offering were direct or indirect payments
to directors, officers, general partners of the Company or their associates, to
persons owning ten percent or more of any class of equity securities of the
Company or to affiliates of the Company. During the three months ended September
30, 1998, the Company used $2.0 million of the proceeds from the Offering toward
general corporate purposes, including working capital, and toward the expansion
of the Company's sales and marketing capabilities. None of these expenses were
direct or indirect payments to directors, officers, general partners of the
Company or their associates, to persons owning ten percent or more of any class
of equity securities of the Company or to affiliates of the Company.
On July 20, 1998, the Company effected a 1-for-4 reverse stock split in
connection with its initial public offering. Accordingly, all references in the
consolidated financial statements to the number of shares and to per share
amounts have been retroactively restated to reflect the stock split.
During the first six months of 1998, the Company issued Series A and Series B
shares of mandatorily redeemable convertible preferred stock. Each Series A and
Series B share was automatically converted into common shares at their
respective conversion prices simultaneously with the closing of the Company's
initial public offering.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
The Company obtained a written consent dated July 19, 1998 of a majority of the
stockholders approving amendments to the Company's Certificate of Incorporation
(i) for the stock split on July 20, 1998; and (ii) to decrease the authorized
number of shares of common stock from 100,000,000 to 70,000,000 and the
authorized number of shares of preferred stock from 30,000,000 to 10,000,000.
Item 5. Other Information.
None.
33
<PAGE>
Item 6. Exhibits and Reports on Form 8-K .
(a) Exhibits.
Exhibit 11.1 Statement of calculation of basic and diluted net loss and pro
forma net loss per share
Exhibit 27 Financial data schedule
(b) Reports on Form 8-K.
None.
34
<PAGE>
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 MEDIA, INC.
Date: November 13, 1998 By: /s/ David J. Moore
------------------------
David J. Moore
President and Chief Executive Officer
By: /s/ C. Andrew Johns
------------------------
C. Andrew Johns
Chief Financial Officer
35
EXHIBIT 11.1
24/7 MEDIA, INC.
CALCULATION OF NET LOSS AND PRO FORMA NET LOSS PER SHARE
(Unaudited)
<TABLE>
<CAPTION>
Actual
-------------------------------------------------------------------------
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- ---------------------------------
1998 1997 1998 1997
------------- ------------ ------------ -------------
<S> <C> <C> <C> <C>
Net Loss $ (5,796,349) $(2,433,302) $(18,350,979) $ (4,645,273)
------------ ----------- ------------ ------------
Cumulative Dividends on Mandatorily
Convertible Preferred Stock (90,607) -- (275,796) --
------------ ----------- ------------ ------------
Net Loss Attributable to Common
Stockholders $ (5,886,956) $(2,433,302) $(18,626,775) $ (4,645,273)
============ =========== ============ ============
Total weighted average
common shares outstanding 11,737,255 1,079,116 7,610,191 1,079,116
============ =========== ============ ============
Basic and diluted net loss per share $ (0.50) $ (2.25) $ (2.45) $ (4.30)
============ =========== ============ ============
</TABLE>
<TABLE>
<CAPTION>
Pro Forma (2)
-------------------------------------------------------------------------
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- ---------------------------------
1998 1997 1998 1997
------------- ------------ ------------ -------------
<S> <C> <C> <C> <C>
Net Loss $ (5,796,349) $(5,882,888) $(15,544,927) $(13,449,881)
------------ ----------- ------------ ------------
Cumulative Dividends on Mandatorily
Convertible Preferred Stock (90,607) (136,500) (275,796) (409,500)
------------ ----------- ------------ ------------
Net Loss Attributable to Common
Stockholders $ (5,886,956) $(6,019,388) $(15,820,723) $(13,859,381)
============ =========== ============ ============
Total weighted average
common shares outstanding 11,737,255 4,652,006 8,688,842 4,363,405
============ =========== ============ ============
Basic and diluted net loss per share $ (0.50) $ (1.30) $ (1.82) $ (3.18)
============ =========== ============ ============
</TABLE>
(1) Net loss per share is computed in accordance with SFAS No. 128, "Earnings
per Share," and SEC Staff Accounting Bulletin No. 98 for all periods
presented. The computation of diluted net loss per share excludes common
stock issuable upon exercise of employee stock options, outstanding
warrants, conversion of mandatorily redeemable convertible preferred stock
and senior convertible notes payable- related parties as their effect on
all periods presented is anti-dilutive.
(2) The computation of pro forma net loss per share is computed on the basis
described in (1) above and giving effect to the common shares issued with
the acquisition of each of the acquired companies as if they had occurred
on January 1, 1997, or date of inception, if later.
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0001062195
<NAME> 24/7 MEDIA, INC.
<MULTIPLIER> 1
<CURRENCY> U.S. DOLLARS
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1998
<PERIOD-START> JUL-1-1998 JAN-1-1998
<PERIOD-END> SEP-30-1998 SEP-30-1998
<EXCHANGE-RATE> 1 1
<CASH> 42,784,975 42,784,975
<SECURITIES> 0 0
<RECEIVABLES> 6,866,514 6,866,514
<ALLOWANCES> 636,840 636,840
<INVENTORY> 0 0
<CURRENT-ASSETS> 49,343,259 49,343,259
<PP&E> 2,209,065 2,209,065
<DEPRECIATION> 734,786 734,786
<TOTAL-ASSETS> 62,566,159 62,566,159
<CURRENT-LIABILITIES> 7,942,426 7,942,426
<BONDS> 0 0
0 0
0 0
<COMMON> 154,828 154,828
<OTHER-SE> 54,426,146 54,426,146
<TOTAL-LIABILITY-AND-EQUITY> 62,566,159 62,566,159
<SALES> 5,527,341 10,303,879
<TOTAL-REVENUES> 5,527,341 10,303,879
<CGS> 0 0
<TOTAL-COSTS> 4,615,542 8,643,492
<OTHER-EXPENSES> 6,953,600 20,124,741
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 4,951 212,911
<INCOME-PRETAX> (5,796,349) (18,350,979)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (5,796,349) (18,350,979)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (5,886,956) (18,626,775)
<EPS-PRIMARY> (0.50) (2.45)
<EPS-DILUTED> (0.50) (2.45)
</TABLE>
