AQUANTIVE INC - 10-Q Quarterly Report

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes x No ¨

The number of shares of the registrant’s Common Stock outstanding as of May 2, 2003 was 58,994,491.

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

aQuantive, Inc. (the Company), formerly Avenue A, Inc., and its operating units, including Avenue A, i-FRONTIER, and Atlas DMT, provide digital marketing services and technologies to businesses. The Company was founded on July 1, 1997 and incorporated on February 27, 1998 in Washington State. The Company’s headquarters are located in Seattle, Washington. Avenue A/NYC was acquired in September 1999 and i-FRONTIER was acquired in November 2002.

Effective January 1, 2001, the Company established two lines of business: digital marketing services and digital marketing technologies. Digital marketing services, including interactive advertising agencies Avenue A and i-FRONTIER, provide service offerings to clients that include web advertising, email services, strategic portal relationships, affiliate programs, customer targeting, analytical services, search engine optimization, and creative and web site development. Digital marketing technologies, including the Atlas DMT operating unit, provides a digital marketing management system, the Atlas Digital Marketing Suite, to traditional and interactive agencies, as well as in-house media buyers for planning, serving, analyzing, and managing online campaigns.

The Company is subject to a number of risks similar to other companies in a comparable stage of development, including the need for continued growth of the Internet advertising market, reliance on key personnel and competition from other companies with greater financial, technical and marketing resources.

Basis of Presentation: The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

These statements reflect all adjustments, consisting only of normal, recurring adjustments that, in the opinion of the Company’s management, are necessary for a fair presentation of the results of operations for the periods presented. Operating results for the quarter ended March 31, 2003 are not necessarily indicative of the results that may be expected for any subsequent quarter or for the year ending December 31, 2003. Certain information and footnote disclosures normally included in financial statements prepared in conformity with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (SEC).

These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s audited financial statements and the accompanying notes for the years ended December 31, 2002, 2001, and 2000, as included in the Company’s Annual Report on Form 10-K filed with the SEC.

Reclassifications: Certain prior year amounts have been reclassified to conform to the current year presentation.

Revenue Recognition: The Company’s digital marketing services, including Avenue A and i-FRONTIER, generate revenue by providing technology-based Internet advertising services to businesses. The Company’s core services include media planning and buying, ad serving, campaign analysis, optimization, data collection and aggregation, and creative and web site development. The Company also generates revenue through the Strategic Partnership Program which manages longer term exclusive or complex partnerships between the Company’s clients and Web sites or advertising networks; the Customer Insight Group which develops and maintains an evolving suite of proprietary analytical tools, fed by agency data, that lend insight into how customers and prospective customers are likely to behave in the future; E-mail which delivers targeted emails to specific customer segments; Customer Targeting which delivers tailored advertisements to the browsers of users who have previously visited clients’ Web sites; and the Search Engine Optimization programs which enables the Company’s clients to improve their rankings on Internet search engines.

The Company follows Staff Accounting Bulletin 101, “Revenue Recognition in Financial Statements.” This pronouncement summarizes certain of the SEC staff’s views in applying generally accepted accounting principles to revenue recognition. In addition, the Company follows the final consensus reached by the Emerging Issues Task Force (EITF) in July 2000 on EITF 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent.”

In accordance with EITF 99-19, the majority of Avenue A revenue is recognized under the gross method, which consists of the gross value of the Company’s billings to the Company’s clients and includes the price of the advertising space that the Company purchases from Web sites to resell to its clients. To generate revenue under gross method contracts, the Company purchases advertising space from publisher Web sites and sells the purchased space to the Company’s clients and is ultimately responsible for payment to Web sites for the cost of space the Company purchases. The Company also recognizes revenue for certain contracts under the net method. To generate revenue under net method contracts, the Company buys advertising space from publisher Web sites on behalf of its clients and earns fees based on the dollar amount of advertising space the Company purchases. Under net method contracts, the Company’s client that is party to the contract is primarily responsible for payment to the publisher Web sites for the cost of the advertising space purchased. All such revenue is recognized over the period that the related advertising is delivered, which includes revenue from the Company’s core services, the Strategic Partnership Program and Customer Targeting.

E-mail is volume based, and revenue is generally recognized when impressions are delivered. The Company recognizes revenue from Search Engine Optimization Programs based on either volume or as a subscription. Revenue from the volume-based service is generally recognized when impressions are delivered and revenue from the subscription-based service is recognized ratably over the service period. Vital Signs and Avondale are monthly subscription-based services, and revenue is recognized for each month that the service is provided. Revenue is generally recognized for Customer Insight services under a proportional performance method of accounting. It is the Company’s policy to recognize any loss on services as soon as management estimates indicate a loss will occur.

The Atlas DMT operating unit provides digital marketing technology services to manage online media planning, buying, ad delivery and analysis for advertising agencies and advertisers. These services are offered online through the Atlas Digital Marketing Suite as are Atlas DMT’s other services such as Vital Signs, GRP and Reach Forecaster. Such services are recognized based on either volume or subscription. Revenue from the volume-based services is recognized based on the volume in the period of usage. Revenue from subscription-based services is recognized ratably over the service period.

Revenue is deferred in cases where the Company has not yet earned advertising revenue but has billed the customer or received payment from the customer prior to providing the services. Revenue is recognized only when collection of the resulting receivable is reasonably assured.

Revenue also includes any reimbursements received from our clients related to expenses incurred by our employees in servicing our clients. Such expenses include airfare, mileage, meals and hotel stays.

The percentage of sales to customers representing more than 10% of consolidated revenues is as follows:

The percentage of accounts receivable representing more than 10% of consolidated accounts receivable from the same customers is as follows (if applicable):

Computation of Basic and Diluted Net Income (Loss) Per Share: Net income (loss) per share has been calculated under Statement of Financial Accounting Standards (SFAS) No. 128 “Earnings per Share.” Basic net income (loss) per share is computed using the weighted average number of shares of common stock outstanding. Unvested outstanding shares subject to repurchase rights are excluded from the calculation. During the quarter ended March 31, 2003, using the “treasury stock method”, common stock equivalent shares related to stock options are included in the calculation of diluted earning (loss) per share, as their effect is dilutive. During the quarter ended March 31, 2002, common stock equivalent shares related to stock options are excluded from the calculation of diluted earnings (loss) per share, as their effect is anti-dilutive. Accordingly, basic and diluted loss per share during the quarter ended March 31, 2002 are equivalent.

Goodwill and Intangible Assets: Intangible assets include identifiable intangible assets purchased through the i-FRONTIER acquisition in November 2002. Intangible assets are presented net of related accumulated amortization and are being amortized on a straight-line basis over three to seven years. The Company performs an impairment test on goodwill and intangible assets with identified lives, in accordance with the guidance provided by SFAS No. 142, “Goodwill and Other Intangible Assets,” at least annually, and more often if events and circumstances indicate that such assets might be impaired. The Company will perform its yearly impairment assessment of goodwill during the fourth quarter of 2003.

Stock-Based Compensation: The Company has elected to apply the disclosure-only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation.” In accordance with the provisions of SFAS No. 123, the Company applies Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB No. 25), and related interpretations in accounting for its stock option plans. The Company has recorded approximately $303 and $772 as compensation expense for the issuance of non-qualified stock options for the quarters ended March 31, 2003 and 2002, respectively.

The following table summarizes relevant information as to reported results under the Company’s intrinsic value method of accounting for stock awards, with supplemental information as if the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” had been applied:

The fair value for each option granted was estimated at the date of grant using the Black-Scholes option-pricing model, assuming no expected dividends and the following weighted average assumptions:

Recent Accounting Pronouncements: In December 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure—an Amendment of FASB Statement No. 123.” This Statement amends FASB SFAS No. 123, “Accounting for Stock-Based Compensation” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The FASB has prescribed a tabular format and location for the disclosures in a company’s footnotes. The Company has adopted all the disclosure requirements related to stock-based compensation proscribed in the SFAS No. 148.

In November 2002, the EITF reached a consensus on Issue 00-21 “Revenue Arrangements with Multiple Deliverables,” addressing how to account for arrangements that involve the delivery or performance of multiple products, services, and/or rights to use assets. Revenue arrangements with multiple deliverables are divided into separate units of accounting if the deliverables in the arrangement meet the following criteria: (1) the delivered item has value to the customer on a standalone basis; (2) there is objective and reliable evidence of the fair value of undelivered items; and (3) delivery of any undelivered item is probable. Arrangement consideration should be allocated among the separate units of accounting based on their relative fair values, with the amount allocated to the delivered item being limited to the amount that is not contingent on the delivery of additional items or meeting other specified performance conditions. The final Consensus will be applicable to agreements entered into in fiscal periods beginning after June 15, 2003 with early adoption permitted. The provisions of this Consensus are not expected to have a significant effect on the Company’s financial position or operating results.

In November 2002, the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34” (FIN 45). FIN 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. FIN 45 clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of FIN 45 was applicable to guarantees issued or modified after December 31, 2002 and did not have a material effect on the Company’s financial statements.

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities, an interpretation of ARB No. 46” (FIN 51). FIN 46 addresses the consolidation by business enterprises of variable interest entities as defined in FIN 46. FIN 46 applies immediately to variable interests in variable entities created after January 31, 2003. The application of FIN 46 did not have a material impact on the Company’s financial statements.

The following is a reconciliation of the numerators and denominators used in computing basic and diluted earnings (loss) per share:

The Company reports selected segment information in its financial reports to shareholders in accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.”

The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The segment information provided reflects the two distinct lines of business within the Company’s organizational structure: digital marketing services, which consists of Avenue A and i-FRONTIER operating units, and digital marketing technologies, which consists of Atlas DMT.

Segment income (loss) from operations excludes amortization and non-cash stock compensation expenses as these are centrally managed at the corporate level and not reviewed by the Company’s chief operating decision maker in evaluating results by segment.

Reconciling items include the elimination of intersegment revenue, as Atlas DMT provides the Atlas Digital Marketing Suite to Avenue A and corporate expense and other non-recurring items not allocated to segments. Intersegment revenue is recorded at market rates as if the transactions occurred with third parties. All of the digital marketing services sales are to external customers. Digital marketing technologies sales to external customers were $1,410 and $56 during quarters ended March 31, 2003 and 2002. Segment information for the quarters ended March 31, 2003 and 2002 is as follows:

Pursuant to SFAS No. 131, total segment assets have not been disclosed as this information is not reported to or used by the chief operating decision maker. Additionally, substantially all of the Company’s assets are located in the United States as of March 31, 2003.

Effective November 25, 2002, the Company acquired 100% of the stock of i-FRONTIER, Corp., a Philadelphia-based, full service interactive advertising agency. Management believes that the purchase of i-FRONTIER further enhances the Company’s digital marketing services with the addition of a strong client portfolio, especially in the pharmaceutical industry. In connection with the acquisition, the Company paid $5,000 in cash in exchange for all of the outstanding common stock of i-FRONTIER. The Company also incurred $191 in acquisition costs, for a total initial purchase price of $5,191. The purchase agreement also includes future contingent payments in 2004 and 2006, which will be determined based upon the earnings of the i-FRONTIER operating unit through December 31, 2005. In the event that i-FRONTIER achieves results consistent with management’s current forecasts, we estimate that future payments will range from $8.4 to $13.0 million. However, these payments will be adjusted based on actual earnings over the four years ending December 31, 2005 and only will be recorded when actually determined, due to the uncertainty of achieving these results. The future contingent payments, when and if made, will be recorded as goodwill.

The Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets,” on January 1, 2002 and completed a transitional impairment test for the intangible assets recorded in connection with the purchase of Avenue A/NYC LLC during September 1999. Upon adoption of SFAS No. 142, the Company reclassified all previously recorded intangible assets as goodwill, as those assets, related to workforce and customer base, did not meet the criteria under SFAS No. 142 for separate identification. Furthermore, as a result of the impairment test, during the quarter ended March 31, 2002, the Company recorded an impairment charge of $1.3 million that has been recognized as a cumulative effect of a change in accounting principle in the accompanying consolidated financial statements. This impairment charge impacted the Digital Marketing Services’ segment. In connection with the acquisition of i-FRONTIER in November 2002, the Company recorded goodwill and intangible assets with definite lives. As of March 31, 2003, goodwill was $2,292 and the intangible assets related to customer base, developed technology, and a non-compete agreement with values of $1,697, $213, and $160, respectively.

In April 2002, the Company announced that its Board of Directors had authorized a stock repurchase program, under which up to $15 million of the Company’s common stock could be repurchased from time to time with available funds. The primary purpose of the stock repurchase program is to allow the Company the flexibility to repurchase its common stock to potentially reduce stock dilution and seek to improve its long-term earnings per share. Repurchases may be made in the open market or in privately negotiated transactions, subject to regulatory considerations, and may be discontinued at any time. During the year ended December 31, 2002, the Company repurchased 714,500 shares of common stock for approximately $1.8 million. During the quarter ended March 31, 2003, the Company did not repurchase any shares of common stock. Although the stock repurchase program remains in place, the Company does not currently intend to make repurchases under the present circumstances. The number of shares of common stock actually acquired, if any, by the Company will depend on subsequent developments, corporate needs and market conditions. If subsequent developments occur or corporate needs and market conditions change that might cause the Company to make one or more repurchases, the Company would not necessarily make a public announcement about it at that time.

The Company is currently the subject of lawsuits concerning the collection and use of Internet user information and a consolidated lawsuit alleging violations of the federal securities laws in connection with disclosures contained in the Company’s prospectus dated February 28, 2000, for its initial public offering of common stock. The Company is also the subject of a lawsuit claiming patent infringement. The Company believes all of these lawsuits are without merit and is vigorously defending against them. The Company may be subject to additional suits in the future regarding its collection and use of Internet user information, regarding intellectual property rights or regarding alleged violations of the federal securities laws. Furthermore, several Internet-related companies, including some in the Internet advertising industry, have had claims brought against them before the Federal Trade Commission, regarding the collection and use of Internet user information, and the Company may be subject to similar claims. The pending lawsuits could seriously harm the Company’s business. In addition, any future claim by a government entity or other third party against the Company regarding its collection and use of Internet user information, regarding intellectual property rights or regarding alleged violations of the federal securities laws could seriously harm the Company’s business.

The following discussion and analysis should be read in conjunction with the financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q. The discussion in this report contains forward-looking statements that involve risks and uncertainties, such as our objectives, expectations and intentions. Our actual results could differ materially from results that may be anticipated by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section entitled “Additional Factors that May Affect Our Business, Future Operating Results and Financial Condition”, included elsewhere in this report. When used in this document, the words “believes,” “expects,” “anticipates,” “intends,” “plans” and similar expressions, are intended to identify certain of these forward-looking statements. However, these words are not the exclusive means of identifying such statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. The cautionary statements made in this document should be read as being applicable to all related forward-looking statements wherever they appear in this document. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. We undertake no obligation to revise any forward-looking statements in order to reflect events or circumstances that may subsequently arise. Readers are urged to carefully review and consider the various disclosures made in this report and in our other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks and factors that may affect our business, prospects and results of operations. Unless the context requires otherwise in this Quarterly Report the terms “aQuantive,” the “Company,” “we,” “us” and “our” refer to aQuantive, Inc. and its subsidiaries, and references to “Avenue A” refer to the Avenue A operating unit, “i-FRONTIER” refer to i-FRONTIER, Corp., in operating unit and wholly-owned subsidiary of aQuantive Inc., and “Atlas DMT LLC” refer to Atlas DMT LLC, a wholly owned subsidiary of aQuantive, Inc.

We are a digital marketing services and technology company that helps marketers acquire, retain, and grow customers across digital media. We are organized into two lines of business, digital marketing services, including our Avenue A and i-FRONTIER operating units, and digital marketing technologies, through our Atlas DMT operating unit.

Through our interactive advertising agencies, Avenue A and i-FRONTIER, which we acquired in November 2002, we offer advertisers a suite of services that enable those advertisers to increase the effectiveness and return on investment of their Internet advertising campaigns. Our agency core services include media planning and buying, ad serving, campaign analysis, optimization, data collection and aggregation and creative and web site development. In addition, we offer our clients services such as our Strategic Partnership Program, Customer Targeting, E-mail, Customer Insights, Search Engine Optimization, and products such as Vital Signs and Avondale.

Through our Atlas DMT operating unit, we provide large traditional advertising agencies, specialty interactive advertising agencies, and large advertisers who buy media directly with the ability to manage online media planning, buying, ad delivery and analysis. Our proprietary digital marketing management system is known as the Atlas Digital Marketing Suite, which is an end-to-end solution that consists of the Atlas Media Console, the Atlas Creative Management System, the Atlas Delivery and Tracking Service, and the Atlas Analysis and Optimization Engine. We also offer our clients additional online tools such as Vital Signs, GRP and Reach Forecaster.

The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities in the consolidated financial statements and accompanying notes. The United States Securities and Exchange Commission (the SEC) has defined a company’s most critical accounting policies as the ones that are most important to the portrayal of the company’s financial condition and results of operations, and that require management’s most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Based on this definition, we have identified the critical accounting policies and judgments addressed below. Although we believe that our estimates and assumptions are reasonable, they are based upon information presently available. Actual results may differ significantly from these estimates under different assumptions or conditions.

The majority of our revenue in 2003 and 2002 has been recognized on a gross basis in accordance with the final consensus reached by the Emerging Issues Task Force (EITF) in July 2000 on EITF 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent.” Revenue generated under gross method contracts, which consists of the gross value of our billings to our clients, includes the price of the advertising space that we purchase from Web sites to resell to our clients. To generate revenue under these contracts, we purchase advertising space from publisher Web sites and sell the purchased space to our clients and are ultimately responsible for payment to Web sites for the cost of space we purchase. We also recognize revenue for certain contracts with clients under the net method. To generate revenue under net method contracts, we buy advertising space from publisher Web sites on behalf of our clients and earn fees based on the dollar amount of advertising space we purchase. Under net method contracts, our clients are primarily responsible for payment to the publisher Web sites for the cost of the advertising space purchased. All such revenue, including revenue from our core services, the Strategic Partnership Program and Customer Targeting, is recognized over the period that the related advertising is delivered or services are provided.

During 2003, we intend to revise contractual agreements with clients and online publishers so that direct liability for media purchases will rest with Avenue A’s clients. We intend to make these new contractual terms effective January 1, 2004. Accordingly, beginning on January 1, 2004, we intend to generate all revenue under net method contracts. We believe that these net method contracts will be consistent with the type of contracts that most advertising agencies use and will better facilitate financial comparisons with competitors in our industry. We also believe that this change in contracts will standardize contractual terms and revenue presentation among our interactive advertising agency operating units and mitigate state tax and certain other business obligations.

The tables below provide a reconciliation of revenue as reported to net revenue, which excludes the cost of media purchased for our Avenue A clients:

We generally recognize revenue from E-mail, which is a volume-based service, when impressions are delivered. We recognize revenue from Search Engine Optimization Programs based on either volume or as a subscription. Revenue from the volume-based service is generally recognized when impressions are delivered and revenue from the subscription-based service is recognized ratably over the service period. Vital Signs and Avondale are monthly subscription-based services, and revenue is recognized for each month that the service is provided. Revenue is generally recognized for Customer Insight services under a proportional performance method of accounting. It is our policy to recognize any loss on services as soon as management estimates indicate a loss will occur. Historically, we have not generated losses on these types of contracts.

Our Atlas DMT operating unit provides digital marketing technology services to manage online media planning, buying, ad delivery and analysis for advertising agencies and advertisers. These services are offered online through the Atlas Digital Marketing Suite as are our other services such as Vital Signs and GRP and Reach Forecaster. Revenue from such services is recognized based on either volume or subscription. Revenue from the volume-based services is recognized based on the volume in the period of usage. Revenue from subscription-based services is recognized ratably over the service period.

Revenue is deferred in cases where we have not yet earned advertising revenue but have billed the customer or received payment from the customer prior to providing the services. Revenue is recognized only when collection of the resulting receivable is reasonably assured.

In June 2001, the FASB issued Statement of Financial Accounting Standards No. 141, “Business Combinations” (SFAS No. 141), which addresses financial accounting and reporting for business combinations. In connection with our acquisition of i-FRONTIER in November 2002, we allocated the cost of the acquisition to the assets acquired and liabilities assumed based on their estimated fair values at date of acquisition in accordance with SFAS No. 141. As a result, the excess of the purchase price over the value of the net tangible assets acquired was allocated to the following (in thousands):

Significant judgment is required to estimate the fair value at date of acquisition, including estimating future cash flows from the acquired business, determining appropriate discount rates, asset lives, and other assumptions.

In June 2001, the FASB issued Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (SFAS No. 142), which provides accounting and reporting standards for acquired intangible assets. Under SFAS No. 142, goodwill and other intangible assets with indefinite useful lives are no longer amortized but tested for impairment at least annually. We adopted SFAS No. 142 on January 1, 2002 and completed a transitional impairment test for the intangible assets recorded in connection with the purchase of Avenue A/NYC LLC in September 1999. Upon adoption of SFAS No. 142, we reclassified all previously recorded intangible assets as goodwill, as those assets related to workforce and customer base did not meet the criteria under SFAS No. 142 for separate identification. Furthermore, as a result of the impairment test, we recorded an impairment charge of $1.3 million that has been recognized as a cumulative effect of a change in accounting principle for the quarter ended March 31, 2002.

In connection with our acquisition of i-FRONTIER in November 2002, we recorded certain goodwill and other intangible assets with finite lives. The separable intangible assets that have finite lives will continue to be amortized over their estimated lives, ranging from three to seven years. We will perform an impairment test on goodwill, in accordance with the guidance provided by SFAS No. 142, at least annually, unless events and circumstances indicate that such assets might be impaired. We will perform our yearly impairment assessment of goodwill during the fourth quarter of 2003. Impairment adjustments recognized, if any, generally are recognized as operating expenses. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value of each reporting unit. Significant judgments required to estimate the fair value of reporting units include estimating future cash flows, determining appropriate discount rates and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value for each reporting unit.

The i-FRONTIER purchase agreement also includes future contingent payments in 2004 and 2006, which will be determined based upon the operating results of i-FRONTIER through December 31, 2005. Any contingent payments will be recorded as goodwill. The calculation of the contingent payments is based upon a combination of a multiple of earnings through December 31, 2005 and an amount equal to the value of net assets at the date of acquisition. The agreement includes the potential for an interim payment based upon i-FRONTIER earnings during the two years ending December 31, 2003, which is partially refundable based upon i-FRONTIER earnings during the four years ending December 31, 2005. During this period, the assets recorded in connection with the contingent payments will be adjusted as actual earnings become known. These adjustments require judgment, including estimating the future earnings of i-FRONTIER.

We have elected to apply the disclosure-only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation.” In accordance with the provisions of SFAS No. 123, the Company applies Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB No. 25), and related interpretations in accounting for its stock option plans. A number of companies have recently adopted or announced their intention to adopt the fair value based method of accounting for stock-based employee compensation. To respond to concerns raised by constituents, in December 2002, the FASB issued SFAS No. 148 “Accounting for Stock-Based Compensation—Transition and Disclosure.” This Statement amends SFAS No. 123, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. We are currently evaluating the alternative methods of transition and if we decide to voluntarily adopt the fair value based method of accounting for stock-based compensation, this could have a significant impact on our operating results.

The discussion and analysis of our financial condition and results of operations is based upon our audited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those affecting revenues, the allowance for doubtful accounts, intangible assets, goodwill, state, local and federal income taxes and general business contingencies. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form our basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Washington State tax authorities issued a ruling in 2002 that permits us to exclude amounts paid by us to purchase media for clients, that is ultimately billed to and paid for by clients, from the measure of Washington State business and occupation tax. We have received reporting instructions from Washington State tax authorities that disallow this exclusion in future periods beginning in February 2003. We are considering alternatives to mitigate the resulting adverse tax consequences, including evaluation of tax strategies that might allow deduction of media purchases in connection with the measure of business and occupation tax and assertion of administrative remedies in accordance with Washington State tax regulations.

The following table presents, in dollars and as a percentage of revenue, statements of operations data for the three months ended March 31, 2003 and 2002. Our discussion of revenue and cost of revenue that follows provides a reconciliation of revenue and cost of revenue as reported and revenue and cost of revenue as if cost of media purchases were excluded (net revenue). We believe the net revenue analysis facilitates a better comparison of our digital marketing services against other companies in our industry, since many of these companies also exclude the cost of media from reported revenue. Furthermore, due to the prospective contractual changes discussed previously, we believe this measure will enhance comparability in future periods. The results of any period are not necessarily indicative of results for any future period.

Revenue. The following table provides a reconciliation of revenue as reported to net revenue, which excludes the cost of media purchased for our Avenue A clients.

Revenue increased to $47.5 million for the quarter ended March 31, 2003 from $23.5 million for the quarter ended March 31, 2002. Revenue from digital marketing services increased to $46.1 million for the quarter ended March 31, 2003 from $23.5 million for the quarter ended March 31, 2002. Revenue from digital marketing technologies increased to $1.4 million for the quarter ended March 31, 2003 from $56,000 for the quarter ended March 31, 2002. During 2002, we experienced a transition in customer base from primarily Internet-based companies to companies in more traditional industries. Revenue continued to increase each quarter of 2002 and during the first quarter of 2003 primarily due to increases in spending for our digital marketing services among our existing customers who operate in more traditional

industries. We believe companies are beginning to understand the effectiveness of online media, resulting in growth of their online budgets. During 2002, our digital marketing services were able to help launch major campaign initiatives, where historically these campaigns were reserved for more traditional advertising media. This trend continued in the first quarter of 2003, where we experienced strong spending from several large clients. During the quarter ended March 31, 2003, revenue from our top 5 clients was 75% of our total revenue compared to 71% during the quarter ended March 31, 2002. Although this concentration has increased, our Avenue A and i-FRONTIER agencies were successful in adding four new clients during the first quarter of 2003. Because of the strong spending of several large clients, though, it may take several quarters for that concentration to decrease. Revenue from our digital marketing technologies increased as our Atlas Digital Marketing Suite continued to add clients including agencies and direct advertisers. During the quarter ended March 31, 2003, our digital marketing technologies line of business was successful in adding a net total of 19 additional clients. During the remainder of 2003, we expect digital marketing services revenue will grow, with an increasing contribution from new clients. In addition, we expect digital marketing technologies to continue to grow its revenue from agencies and direct advertisers. Accordingly, we expect total revenues in the range of $190.0 to $210.0 million in 2003.

Net revenue, which excludes the cost of media purchases, increased to $14.9 million for the quarter ended March 31, 2003, from $7.2 million for the quarter ended March 31, 2002. The increase in net revenue was primarily due to increases in spending from our existing customers, resulting in increased fees earned from our clients. In addition, revenue from digital marketing technologies increased to $1.4 million during the quarter ended March 31, 2003, compared to $56,000 during the quarter ended March 31, 2002, as our Atlas Digital Marketing Suite continued to add clients from external agencies and direct advertisers.

Cost of revenue. The following table provides a reconciliation of cost of revenue as reported to cost of revenue exclusive of the cost of media purchased for our Avenue A clients.

Cost of revenue consists mainly of the costs of media that we purchase from publishers’ Web sites, and the variable costs of delivering the advertisements over the Internet. It also consists of costs paid to third parties for email delivery and search engine optimization. Cost of revenue increased to $33.3 million, or 70.1% of revenue, for the quarter ended March 31, 2003 from $16.7 million, or 71.0% of revenue, for the quarter ended March 31, 2002. The dollar increase in cost of revenue was primarily due to increases in the volume of advertising space we purchased for our clients, as spending for our services increased among our existing customers. Due to the expected growth in revenue from existing clients and increased contribution from new clients, we anticipate cost of revenue in the range of $134.0 to $180.0 million in 2003.

The cost of revenue exclusive of media purchases increased to $673,000 for the quarter ended March 31, 2003 from $433,000 for the quarter ended March 31, 2002, respectively. The increase in cost of revenue under the net revenue method was primarily due to increased bandwidth costs associated with the increase in the volume of ads served.

Client support. Client support expenses consist primarily of salaries and related expenses for client support personnel, including employees within our digital marketing services client teams and client service employees within digital marketing technologies. Client support expenses also include employees who support other functions such as the Strategic Partnership Program and Customer Insight services. Client support expenses increased to $6.2 million, or 13.0% of revenue, for the quarter ended March 31, 2003 from $3.3 million, or 14.2% of revenue, for the quarter ended March 31, 2002. The dollar increase in client support expenses was primarily due to the increased headcount associated with the addition of our i-FRONTIER agency. In addition, headcount in account management increased to support increased spending by our digital marketing services clients and the new clients added in our digital marketing technologies line of business. The decrease in client support expenses as a percentage of revenue was primarily due to increased revenue from existing clients, while headcount and the related expenses for client support staff increased at a slower rate. In general, increased spending from existing clients requires only modest increases in client support costs, while increased spending from new clients increases the need for client support staff, resulting in more significant increases in client support costs.

Product development. Product development expenses consist of salaries and related expenses for product development as well as research and development personnel. In addition, product development expenses include the costs of software development and the costs incurred in preparing our Atlas^™ Digital Marketing Suite for marketing to external clients. Product development expenses decreased to $1.1 million, or 2.3% of revenue, for the quarter ended March 31 2003, from $1.7 million, or 7.4% of revenue, for the quarter ended March 31, 2002. The dollar and percentage decreases in product development expenses were primarily due to the capitalization of certain direct costs incurred in the development of our Atlas Digital Marketing Suite 3.5, which was launched in April 2003.

Selling, general and administrative. Selling, general and administrative expenses consist primarily of salaries and related expenses for executive, sales, finance, marketing, human resource and administrative personnel, professional fees, and other general corporate expenses including rent. In addition, these expenses include marketing costs such as trade shows and the costs of advertising our services in trade publications. Selling, general and administrative expenses increased to $4.3 million, or 8.9% of revenue, for the quarter ended March 31, 2003, from $3.6 million, or 15.4% of revenue, for the quarter ended March 31, 2002. The dollar increase in selling, general and administrative expenses was primarily due to increased professional services expenses associated with the increased corporate governance requirements and an increase in sales and marketing efforts associated with our digital marketing technologies line of business. The decrease in selling, general and administrative costs as a percentage of revenue was primarily due to increased revenue from existing clients, while headcount and the related expenses increased at a slower rate. In general, increased revenue from existing clients is a function of the performance of our client support personnel and not a direct result of increased selling expenses. In addition, we can support increased spending from clients with modest increases in general and administrative expenses.

Depreciation and amortization of property and equipment. Depreciation and amortization of property and equipment consists primarily of depreciation expense on computer equipment, furniture and fixtures, and software costs and amortization expense of leasehold improvements. Depreciation and amortization of property and equipment decreased to $901,000, or 1.9% of revenue, for the quarter ended March 31, 2003 from $1.2 million, or 4.9% of revenue, for the quarter ended March 31, 2002. The dollar and percentage decreases were primarily due to certain assets becoming fully depreciated, partially offset by the purchase of new equipment.

Amortization of deferred stock compensation. Amortization of deferred stock compensation consists of expenses related to employee stock option grants with option exercise prices below the fair value of our common stock as of the date of grant. Deferred stock compensation is being amortized on an accelerated basis over the four-year vesting period of the applicable options. Amortization of deferred stock compensation decreased to $303,000, or 0.6% of revenue, for the quarter ended March 31, 2003 from $772,000, or 3.3% of revenue, for the quarter ended March 31, 2002. The dollar and percentage decreases were primarily related to the decrease in deferred stock compensation due to our use of the accelerated method of amortization for our employee stock compensation arrangements plus the reversal of balances of unamortized stock-based compensation as a result of employee terminations. We anticipate that all deferred stock compensation recorded as a result of options granted prior to our initial public offering will be fully amortized by the end of 2003.

Amortization of intangible assets. Amortization of intangible assets relates to the customer base, developed technology, and non-compete agreement recorded in connection with the purchase of i-FRONTIER in November 2002. Amortization of intangible assets was $60,000 and $0 during the quarters ended March 31, 2003 and 2002, respectively. As of March 31, 2003, intangible assets consisted of a non-compete agreement, customer base, and developed technology with values of $160,000, $1.7 million, and $213,000, respectively. The intangible assets are amortized on a straight-line basis over useful lives of five, seven, and three years, respectively.

Interest and other income, net. Net interest and other income consists primarily of earnings on our cash, cash equivalents, and short-term investments. Net interest income decreased to $537,000, or 1.1% of revenue, for the quarter ended March 31, 2003 from $1.2 million, or 5.3% of revenue, for the quarter ended March 31, 2002. The dollar and percentage decreases were primarily due to lower returns on our invested funds due to the declining interest rates experienced in the economy.

Cumulative effect on prior years of a change in accounting principle. On January 1, 2002, we adopted SFAS No. 142 and completed a transitional impairment test for the intangible assets recorded in connection with the purchase of Avenue A/NYC LLC during September 1999. Upon adoption of SFAS No. 142, we reclassified all previously recorded intangible assets as goodwill, as those assets, related to workforce and customer base, did not meet the criteria under SFAS No. 142 for separate identification. Furthermore, as a result of the impairment test, we recorded an impairment charge of $1.3 million that has been recognized as a cumulative effect on prior years of a change in accounting principle in the accompanying consolidated financial statements.

Since our inception, we have financed our operations primarily through the net proceeds from private sales of equity securities, which raised $30.4 million through December 31, 1999, and our initial public offering of common stock, which raised $132.5 million during the first quarter of 2000.

As of March 31, 2003, we had cash and cash equivalents of $42.4 million and short-term investments of $78.9 million. We have a $5.5 million equipment term loan facility with a bank, of which $1.1 million is outstanding as of March 31, 2003.

Net cash provided by operating activities was $1.3 million for the three months ended March 31, 2003. Net cash used in operating activities was $3.1 million for the three months ended March 31, 2002.

Net cash provided by investing activities was $8.8 and $1.7 million for the three months ended March 31, 2003 and 2002, respectively. Net cash provided by investing activities was primarily related to net proceeds from the sale of marketable securities, offset by purchases of equipment.

Net cash provided by financing activities was $85,000 for the three months ended March 31, 2003. Net cash used in financing activities was $369,000 for the three months ended March 31, 2002. Net cash provided by or used in financing activities was related to payments on our equipment loan. These payments were offset by proceeds from sales of securities.

As of March 31, 2003, we had material commitments related to operating leases for office space and office equipment, and notes payable to a bank. The notes are secured by the equipment purchased with the proceeds from the notes. In addition, we had material obligations related to the facility leases for our ad serving systems.

During the quarter ended March 31, 2003, we entered into an agreement with an entity that will provide sales and service support to the Atlas DMT operating unit in the United Kingdom. If the contract is terminated, we will pay a minimum of £200,000 (approximately $321,000).

The i-FRONTIER purchase agreement includes potential contingent payments in 2004 and 2006, which are determined by the operating results of our i-FRONTIER operating unit for the four years ending December 31, 2005. We estimate that future payments will range from $8.4 to $13.0 million. This estimate will be adjusted based on actual earnings over the four years ending December 31, 2005. Our estimates require judgment, based on estimating the future earnings of i-FRONTIER. We cannot assure you that actual future payments will not be materially different than our current estimates.

In April 2002, we announced that our Board of Directors had authorized a stock repurchase program under which up to $15 million of our common stock could be repurchased from time to time with available funds. The primary purpose of the stock repurchase program is to allow us the flexibility to repurchase our common stock to potentially reduce stock dilution and seek to improve our long-term earnings per share. Repurchases may be made in the open market or in privately negotiated transactions, subject to regulatory considerations, and may be discontinued at any time. During the year ended December 31, 2002, we repurchased 714,500 shares of common stock for approximately $1.8 million. During the quarter ended March 31, 2003, we did not repurchase any shares of common stock. Although the stock repurchase program remains in place, we do not currently intend to make repurchases under the present circumstances. Future repurchases, if any, will depend on subsequent developments, corporate needs and market conditions. If subsequent developments occur or corporate needs and market conditions change that might cause us to make one or more repurchases, we would not necessarily make a public announcement about it at that time.

Since our inception, we have significantly increased our operating expenses. Due to the estimated increase in revenue in 2003, we currently anticipate that we will continue to experience some growth in our operating expenses and such expenses will be a material use of our cash resources. We believe that our current cash, cash equivalents and short-term investments will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure—an Amendment of FASB Statement No. 123.” This Statement amends FASB Statement No. 123, “Accounting for Stock-Based Compensation” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of Statement No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. SFAS No. 148 prescribes a tabular format and location for the disclosures in a company’s footnotes. We are in the process of evaluating the impact of the transition alternatives described in the pronouncement. In addition, we have adopted all of the disclosure requirements related to stock-based compensation proscribed in the pronouncement.

In November 2002, the EITF reached a consensus on Issue 00-21, addressing how to account for arrangements that involve the delivery or performance of multiple products, services, and/or rights to use assets. Revenue arrangements with multiple deliverables are divided into separate units of accounting if the deliverables in the arrangement meet the following criteria: (1) the delivered item has value to the customer on a standalone basis; (2) there is objective and reliable evidence of the fair value of undelivered items; and (3) delivery of any undelivered item is probable. Arrangement consideration should be allocated among the separate units of accounting based on their relative fair values, with the amount allocated to the delivered item being limited to the amount that is not contingent on the delivery of additional items or meeting other specified performance conditions. The final consensus will be applicable to agreements entered into in fiscal periods beginning after June 15, 2003 with early adoption permitted. We do not believe there will be a material financial statement impact upon adoption of EITF Issue 00-21.

In November 2002, the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34 “ (FIN 45). FIN 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. FIN 45 clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of FIN 45 are applicable to guarantees issued or modified after December 31, 2002 and did not have a material effect on our financial statements. The disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002.

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51” (FIN 46). FIN 46 addresses the consolidation by business enterprises of variable interest entities as defined in FIN 46. FIN 46 applies immediately to variable interests in variable entities created after January 31, 2003. The application of FIN 46 did not have a material impact on our financial statements.

Additional Factors That May Affect Our Business, Future Operating Results and Financial Condition

You should carefully consider the following factors that may affect our business, future operating results and financial condition, as well as other information included in this Quarterly Report. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. If any of the following risks actually occur, our business, financial condition and operating results could be materially adversely affected.

We are subject to risks frequently encountered by companies in the Internet advertising market

Our prospects for financial and operational success must be considered in light of the risks frequently encountered by companies in the Internet advertising industry. These risks include the need to:

We have a history of losses and may not maintain profitability, which we first achieved in the quarter ended December 31, 2002

We incurred net losses of $105.1 million for the period from our inception on July 1, 1997 through September 30, 2002. As of March 31, 2003, our accumulated deficit was $100.9 million. We expect to continue to make additional operating and capital expenditures and, as a result, we will need to generate additional revenue to maintain profitability, which we first achieved in the quarter ended December 31, 2002. We cannot assure you that we will generate sufficient revenue to maintain profitability. If our revenue grows more slowly than we anticipate or declines, or if our operating expenses exceed our expectations or cannot be reduced, we may be unable to maintain profitability.

Our quarterly operating results are subject to fluctuations that may cause our stock price to decline

Our quarterly operating results have fluctuated in the past and are likely to continue to do so in the future. It is possible that in the future our operating results in a particular quarter or quarters will not meet the expectations of securities analysts, investors or us. If our operating results fail to meet these expectations, the market price of our common stock could decline. We believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance and should not be relied upon to predict the future performance of our stock price. For example, although we recorded a profit in the fourth quarter of 2002 and the first quarter of 2003, we cannot assure you that we will be profitable in subsequent quarters.

Our revenue, expenses and operating results could vary significantly from quarter to quarter for several reasons, including:

We intend to restructure most or all of our contracts with clients and publishers such that we recognize revenue under the net method rather than the gross method, which could have an adverse effect on our stock price

We intend to restructure most of our Avenue A agency contracts with clients and publishers such that we recognize revenue under the net method rather than the gross method, which will change the amount of revenue and cost of revenue we report effective January 1, 2004. Such a change could alter the perceptions of securities analysts or investors, which could have an adverse effect on our stock price. Such a decrease in the market price of our stock could subject us to securities class action litigation, which could result in substantial costs and payment of damages, divert our management’s attention from other business concerns and otherwise harm our business.

We rely on a limited number of clients, and the loss of a major client or a reduction in a major client’s Internet advertising budget could significantly reduce our revenue

Our business would be harmed by the loss of any of our major clients, a reduction in the Internet advertising budgets of any of these clients or any significant reduction in revenue generated from these clients. Current clients may decide not to continue purchasing advertising services from us or may significantly reduce their advertising spending, and we may not be able to successfully attract additional clients. In addition, the non-payment of amounts due to us from one or more of our significant clients could harm our business.

Our client contracts have short terms, and the loss of one or more of these contracts in a short period of time could harm our business

We derive substantially all of our revenue from the sale of advertising services under short-term advertising campaign services contracts, all of which are cancelable upon 90 days’ or less notice. In addition, these contracts generally do not contain penalty provisions for cancellation before the end of the contract term. The non-renewal, cancellation or deferral of a significant number of these contracts in any one period could cause an immediate and significant decline in our revenue and harm our business.

The Internet advertising market may deteriorate, or develop more slowly than expected, which could harm our business

If the market for Internet advertising deteriorates, or develops more slowly than we expect, our business could suffer. Our future success is highly dependent on an increase in the use of the Internet, the commitment of advertisers to the Internet as an advertising medium, the willingness of our potential clients to outsource their Internet advertising and marketing needs, and our ability to sell technology services to advertising agencies. The Internet advertising market is relatively new and rapidly evolving. As a result, demand and market acceptance for Internet advertising and technology services is uncertain. Many of our current or potential clients have little or no experience using the Internet for advertising purposes and have allocated only a limited portion of their advertising budgets to Internet advertising. Also, we must compete with traditional advertising media, including television, radio, cable and print, for a share of our clients’ total advertising budgets. Our current and potential clients may find Internet advertising to be less effective than traditional advertising media for promoting their products and services, and therefore the market for Internet advertising and technology services may deteriorate or develop more slowly than expected. In addition, “filter” software programs are available that limit or prevent advertising from being delivered to an Internet user’s computer. The widespread adoption of such software could significantly undermine the commercial viability of Internet advertising.

Our business may be seriously harmed by third-party litigation against us relating to the collection and use of Internet user information

We have been subject to class action lawsuits alleging, among other things, that our collection and use of Internet user information violates federal and state laws, and may be subject to additional suits in the future. Class action litigation is often expensive and time-consuming, and the outcome of such litigation is often uncertain. Such lawsuits, regardless of their outcome, may cause us to incur significant expenses and divert the attention of our management and key personnel from our business operations. In addition, such lawsuits may require us to pay substantial damages, prevent us from conducting targeted advertising and aggregating data from our clients’ advertising campaigns, and otherwise seriously harm our business. Furthermore, several Internet-related companies, including some in the Internet advertising industry, have had claims brought against them before the Federal Trade Commission regarding the collection and use of Internet user information, and we may be subject to similar claims. Such claims and any other claim by a government entity or other third party against us regarding our collection and use of Internet user information could seriously harm our business.

Our short-term investments represent a significant portion of our cash position. As of March 31, 2003, short-term investments constituted $78.9 million of our cash position of $121.4 million. If issuers of the short-term debt in which we have invested default or if the market value of such investments becomes impaired, such defaults and impairments could significantly harm our financial condition.

Privacy concerns could lead to legislative and other limitations on our ability to collect personal data from Internet users, including limitations on our use of cookie or action tag technology and user profiling

Privacy concerns could lead to legislative and other limitations on our ability to conduct targeted advertising campaigns and compile data that we use to formulate campaign strategies for our clients. Our systems use “cookies” and “action tags” to track Internet users and their online behavior to build anonymous user profiles. A cookie is a small file of information stored on a user’s computer that allows us to recognize that user’s browser when we serve advertisements. An action tag functions similarly to a banner ad, except that the action tag is not visible. Our action tags may be placed on specific pages of our clients’ or prospective clients’ Web sites. This enables our measurement of an advertising campaign’s effectiveness in driving consumers to specific actions. We are substantially dependent on cookie and action tag technology to target our clients’ advertising campaigns and measure their effectiveness. Any reduction in our ability to use cookies or action tags or other means to build anonymous user profiles could harm our business. Such a reduction may result from several causes, including governmental action, technology or litigation. First, governmental bodies concerned with the privacy of Internet users have suggested limiting or eliminating the use of cookies, action tags or user profiling. Bills aimed at regulating the collection and use of personal data from Internet users are currently pending in Congress and many state

legislatures. Also, the Federal Trade Commission and the Department of Commerce have conducted hearings regarding user profiling, the collection of non-personally identifiable information and online privacy. Outside the United States, privacy concerns have led to legal and technical limitations on the use of cookies, action tags and user profiling. For example, the European Union has adopted a directive addressing data privacy that limits the collection, disclosure and use of information regarding European Internet users. The European Union has also enacted an electronic communications directive that imposes certain restrictions on the use of cookies and action tags. The directive also places restrictions on the sending of unsolicited communications. Each European Union member country is required to enact legislation to comply with the provisions of the directive by October 31, 2003. Germany already has imposed its own laws limiting the use of user profiling, and other countries (both in and out of the European Union) may impose similar limitations. Second, users may limit or eliminate the placement of cookies on their computers by using third-party software that blocks cookies, or by disabling the cookie functions of their Internet browser software. Also, Internet browser software upgrades may result in limitations on the use of cookies or action tags. Technologies like the Platform for Privacy Preferences (P3P) Project may limit collection of cookie and action tag information. Finally, third parties have brought class action lawsuits against us and other companies relating to the use of cookies, and we may be subject to similar lawsuits in the future. The results of such lawsuits could limit or eliminate our ability to use cookies and action tags. If our ability to use cookies or action tags or to build user profiles were substantially restricted, we would likely have to use other technology or methods that allow the gathering of user profile data in other ways in order to provide our services to our clients. This change in technology or methods could require significant reengineering time and resources, and might not be done in time to avoid negative consequences to our business. In addition, alternative technology or methods might not be available on commercially reasonable terms, if at all.

Our business may be seriously harmed by litigation alleging violations of federal and state securities laws

We and some of the underwriters of our initial public offering of common stock in February 2000 are defendants in a pending consolidated class action lawsuit that alleges violations of federal and state securities laws in connection with our initial public offering. The claims in the lawsuit include, among other things, allegations of misrepresentations or failures to disclose alleged facts relating to the defendant underwriters’ compensation and commissions in connection with our initial public offering and alleged agreements between the underwriters and their customers relating to future purchases of our stock. Class action litigation is often expensive and time-consuming, and the outcome of such litigation is often uncertain. Such lawsuits, regardless of their outcome, may cause us to incur significant expenses and divert the attention of our management and key personnel from our business operations. In addition, such lawsuits may result in the payment by us of substantial damages, and may otherwise seriously harm our business.

We are subject to patent infringement claims and may be subject to additional claims in the future, including claims that our ad serving technologies, processes or methods infringe the patents of other parties

Other parties have been issued patents that may cover some of the technologies, processes or methods that we use in our ad serving systems. We cannot assure you that we would be able to distinguish our technologies, processes or methods from those covered under any of these third-party patents or that these patents would be invalidated if challenged. The patent field covering Internet-related technologies is rapidly evolving and surrounded by a great deal of uncertainty, and other patents or patent applications relating to the delivery of Internet advertising may exist of which we are unaware.

In addition, other parties may claim that our technologies, processes or methods infringe their patents. For example, in November 2001, we received correspondence from counsel for 24/7 Real Media, Inc. alleging that we infringe claims of U.S. Patent No. 6,026,368. In April 2002, we filed a lawsuit against 24/7 Real Media seeking a declaratory judgment that we are not infringing any claims of this patent and/or that the claims of this patent are invalid. 24/7 Real Media has counterclaimed, seeking dismissal of our claim, alleging current and past infringement of this patent, seeking an injunction precluding us from using technology allegedly covered by the patent through the life of the patent, and seeking reasonable royalty or lost profits for alleged past infringement. We filed a motion for partial summary judgment of non-infringement on January 3, 2003.

Several other companies in the Internet advertising field have brought patent infringement suits against competitors in connection with patents relating to ad serving technologies, and we expect this type of litigation to increase in the future. Any patent infringement claims brought against us may cause us to incur significant expenses and, if successfully asserted against us, may cause us to pay substantial damages and limit our ability to use the intellectual property subject to these claims. Even if we were to prevail, any litigation would likely be costly and time-consuming and divert the attention of our management and key personnel from our business operations. Furthermore, as a result of a patent infringement suit, we may be prevented from providing some of our services, including our core ad serving services, unless we enter into royalty or license agreements. We may not be able to obtain royalty or license agreements on terms acceptable to us, if at all.

We may be subject to service mark infringement claims and other legal challenges, which could cause us to incur significant expenses, pay substantial damages and be prevented from using our service marks

Our use of our service marks may result in infringement claims and other legal challenges, which could cause us to incur significant expenses, pay substantial damages and be prevented from using these marks. We are aware of third parties that use marks or names, including Internet domain names, that are the same or similar to the names for which we have sought service mark protection. There may be other third parties using names similar to ours of whom we are unaware. As a result of any infringement claims or challenges, we may incur significant expenses, pay substantial damages and be prevented from using our service marks unless we enter into royalty, license or coexistence agreements. We may not be able to obtain such royalty, license or coexistence agreements on terms acceptable to us, if at all. Use of our service marks by third parties may also cause confusion to our clients and confusion in the market, which could decrease the value of our brand and harm our reputation.

In addition to patent and service mark claims, third parties may assert other intellectual property claims, which may cause us to incur significant expenses, pay substantial damages and be prevented from providing our services

In addition to patent and service mark claims, third parties may claim that we are infringing or violating their other intellectual property rights, including their copyrights and trade secrets, or otherwise challenge our intellectual property, which may cause us to incur significant expenses and, if successfully asserted against us, pay substantial damages and be prevented from providing our services. Even if we were to prevail, any litigation regarding our intellectual property could be costly and time-consuming and divert the attention of our management and key personnel from our business operations. Furthermore, as a result of an intellectual property challenge, we may be prevented from providing some of our services unless we enter into royalty, license or coexistence agreements. We may not be able to obtain such royalty, license or coexistence agreements on terms acceptable to us, if at all. Failure of our services to perform properly or improper use of our services by our clients could give rise to legal claims against us or damage our reputation.

Failure of our services to perform properly or improper use of our services by our clients could give rise to legal claims against us or damage our reputation

If our services fail to perform properly for our clients, we may be exposed to liability to our clients or to their customers for whom our clients used our services. In addition, our clients may use our technology-based services in a manner that fails to comply with applicable laws, including but not limited to laws and regulations surrounding the Internet. For example, because our services may be used by clients to transmit information over the Internet, our services might be used by clients to transmit information that violates laws or regulations, or to transmit negative messages, unauthorized reproduction of copyrighted material, inaccurate data, harmful applications or computer viruses to end-users in the course of delivery. Any claims made against us arising in connection with our clients’ use of our services, regardless of their outcome, may cause us to incur significant expenses and divert the attention of our management and key personnel from business operations. In addition, such claims may require us to pay substantial damages, modify or discontinue some of our services and otherwise seriously harm our business and damage our reputation.

The loss of key personnel or any inability to attract and retain additional personnel could impair our ability to maintain or expand our business

The loss of the services of members of our management team or other key personnel could harm our business. Our future success depends to a significant extent on the continued service of our key management, client service, product development, sales and technical personnel. We do not maintain key person life insurance on any of our executive officers and do not intend to purchase any in the future. Although we generally enter into non-competition agreements with our employees, our business could be harmed if one or more of our officers or key employees decided to join a competitor or otherwise compete with us.

Our future success also depends on our ability to attract, retain and motivate highly skilled personnel. If we fail to hire and retain a sufficient number of qualified client service, product development, sales and technical personnel, we may not be able to maintain or expand our business.

Some of our clients have limited operating histories, are unprofitable and may not be able to pay for our services

If any of our current or future clients is unable to pay for our services, our business could suffer. Some of our clients have limited operating histories and have not achieved profitability. In the past we have lost clients, or have had difficulty collecting payments from clients, who could not pay for our services because they were unable to secure ongoing funding. The ability of several of our clients to meet their payment obligations is affected by the risks and difficulties encountered by companies with limited operating histories, particularly in the evolving Internet market.

We may not be able to compete successfully in the market for Internet advertising

The market for Internet advertising is relatively new, yet competitive. Our digital marketing services, including our Avenue A and i-FRONTIER operating units, compete with interactive advertising agencies, enabling online advertising technology providers, advertising networks, targeted email service providers and traditional advertising agencies that perform Internet advertising and marketing as part of their services to clients. Our digital marketing technologies, through our Atlas DMT operating unit, compete with third-party ad serving companies and campaign management technology companies.

Many of our competitors have longer operating histories, greater name recognition, larger client bases and significantly greater financial, technical and marketing resources than we have. Also, many of our current and potential competitors have established or may establish cooperative relationships among themselves or with third parties. In addition, several of our competitors have combined or may combine in the future with larger companies with greater resources than ours. These competitors may engage in more extensive research and development, undertake more far-reaching marketing campaigns and make more attractive offers to existing and potential employees and clients than we do. They could also adopt more aggressive pricing policies and may even provide services similar to ours at no additional cost by bundling them with their other product and service offerings. They may also develop services that are equal or superior to our services or that achieve greater market acceptance than our services. Increased competition is likely to result in price reductions, reduced gross margins and loss of market share. We cannot assure you that we will be able to compete successfully, and competitive pressures may harm our business.

Consolidation of Internet advertising networks, large Internet portals and web publishers may impair our ability to serve advertisements, to acquire advertising space at favorable rates and to collect campaign data

The consolidation of Internet advertising networks, large Internet portals and web publishers could harm our business. This type of consolidation could eventually lead to a concentration of desirable advertising space on a very small number of networks and large Web sites. This type of concentration could substantially impair our ability to serve advertisements if these networks or large Web sites decide not to permit us to serve advertisements on their Web sites or if they develop ad placement systems that are not compatible with our ad serving systems. These networks or Web sites could also use their greater bargaining power to increase their rates for advertising space or prohibit or limit our aggregation of advertising campaign data. In addition, concentration of desirable advertising space in a small number of networks and Web sites could diminish the value of our advertising campaign databases, as the value of these databases depends on the continuous aggregation of data from advertising campaigns on a variety of different Web sites and advertising networks.

Sustained or repeated system failures could significantly impair our operations and lead to client dissatisfaction

Sustained or repeated system failures could significantly impair our operations and reduce the attractiveness of our services to our current and potential clients. The continuous and uninterrupted performance of our systems is critical to our success. Our operations depend on our ability to protect these systems against damage from fire, power loss, water damage, earthquakes, telecommunications failures, viruses, vandalism and other malicious acts, and similar unexpected adverse events. Clients may become dissatisfied by any system failure that interrupts our ability to provide our services to them. In particular, the failure of our ad serving systems, including failures that delay or prevent the delivery of targeted advertisements to Web sites and advertising networks, could reduce client satisfaction and damage our reputation.

Our services are substantially dependent on certain systems provided by third parties, over whom we have little control. Interruptions in our services could result from the failure of telecommunications providers and other third parties to provide the necessary data communications capacity in the time frame required. Our ad serving systems and computer hardware are primarily located in Seattle, Washington, Weehawken, New Jersey, and Dallas, Texas at facilities operated by Cable & Wireless Internet Services, Inc. Additionally, Speedera Networks Inc. provides content delivery for us at their facilities. We depend on these third-party providers of Internet communication services to provide continuous and uninterrupted service. We also depend upon Internet service providers that provide access to our services. In the past, we have occasionally experienced significant difficulties delivering advertisements to Web sites and advertising networks due to system failures unrelated to our own systems. Any disruption in the Internet access provided by third-party providers or any failure of third-party providers to handle higher volumes of user traffic could impair our ability to deliver advertisements and harm our business.

There may be risks related to our prior use of Arthur Andersen LLP as our independent auditor

Arthur Andersen LLP (Andersen) served as our independent auditor from 1998 until May of 2002, when our Board of Directors dismissed Andersen. Our access to the capital markets could be impaired because Andersen can no longer make representations on our behalf with respect to audits completed by Andersen prior to its dismissal. In addition, it is possible that the SEC may cease accepting financial statements that were audited by Andersen. If it is necessary for us to re-audit our prior financial statements, such a change could disrupt our operations and divert the attention of our management from other business matters, and we could experience additional cost or delay in completing our periodic reports required to be filed with the SEC.

Acquisitions or investments may be unsuccessful and may divert our management’s attention and consume significant resources

We recently acquired i-FRONTIER, a Philadelphia-based interactive advertising agency. We may in the future acquire or make investments in other businesses, or acquire products and technologies, to complement our current business. Any future acquisition or investment may require us to use significant amounts of cash, issue potentially dilutive equity securities or incur debt. In addition, acquisitions involve numerous risks, any of which could harm our business, including:

Clients may attempt to prohibit us from providing services to their competitors, limiting our business opportunities

To use our services more effectively, clients often provide us with confidential business and marketing information. Many companies are wary of third parties having access to this information, because access by third parties increases the risk that confidential business and marketing information may become known, even if unintentionally, to these companies’ competitors. These confidentiality concerns may prompt our clients to attempt to contractually prohibit us from managing the Internet advertising campaigns of their competitors. Limitation of our client base in a particular industry in this manner could limit the growth of our business.

We may need additional financing in the future, which we may be unable to obtain

We may need additional funds to finance our operations in the future, as well as to enhance our services, respond to competitive pressures or acquire complementary businesses or technologies. We may be unable to obtain financing on terms favorable to us, if at all. Poor financial results, unanticipated expenses or unanticipated opportunities that require financial commitments could give rise to additional financing requirements sooner than we expect. If we raise additional funds through the issuance of equity or convertible debt securities, this may reduce the percentage ownership of our existing shareholders, and these securities might have rights, preferences or privileges senior to those of our common stock. If adequate funds are not available or are not available on acceptable terms, our ability to enhance our services, respond to competitive pressures or take advantage of business opportunities would be significantly limited, and we might need to significantly restrict our operations.

Legislation, regulations, or standards may be adopted that could impair our ability to provide our services to clients or otherwise harm our business

Legislation, regulations, or standards may be adopted that could impair our ability to provide our services to clients or otherwise harm our business. The legal and regulatory environment governing the Internet and Internet advertising is uncertain and may change. Laws, regulations, and standards may be adopted or amended covering issues such as privacy, pricing, acceptable content, consumer protection and quality of products and services on the Internet. These laws, regulations, and standards could dampen the growth in use of the Internet generally and decrease the acceptance of the Internet as an advertising medium. Also, due to the global nature of the Internet, it is possible that multiple federal, state or foreign jurisdictions might inconsistently regulate our activities or the activities of advertising networks or Web sites. Any of these developments could harm our business.

In addition, laws, regulations, and standards may be adopted or amended relating to the taxation of our services. Although we historically have not been required to pay Washington State business and occupation tax on the media we purchase on behalf of our clients, we received reporting instructions from Washington State tax authorities that require us to do so beginning February 2003. We expect to assert administrative remedies with the Washington State tax authorities and evaluate tax strategies that might allow deduction of media purchases in connection with the measure of business and occupation tax. If these efforts are not successful, this business and occupation tax requirement, and any other tax-related requirements, could substantially increase our cost of conducting business.

Our service offering includes email advertising and marketing services. The market for email advertising and marketing in general is vulnerable to the negative public perception associated with unsolicited email. Various states have enacted legislation and several bills have been introduced in Congress that limit or prohibit the use of unsolicited email. Government action, public perception or press reports related to solicited or unsolicited email could reduce the overall demand for email advertising and marketing in general and our email services in particular.

We may not be able to adapt to rapidly changing Internet technology trends and evolving industry standards

The Internet and Internet advertising markets are characterized by rapidly changing technologies, evolving industry standards, frequent new product and service introductions, and changing client demands. The introduction of new products and services embodying new technologies and the emergence of new industry standards may render our services obsolete. Our future success will depend on our ability to adapt to rapidly changing technologies, enhance our existing Internet advertising services and develop and introduce a variety of new services to address our clients’ changing demands. We may experience difficulties that could delay or prevent the successful design, development, introduction or marketing of our services. In addition, any new services or enhancements must meet the requirements of our current clients and must achieve market acceptance. Material delays in introducing new services and enhancements may cause clients to discontinue use of our services and use the services of our competitors.

The trading price of our common stock has been and is likely to continue to be highly volatile. For example, during the 52-week period ended April 25, 2003, the closing price of our common stock ranged from $1.97 to $6.68 per share. The market price of our common stock may fluctuate significantly in response to a number of factors, including:

In the past, many companies that have experienced volatility in the market price of their stock have been subject to securities class action litigation. We are currently the subject of securities class action litigation and may be the target of additional lawsuits in the future. This litigation and any future securities litigation against us could result in substantial costs and divert our management’s attention from business concerns, which could harm our business.

Our exposure to market risk is limited to interest income sensitivity, which is affected by changes in the general level of U.S. interest rates, particularly because the majority of our investments are in short-term, investment-grade debt securities issued by corporations. We place our investments with high-quality issuers and limit the amount of credit exposure to any one issuer. Due to the nature of our short-term investments, we believe that we are not subject to any material market risk exposure. We do not have any foreign currency or other derivative financial instruments.

Within 90 days prior to the date of this report, we carried out an evaluation, under the supervision and with the participation of our chief executive officer and our chief financial officer, of the effectiveness of our “disclosure controls and procedures” (as defined in Rules 13a-14(c) and 15d-14(c) of the Securities Exchange Act of 1934). Based on this evaluation, our chief executive officer and our chief financial officer have concluded that, as of the date of the evaluation, our disclosure controls and procedures were effective. It should be noted that the design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

There were no significant changes in our internal controls or, to our knowledge, in other factors that could significantly affect these internal controls subsequent to the date of the evaluation.

We have been the subject of lawsuits concerning our collection and use of Internet user information. In Chance et al. v. Avenue A, Inc., plaintiffs, on behalf of themselves and all others similarly situated throughout the nation, filed a class action complaint against us on or about November 20, 2000 in the United States District Court for the Western District of Washington. Plaintiffs in two separate suits—Werber v. Avenue A, Inc., and Bowles v. Avenue A, Inc.—agreed to join the Chance case as plaintiffs rather than pursue their own individual cases against us. Accordingly, on or about May 29, 2001, plaintiffs filed a First Amended Consolidated Class Action Complaint in the Chance case adding Werber and Bowles as plaintiffs. The complaint contained the following purported claims relating to our collection and use of Internet user information: (1) violation of 18 U.S.C. section 2510 et seq. (the Wiretap/Interception section of the Electronic Communications Privacy Act), (2) violation of 18 U.S.C. section 2701 et seq. (the Access to Stored Information section of the Electronic Communications Privacy Act), (3) violation of 18 U.S.C. section 1030 et seq. (the Computer Fraud and Abuse Act), (4) violation of RCW section 9.73.030 et seq. (the Washington State Wiretap/Interception statute), (5) common law trespass to personal property and conversion, (6) common law invasion of privacy, (7) unjust enrichment, (8) violation of state consumer protection and deceptive practices statutes, and (9) declaratory judgment. The plaintiffs sought declaratory and injunctive relief as well as monetary damages and disgorgement of profits. On September 17, 2001, the Court granted our motion for summary judgment and entered judgment in our favor. On October 15, 2001, plaintiffs filed a notice of appeal. On October 17, 2002, the Court entered an order granting preliminary approval of a nationwide class action settlement of this action. The Court ordered that notice to the class be provided, and scheduled a final approval hearing on March 6, 2003. On March 7, 2003, the Court entered a final judgment and order of dismissal, granting final approval to the settlement and dismissing the Chance case.

In Lopez v. Avenue A, Inc., the plaintiff, on behalf of himself and all others similarly situated in the State of Texas, filed a class action complaint against us on or about February 13, 2001, in the District Court of Cameron County, Texas. The complaint contains the following claims relating to our collection and use of Internet user information: (1) common law invasion of privacy, and (2) unjust enrichment. The plaintiff seeks declaratory and injunctive relief as well as monetary damages and disgorgement of profits that we have received in connection with the alleged illegal practices. On or about February 12, 2002, we filed a notice of removal in federal district court, thereby removing the case to federal court. On July 31, 2002, the federal district court remanded the case to state court. This case is subject to the nationwide class action settlement. Pursuant to the terms of the settlement and the Court’s order of dismissal, class counsel have agreed to take such steps as necessary to voluntarily dismiss with prejudice all asserted claims in this case within 30 days of entry of the final judgment and order of dismissal.

In Garcia v. Avenue A, Inc., the plaintiff, on behalf of herself and all others similarly situated in the State of California, filed a class action complaint against us on or about October 9, 2001, in the Superior Court for San Bernardino County, California. The complaint contained the following claims relating to our collection and use of Internet user information: (1) invasion of privacy in violation of article I, section 1 of the California Constitution, (2) common law invasion of privacy, (3) violation of California Penal Code §§ 631 et seq. (the California wiretapping and eavesdropping statutes), (4) violation of California Business & Professions Code §§ 17200 et seq. (the California unfair competition statute), and (5) unjust enrichment. The plaintiff sought declaratory and injunctive relief as well as monetary damages. This case is subject to the nationwide class action settlement. Pursuant to the terms of the settlement and the Court’s order of dismissal, an order dismissing the action was entered by the California court on April 3, 2003.

We have been named as a defendant in a consolidated amended class action complaint filed in the United States District Court for the Southern District of New York on or about April 19, 2002 and captioned In re Avenue A, Inc. Initial Public Offering Securities Litigation. This consolidated complaint relates to several previously filed class action complaints filed against us, the first of which was originally filed on or about June 15, 2001. Plaintiffs filed the consolidated complaint on behalf of themselves and all others who acquired our common stock between February 28, 2000 and December 6, 2000, pursuant or traceable to our prospectus dated February 28, 2000. The complaint also named as defendants Morgan Stanley & Co., Salomon Smith Barney, Inc., Thomas Weisel Partners, LLC, and RBC Dain Rauscher, Inc., certain of the underwriters of our initial public offering; Brian P. McAndrews, our President and Chief Executive

Officer; Nicolas Hanauer, our Chairman of the Board; and Robert Littauer, our former Chief Financial Officer. The complaint contains the following purported claims against all defendants: (1) violation of 15 U.S.C. section 77k (section 11 of the Securities Act of 1933), and (2) violation of 15 U.S.C. section 78j(b) (section 10(b) of the Securities Exchange Act of 1934) and 17 C.F.R. section 240.10b-5 (Exchange Act Rule 10b-5). The complaint contains the following purported claims against the individual defendants alone: (1) violation of 15 U.S.C. section 77o (section 15 of the Securities Act of 1933), and (2) violation of 15 U.S.C. section 78t(a) (section 20(a) of the Securities Exchange Act of 1934). Plaintiffs seek monetary damages. The complaint alleged violations of federal securities laws in connection with disclosures contained in our prospectus dated February 28, 2000, for our initial public offering of common stock. The complaint alleges incorrect disclosure or omissions in our prospectus relating generally to commissions to be earned by the underwriters and certain allegedly improper agreements between the underwriters and certain purchasers of our common stock. It also alleged that the SEC and/or other regulatory authorities are investigating underwriting practices similar to those alleged in the complaint. We have no knowledge as to whether aQuantive or our initial public offering is the subject of any such investigation.

This consolidated complaint is among over 300 similar consolidated class action lawsuits filed in the United States District Court for the Southern District of New York against underwriters and other issuers of stock in initial public offerings. The Court has coordinated the cases under a single case number for pretrial proceedings. On July 15, 2002, the issuer defendants as a group filed a motion to dismiss the claims alleged in the consolidated complaints. On October 8, 2002, the court entered an order dismissing, without prejudice, all of the claims against Messrs. McAndrews, Hanauer, and Littauer in the consolidated class action lawsuit pursuant to an agreement between plaintiffs and Messrs. McAndrews, Hanauer and Littauer. On February 19, 2003, the court granted aQuantive’s motion to dismiss the claims against it under Section 10(b) of the Securities Exchange Act of 1934 and denied its motion to dismiss the claims against it under Section 11 of the Securities Exchange Act of 1933.

On or about April 19, 2002, we filed a lawsuit against 24/7 Real Media, Inc. in the United States District Court for the Western District of Washington seeking a declaratory judgment that aQuantive is not infringing any claims of U.S. patent no. 6,026,368 and/or that the claims of the patent are invalid. On May 10, 2002, 24/7 Real Media filed an answer to our complaint and counterclaimed, seeking dismissal of our claim, alleging current and past infringement of this patent, seeking an injunction precluding us from using technology allegedly covered by the patent through the life of the patent, and seeking reasonable royalty or lost profits for alleged past infringement. We filed a motion for partial summary judgment of non-infringement on January 3, 2003. 24/7 Real Media filed an opposition to our motion for summary judgment on April 28, 2003. We filed a reply in support of our motion for summary judgment on May 12, 2003. Oral argument has been requested by both parties.

On February 28, 2000, the SEC declared effective our registration statement on Form S-1 as filed with the Commission in connection with our initial public offering of common stock, par value $0.01 per share. The offering was co-managed by Morgan Stanley & Co. Incorporated, Salomon Smith Barney Inc. and Thomas Weisel Partners LLC. Pursuant to the registration statement, we registered and sold an aggregate of 6,037,500 shares of common stock for a gross aggregate offering price of $144.9 million. In connection with the offering, we incurred total expenses of approximately $12.4 million, including underwriting discounts and commissions of approximately $10.1 million. All of these expenses were direct or indirect payments to others and not payments to our directors or officers (or their associates) or to our affiliates or 10% shareholders.

As of March 31, 2003, we have used approximately $18.8 million of the net proceeds of the public offering primarily for general corporate purposes, including working capital and capital expenditures. The remaining proceeds have been placed in temporary investments consisting of cash, cash equivalents and short-term investments. None of the proceeds was used as payments to our directors or officers (or their associates), or to our affiliates or 10% shareholders.

On February 27, 2003, we filed a report on Form 8-K regarding a press release announcing that we changed our name to aQuantive, Inc. We also announced that we intend to change our contractual agreements within our Avenue A operating unit, which is expected to result in reporting revenue on a net basis effective January 1, 2004.

On May 52003, we filed a report on Form 8-K regarding a press release announcing our first quarter earnings for the fiscal quarter ended March 31, 2003.

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, on May 14, 2003.

AQUANTIVE,INC.

By:		/S/ MICHAEL VERNON
		Michael Vernon Chief Financial Officer (Authorized Officer and Principal Financial Officer)

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

/s/ Brian P. McAndrews

Brian P. McAndrews

Chief Executive Officer and President

b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

/s/ Michael Vernon

Michael Vernon

Chief Financial Officer

Washington		91-1819567
(State of Incorporation)		(I.R.S. Employer Identification Number)

		Page
	PART I. FINANCIAL INFORMATION

Item 1.	Condensed Consolidated Financial Statements	3

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	33

Item 4.	Controls and Procedures	33

	PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	34

Item 2.	Changes in Securities and Use of Proceeds	35

Item 6.	Exhibits and Reports on Form 8-K	36

	March 31, 2003			December 31, 2002
Assets
Current assets:
Cash and cash equivalents	$	42,420		$	32,248
Short-term investments		78,930			89,143
Accounts receivable, net of allowances of $1,990 and $1,785, respectively		29,926			26,587
Other receivables		970			1,316
Prepaid expenses and other current assets		1,062			398

Total current assets		153,308			149,692
Property and equipment, net		4,696			4,166
Goodwill		2,292			2,292
Other intangible assets, net		2,070			2,147
Other assets		829			843

Total assets	$	163,195		$	159,140


Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable	$	33,974		$	31,505
Accrued expenses		6,195			6,918
Pre-billed media		2,833			3,757
Notes payable		1,111			1,569
Deferred revenue		3,413			2,554

Total current liabilities		47,526			46,303
Deferred income taxes		14			—

Total liabilities		47,540			46,303

Shareholders’ equity:
Common stock, $0.01 par value; 200,000 shares authorized; 58,736 and 58,380 shares issued and outstanding at March 31, 2003 and December 31, 2002, respectively		587			584
Paid-in capital		216,398			215,858
Deferred stock compensation		(805	)		(1,116	)
Subscription receivable		(213	)		(280	)
Accumulated deficit		(100,890	)		(102,766	)
Accumulated other comprehensive income		578			557

Total shareholders’ equity		115,655			112,837

Total liabilities and shareholders’ equity	$	163,195		$	159,140

	Three Months Ended March 31,
	2003		2002
Revenue	$	47,533	$	23,534
Expenses:
Cost of revenue		33,318		16,719
Client support (excluding amortization of deferred stock compensation of $221 and $422, respectively)		6,184		3,338
Product development (excluding amortization of deferred stock compensation of $35 and $202, respectively)		1,110		1,732
Selling, general, and administrative (excluding amortization of deferred Stock compensation of $47 and $148, respectively)		4,251		3,627
Depreciation and amortization of property and equipment		901		1,161
Amortization of deferred stock compensation		303		772
Amortization of intangible assets		60		—

Total expenses		46,127		27,349

Income (loss) from operations		1,406		(3,815	)
Interest and other income, net		537		1,249

Income (loss) before provision for income taxes or cumulative effect on prior years of change in accounting principle		1,943		(2,566	)
Provision for income taxes		67		—

Net income (loss) before cumulative effect on prior years of change in accounting principle		1,876		(2,566	)
Cumulative effect on prior years of change in accounting principle		—		(1,330	)

Net income (loss)	$	1,876	$	(3,896	)

Basic and diluted net income (loss) per share before change in accounting principle	$	0.03	$	(0.04	)
Cumulative effect of change in accounting principle		—		(0.02	)

Basic and diluted net income (loss) per share	$	0.03	$	(0.06	)

Shares used in computing basic net income (loss) per share		58,473		58,130

Shares used in computing diluted net income (loss) per share		64,374		58,130

Comprehensive income (loss):
Net income (loss)	$	1,876	$	(3,896	)
Items of comprehensive income (loss)		21		(692	)

Comprehensive income (loss)	$	1,897	$	(4,588	)

	Three Months Ended March 31,
	2003			2002
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$	1,876		$	(3,896	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization		1,289			1,933
Impairment of intangible assets		—			1,330
Non-cash compensation		67			67
Amortization of premiums on short-term investments		21			—
Changes in assets and liabilities:
Accounts receivable		(3,339	)		1,718
Other receivables, prepaid expenses and other current assets		(318	)		(377	)
Other assets		14			262
Accounts payable		2,469			(2,246	)
Accrued expenses		(723	)		(1,848	)
Pre-billed media		(924	)		—
Deferred revenue		859			(30	)
Deferred taxes		14			—

Net cash provided by (used in) operating activities		1,305			(3,087	)

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment		(1,431	)		(78	)
Sales of marketable securities, net		10,213			1,753

Net cash provided by investing activities		8,782			1,675

CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of notes payable		(458	)		(500	)
Proceeds from issuance of common stock and exercises of common stock options, net		543			131

Net cash provided by (used in) financing activities		85			(369	)

Net increase (decrease) in cash and cash equivalents		10,172			(1,781	)
Cash and cash equivalents, beginning of period		32,248			30,821

Cash and cash equivalents, end of period	$	42,420		$	29,040

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	March 31,		December 31,
	2003		2002
Customer A	24	%	15	%
Customer B	26	%	26	%
Customer D	*		13	%

	Three Months Ended March 31,
	2003			2002
Net income (loss), as reported	$	1,876		$	(3,896	)
Add: Stock-based employee compensation expense included in reported net income (loss)		303			772
Deduct: total stock-based compensation determined under fair value based method for all awards		(2,130	)		(2,961	)

Pro forma net income (loss), fair value method for all stock-based awards	$	49		$	(6,085	)
Basic and diluted net income (loss) per share:
As reported	$	.03		$	(.06	)
Pro forma	$	.00		$	(.10	)

Non-compete agreement	$	172
Customer relationships		1,785
Developed technology		240
Goodwill		2,292

	$	4,489


		99.1		Certification of Brian P. McAndrews Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to §906 of the Sarbanes-Oxley Act of 2002

		99.2		Certification of Michael Vernon Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to §906 of the Sarbanes-Oxley Act of 2002

		Exhibit No.		Description

		99.1		Certification of Brian P. McAndrews Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to §906 of the Sarbanes-Oxley Act of 2002

		99.2		Certification of Michael Vernon Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to §906 of the Sarbanes-Oxley Act of 2002

	March 31,
	2003		2002
Weighted average risk-free interest rate	3.15-3.70	%	3.83	%
Expected lives (in years)	1-6.5		1-4.5
Expected dividend yields	—		—
Expected volatility	114	%	108	%