| DIGITAL RIVER INC /DE ITEM 1A RISK FACTORS The risks described below are not the only ones facing our company |
| Additional risks not presently known to us or that we currently deem immaterial also may impair our business operations |
| Our business, financial condition or results of operations could be materially adversely affected by any of these risks and the value of our common stock could decline due to any of these risks |
| This annual report also contains forward-looking statements that involve risks and uncertainties |
| Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the risks faced by us described below and elsewhere in this report |
| Our limited profitable operating history, which we first achieved in the quarter ended September 30, 2002, makes it difficult to evaluate our ability to sustain profitability in the future |
| The success of our business model depends upon our success in generating sufficient transaction and service fees from the use of our e-commerce solutions by existing and future clients |
| Accordingly, we must maintain our existing relationships and develop new relationships with software publishers, online retailers and physical goods clients |
| To achieve this goal, we intend to continue to expend significant financial and management resources on the development of additional services, sales and marketing, improved technology and expanded operations |
| If we are unable to maintain existing, and develop new, client relationships, we will not generate a profitable return on our investments and we will be unable to gain meaningful market share to justify those investments |
| Further, we may be unable to sustain profitability if our revenues decrease or increase at a slower rate than expected, or if operating expenses exceed our expectations and cannot be adjusted to compensate for lower than expected revenues |
| A loss of any client that accounts for a large portion of our revenue would cause our revenue to decline |
| In addition, in 2005, revenues derived from proprietary Digital River services sold to Symantec end-users and dealer network sales of Symantec products together amounted to approximately dlra31dtta8 million, or approximately 14dtta4prca of total Digital River revenue |
| In addition, a limited number of other software and physical goods clients contribute a large portion of our annual revenue |
| Contracts with our clients are generally one or two years in length |
| If any one of these key contracts is not renewed or otherwise terminates, or if revenues from these clients decline for any other reason (such as competitive developments), our revenue would decline and our ability to sustain profitability would be impaired |
| If our contract with Symantec is not renewed or otherwise terminated, or if revenues from Symantec and Symantec-related services decline for any other reason, our revenue and our ability to sustain profitability could be materially adversely impaired |
| It is important to our ongoing success that we maintain our key client relationships and, at the same time, develop new client relationships |
| Failure to properly manage and sustain our expansion efforts could strain our management and other resources |
| Through acquisitions and organic growth, we are rapidly and significantly expanding our operations, both domestically and internationally |
| We will continue to expand further to pursue growth of our service offerings and customer base |
| This expansion increases the complexity of our business and places a significant strain on our management, operations, technical performance, financial resources, and internal financial control and reporting functions, and there can be no assurance that we will be able to manage it effectively |
| Our personnel, systems, procedures and controls may not be adequate to effectively manage our future operations, especially as we employ personnel in multiple domestic and international locations |
| Failure to 13 _________________________________________________________________ [63]Table of Contents effectively manage our growth opportunities could damage our reputation, limit our future growth, negatively affect our operating results and harm our business |
| We intend to continue to expand our international operations and these efforts may not be successful in generating additional revenue |
| We sell products and services to end-users outside the United States and we intend to continue expanding our international presence |
| In 2005, our international revenues represented approximately 39prca of our total revenues |
| Expansion into international markets, particularly the European and Asia-Pacific regions, requires significant resources that we may fail to recover by generating additional revenue |
| Conducting business outside of the United States is subject to risks, including: • Changes in regulatory requirements and tariffs; • Uncertainty of application of local commercial, tax, privacy and other laws and regulations; • Reduced protection of intellectual property rights; • Difficulties in physical distribution for international sales; • Higher incidences of credit card fraud and difficulties in accounts receivable collection; • The burden and cost of complying with a variety of foreign laws; • The possibility of unionization of our workforce outside the United States, particularly in Europe; and • Political or economic constraints on international trade or instability |
| These risks have grown with the acquisitions of element 5 and SWReg, which have substantial operations outside the US, and with our expansion into the Asia-Pacific region |
| We may be unable to successfully and cost-effectively market, sell and distribute our services in foreign markets |
| This may be more difficult or take longer than anticipated especially due to international challenges, such as language barriers, currency exchange issues and the fact that the Internet infrastructure in foreign countries may be less advanced than the US Internet infrastructure |
| If we are unable to successfully expand our international operations, or manage this expansion, our operating results and financial condition could be harmed |
| Our operating results are subject to fluctuations in demand for products and services offered by us or our clients |
| Our quarterly and annual operating results are subject to fluctuations in demand for the products or services offered by us or our clients, such as anti-virus software and anti-spyware software |
| In particular, sales of anti-virus software represented a significant portion of our revenues in recent years, and continue to be very important to our business |
| Demand for anti-virus software is subject to the unpredictable introduction of significant computer viruses |
| In February 2006, Microsoft Corporation announced plans to introduce products to protect businesses and consumers from computer viruses and other security risks |
| To the extent that Microsoft or others successfully introduce products or services not sold through our platform that are competitive with products and services sold by current Digital River clients (including anti-virus products and services), our revenues could be materially adversely affected |
| New obligations to collect or pay transaction taxes could substantially increase the cost to us of doing business |
| Currently, we collect sales, use, value added tax (VAT) or other similar transaction taxes with respect to electronic software download and physical delivery of products in tax jurisdictions where we believe we have taxable presences |
| The application of transaction taxes to interstate and international sales over the Internet is complex and evolving |
| Local, state or international jurisdictions may seek to impose transaction tax collection obligations on companies like ours that engage in e-commerce, and they may seek to impose taxes retroactively on past transactions that we believed were exempt from transaction tax liability |
| A successful assertion by one or more tax jurisdictions that we should collect or were obligated to collect transaction taxes on the products we sell could harm our results of operations |
| We could be liable for fraudulent, improper or illegal uses of our platforms |
| In recent years revenues from our “remote control” platforms have grown as a percentage of our overall business, and we plan to continue to emphasize our self service e-commerce solutions |
| These platforms typically have an automated structure that allows customers to use our e-commerce services without significant participation from Digital River personnel |
| Despite our efforts to detect and contractually prohibit the sale of inappropriate and illegal goods and services, the remote control nature of these platforms makes it more likely that transactions involving the sale of unlawful goods or services or the violation of the proprietary rights of others may occur before we become aware of them |
| Furthermore, unscrupulous individuals may offer illegal products for sale via such platforms under innocuous names, further frustrating attempts to prevent inappropriate use of our services |
| Failure to detect inappropriate or illegal uses of our platforms by third parties could expose us to a number of risks, including fines, increased fees or termination of services by payment processors or credit card associations, risks of lawsuits, and civil and criminal penalties |
| Loss of our credit card acceptance privileges would seriously hamper our ability to process the sale of merchandise |
| The payment by end-users for the purchase of digital goods that we process is typically made by credit card or similar payment method |
| As a result, we must rely on banks or payment processors to process transactions, and must pay a fee for this service |
| From time to time, credit card associations may increase the interchange fees that they charge for each transaction using one of their cards |
| Any such increased fees will increase our operating costs and reduce our profit margins |
| We also are required by our processors to comply with credit card association operating rules, and we have agreed to reimburse our processors for any fines they are assessed by credit card associations as a result of processing payments for us |
| The credit card associations and their member banks set and interpret the credit card rules |
| Visa, MasterCard, American Express, or Discover could adopt new operating rules or re-interpret existing rules that we or our processors might find difficult to follow |
| We have had payment processing agreements with certain of our payment processors terminated due to violations of their rules, and although we have been able to successfully migrate to new processors, such migrations require significant attention from our personnel, and often result in higher fees and customer dissatisfaction |
| Any disputes or problems associated with our payment processors could impair our ability to give customers the option of using credit cards to fund their payments |
| If we were unable to accept credit cards, our business would be seriously damaged |
| We also could be subject to fines or increased fees from MasterCard and Visa if we fail to detect that merchants are engaging in activities that are illegal or activities that are considered “high risk,” primarily the sale of certain types of digital content |
| We may be required to expend significant capital and other resources to monitor these activities |
| Our failure to attract and retain software and digital products publishers, manufacturers, online retailers and online channel partners as clients would cause our revenue and operating profits to decline |
| We generate revenue by providing outsourced services to a wide variety of companies, primarily in the software and high-tech products markets |
| If we cannot develop and maintain satisfactory relationships with software and digital products publishers, manufacturers, online retailers and online channel partners on acceptable commercial terms, we will likely experience a decline in revenue and operating profit |
| We also depend on our software and digital publisher clients creating and supporting software and digital products that end-users will purchase |
| If we are unable to obtain sufficient quantities of software and digital products for any reason, or if the quality of service provided by these software and digital products 15 _________________________________________________________________ [65]Table of Contents publishers falls below a satisfactory level, we could also experience a decline in revenue, operating profit and end-user satisfaction, and our reputation could be harmed |
| Our contracts with our software and digital products publisher clients are generally one to two years in duration, with an automatic renewal provision for additional one-year periods, unless we are provided with a written notice at least 90 days before the end of the contract |
| As is common in our industry, we have no material long-term or exclusive contracts or arrangements with any software or digital products publishers that guarantee the availability of software or digital products |
| Software and digital products publishers that currently supply software or digital products to us may not continue to do so and we may be unable to establish new relationships with software or digital product publishers to supplement or replace existing relationships |
| Implementing our acquisition strategy could result in dilution and operating difficulties leading to a decline in revenue and operating profit |
| We have acquired, and intend to continue engaging in strategic acquisitions of businesses, technologies, services and products |
| For example, in April 2004, we acquired element 5, and in December 2005, we acquired Commerce5, each a provider of outsourced e-commerce solutions |
| The process of integrating an acquired business, technology, service or product into our business and operations may result in unforeseen operating difficulties and expenditures |
| Integration of an acquired business also may disrupt our ongoing business, distract management and make it difficult to maintain standards, controls and procedures |
| Moreover, the anticipated benefits of any acquisition may not be realized |
| If a significant number of clients of the acquired businesses cease doing business with us, we would experience lost revenue and operating profit, and any synergies from the acquisition may be lost |
| Future acquisitions could result in potentially dilutive issuances of equity securities, the incurrence of debt, contingent liabilities, amortization of intangible assets or impairment of goodwill |
| We may need to raise additional capital to achieve our business objectives, which could result in dilution to existing investors or increase our debt obligations |
| In January 2005, we filed a registration statement to increase our available shelf registration amount from approximately dlra55 million to dlra255 million |
| In addition, we filed an acquisition shelf for up to approximately 1dtta5 million shares |
| In February 2006, we filed a shelf registration that would allow us to sell an undetermined amount of equity or debt securities in accordance with the recently approved rules applying to “well-known seasoned issuers |
| ” If additional funds are raised through the issuance of equity securities, the percentage ownership of our stockholders will be reduced and these equity securities may have rights, preferences or privileges senior to those of our common stock |
| In June 2004, we issued 1dtta25prca convertible notes which require us to make interest payments and will require us to pay principal when the notes become due in 2024 or in the event of acceleration under certain circumstances, unless the notes are converted into our common stock prior to that |
| We may not have sufficient capital to service this or any future debt securities that we may issue, and the conversion of the notes into our common stock may result in further dilution to our stockholders |
| Our capital requirements depend on several factors, including the rate of market acceptance of our products, the ability to expand our client base, the growth of sales and marketing, and opportunities for acquisitions of other businesses |
| We have had significant operating losses and negative cash flow from operations since inception |
| Additional financing may not be available when needed, on terms favorable to us or at all |
| If adequate funds are not available or are not available on acceptable terms, we may be unable to develop or enhance our services, take advantage of future opportunities or respond to competitive pressures, which would harm our operating results and adversely affect our ability to sustain profitability |
| Our operating results have fluctuated in the past and are likely to continue to do so, which could cause the price of our common stock to be volatile |
| Our quarterly and annual operating results have fluctuated significantly in the past and are likely to continue to do so in the future due to a variety of factors, some of which are outside our control |
| As a result, we believe that quarter-to-quarter and year-to-year comparisons of our revenue and operating results 16 _________________________________________________________________ [66]Table of Contents are not necessarily meaningful, and that these comparisons may not be accurate indicators of future performance |
| If our annual or quarterly operating results fail to meet the guidance we provide to securities analysts and investors or otherwise fail to meet their expectations, the trading price of our common stock will likely decline |
| Some of the factors that have or may contribute to fluctuations in our quarterly and annual operating results include: • The addition of new clients or loss of current clients; • The introduction by us of new websites, web stores or services that may require a substantial investment of our resources; • The introduction by others of competitive websites, web stores or services or products; • Our ability to continue to upgrade and develop our systems and infrastructure to meet emerging market needs and remain competitive in our service offerings; • Economic conditions, particularly those affecting e-commerce; • Client decisions to delay new product launches or to invest in e-commerce initiatives; • The performance of our newly acquired assets or companies; • Slower than anticipated growth of the online market as a vehicle for the purchase of software products; • The cost of compliance with US and foreign regulations relating to our business; and • Our ability to retain and attract personnel commensurate with our business needs |
| In addition, revenue generated by our software and digital commerce services is likely to fluctuate on a seasonal basis that is typical for the software publishing market in general |
| We believe that our first and fourth quarters are generally seasonally stronger than our second and third quarters due to the timing of new product introductions, which generally do not occur in the summer months, the holiday selling period, and the post-holiday retail season |
| Our operating expenses are based on our expectations of future revenue |
| These expenses are relatively fixed in the short-term |
| If our revenue for a quarter falls below our expectations and we are unable to quickly reduce spending in response, our operating results for that quarter would be harmed |
| In addition, the operating results of companies in the electronic commerce industry have, in the past, experienced significant quarter-to-quarter fluctuations that may adversely affect our stock price |
| Security breaches could hinder our ability to securely transmit confidential information |
| A significant barrier to e-commerce and communications is the secure transmission of confidential information over public networks |
| Any compromise or elimination of our security could be costly to remedy, damage our reputation and expose us to liability, and dissuade existing and new clients from using our services |
| We rely on encryption and authentication technology licensed from third parties to provide the security and authentication necessary for secure transmission of confidential information, such as end-user credit card numbers |
| A party who circumvents our security measures could misappropriate proprietary information or interrupt our operations |
| We may be required to expend significant capital and other resources to protect against security breaches or address problems caused by breaches |
| Concerns over the security of the Internet and other online transactions and the privacy of users could deter people from using the Internet to conduct transactions that involve transmitting confidential information, thereby inhibiting the growth of our business |
| To the extent that our activities or those of third-party contractors involve the storage and transmission of proprietary information, such as credit card numbers, security breaches could damage our reputation and expose us to a risk of loss, fines or litigation and possible liability |
| Our security measures may not prevent security breaches, and failure to prevent security breaches could lead to a loss of existing clients and also deter potential clients away from our services |
| 17 _________________________________________________________________ [67]Table of Contents Claims of infringement of other parties’ intellectual property rights could require us to expend significant resources, enter into unfavorable licenses or require us to change our business plans |
| From time-to-time we are named as a defendant in lawsuits claiming that we have, in some way, violated the intellectual property rights of others |
| Any assertions or prosecutions of claims like these, could require us to expend significant financial and managerial resources |
| The defense of any claims, with or without merit, could be time-consuming, result in costly litigation and diversion of technical and management personnel, cause product enhancement delays or require that we develop non-infringing technology or enter into royalty or licensing agreements |
| Royalty or licensing agreements, if required, may be unavailable on terms acceptable to us or at all |
| In the event of a successful claim of infringement against us and our failure or inability to develop non-infringing technology or license the infringed or similar technology on a timely basis, we may be unable to pursue our current business plan |
| We expect that we will increasingly be subject to patent infringement claims as our services expand in scope and complexity, and our results of operation and financial condition could be materially adversely affected |
| Claims against us related to the software products that we deliver electronically and the tangible goods that we deliver physically could require us to expend significant resources |
| We may become more vulnerable to third party claims as laws such as the Digital Millennium Copyright Act, the Lanham Act and the Communications Decency Act are interpreted by the courts |
| Claims may be made against us for negligence, copyright or trademark infringement, products liability or other theories based on the nature and content of software products or tangible goods that we deliver electronically and physically |
| Because we did not create these products, we are generally not in a position to know the quality or nature of the content of these products |
| Although we carry general liability insurance and require that our customers indemnify us against end-user claims, our insurance and indemnification measures may not cover potential claims of this type, may not adequately cover all costs incurred in defense of potential claims, or may not reimburse us for all liability that may be imposed |
| Any costs or imposition of liability that are not covered by insurance or indemnification measures could be expensive and time-consuming to address, distract management and delay product deliveries, even if we are ultimately successful in the defense of these claims |
| The growth of the market for our services depends on the development and maintenance of the Internet infrastructure |
| Our business is based on highly reliable Internet delivery of services |
| The success of our business therefore depends on the development and maintenance of a sound Internet infrastructure |
| This includes maintenance of a reliable network backbone with the necessary speed, data capacity and security, as well as timely development of complementary products, such as routers, for providing reliable Internet access and services |
| Our ability to increase the speed and scope of our services is limited by, and depends upon, the speed and reliability of both the Internet and our clients’ internal networks |
| Consequently, as Internet usage increases, the growth of the market for our services depends upon improvements made to the Internet as well as to individual clients’ networking infrastructures to alleviate overloading and congestion |
| In addition, any delays in the adoption of new standards and protocols required to govern increased levels of Internet activity or increased governmental regulation may have a detrimental effect on the Internet infrastructure |
| Because the e-commerce industry is highly competitive and has low barriers to entry, we may be unable to compete effectively |
| The market for e-commerce solutions is extremely competitive and we may find ourselves unable to compete effectively |
| Because there are relatively low barriers to entry in the e-commerce market, we expect continued intense competition as current competitors expand their product offerings and new competitors enter the market |
| In addition, our clients may become competitors in the future |
| Increased competition is likely to result in price reductions, reduced margins, longer sales cycles and a decrease or 18 _________________________________________________________________ [68]Table of Contents loss of our market share, any of which could negatively impact our revenue and earnings |
| We face competition from the following sources: • In-house development of e-commerce capabilities using tools or applications from companies, such as Art Technology Group, Inc |
| ; • Other providers of outsourced e-commerce solutions, such as GSI Commerce, Inc, Macrovision Corporation, asknet Inc |
| ; • Companies that provide technologies, services or products that support a portion of the e-commerce process, such as payment processing, including CyberSource Corporation and PayPal Corp |
| ; • Companies that offer various online marketing services, technologies and products, including ValueClick, Inc |
| ; • High-traffic, branded websites that generate a substantial portion of their revenue from e-commerce and may offer or provide to others the means to offer their products for sale, such as Amazon |
| ; and • Web hosting, web services and infrastructure companies that offer portions of our solution and are seeking to expand the range of their offering, such as Network Solutions, LLC, Akamai Technologies, Inc, Yahoo! |
| We believe that the principal competitive factors in our market are the breadth of products and services offered, the number of clients and online channel partnerships, brand recognition, system reliability and scalability, price, customer service, ease of use, speed to market, convenience and quality of delivery |
| The online channel partners and the other companies described above may compete directly with us by adopting a similar business model |
| Moreover, while some of these companies also are clients or potential clients of ours, they may compete with our e-commerce outsourcing solution to the extent that they develop e-commerce systems or acquire such systems from other software vendors or service providers |
| Many of our competitors have, and new potential competitors may have, more experience developing Internet-based software and e-commerce solutions, larger technical staffs, larger customer bases, more established distribution channels and customer relationships, greater brand recognition and greater financial, marketing and other resources than we have |
| In addition, competitors may be able to develop services that are superior to our services, achieve greater customer acceptance or have significantly improved functionality as compared to our existing and future products and services |
| Our competitors may be able to respond more quickly to technological developments and changes in customers’ needs |
| Our inability to compete successfully against current and future competitors could cause our revenue and earnings to decline |
| Changes in government regulation could limit our Internet activities or result in additional costs of doing business over the Internet |
| We are subject to the same international, federal, state and local laws as other companies conducting business over the Internet |
| The adoption or modification of laws related to the Internet could harm our business, operating results and financial condition by increasing our costs and administrative burdens |
| Due to the increasing popularity and use of the Internet, many laws and regulations relating to the Internet are being debated at the international, federal and state levels |
| These laws and regulations could cover issues such as: • User privacy with respect to adults and minors; • Our ability to collect and/or share necessary information that allows us to conduct business on the Internet; 19 _________________________________________________________________ [69]Table of Contents • Export compliance; • Pricing and taxation; • Fraud; • Advertising; • Intellectual property rights; • Information security; and • Quality of products and services |
| Applicability to the Internet of existing laws governing issues, such as property ownership, copyrights and other intellectual property issues, taxation, libel, obscenity and personal privacy also could harm our operating results and substantially increase the cost to us of doing business |
| For example, numerous state legislatures have proposed that tax rules for Internet retailing and catalog sales correspond to enacted tax rules for sales from physical stores |
| Any requirement that we collect sales tax for each online purchase and remit the tax to the appropriate state authority would be a significant administrative burden to us, and would likely depress online sales |
| This and any other change in laws applicable to the Internet also might require significant management resources to respond appropriately |
| The vast majority of these laws were adopted prior to the advent of the Internet, and do not contemplate or address the unique issues raised thereby |
| Those laws that do reference the Internet, such as the Digital Millennium Copyright Act, are only beginning to be interpreted by the courts, and their applicability and reach are therefore uncertain |
| Failure to develop our technology to accommodate increased traffic could reduce demand for our services and impair the growth of our business |
| We periodically enhance and expand our technology and transaction-processing systems, network infrastructure and other technologies to accommodate increases in the volume of traffic on our technology platforms |
| Any inability to add software and hardware or to develop and upgrade existing technology, transaction-processing systems or network infrastructure to manage increased traffic on this platform may cause unanticipated systems disruptions, slower response times and degradation in client services, including impaired quality and speed of order fulfillment |
| Failure to manage increased traffic could harm our reputation and significantly reduce demand for our services, which would impair the growth of our business |
| We may be unable to improve and increase the capacity of our network infrastructure sufficiently or anticipate and react to expected increases in the use of the platform to handle increased volume |
| Further, additional network capacity may not be available from third-party suppliers when we need it |
| Our network and our suppliers’ networks may be unable to maintain an acceptable data transmission capability, especially if demands on the platform increase |
| To remain competitive, we must continue to enhance and improve the responsiveness, functionality and features of our e-commerce platforms and the underlying network infrastructure |
| If we incur significant costs without adequate results, or are unable to adapt rapidly to technological changes, we may fail to achieve our business plan |
| The Internet and the e-commerce industry are characterized by rapid technological changes, changes in user and client requirements and preferences, frequent new product and service introductions embodying new technologies and the emergence of new industry standards and practices that could render our technology and systems obsolete |
| To be successful, we must adapt to rapid technological changes by licensing and internally developing leading technologies to enhance our existing services, developing new products, services and technologies that address the increasingly sophisticated and varied needs of our clients, and responding to technological advances and emerging industry standards and practices on a cost-effective and timely basis |
| The development of our proprietary technologies involves significant technical and business risks |
| We may fail to use new technologies effectively or fail to adapt our proprietary technology and systems to client requirements or emerging industry standards |
| 20 _________________________________________________________________ [70]Table of Contents System failures could reduce the attractiveness of our service offerings |
| We provide commerce, marketing and delivery services to our clients and end-users through our proprietary technology transaction processing and client management systems |
| These systems also maintain an electronic inventory of products and gather consumer marketing information |
| The satisfactory performance, reliability and availability of the technology and the underlying network infrastructure are critical to our operations, level of client service, reputation and ability to attract and retain clients |
| We have experienced periodic interruptions, affecting all or a portion of our systems, which we believe will continue to occur from time-to-time |
| Any systems damage or interruption that impairs our ability to accept and fill client orders could result in an immediate loss of revenue to us, and could cause some clients to purchase services offered by our competitors |
| In addition, frequent systems failures could harm our reputation |
| Although we maintain system redundancies in multiple physical locations, our systems and operations are vulnerable to damage or interruption from: • Fire, flood and other natural disasters; • Operator negligence, improper operation by, or supervision of, employees, physical and electronic break-ins, misappropriation, computer viruses and similar events; and • Power loss, computer systems failures, and Internet and telecommunications failure |
| We do not carry sufficient business interruption insurance to fully compensate us for losses that may occur |
| We may become liable to clients who are dissatisfied with our services |
| We design, develop, implement and manage e-commerce solutions that are crucial to the operation of our clients’ businesses |
| Defects in the solutions we develop could result in delayed or lost revenue, adverse end-user reaction, and/or negative publicity, which could require expensive corrections |
| As a result, clients who experience these adverse consequences either directly or indirectly by using our services could bring claims against us for substantial damages |
| Any claims asserted could exceed the level of any insurance coverage that may be available to us |
| The successful assertion of one or more large claims that are uninsured, that exceed insurance coverage or that result in changes to insurance policies, including future premium increases that could adversely affect our operating results or financial condition |
| We depend on key personnel |
| Our future success significantly depends on the continued services and performance of our senior management |
| Our performance also depends on our ability to retain and motivate our key technical employees who are skilled in maintaining our proprietary technology platforms |
| The loss of the services of any of our executive officers or key employees could harm our business if we are unable to effectively replace that officer or employee, or if that person should decide to join a competitor or otherwise directly or indirectly compete with us |
| Further, we may need to incur additional operating expenses and divert other management time in order to search for a replacement |
| Our future success depends on our ability to continue to identify, attract, hire, train, retain and motivate highly skilled personnel |
| Competition for these personnel is intense, particularly in the Internet industry |
| We may be unable to successfully attract, assimilate or retain sufficiently qualified personnel |
| In making employment decisions, particularly in the Internet and high-technology industries, job candidates often consider the value of stock option grants they are to receive in connection with their employment |
| Fluctuations in our stock price may make it more difficult to retain and motivate employees |
| Consequently, potential employees may perceive our equity incentives as less attractive and current employees whose equity incentives are no longer attractively priced may choose not to remain with our organization |
| In that case, our ability to attract employees will be adversely affected |
| As a result, our ability to use stock options as equity incentives will be adversely affected, which will make it more difficult 21 _________________________________________________________________ [71]Table of Contents to compete for and attract qualified personnel |
| Finally, should our stock price substantially decline, the retention value of stock options may weaken and employees who hold such options may choose not to remain with our organization |
| Protecting our intellectual property is critical to our success |
| We regard the protection of our trademarks, copyrights, trade secrets and other intellectual property as critical to our success |
| We rely on a combination of patent, copyright, trademark, service mark and trade secret laws and contractual restrictions to protect our proprietary rights |
| We have entered into confidentiality and invention assignment agreements with our employees and contractors, and nondisclosure agreements with parties with whom we conduct business, in order to limit access to and disclosure of our proprietary information |
| These contractual arrangements and the other steps taken by us to protect our intellectual property may not prevent misappropriation of our technology or deter independent third-party development of similar technologies |
| We also seek to protect our proprietary position by filing US patent applications related to our proprietary technology, inventions and improvements that are important to the development of our business |
| Proprietary rights relating to our technologies will be protected from unauthorized use by third parties only to the extent they are covered by valid and enforceable patents or are effectively maintained as trade secrets |
| We pursue the registration of our trademarks and service marks in the US and internationally |
| Effective trademark, service mark, copyright and trade secret protection may not be available in every country in which our services are made available online |
| The steps we have taken to protect our proprietary rights may be inadequate and third parties may infringe or misappropriate our trade secrets, trademarks and similar proprietary rights |
| Any significant failure on our part to protect our intellectual property could make it easier for our competitors to offer similar services and thereby adversely affect our market opportunities |
| In addition, litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others |
| Litigation could result in substantial costs and diversion of management and technical resources |
| Our clients’ sales cycles are lengthy, which may cause us to incur substantial expenses and expend management time without generating corresponding consumer revenue, which would impair our cash flow |
| We market our services directly to software publishers, online retailers and other prospective customers outside of the software industry |
| These relationships are typically complex and take time to finalize |
| Due to operating procedures in many organizations, a significant amount of time may pass between selection of our products and services by key decision-makers and the signing of a contract |
| The period between the initial client sales call and the signing of a contract with significant sales potential is difficult to predict and typically ranges from six to twelve months |
| If at the end of a sales effort a prospective client does not purchase our products or services, we may have incurred substantial expenses and expended management time that cannot be recovered and that will not generate corresponding revenue |
| As a result, our cash flow and our ability to fund expenditures incurred during the sales cycle may be impaired |
| The listing of our network addresses on anti-SPAM lists could harm our ability to service our clients and deliver goods over the Internet |
| Certain privacy and anti-email proponents have engaged in a practice of gathering, and publicly listing, network addresses that they believe have been involved in sending unwanted, unsolicited emails commonly known as SPAM In response to user complaints about SPAM, Internet service providers have from time-to-time blocked such network addresses from sending emails to their users |
| If our network addresses mistakenly end up on these SPAM lists, our ability to provide services for our clients and consummate the sales of digital and physical goods over the Internet could be harmed |
| 22 _________________________________________________________________ [72]Table of Contents We are subject to regulations relating to consumer privacy |
| We collect and maintain end-user data for our clients, which subjects us to increasing international, federal and state regulations related to online privacy and the use of personal user information |
| Congress has enacted anti-SPAM legislation with which we must comply when providing email campaigns for our clients |
| Legislation and regulations are pending in various domestic and international governmental bodies that address online privacy protections |
| Several governments have proposed, and some have enacted, legislation that would limit the use of personal user information or require online services to establish privacy policies |
| In addition, the US Federal Trade Commission, or FTC, has urged Congress to adopt legislation regarding the collection and use of personal identifying information obtained from individuals when accessing websites |
| Focus has now shifted to include online privacy protection for minors and adults |
| Even in the absence of laws requiring companies to establish these procedures, the FTC has settled several proceedings resulting in consent decrees in which Internet companies have been required to establish programs regarding the manner in which personal information is collected from users and provided to third parties |
| We could become a party to a similar enforcement proceeding |
| These regulatory and enforcement efforts could limit our collection of and/or ability to share with our clients demographic and personal information from end-users, which could adversely affect our ability to comprehensively serve our clients |
| The European Union has adopted a privacy directive that regulates the collection and use of information that identifies an individual person |
| These regulations may inhibit or prohibit the collection and sharing of personal information in ways that could harm our clients or us |
| The globalization of Internet commerce may be harmed by these and similar regulations because the European Union privacy directive prohibits transmission of personal information outside the European Union |
| The United States and the European Union have negotiated an agreement providing a “safe harbor” for those companies who agree to comply with the principles set forth by the US Department of Commerce and agreed to by the European Union |
| Failure to comply with these principles may result in fines, private lawsuits and enforcement actions |
| These enforcement actions can include interruption or shutdown of operations relating to the collection and sharing of information pertaining to citizens of the European Union |
| Compliance with future laws imposed on e-commerce may substantially increase our costs of doing business or otherwise adversely affect our ability to offer our services |
| Because our services are accessible worldwide, and we facilitate sales of products to end-users worldwide, international jurisdictions may claim that we are required to comply with their laws |
| Laws regulating Internet companies outside of the United States may be less favorable than those in the United States, giving greater rights to consumers, content owners and users |
| Compliance may be more costly or may require us to change our business practices or restrict our service offerings relative to those provided in the United States |
| Any failure to comply with foreign laws could subject us to penalties ranging from fines to bans on our ability to offer our services |
| As our services are available over the Internet in multiple states and foreign countries, these jurisdictions may claim that we are required to qualify to do business as a foreign corporation in each state or foreign country |
| We and/or our subsidiaries are qualified to do business only in certain states |
| Failure to qualify as a foreign corporation in a required jurisdiction could subject us to taxes and penalties and could result in our inability to enforce contracts in these jurisdictions |
| In addition, we are subject to United States laws governing the conduct of business with other countries, such as export control laws, which prohibit or restrict the export of goods, services and technology to designated countries, denied persons or denied entities from the United States |
| Violation of these laws could result in fines or other actions by regulatory agencies and result in increased costs of doing business and reduced profits |
| In addition, any significant changes in these laws, particularly an expansion in export control laws, will increase our costs of compliance and may further restrict our overseas client base |
| 23 _________________________________________________________________ [73]Table of Contents We are exposed to foreign currency exchange risk |
| Net revenues outside the United States accounted for approximately 39prca of our net revenues in 2005 |
| The results of operations of, and certain of our intercompany balances associated with, our internationally-focused websites are exposed to foreign exchange rate fluctuations |
| Upon translation, net sales and other operating results from our international operations may differ materially from expectations, and we may record significant gains or losses on the remeasurement of intercompany balances |
| If the US dollar weakens against foreign currencies, the translation of these foreign-currency-denominated transactions will result in increased net revenues and operating expenses |
| Similarly, our net revenues and operating expenses will decrease if the US dollar strengthens against foreign currencies |
| As we have expanded our international operations, our exposure to exchange rate fluctuations has become more pronounced |
| We do not currently have a currency hedging program to mitigate the effect of fluctuations of currency prices on our financial results |
| See Item 7A of Part II, for information demonstrating the effect on our consolidated statements of operations from changes in exchange rates versus the US dollar |
| Developments in accounting standards may cause us to increase our recorded expenses, which in turn would jeopardize our ability to demonstrate sustained profitability |
| In January 2002, we adopted Statement of Financial Accounting Standard Nodtta 142, “Goodwill and Other Intangible Assets” (SFAS Nodtta 142) |
| The statement generally establishes that goodwill and intangible assets with indefinite lives are not amortized, but are to be tested on an annual basis for impairment and, if impaired, are recorded as an impairment charge in income from operations |
| As of December 31, 2005, we had goodwill with an indefinite life of dlra195dtta3 million from our acquisitions |
| If our goodwill is determined for any reason to be impaired, the subsequent accounting of the impaired portion as an expense would lower our earnings and jeopardize our ability to demonstrate sustained profitability |
| In 2004, the Financial Accounting Standards Board adopted a proposal to require that the fair value of stock options and other share-based payments be reflected as an expense item in the financial statements of public companies for annual periods beginning after June 15, 2005 |
| As a result of the adoption of this proposal, our recorded non-cash expenses will significantly increase in 2006, which could impair our ability to maintain profitability |
| Compliance with changing regulation of corporate governance and public disclosure may result in additional expenses |
| Keeping abreast of, and in compliance with, changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and the NASDAQ Stock Market rules, have required an increased amount of management attention and external resources |
| We intend to invest all reasonably necessary resources to comply with evolving corporate governance and public disclosure standards, and this investment may result in increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities |
| Internet-related stock prices are especially volatile and this volatility may depress our stock price or cause it to fluctuate significantly |
| The stock market, and the trading prices of Internet-related companies in particular, have been notably volatile |
| This volatility is likely to continue in the short-term and is not necessarily related to the operating performance of affected companies |
| This broad market and industry volatility could significantly reduce the price of our common stock at any time, without regard to our operating performance |
| Factors that could cause our stock price in particular to fluctuate include, but are not limited to: • Actual or anticipated variations in quarterly operating results; • Announcements of technological innovations; • The ability to sign new clients and the retention of existing clients; 24 _________________________________________________________________ [74]Table of Contents • New products or services that we offer; • Competitive developments, including new products or services, or new relationships by our competitors; • Changes that affect our clients or the viability of their product lines; • Changes in financial estimates by securities analysts; • Conditions or trends in the Internet and online commerce industries; • Global unrest and terrorist activities; • Changes in the economic performance and/or market valuations of other Internet or online e-commerce companies; • Required changes in generally accepted accounting principles and disclosures; • Our announcement of significant acquisitions, strategic partnerships, joint ventures or capital commitments or results of operations or other developments related to those acquisitions; • Additions or departures of key personnel; and • Sales or other transactions involving our common stock or our convertible notes |
| In addition, our stock price may be impacted by the short sales and actions of other parties who may disseminate misleading information about us in an effort to profit from fluctuations in our stock price |
| Provisions of our charter documents, other agreements and Delaware law may inhibit potential acquisition bids for us |
| Certain provisions of our amended and restated certificate of incorporation, bylaws, other agreements and Delaware law could make it more difficult for a third party to acquire us, even if a change in control would be beneficial to our stockholders |