| DIGITAS INC Item 1A Risk Factors Risk Factors and Important Factors that may Affect Future Results Set forth below are certain risk factors that could harm our business prospects, results of operations and financial condition |
| You should carefully read the following risk factors, together with the financial statements, related notes and other information contained in this Form 10-K This Form 10-K contains forward-looking statements that contain risks and uncertainties |
| Please refer to the discussion of “Forward-Looking Statements” on page three in connection with your consideration of the risk factors and other important factors that may affect future results described below |
| Risks Related to our Business The loss of even one significant client or any significant reduction in the use of our services could have a material adverse effect on our business, financial condition and results of operations |
| We derive a significant portion of our revenues from large-scale engagements with a limited number of clients |
| Most of these relationships, including those with our two largest clients, are terminable by the client without penalty on 90 days prior written notice |
| For the twelve months ended December 31, 2005, our two largest clients, American Express and General Motors, accounted for approximately 26prca and 22prca, respectively, of our fee revenue |
| For the twelve months ended December 31, 2004, General Motors, American Express and AT&T, our three largest clients for that year, accounted for approximately 24prca, 23prca and 12prca, respectively, of our fee revenue |
| The loss of any major client or any significant reduction in the use of our services by a major client could materially reduce our revenue and have a negative impact on our operating results, financial condition and reputation in our market |
| 7 ______________________________________________________________________ [28]Table of Contents The bankruptcy or insolvency of a significant client could have a material adverse effect on our business, financial condition and results of operations |
| Due to our dependence on a limited number of clients, we are subject to a concentration of credit risk with respect to accounts receivable |
| In the case of bankruptcy or insolvency by one of our significant clients, accounts receivable with respect to that client would potentially be uncollectible, adversely affecting our financial performance |
| For example, in September 2005, Delta Air Lines filed voluntary petitions for reorganization under Chapter 11 of the US Bankruptcy Code |
| We recorded a dlra3dtta2 million charge to professional services costs related to estimated exposure on collectibility of receivables due from Delta as of the bankruptcy filing date for services performed prior to that date |
| Our ability to collect those receivables remains uncertain and will depend upon the outcome of Delta’s reorganization proceedings |
| In 2005, General Motors suffered large financial losses |
| For the twelve months ended December 31, 2005, General Motors accounted for approximately 22prca of our fee revenue |
| In the event General Motors were to seek legal protection against its creditors, we may not be able to collect our outstanding accounts receivable which could have a material adverse effect on our business, operating results and financial condition |
| Our General Motors’ gross accounts receivable balance, which includes amounts billed and unbilled for both fee revenue and pass-through expenses, can fluctuate significantly based on the timing of payment and billings for fee and pass-through expenses |
| We may be held liable for financial or other commitments that we enter into for or on behalf of our clients |
| We incur expenses with third parties on our clients’ behalf in connection with providing marketing services |
| For example, for the printing of marketing materials for a direct mail campaign we may in some instances be required to pay the printer for the costs of production and postage in advance of receiving these funds from our client |
| In the event our client fails to pay us for these pass-through expenses and we have already paid these amounts to the vendor, we may not be able to recover these amounts from either our client or the vendor |
| Also, we sometimes sign contracts with vendors on our client’s behalf as an agent for a disclosed principal |
| If the client later decides not to engage a particular vendor with which we have already contracted, or if the client becomes insolvent or files for bankruptcy, the vendor may seek to be paid by us |
| While we try to negotiate terms into our vendor agreements that protect us from liability for payment due to the non-performance of our client, there can be no guarantees that we will be successful in negotiating these terms with all of our client vendors, or that the terms of these provisions will be found enforceable by a court |
| Our failure to meet clients’ expectations could result in losses or negative publicity and could subject us to liability for the services we provide |
| As clients have dedicated more money and resources to our engagements with them, their expectations have also increased |
| As client engagements become larger and more complex and are required to be completed in a shorter time frame, we face increased management challenges and greater risk of mistakes or late delivery |
| Any failure on our part to deliver services in accordance with clients’ expectations could result in: • additional expenditures by us to correct the problem; • delayed or lost client revenues; • adverse client reactions and negative publicity; and • claims against us |
| Although client agreements often limit our liability to damages arising from the rendering of services, we cannot assure that these provisions will be enforceable in all instances or would otherwise protect us from liability |
| While we carry general liability insurance coverage, insurance may not cover all potential claims to which we are exposed or may not be adequate to indemnify us for all liability that may be imposed |
| If we succeed in expanding our business, that expansion may place increased demands on our management, operating systems, internal controls and financial and physical resources |
| If not managed effectively, these 8 ______________________________________________________________________ [29]Table of Contents increased demands may adversely affect the services we provide to existing clients |
| In addition, our personnel, systems, procedures and controls may be inadequate to support future operations |
| These increased demands could result in increased employee attrition which would create greater strain on our operations |
| Consequently, in order to manage growth effectively, we may be required to increase expenditures to expand, train and manage employee base, improve management, financial and information systems and controls, or make other capital expenditures |
| Our results of operations and financial condition could be harmed if we encounter difficulties in effectively managing the budgeting, forecasting and other process control issues presented by future growth |
| Our agencies have entered into exclusivity arrangements with several of their clients that prohibit them from providing services to competitors of those clients or client brands |
| In addition, although not contractually prohibited from providing services to a competitor of a client, our agencies sometimes decline to accept potential clients because of actual or perceived conflicts of interest with their existing clients or because a client insists, for whatever reason, that the agency not work with its competitors |
| In addition, potential clients may choose not to retain our agencies for reasons of actual or perceived conflicts of interest |
| Many of our agencies’ clients compete in industries where only a limited number of companies gain meaningful market share |
| As a result, if one of our agencies decides not to perform services for a particular client’s competitors, or if potential clients choose not to retain them because of actual or perceived conflicts and the agency client fails to capture a significant portion of its market, that agency may receive reduced or no future revenue in that particular industry |
| Clients of Digitas, MBC and Modem Media agencies that compete with one another may not be satisfied with the organizational steps we have taken to address the actual or perceived conflicts of interest and may choose not to continue to engage our agencies for services |
| We may need to increase reserves for surplus office space if subtenants fail to pay their rent |
| As part of a series of cost reduction efforts, we determined that we had surplus office space |
| As a result of these efforts, we abandoned the surplus office space and recorded reserves for lease liabilities based on minimum lease payments for the space abandoned net of the rent we estimated we could realize upon subletting the space |
| We have sublet approximately 22cmam000 square feet of surplus New York City office space, approximately 53cmam000 square feet of surplus San Francisco office space, approximately 15cmam000 square feet of surplus Miami office space and approximately 33cmam000 square feet in Norwalk |
| The New York sublease expires in March 2011, the San Francisco sublease expires in January 2010, and the Miami sublease expires in January 2008 |
| If one or more subtenants fail to pay their rent to us, we may need to increase reserves, depending on the circumstances at the time |
| Fluctuations in our quarterly revenues and operating results may lead to reduced prices for our stock |
| Our quarterly revenues and operating results can be volatile |
| We believe that period-to-period comparisons of operating results are not necessarily meaningful |
| These comparisons cannot be relied upon as indicators of future performance |
| However, if our operating results in any future period fall below the expectations of securities analysts and investors, the market price of our securities would likely decline |
| Factors that may cause our quarterly results to fluctuate in the future include the following: • variability in market demand for services; • length of the sales cycle associated with service offerings; • unanticipated variations in the size, budget, number or progress toward completion of engagements; • unanticipated termination of a major engagement, a client’s decision not to proceed with an anticipated engagement or the completion or delay during a quarter of several major client engagements; 9 ______________________________________________________________________ [30]Table of Contents • our ability to manage operating costs, a large portion of which are fixed in advance of any particular quarter; • changes in pricing policies by us or our competitors; • our ability to manage future growth and retain employees; • timing and amount of client bonus payments; and • costs of attracting and training skilled personnel |
| Our business will be negatively affected if we do not keep up with rapid technological changes, evolving industry standards and changing client requirements |
| Our industry is characterized by rapidly changing technology, evolving industry standards and changing client needs |
| Accordingly, our future success will depend, in part, on our ability to meet these challenges in a timely and cost-effective manner |
| Among the most important challenges facing us is the need to: • effectively use leading technologies; • continue to develop strategic and technical expertise; • influence and respond to emerging industry standards and other technological changes; • enhance current service offerings; and • develop new services that meet changing customer needs |
| If we are not successful in expanding our ability to service clients on a worldwide basis, we may jeopardize relationships with existing clients and limit our ability to attract new clients |
| Failure to meet client demands that their relationship marketing service providers be able to handle assignments on a worldwide basis may jeopardize our existing client relationships and limit our ability to attract new clients |
| Currently, Modem Media serves European markets from its office in London and all three of our agencies can serve markets in other regions from offices in the United States |
| To succeed we may also need to deepen and broaden expertise in dealing with worldwide assignments by expanding our presence outside of the United States or by hiring more senior executives with multi-national technology, marketing and customer relationship management expertise; and there is no assurance that we can attract those people or establish on a profitable basis offices outside of the United States |
| We have limited experience in marketing, selling and supporting services outside of North America and the United Kingdom, and development of those skills may be more difficult or take longer than we anticipate |
| Operations outside the United States may be unprofitable or less profitable than operations in the United States, especially due to language barriers, cultural differences, economic and political conditions in countries outside the United States, currency exchange risks, differences in terms of payment and collectibility of receivables, reduced protection for intellectual property rights in some countries, the burden and expense of complying with foreign laws and regulations and the fact that the Internet infrastructure in foreign countries may be less advanced than in the United States |
| Failure to maintain our reputation and expand name recognition could impair our ability to remain competitive |
| We believe that establishing and maintaining name recognition and a good reputation for us and our agencies is critical to attracting and expanding a targeted client base as well as attracting and retaining qualified employees |
| If our reputation is damaged or if we are unable to establish name recognition, we may become less competitive or lose market share |
| In addition, our name, or the name of any of our agencies, could be associated with any business difficulties of our agencies’ clients |
| As a result, the difficulties or failure of one of our clients could damage our reputation and name and make it difficult for us to compete for new business |
| 10 ______________________________________________________________________ [31]Table of Contents Our industry is highly competitive, rapidly changing and has low barriers to entry; if we cannot effectively compete, our revenue may decline |
| Our industry is relatively new and intensely competitive |
| We expect competition to intensify even further as the industry matures |
| Some of our current competitors have more clients, greater brand or name recognition and greater financial, technical, marketing and public relations resources than we do |
| Furthermore, our industry, and the related technology, is evolving quickly and has relatively low barriers to entry |
| Current or future competitors may also develop or offer services that are comparable or superior to ours at a lower price, which could affect our ability to retain existing clients and attract new clients |
| In addition, current and potential competitors have established or may establish corporate relationships among themselves or other third parties to increase their ability to address customer needs |
| Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share |
| We cannot assure you that we will be able to continue to compete successfully with existing competitors or any new competitors |
| Past and potential future acquisitions could be difficult to integrate, disrupt business, adversely affect operating results and dilute shareholder value |
| In January 2006 we acquired Medical Broadcasting, LLC, and in October 2004 we acquired Modem Media, Inc, each a provider of interactive marketing strategy services |
| We may acquire other businesses in the future, which may complicate our management tasks |
| We may need to integrate widely dispersed operations with distinct corporate cultures |
| Our failure to do so could result in our inability to retain the management, key personnel, employees and clients of the acquired business |
| Integration efforts also may distract our management from servicing existing clients |
| Failure to manage future acquisitions successfully could seriously harm operating results |
| Also, acquisition costs could cause quarterly operating results to vary significantly |
| Furthermore, our stockholders could be diluted if we finance the acquisitions by issuing equity securities |
| In addition, we may not realize the anticipated benefits of prior or any future acquisitions to the extent anticipated or at all |
| For example, if MBC’s revenue decreases or its operating costs increase to levels not expected by our management, or if the acquisition results in unforeseen liabilities, including lawsuits or demands on resources, our business, results of operations and financial condition could be materially and adversely affected |
| Increased government regulation of various direct marketing channels and the marketing of some products could adversely affect our business |
| State and federal government regulation of various direct marketing channels, such as the Internet, electronic mail and telephone, and regulation of the marketing of some products, such as pharmaceuticals, is increasing |
| New laws and regulations, or new interpretations of existing laws and regulations, could impact us directly or indirectly by preventing clients from using certain direct marketing methods |
| For example, privacy laws have curtailed the use of customer information by companies |
| Violations of these laws and regulations could also result in liability for us and our clients |
| New laws and regulations could create limitations on clients’ ability to market to targeted customers which in turn could decrease the demand for our services and have a material adverse effect on our future operating performance |
| We may need to raise additional capital, which may not be available, and which may dilute the ownership interests of current investors |
| We may need to raise additional funds to meet working capital and capital expenditure needs and to otherwise support our business and implement strategy |
| We cannot be certain that we will be able to obtain additional financing on favorable terms or at all |
| If we need additional capital and cannot raise it on acceptable terms, we may not be able to: • create additional market-specific business units; 11 ______________________________________________________________________ [32]Table of Contents • enhance infrastructure; • hire, train and retain employees; • keep up with technological advances; or • respond to competitive pressures or unanticipated requirements |
| Failure to do any of these things could restrict the growth, hinder the ability to compete and seriously harm our financial condition |
| Additionally, if we are able to raise additional funds through equity financings, the ownership interest of our stockholders will be diluted |
| Acts of war or terrorism, or related effects could adversely affect our business, operating results and financial condition |
| A significant amount of our revenue comes from clients whose businesses are particularly vulnerable to war and terrorism because they work in industries that include financial services, travel-related services and the hospitality industry |
| An act of war or terrorism could adversely affect our business, operating results and financial condition |
| The related effects of an act of war or terrorism, such as disruptions in air transportation, enhanced security measures and political instability in certain foreign countries may interrupt our business and that of our clients |
| An act of war or terrorism may result in a significant reduction in client spending or contribute to an economic downturn and adversely affect our business, operating results and financial condition |
| An economic recession or downturn in the United States or abroad may result in a reduction in our revenues and operating results |
| Our ability to succeed depends on the continued investment by our current and future clients in the services that we offer |
| In the past our business has been adversely impacted by a decline in demand for our services, primarily related to an overall economic downturn |
| An economic recession or downturn in the United States and abroad may cause some of our current and future clients to reduce or eliminate their budgets for our services |
| Furthermore, the reduction in client budgets may intensify competition and further increase pressure for us to reduce the fees charged to clients |
| A lasting economic recession or downturn in the United States or abroad may have a material adverse effect on our business, financial condition and results of operations |
| The market price of our common stock has been and is likely to continue to be highly volatile |
| Since completing our initial public offering in March 2000, the market price for our common stock has been as high as dlra40dtta00 per share and as low as dlra0dtta88 per share |
| Additionally, the stock market in general, and the market for technology-related stocks in particular, has been highly volatile and was characterized by significant decreases in market prices during 2001, 2002 and 2003 |
| This volatility often has been unrelated to the operating performance of particular companies |
| In addition, the trading price of our common stock could be subject to wide fluctuations in response to: • perceived prospects; • variations in operating results and achievement of key business targets; • changes in securities analysts’ recommendations or earnings estimates; • differences between reported results and those expected by investors and securities analysts; • announcements of new contracts or service offerings by us or our competitors; 12 ______________________________________________________________________ [33]Table of Contents • market reaction to any acquisitions, joint ventures or strategic investments announced by us or our competitors; and • general economic or stock market conditions unrelated to our operating performance |
| In the past, securities class action litigation has often been instituted against companies following periods of volatility in the market price of their securities |
| This type of litigation could result in substantial costs and a diversion of management attention and resources |
| Risks Related to Legal Uncertainty We may be subject to claims that our client work, or our client’s use of our work, violates the intellectual property rights of a third party |
| Third parties may have legal rights, including ownership of patents, trade secrets, trademarks and copyrights, to ideas, materials or processes that are the same or similar to those we use in the work we produce for our clients |
| Third parties may bring claims, or threaten to bring claims, against us or our clients that these intellectual property rights are being infringed or violated by our use or our clients’ use of intellectual property |
| Litigation or threatened litigation could be costly and distract our senior management from operating our business |
| Further, if we cannot establish our right or obtain the right to use the intellectual property on reasonable terms, we may be required to develop alternative intellectual property at our expense to mitigate potential harm and permit our clients’ marketing programs to proceed |
| Where a third party brings or threatens to bring a claim, our clients may also seek indemnification from us to the extent their business is harmed by the claim or threatened claim |
| We also risk being subject to a third party claim where we secure the rights to use the third party’s intellectual property, but where a client uses it in a way inconsistent with the scope of the license |
| We may not be able to protect our intellectual property and proprietary rights |
| We cannot guarantee that the steps taken to protect proprietary rights will be adequate to deter misappropriation of our intellectual property |
| In addition, we may not be able to detect unauthorized use of our intellectual property and take appropriate steps to enforce our rights |
| If third parties infringe or misappropriate our trade secrets, copyrights, trademarks or other proprietary information, our business could be seriously harmed |
| In addition, although we believe our proprietary rights do not infringe on the intellectual property rights of others, other parties may assert infringement claims against us or claim that we have violated their intellectual property rights |
| Such claims, even if not true, could result in significant legal and other costs and may be a distraction to management |
| If any party asserts a claim against us relating to proprietary technology or information, we may need to obtain licenses to the disputed intellectual property |
| We cannot guarantee, however, that we will be able to obtain any licenses at all |
| In addition, protection of intellectual property in many foreign countries is weaker and less reliable than in the United States so, as our business expands into foreign countries, risks associated with protecting our intellectual property will increase |
| Changes in government regulation of the Internet and other emerging technologies could adversely affect our business |
| To date, government regulations have not materially restricted the use of the Internet and other emerging technologies by our clients in their markets |
| However, the legal and regulatory environment that pertains to such technologies may change |
| New state, federal and foreign laws and regulations, or new interpretations of existing laws and regulations, especially those relating to privacy, could impact us directly or indirectly by preventing clients from delivering products or services over technology-based distribution channels |
| Failure to comply with applicable government regulations could result in liability |
| Any new legislation could inhibit the increased use of the Internet and emerging technologies as commercial mediums which in turn could decrease the demand for our services and have a material adverse effect on future operating performance |
| 13 ______________________________________________________________________ [34]Table of Contents We may become subject to claims regarding foreign laws and regulations that could result in increased expenses |
| Because we plan to expand international operations and because many of our current clients have international operations, we may be subject to the laws of foreign jurisdictions |
| These laws may change, or new, more restrictive laws may be enacted in the future |
| Failure to comply with applicable foreign laws and regulations could result in a liability |
| International litigation is often expensive and time-consuming and could distract management’s attention away from the operation of the business |
| Provisions of Delaware law and of our charter and by-laws may make a takeover more difficult |
| Provisions in our certificate of incorporation and by-laws and Delaware corporate law may make it difficult and expensive for a third party to pursue a tender offer, change-in-control or takeover attempt that is opposed by our management and board of directors |
| Public shareholders who might desire to participate in such a transaction may not have an opportunity to do so |
| Our certificate of incorporation provides for a staggered board of directors, which makes it difficult for stockholders to change the composition of the board of directors in any one year |
| These anti-takeover provisions could substantially impede the ability of public stockholders to benefit from a change-in-control or to change our management and board of directors |
| Anti-takeover provisions could make it more difficult for a third party to acquire us |
| We adopted a shareholder rights plan and declared a dividend distribution of one right for each outstanding share of common stock to stockholders of record as of January 26, 2005 |
| Each right entitles the holder to purchase one unit consisting of one ten-thousandth of a share of Series A Junior Participating Cumulative Preferred Stock for dlra45 per unit |
| Under circumstances specified in the plan, if a person or group acquires 15 percent or more of our outstanding common stock, holders of the rights (other than the person or group that triggered the exercise) will be able to purchase, for the dlra45 exercise price, shares of our common stock or common stock of any company into which we have merged having a market value of dlra90 |
| The rights expire on January 26, 2015, unless extended by our board of directors |
| Because the rights may substantially dilute the stock ownership of a person or group attempting to take us over without the approval of our board of directors, our rights plan could make it more difficult for a third party to acquire us (or a significant percentage of our outstanding capital stock) without first negotiating with our board of directors |