| You should carefully consider the risks described below and the other information in this annual report |
| If any of the following risks occur, our business could be materially harmed, and our financial condition and results of operations could be materially and adversely affected |
| As a result, the price of our common stock could decline, and you could lose all or part of your investment |
| Our digital music distribution business has a limited operating history and a history of losses and may not be successful |
| On May 19, 2003, we acquired substantially all of the ownership interests of Napster, LLC (f/k/a Pressplay) |
| We used the Pressplay-branded service as a technology platform to roll-out our online music services division in October 2003 |
| The business models, technologies and market for digital music services are new and unproven |
| Prior to our acquisition of Napster, LLC, consumer adoption and usage of the Pressplay-branded service had not been significant |
| On December 17, 2004, we completed the sale of our consumer software division to Sonic Solutions and have subsequently focused our business exclusively on paid digital music distribution and our recently launched advertising-supported music website, under the Napster brand |
| You should consider our business and prospects in light of the risks, expenses and difficulties encountered by companies in their early stage of development |
| Our digital music distribution business has experienced significant net losses since its inception and, given the significant operating and capital expenditures associated with our business plan, we expect to incur net losses for at least the next twelve months and will likely continue to experience net losses thereafter |
| No assurance can be made that our paid Napster service or the free music service will ever contribute net income to our statement of operations |
| During the period beginning April 1, 2003, just prior to our acquisition of Pressplay in May 2003, through March 31, 2006, we incurred approximately dlra155dtta7 million of after tax losses from continuing operations |
| The success of our paid Napster service depends upon our ability to add new subscribers and reduce churn |
| We cannot assure you that we will be able to attract new subscribers to the paid Napster service or that existing subscribers will continue to subscribe |
| Existing subscribers may cancel their subscriptions to the paid Napster service for many reasons, including a perception that they do not use the services enough to justify the expense or that the service does not provide enough value, or availability of content relative to our competition |
| The early stages of subscription services such as ours are characterized by higher than normal churn rates and customer acquisition cost |
| In addition, there is significant seasonality in our subscriber numbers due to our university program and softness in customer acquisition during the summer months when consumers spend less time online |
| Students who subscribe to the paid Napster service generally only do so during the school year when the school is paying for their subscriptions and most of the students do not maintain such subscriptions during the summer in between school terms |
| If we do not continue to increase the total number of subscribers each quarter, our operating results will be adversely impacted |
| 7 ______________________________________________________________________ [38]Table of Contents Our future success will depend on advertising revenues to grow our business and obtain profitability, and if advertising revenues were to fail to grow as expected, our results of operations and business would be harmed |
| Revenues from advertising are important to the future success of our business |
| Advertising revenues are based on the number of page views by visitors to the Napster |
| If our free music service, including Narchive, fails to attract and retain visitors, our revenues will not grow as expected |
| Most advertisers currently spend only a small portion of their advertising budgets on Internet advertising |
| There are also significant lead times associated with securing these advertising dollars |
| Furthermore, expenditures by advertisers tend to be cyclical, reflecting overall economic conditions and budgeting and buying patterns |
| If we fail to persuade potential advertisers to spend a portion of their budget on advertising with us, or if advertising spending declines due to general economic conditions or the failure of the Internet to be an effective advertising medium, our business and revenues could be adversely affected |
| In addition, sales of advertisements occur under short-term contracts, which are difficult to forecast accurately |
| Advertisers generally have the right to cancel an advertising campaign on short notice without penalty |
| Accordingly, the cancellation or deferral of advertising agreements could have a material adverse effect on our financial results |
| We experience fluctuations in our quarterly operating results, which may cause our stock price to decline |
| Our quarterly operating results may fluctuate from quarter to quarter |
| We cannot reliably predict future revenue and margin trends and such trends may cause us to adjust our operations |
| Other factors that could affect our quarterly operating results include: • timing of service introductions; • seasonal fluctuations in sales of our prepaid cards, university subscriptions, and bundled hardware promotions, as well as other products and services; • potential declines in selling prices of music as a result of competitive pressures; • changes in the mix of our revenues represented by our various services; • fluctuations in traffic levels on our Web sites, which can be significant as a result of business, financial and other news events; • fluctuating and unpredictable demand for advertising on our Web sites as well as on the Web in general; • reductions in rates paid for Web advertising resulting from softening demand, competition, or other factors; • adverse changes in the level of economic activity in the United States or other major economies in which we do business, or in industries, such as the music industry, on which we are particularly dependent; • foreign currency exchange rate fluctuations; • expenses related to, and the financial impact of, possible acquisitions of other businesses; and • expenses incurred in connection with the development of our digital music distribution services |
| 8 ______________________________________________________________________ [39]Table of Contents We rely on the value of the Napster brand, and our revenues could suffer if we are not able to maintain its high level of recognition in the digital music sector |
| We believe that maintaining and expanding the Napster brand is an important aspect of our efforts to attract and expand our user and advertiser base |
| We have embarked on a broad branding program to ensure that our position in the digital music sector continues to be strongly associated with the Napster name |
| Promotion and enhancement of the Napster brand will depend in part on our ability to provide consistently high-quality products and services |
| If we are not able to successfully maintain or enhance consumer awareness of the Napster brand or, even if we are successful in our branding efforts, if we are unable to maintain or enhance customer awareness of the Napster brand in a cost effective manner, our business, operating results and financial condition would be harmed |
| We face significant competition from traditional retail music distributors, from emerging paid online music services delivered electronically such as ours, and from “free” peer-to-peer services |
| These retailers may include regional and national mall-based music chains, international chains, deep-discount retailers, mass merchandisers, consumer electronics outlets, mail order, record clubs, independent operators and online physical retail music distributors, some of which have greater financial and other resources than we do |
| To the extent that consumers choose to purchase media in non-electronic formats, it may reduce our sales, reduce our gross margins, increase our operating expenses and decrease our profit margins in specific markets |
| Our digital music distribution services competitors currently include Apple Computer’s iTunes Music Store, AOL Music Now, RealNetworks, Inc, the provider of the Rhapsody service, MTV’s Urge, Sony Connect, Walmart |
| com, FYE, Microsoft’s MSN Music service and online music services powered by MusicNet such as Yahoo! |
| Other potential competitors such as Amazon |
| com have announced their intention to provide competing music distribution services |
| Internationally we currently compete with OD2, Puretracks, Music Store and Vodafone’s music offerings, as well as with a number of the other competitors described above |
| Our digital music distribution business also faces significant competition from “free” peer-to-peer services, such as KaZaA, Morpheus, Grokster and a variety of similar services that allow computer users to connect with each other and to copy many types of program files, including music and other media, from one another’s hard drives, all without securing licenses from content providers |
| While the US Supreme Court has recently found that Grokster may violate copyright laws, the court did not establish that such services are necessarily liable for copyright infringement, opting instead for a fact-based analysis of the services’ efforts to promote copyright infringement |
| Additionally, enforcement efforts against those in violation have not effectively shut down these services, and there can be no assurance that these services will ever be shut down |
| The ongoing presence of these “free” services substantially impairs the marketability of legitimate services, regardless of the ultimate resolution of their legal status |
| Our advertising-supported music website competes, directly and indirectly, for advertisers, viewers, members, and content providers with publishers and distributors of traditional off-line media, such as television, radio and print, including those targeted to music, many of which have established or may establish websites, such as MTV We also face intense competition from general purpose consumer online services such as Yahoo, MSN and Google, each of which provides access to music-related content and services and from websites targeted to music related content, such as Yahoo and myspace |
| Finally, we compete directly for content and for users of our advertising-supported website from community-generated information websites that include music-related content, such as Wikipedia |
| Many of our competitors have significantly more resources than we do, and some of our competitors may be able to leverage their experience in providing digital music distribution services or similar services to their customers in other businesses |
| We or our competitors may be able to secure limited exclusive rights to content from time to time |
| If our competitors secure significant exclusive content, it could harm the ability of our online music services to compete effectively in the marketplace |
| 9 ______________________________________________________________________ [40]Table of Contents In particular, some of these competitors offer other goods and services and may be willing and able to offer music services at a lower price than we can in order to promote the sale of these goods and services |
| If we lower our prices, our gross margins and operating results will be adversely affected |
| If we do not lower our prices, we may be unable to compete with discount services |
| This could harm the ability of our online music services to compete effectively in the marketplace |
| Digital music distribution services in general are new and rapidly evolving and may not prove to be a profitable or even viable business model |
| Digital music distribution services are a relatively new business model for delivering digital media over the Internet |
| It is too early to predict whether consumers will accept, in significant numbers, digital music services and accordingly whether the services will be financially viable |
| If digital music distribution services do not prove to be popular with consumers, or if these services cannot sustain any such popularity, our business and prospects would be harmed |
| We rely on content provided by third parties, which may not be available to us on commercially reasonable terms or at all |
| We rely on third-party content providers, including music publishers and music labels, to offer online music content that can be delivered to users of our digital music distribution services |
| Rights to provide this content to our customers, particularly publishing rights, are difficult to obtain and require significant time and expense |
| In order to provide a compelling service, we must be able to continue to license a wide variety of music content to our customers with attractive usage rights such as CD recording, output to MP3 players, portable subscription rights and other rights |
| In addition, if we do not have sufficient breadth and depth of the titles necessary to satisfy increased demand arising from growth in our subscriber base, our subscriber satisfaction will be affected adversely |
| Under copyright law we are required to pay licensing fees for compositions embodied in digital sound recordings and for the sound recordings themselves that we deliver in our Napster service |
| Copyright law generally does not specify the rate and terms of the licenses, which are determined by voluntary negotiations among the parties or, for certain compulsory publishing licenses where voluntary negotiations are unsuccessful, by a copyright royalty board (“CRB”), an administrative judicial proceeding supervised by the United States Copyright Office |
| Past copyright proceedings have resulted in proposed rates for statutory webcasting that were significantly in excess of rates requested by webcasters |
| We cannot predict the outcome of any negotiations or CRB proceedings |
| We may also elect to attempt to directly license compositions for our services, either alone or in concert with other affected companies |
| Such licenses may only apply to music performed in the United States |
| The availability of licenses for compositions used in certain international versions of the services is unclear |
| Therefore, our ability to negotiate appropriate licenses is uncertain |
| Voluntarily negotiated rates for mechanical licenses with respect to streaming and conditional digital downloads with the Harry Fox Agency and National Music Publishers Association have not been agreed to, and we are currently operating under a standstill agreement until such rates are negotiated |
| No final agreement has been reached with performing rights societies such as ASCAP or BMI regarding whether digital downloads constitute public performances of copyrighted works that would trigger payment of public performance royalties |
| In addition to certain other negotiations, European Union and Canadian tribunals are in process, which will set rates for subscription music services and services that deliver digital downloads of music, and the outcome of these negotiations and proceedings will also likely affect our business in ways that we cannot predict |
| Napster accrues for the cost of these fees, based on contracted or statutory rates, when established, or management’s best estimates based on facts and circumstances regarding the specific music services and agreements in similar geographies or with similar agencies |
| If the final agreed rates differ significantly from management’s estimate, the actual amount paid and expensed could differ materially from the recorded amounts |
| 10 ______________________________________________________________________ [41]Table of Contents Our success depends on our digital music distribution service’s interoperability with our customer’s music playback hardware |
| In order for the paid Napster service to be successful, we must design our service to interoperate effectively with a variety of hardware products, including home stereos, car stereos, portable MP3 players, cell phones, PCs and other mobile devices |
| We depend on significant cooperation with manufacturers of these products and with software manufacturers that create the operating systems for such hardware devices to achieve our design objectives and to offer a service that is attractive to our customers |
| Currently, there are a limited number of devices that offer the portable subscription functionality that is required to support our Napster To Go service |
| Our software is not compatible with the iPod music player, the current equipment market leader |
| If we cannot successfully design our service to interoperate with the music playback devices that our customers own, our business will be harmed |
| We may not successfully develop new products and services |
| The success of our digital music distribution services will depend on our ability to develop leading-edge media and digital distribution products and services |
| Our business and operating results will be harmed if we fail to develop products and services that achieve widespread market acceptance or that fail to generate significant revenues or gross profits to offset our development and operating costs |
| We may not timely and successfully identify, develop and market new product and service opportunities |
| We may not be able to add new content such as video, spoken word or other content as quickly or as efficiently as our competitors or at all |
| If we introduce new products and services, they may not attain broad market acceptance or contribute meaningfully to our revenues or profitability |
| Competitive or technological developments may require us to make substantial, unanticipated investments in new products and technologies, and we may not have sufficient resources to make these investments |
| Delays and cost overruns could affect our ability to respond to technological changes, evolving industry standards, competitive developments or customer requirements |
| Our products also may contain undetected errors that could cause increased development costs, loss of revenues, adverse publicity, reduced market acceptance of our products or services or lawsuits by customers |
| We must maintain and add to our strategic marketing relationships in order to be successful |
| We depend on a number of strategic relationships with third parties to co-market our services |
| We have entered into co-marketing agreements with infrastructure providers, retailers and other companies to broaden the distribution of our brand and our services |
| There is no guarantee that we will be able to renew existing agreements or enter into new agreements on acceptable terms, or at all |
| If we cannot maintain existing strategic relationships or enter into new relationships, our ability to market our services will be harmed |
| In addition, because of the rapidly evolving nature of digital music distribution and our short history of operations, we often enter into strategic agreements where the financial impact on our business and operations is uncertain |
| We cannot guarantee that any of these agreements will result in the desired benefits to our business or result in significant additional revenue |
| 11 ______________________________________________________________________ [42]Table of Contents Our network is subject to security and stability risks that could harm our business and reputation and expose us to litigation or liability |
| Online commerce and communications depend on the ability to transmit confidential information and licensed intellectual property securely over private and public networks |
| Any compromise of our ability to transmit such information and data securely or reliably, and any costs associated with preventing or eliminating such problems, could harm our business |
| Online transmissions are subject to a number of security and stability risks, including: • our own or licensed encryption and authentication technology, and access and security procedures, may be compromised, breached or otherwise be insufficient to ensure the security of customer information or our music content; • we could experience unauthorized access, computer viruses, system interference or destruction, “denial of service” attacks and other disruptive problems, whether intentional or accidental, that may inhibit or prevent access to our web sites or use of our products and services; • someone could circumvent our security measures and misappropriate our, our partners’ or our customers’ intellectual property or interrupt operations, or jeopardize our licensing arrangements, which are contingent on our sustaining appropriate security protections; • our computer systems could fail and lead to service interruptions; • we may be unable to scale our infrastructure with increases in customer demand; or • our network of facilities may be affected by a natural disaster, terrorist attack or other catastrophic events |
| The occurrence of any of these or similar events could damage our business, hurt our ability to distribute products and services and collect revenue, threaten the proprietary or confidential nature of our technology, harm our reputation and expose us to litigation or liability |
| We may be required to expend significant capital or other resources to protect against the threat of security breaches, hacker attacks or system malfunctions or to alleviate problems caused by such breaches, attacks or failures |
| We depend on key personnel who may not continue to work for us |
| Our success substantially depends on the continued employment of certain executive officers and key employees, including, in particular, Christopher Gorog, our Chief Executive Officer |
| The loss of the services of these key officers and employees could harm our business |
| If any of these individuals were to leave our company, we could face substantial difficulty in hiring qualified successors and could experience a loss in productivity while any such successor obtains the necessary training and experience |
| If we fail to manage expansion effectively, we may not be able to successfully manage our business, which could cause us to fail to meet our customer demand or to attract new customers, which would adversely affect our revenue |
| Our ability to successfully offer our products and services and implement our business plan in a rapidly evolving market requires an effective planning and management process |
| We plan to continue to increase the scope of our digital music distribution operations domestically and internationally |
| In addition, we plan to continue to hire a significant number of employees in the next twelve months for the development of new products and services |
| This anticipated growth in future operations will place a significant strain on our management resources |
| In addition, we plan to continue to expand, train and manage our work force worldwide |
| 12 ______________________________________________________________________ [43]Table of Contents A significant portion of the revenues from our paid Napster service is derived from international revenues |
| Economic, political, regulatory and other risks associated with international revenues and operations could have an adverse effect on our revenues |
| Because we operate worldwide, our business is subject to risks associated with doing business internationally |
| International net revenues did not account for a significant percentage of our net revenues prior to the sale of our consumer software division; however, revenues from international operations have represented a significant portion of our total net revenues from our digital music distribution business |
| We anticipate that revenues from international operations will continue to represent a substantial portion of our total net revenues as we expand our Napster service abroad and enter into joint venture arrangements with international partners such as Tower Records Japan, Inc |
| Accordingly, our future revenues could decrease based on a variety of factors, including: • disputes with joint venture partners; • mismanagement or fraud by joint venture partners; • changes in foreign currency exchange rates; • seasonal fluctuations in sales of our prepaid cards as well as other products and services; • changes in a specific country’s or region’s political or economic condition, particularly in emerging markets; • unexpected changes in foreign laws and regulatory requirements; • difficulty of effective enforcement of contractual provisions in local jurisdictions; • trade protection measures and import or export licensing requirements; • potentially adverse tax consequences including changes to the VAT collection scheme; • difficulty in managing widespread sales operations; and • less effective protection of intellectual property |
| To grow our business, we must be able to hire and retain sufficient qualified technical, sales, marketing and administrative personnel |
| Our future success depends in part on our ability to attract and retain engineering, sales, marketing, finance and customer support personnel |
| We cannot assure you that we will be able to hire and retain a sufficient number of qualified personnel to meet our business objectives |
| 13 ______________________________________________________________________ [44]Table of Contents We may be unable to adequately protect our proprietary rights |
| Our inability to protect our proprietary rights, and the costs of failing to do so, could harm our business |
| Our success and ability to compete partly depend on the superiority, uniqueness or value of our technology, including both internally developed technology and technology licensed from third parties |
| To protect our proprietary rights, we rely on a combination of patent, trademark, copyright and trade secret laws, confidentiality agreements with our employees and third parties, and protective contractual provisions |
| These efforts to protect our intellectual property rights may not be effective in preventing misappropriation of our technology |
| These efforts also may not prevent the development and design by others of products or technologies similar to, competitive with or superior to those we develop |
| Any of these results could reduce the value of our intellectual property |
| We may be forced to litigate to enforce or defend our intellectual property rights and to protect our trade secrets |
| Any such litigation could be very costly and could distract our management from focusing on operating our business |
| We may be subject to intellectual property infringement claims, such as those claimed by SightSound Technologies, which are costly to defend and could limit our ability to use certain technologies in the future |
| Many parties are actively developing streaming media and digital distribution-related technologies, e-commerce and other Web-related technologies, as well as a variety of online business methods and models |
| We believe that these parties will continue to take steps to protect these technologies, including, but not limited to, seeking patent protection |
| As a result, disputes regarding the ownership of these technologies and rights associated with streaming media, digital distribution and online businesses are likely to arise in the future and may be very costly |
| In addition to existing patents and intellectual property rights, we anticipate that additional third-party patents related to our products and services will be issued in the future |
| We may not be able to obtain such a license on acceptable terms, if at all, or design around the patent, which could harm our business |
| Companies in the technology and content-related industries have frequently resorted to litigation regarding intellectual property rights |
| We may be forced to litigate to determine the validity and scope of other parties’ proprietary rights |
| Any such litigation could be very costly and could distract our management from focusing on operating our business |
| In addition, we believe these industries are experiencing an increased level of litigation to determine the applicability of current laws to, and the impact of new technologies on, the use and distribution of content over the Internet and through new devices, especially in the music industry |
| As we develop products and services that provide or enable the provision of content, in such ways, our litigation risk may increase |
| The existence and/or outcome of such litigation could harm our business |
| 14 ______________________________________________________________________ [45]Table of Contents From time to time we receive claims and inquiries from third parties alleging that our internally developed technology, or technology we license from third parties, may infringe the other third parties’ proprietary rights, especially patents |
| Third parties have also asserted and most likely will continue to assert claims against us alleging infringement of copyrights, trademark rights, or other proprietary rights, or alleging unfair competition or violations of privacy rights |
| We could be required to spend significant amounts of time and money to defend ourselves against such claims |
| If any of these claims were to prevail, we could be forced to pay damages, comply with injunctions, or stop distributing our products and services while we re-engineer them or seek licenses to necessary technology, which might not be available on reasonable terms, or at all |
| We could also be subject to claims for indemnification resulting from infringement claims made against our customers and strategic partners, which could increase our defense costs and potential damages |
| We may be subject to legal liability for online services |
| Our free music service allows individuals and businesses to post content, advertise products and services, conduct business and engage in various online activities on an international basis |
| The law relating to the liability of providers of these online services for activities of their users is currently unsettled both within the United States and internationally |
| Claims have been threatened and have been brought against similar website owners for defamation, negligence, copyright or trademark infringement, unlawful activity, tort, including personal injury, fraud, or other theories based on the nature and content of information that such websites provide links to or that may be posted online or generated by users |
| We may be subject to similar actions in domestic or other international jurisdictions in the future |
| Although we generally will obtain representations as to the origin and ownership of content licensed from third parties and generally will obtain indemnification from these third parties to cover a breach of any such representation, we may not receive representations or indemnification that are sufficient to cover all liability relating to the third-party content |
| Our defense of any such actions could be costly and involve significant time and attention of our management and other resources |
| A decline in current levels of consumer spending could reduce our sales |
| Our business is directly affected by the level of consumer spending |
| Lower levels of consumer spending in regions in which we have significant operations could have a negative impact on our business, financial condition or results of operations |
| We depend on software from third parties to deliver and to track and measure the delivery of advertisements and it could be difficult to replace these services |
| It is important to our future success that we are able to effectively deliver our advertisers’ advertisements and it is important to our advertisers that we accurately measure the delivery of such advertisements on our websites |
| We depend on third-party software to provide these measurement and delivery services |
| If these third parties are unable to provide these services in the future, we would be required to perform them ourselves or obtain them from other providers |
| This could cause us to incur additional costs or cause interruptions in our business during the time we are replacing these services |
| Companies may not advertise on our websites or may pay less for advertising if they do not perceive our measurements or measurements made by third parties to be reliable |
| 15 ______________________________________________________________________ [46]Table of Contents We may need additional capital, and we cannot be sure that additional financing will be available |
| Although we currently anticipate that our available funds and expected cash flows from operations will be sufficient to meet our cash needs for at least the next twelve months, we may require additional financing |
| Our ability to obtain financing will depend, among other things, on our development efforts, business plans, operating performance and condition of the capital markets at the time we seek financing |
| We expect to experience operating losses from the digital music distribution business in at least the short-term |
| We cannot assure you that additional financing will be available to us on favorable terms when required, or at all |
| If we raise additional funds through the issuance of equity, equity-linked or debt securities, those securities may have rights, preferences or privileges senior to the rights of our common stock, and our stockholders may experience dilution |
| Changes in stock option accounting rules may adversely impact our reported operating results prepared in accordance with generally accepted accounting principles, our stock price and our competitiveness in the employee marketplace |
| Technology companies like ours have a history of using broad-based employee stock option programs to hire, provide incentives to and retain our workforce in a competitive marketplace |
| We have elected to apply Accounting Principles Board (“APB”) Opinion Nodtta 25, “Accounting for Stock Issued to Employees” (“APB Nodtta 25”), to account for stock options |
| Accordingly we generally have not recognized any expense with respect to employee stock options as long as such options are granted at exercise prices equal to the fair value of our common stock on the date of grant |
| On December 16, 2004, the Financial Accounting Standards Board (“FASB”) adopted Statement of Financial Accounting Standards (“SFAS”) Nodtta 123(R), “Share-Based Payment” (“SFAS Nodtta 123(R)”), which revises the previously effective SFAS Nodtta 123, “Accounting for Stock-Based Compensation”, and supersedes APB Nodtta 25 |
| This statement addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for either equity instruments of the enterprise or liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments |
| The statement eliminates the ability to account for share-based compensation transactions using APB Nodtta 25 and generally requires that such transactions be accounted for using a fair-value-based method and recognized as expenses in our consolidated statements of operations |
| The effective date of the standard for public companies is for the first annual reporting periods beginning after June 15, 2005 |
| We will adopt SFAS Nodtta 123(R) effective April 1, 2006 and expect it to have an adverse impact on our consolidated statements of operations and net income (loss) per share |
| 16 ______________________________________________________________________ [47]Table of Contents We are subject to risks associated with governmental regulation and legal uncertainties |
| Few existing laws or regulations specifically apply to the Internet, other than laws and regulations generally applicable to businesses |
| Certain United States export controls and import controls of other countries, including controls on the use of encryption technologies, may apply to our products |
| Many laws and regulations, however, are pending and may be adopted in the United States, individual states, and local jurisdictions and other countries with respect to the Internet |
| These laws may relate to many areas that impact our business, including content issues (such as obscenity, indecency and defamation), copyright and other intellectual property rights, digital rights management, encryption, caching of content by server products, personal privacy, taxation, e-mail, sweepstakes, promotions, prepaid card expiration, escheatment, network and information security and the convergence of traditional communication services with Internet communications, including the future availability of broadband transmission capability and wireless networks |
| These types of regulations are likely to differ between countries and other political and geographic divisions |
| Other countries and political organizations are likely to impose or favor more and/or different regulations than that which has been proposed in the United States, thus furthering the complexity of regulation |
| In addition, state and local governments may impose regulations in addition to, inconsistent with, or stricter than federal regulations |
| The adoption of such laws or regulations, and uncertainties associated with their validity, interpretation, applicability and enforcement, may affect the available distribution channels for and costs associated with our products and services and may affect the growth of the Internet |
| Such laws or regulations may harm our business |
| Our products and services may also become subject to investigation and regulation of foreign data protection and e-commerce authorities, including those in the European Union |
| Such activities could result in additional product and distribution costs for us in order to comply with such regulations |
| We do not know for certain how existing laws governing issues such as property ownership, copyright and other intellectual property issues, digital rights management, taxation, gambling, security, illegal or obscene content, retransmission of media, personal privacy and data protection apply to the Internet |
| The vast majority of such laws were adopted before the advent of the Internet and related technologies and do not address the unique issues associated with the Internet and related technologies |
| Most of the laws that relate to the Internet have not yet been interpreted |
| In addition to potential legislation from local, state and federal governments, labor guild agreements and other laws and regulations that impose fees, royalties or unanticipated payments regarding the distribution of media over the Internet may directly or indirectly affect our business |
| While we and our customers may be directly affected by such agreements, we are not a party to such agreements and have little ability to influence the degree such agreements favor or disfavor Internet distribution or our business models |
| Changes to or the interpretation of these laws and the entry into such industry agreements could: • limit the growth of the Internet; • create uncertainty in the marketplace that could reduce demand for our products and services; • increase our cost of doing business; • expose us to increased litigation risk, substantial defense costs and significant liabilities associated with content available on our web sites or distributed or accessed through our products or services, with our provision of products and services and with the features or performance of our products and web sites; • lead to increased product development costs or otherwise harm our business; or • decrease the rate of growth of our user base and limit our ability to effectively communicate with and market to our user base |
| 17 ______________________________________________________________________ [48]Table of Contents The Child Online Protection Act and the Child Online Privacy Protection Act impose civil and criminal penalties on persons distributing material harmful to minors (eg, obscene material) over the Internet to persons under the age of 17, or collecting personal information from children under the age of 13 |
| We do not knowingly distribute harmful materials to minors or collect personal information from children under the age of 13 |
| The manner in which these Acts may be interpreted and enforced cannot be fully determined, and future legislation similar to these Acts could subject us to potential liability if we were deemed to be non-compliant with such rules and regulations, which in turn could harm our business |
| There are a large number of legislative proposals before the United States Congress and various state legislatures regarding intellectual property, digital rights management, copy protection requirements, privacy, email marketing and security issues related to our business |
| Furthermore, as part of our regular business activities now, and in the past, we engage in the issuance of gift cards redeemable for our services |
| It is possible that money received by us for the sale of gift cards could be subject to state and federal escheat, or unclaimed property, laws in the future |
| If this were the case, our business could be adversely impacted |
| It is not possible to predict whether or when such legislation may be adopted, and certain proposals, if adopted, could materially and adversely affect our business through a decrease in user registration and revenue, and influence how and whether we can communicate with our customers |
| We may need to make additional future acquisitions to remain competitive |
| The process of identifying, acquiring and integrating future acquisitions may constrain valuable management resources, and our failure to effectively integrate future acquisitions may result in the loss of key employees and the dilution of stockholder value and have an adverse effect on our operating results |
| We have completed several acquisitions and may continue to pursue strategic acquisitions in the future |
| Completing any potential future acquisitions could cause significant diversions of management time and resources |
| Financing for future acquisitions may not be available on favorable terms, or at all |
| If we identify an appropriate acquisition candidate, we may not be able to negotiate the terms of the acquisition successfully, finance the acquisition or integrate the acquired business, products, technologies or employees into our existing business and operations |
| Future acquisitions may not be well-received by the investment community, which may cause our stock price to fall |
| We have not entered into any agreements or understandings regarding any future acquisitions and cannot ensure that we will be able to identify or complete any acquisition in the future |
| If we acquire businesses, new products or technologies in the future, we may be required to amortize significant amounts of identifiable intangible assets, and we may record significant amounts of goodwill that will be subject to annual testing for impairment |
| If we consummate one or more significant future acquisitions in which the consideration consists of stock or other securities, our existing stockholders’ ownership could be significantly diluted |
| If we were to proceed with one or more significant future acquisitions in which the consideration included cash, we could be required to use a substantial portion of our available cash |
| 18 ______________________________________________________________________ [49]Table of Contents We may be subject to market risk and legal liability in connection with the data collection capabilities of our products and services |
| Many of our products are interactive Internet applications which by their very nature require communication between a client and server to operate |
| To provide better consumer experiences and to operate effectively, our products send information to servers |
| Many of the services we provide also require that a user provide certain information to us |
| We post an extensive privacy policy concerning the collection, use and disclosure of user data involved in interactions between our client and server products |
| Any failure by us to comply with our posted privacy policy and existing or new legislation regarding privacy issues could impact the market for our products and services, subject us to litigation and harm our business |
| If, in the future, we conclude that our internal control over financial reporting is not adequate, or if our auditors conclude that our evaluation of internal controls over financial reporting is not adequate, investors could lose confidence in the reliability of our financial statements, which could result in a decrease in the value of our common stock |
| As directed by Section 404 of the Sarbanes-Oxley Act of 2002, the Securities and Exchange Commission (“SEC”) adopted rules requiring public companies to include a report of management on the company’s internal control over financial reporting in their annual reports on Form 10-K This report is required to contain an assessment by management of the effectiveness of such company’s internal control over financial reporting |
| In addition, the independent registered public accounting firm auditing a public company’s financial statements must attest to and report on management’s assessment of the effectiveness of the company’s internal control over financial reporting |
| There is a risk that in the future we may identify internal control deficiencies that suggest that our controls are no longer effective |
| This could result in an adverse reaction in the financial markets due to a loss of confidence in the reliability of our financial statements, which could cause the market price of our common stock to decline and make it more difficult for us to finance its operations |
| The effectiveness of our disclosure and internal controls may be limited |
| Our disclosure controls and procedures and internal control over financial reporting may not prevent all errors and misrepresentations |
| In the event that there are errors or misrepresentations in our historical financial statements or the SEC disagrees with our accounting, we may need to restate our financial statements |
| For example, in November 2004 we restated our financial statements in order to correct the valuation of a previously issued warrant and to adjust the purchase accounting of our former subsidiary, MGI Software, and in May 2005 we restated our financial statements to reallocate the tax benefit of certain operating losses from our discontinued operation to our continuing operations |
| Any system of internal controls can only provide reasonable assurance that all control objectives are met |
| Some of the potential risks involved could include but are not limited to management judgments, simple errors or mistakes, willful misconduct regarding controls or misinterpretation |
| There is no guarantee that existing controls will prevent or detect all material issues or be effective in future conditions, which could materially and adversely impact our financial results in the future |
| We hold cash in foreign subsidiaries, which we may repatriate to the United States, and which may result in income taxes that could negatively impact our results of operations and financial position |
| We are in the process of completing a corporate restructuring to close the overseas operations of certain dormant subsidiaries of our former consumer software division |
| We may repatriate our cash from these foreign subsidiaries to the United States |
| We may incur additional income taxes from the repatriation, which could negatively affect our results of operations and financial position |
| 19 ______________________________________________________________________ [50]Table of Contents The asset purchase agreement with Sonic Solutions exposes us to contingent liabilities |
| Under the asset purchase agreement with Sonic Solutions, we have retained various liabilities relating to the consumer software division and have agreed to indemnify Sonic Solutions under certain circumstances, such as if we breach our representations and warranties contained in the asset purchase agreement and for other matters, including all liabilities retained by us under that agreement |
| For example, an indemnification claim by Sonic Solutions might result if we breach or default on any of our representations about the assets comprising our consumer software division |
| Under the terms of the asset purchase agreement, if claims are made by Sonic Solutions, we may be required to expend significant cash resources in defense and settlement of such claims, which may adversely affect our business, results of operations and financial condition |
| Provisions in our agreements, charter documents, stockholder rights plan and Delaware law may delay or prevent acquisition of us, which could decrease the value of our stock |
| Our certificate of incorporation and bylaws and Delaware law contain provisions that could make it more difficult for a third party to acquire us without the consent of our board of directors |
| These provisions include a classified board of directors and limitations on actions by our stockholders by written consent |
| In addition, our board of directors has the right to issue preferred stock without stockholder approval, which could be used to dilute the stock ownership of a potential hostile acquirer |
| Delaware law also imposes some restrictions on mergers and other business combinations between us and any holder of 15prca or more of our outstanding common stock |
| In addition, we have adopted a stockholder rights plan that makes it more difficult for a third party to acquire us without the approval of our board of directors |
| Although we believe these provisions provide for an opportunity to receive a higher bid by requiring potential acquirers to negotiate with our board of directors, these provisions apply even if the offer may be considered beneficial by some stockholders |