ITEM 1.
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Legal Proceedings.
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United States Attorney and SEC Inquiries
On June 26, 2006, we received a grand jury document subpoena from the U.S. Attorney for the Northern District of California requesting records
pertaining to the granting of stock options. We produced documents to the U.S. Attorneys Office in late 2006, and the U.S. Attorneys Office has not requested any further documents from us since that time.
In May 2006, we received notice that the Securities and Exchange Commission (SEC) was conducting an informal inquiry into CNET Networks stock option
grants. In May 2007, we learned that the SEC had issued a formal order of investigation and served subpoenas on certain of our former officers and directors in connection with its inquiry. On September 4, 2007, we received notice that the
SECs investigation had been terminated and no enforcement action had been recommended.
Class Action Suits
Two shareholder class action lawsuits were filed in the United States District Court for the Southern District of New York on August 16, 2001 and September 26,
2001. A Consolidated Amended Complaint, which is not the operative complaint, was filed on April 19, 2002. The complaint names as defendants Eric Hippeau, Timothy OBrien, and investment banks that were the underwriters of the public
offering of ZDNet series of Ziff-Davis stock (the ZDNet Offering), and CNET Networks as successor in
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liability to Ziff-Davis. The claims under the Securities Exchange Act were later dismissed, as were the claims against the individuals. The complaint alleges
the receipt of excessive and undisclosed commissions by the underwriters in connection with the allocation of shares of common stock to certain investors in the ZDNet Offering and agreements by those investors to make additional purchases of stock
in the aftermarket at pre-determined prices. Plaintiffs allege that the prospectus for the ZDNet Offering was false and misleading and in violation of the securities laws because it did not disclose the arrangements. For more details on this matter,
please see the Companys Annual Report on Form 10-K for the year ended December 31, 2006. Since the filing of the Companys Annual Report on Form 10-K for the year ended December 31, 2006, the Second Circuit vacated the district
courts order granting class certification in six of the approximately 300 nearly identical actions that are part of the consolidated litigation. These six cases are the class certification focus cases, which were selected by
plaintiffs and do not include CNET Networks. The focus cases are intended to serve as test cases. The Second Circuit rejected the plaintiffs petition for rehearing, but noted that plaintiffs could ask the district court to certify a more
narrow class than the one that was rejected. Prior to the Second Circuit opinion, Plaintiffs, Ziff-Davis, CNET Networks and other issuer defendants sued in similar cases had submitted a settlement agreement to the district court for
approval. In light of the Second Circuit opinion, the parties agreed that the settlement agreement could no longer be approved, because the defined settlement class, like the litigation class, cannot be certified. On June 25,
2007, the Court approved a stipulation filed by the plaintiffs and the issuers terminating the proposed settlement. On August 14, 2007, the plaintiffs filed amended complaints in the six focus cases. The amended complaints include a number of
changes, such as changes to the definition of the purported class of investors. On September 27, 2007, the plaintiffs filed a motion for class certification in the six focus cases. If plaintiffs are successful in obtaining class certification,
they are expected to amend the complaint against the focus case issuers and to seek certification of a class in the CNET Networks case. Due to the inherent uncertainties of litigation, we cannot accurately predict the ultimate outcome of the matter
or predict whether we will be able to renegotiate a settlement that complies with the Second Circuits mandate. We cannot predict the impact of this litigation on our business, financial condition, results of operations or cash flows.
Shareholder Derivative Suits
CNET Networks is named
as a nominal defendant in two sets of consolidated derivative actions, one pending in the United States District Court for the Northern District of California (In re CNET Networks, Inc. Shareholder Derivative Litigation) and one pending in San
Francisco County Superior Court (In re CNET Networks, Inc. Derivative Shareholder Litigation). In each case, the plaintiffs have alleged that certain of our current and former officers and directors caused the company to backdate employee stock
option grants. The complaints, which purport to have been brought on CNET Networks behalf, seek to recover unspecified damages, for the companys benefit, from the individual defendants. The complaints do not seek any monetary relief
against CNET Networks, although they seek an award of attorneys fees and costs.
The first federal court case was filed on June 19, 2006, and
consolidated amended complaints were filed on November 9, 2006 and February 12, 2007. On April 11, 2007, the United States District Court for the Northern District of California dismissed the federal court complaint. On April 30,
2007, the court granted the federal court plaintiffs leave to amend but stayed the case pending a books and records inspection. On June 14, 2007, one of the federal court plaintiffs, together with another purported shareholder, filed a
complaint in the Delaware Court of Chancery seeking an order permitting them to inspect various CNET Networks books and records. The Delaware case is scheduled for trial in November 2007.
The first state court case was filed on May 31, 2006, and consolidated amended complaints were filed on August 11, 2006 and November 16, 2006. On
January 3, 2007, the Superior Court denied our motion to stay the state court cases, without prejudice, but extended until further notice our time to respond to the complaint and ordered that no discovery may take place pending further order of
the court. The state court plaintiffs have filed a motion to compel us to produce to them any documents produced to the federal court plaintiffs in connection with the Delaware books and records proceeding.
We cannot predict the impact of this litigation on our business, financial condition, results of operations or cash flows. Except as disclosed above, there have been no
material developments in the legal proceedings disclosed in our Annual Report on Form 10-K for the year ended December 31, 2006.
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SPECIAL NOTE REGARDING FORWARD-LOOKING
STATEMENTS AND RISK FACTORS
This Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are any statements other than statements of historical fact. Examples of forward-looking statements include
projections of earnings, revenues or other financial items, statements of the plans and objectives of management for future operations, and statements concerning proposed new products and services, and any statements of assumptions underlying any of
the foregoing. In some cases, you can identify forward-looking statements by the use of words such as may, will, expects, should, believes, plans, anticipates,
estimates, predicts, potential, or continue, and any other words of similar meaning.
Any or all of our
forward-looking statements in this report and in any other public statements we make may turn out to be wrong and may cause our actual results to differ materially from forecasted or historical results. They can be affected by inaccurate assumptions
we might make or by known or unknown risks and uncertainties, including those outlined below. Consequently, no forward-looking statement can be guaranteed. We undertake no obligation to publicly update any forward-looking statements, whether as a
result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make on related subjects in our reports to the Securities and Exchange Commission. Also note that we provide cautionary discussion
of risks, uncertainties and possibly inaccurate assumptions relevant to our businesses. These are factors that we think could cause our actual results to differ materially from expected and historical results. Other factors besides those listed here
could also adversely affect us. This discussion is provided as permitted by the Private Securities Litigation Reform Act of 1995.
You should carefully
consider the risks described below before making an investment decision regarding CNET Networks securities. Our business, financial condition or results of operations could be materially adversely affected by any of these risks. The trading price of
our common stock could decline due to any of these risks. The risks described below are not the only ones we face. Additional risks not presently known to us or that we currently deem immaterial may also impair our business operations.
Our revenues might not grow, and they might decrease.
Several factors, many of which are outside of our control, contribute to our revenue growth. Some scenarios that might impede our revenue growth in the future include:
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our failure to maintain existing customers and to attract new marketing customers due to competition from other media outlets, dissatisfaction with our services or
reduced advertising budgets;
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our loss of advertising and other marketing opportunities to competitors, especially as other media companies increase their online presence in areas where we
focus;
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our inability to attract advertisers and users for our newer websites;
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our loss of revenue related to any sale or closure of an existing business;
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our inability to respond to ad-blocking technology might decrease the effectiveness of online advertising;
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our failure to attract and retain users to our websites where advertising inventory is purchased;
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weakness in corporate and consumer spending in the markets in which we operate, including in the United States, the United Kingdom, China, France and Australia, may
lead to a decline in advertising, which is the primary source of our revenues;
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a decline in general economic conditions, which could occur as a result of currency fluctuations, rising interest rates, or other factors;
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disruption of our operations due to technical difficulties, system downtime, Internet brownouts or denial of service or other similar attacks; and
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disruption to our operations, employees, partners, customers and facilities caused by natural disasters, international or domestic terrorist attacks or armed
conflict.
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We may not be able to achieve our targeted profit measures and accordingly we may fail to make expected improvements in
our overall profit measures.
We have identified various profit measures as a useful way to evaluate operating performance. We may fail to achieve
our profit measure targets. Some of the factors that could cause us not to achieve these targets include:
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greater than expected expenses due to a decision to invest in new products, services or websites;
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acquisitions of businesses that cannot immediately achieve these profit measures;
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greater than expected compensation expenses due to competition for qualified employees;
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a failure to achieve projected revenues growth;
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a failure to manage the costs associated with innovation and growth; or
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an inability to achieve or to execute on an effective sales strategy.
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Competition is intense and we might not compete successfully.
The media industry is intensely competitive and
rapidly evolving. We compete for advertisers, users and business partners with numerous companies throughout the world and expect the market to become increasingly competitive as Internet usage and marketing continues to grow in acceptance. We
compete with diversified media companies that provide both online and offline content, including magazines, cable television, network television, radio and newspapers. In addition, as diversified media companies continue to introduce and acquire
more interactive media offerings, we will increasingly compete with them for consumers and advertisers.
Our brands also compete with sites focused on the
same vertical markets on which we focus. For example, our gaming properties compete with other gaming sites such as IGN Entertainment, and our business properties compete with smaller, niche sites such as TechTarget. As Internet media consumption
and advertising continues to gain share, we compete with a variety of online properties for users and marketers, including the following: general purpose portals like AOL, MSN and Yahoo!, especially as these properties expand their content offering
in our areas of expertise; search engines like Google, Yahoo! and MSN; online comparison shopping and retail properties, including Shopping.com, Amazon.com and eBay; social networking and community properties such as MySpace and Facebook; and
emerging platforms such as blogs, podcasts and video properties. We expect competition for advertisers and users to remain or become more intense and we may not be able to compete successfully in the market.
Our advertising and other operating revenues may be subject to fluctuations, which could have a material adverse effect on our business, operating results and
financial condition.
We believe that advertising spending on the Internet, as in traditional media, fluctuates significantly with economic
conditions. Because a majority of our revenues are derived from advertising, fluctuations in advertising spending generally, or with respect to Internet-based spending specifically, could adversely impact our revenues. In addition, marketing
spending follows seasonal consumer behavior throughout the calendar year to reflect trends during the calendar year, with spending historically weighted towards the fourth quarter. Consistent with industry trends, our revenues in 2006 were weighted
toward the end of the year, with 31% of our revenues being earned in the fourth quarter.
Most of our revenues are derived from short-term contracts
which may not be renewed.
Our revenues are derived in large part from the sale of advertising and we expect that this will continue to be the case
for the foreseeable future. Most of our advertising contracts are short-term and are subject to termination by the customer at any time on thirty-day prior written notice. Advertisers who have longer-term contracts may fail to honor their existing
contracts or fail to renew their contracts. If a significant number of advertisers or a few large advertisers decided not to continue advertising on our websites, we could experience a rapid decline in our revenues over a relatively short period of
time.
We depend on, and receive, a significant percentage of our revenues from a relatively small number of advertisers.
A relatively small number of advertisers contribute a significant percentage of our revenues. Our top one hundred customers in the United States contributed 53% of our
consolidated revenues in the quarter ended September 30, 2007. These customers may not continue to use our services to the same extent, or at all, in the future. A significant reduction in advertising by one or more of our largest customers
could have a material adverse effect on our financial condition and results of operation.
Users may not always accept, or may be drawn away from,
our brands, content and services.
Our future success depends upon the strength of our brands and our ability to deliver original and compelling
content and services that attract and retain users. We will endeavor to continue building existing brands and introducing new brands that resonate with
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their audiences, but we may not be successful. The specialized nature of certain of our sites may limit those sites potential user base. Our content
and services might not be attractive to a sufficient number of users to generate revenues consistent with our estimates. In addition, we might not develop new content or services in a timely or cost-effective manner. If we are not successful in
growing our user base and increasing user interaction on our sites, then our ability to attract the advertisers who seek to market to the demographic represented by our user base may be affected which would in turn impact our revenues. Our ability
to successfully develop and produce content and services is subject to numerous uncertainties, including the ability to:
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anticipate and successfully respond to rapidly changing consumer tastes and preferences;
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fund new program development;
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attract and retain qualified editors, producers, writers, and technical personnel; and
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successfully expand our content offerings into new platform and delivery mechanisms.
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Our business may be impacted by any event that decreases the amount of the time that users spend on our properties, including but not limited to geopolitical events and natural disasters. During these times, our
traffic and revenues may decrease.
We may not innovate and adapt to market opportunities and industry changes at a successful pace.
Our industry is rapidly adopting new technologies, standards and business models to create and satisfy consumer demand and to more effectively
address market opportunities. It is critical that we continue to innovate, anticipate and adapt to these changes to ensure that our content delivery platforms, services and products remain interesting to our users, advertisers and partners. In
addition, we may discover that we must make significant expenditures to achieve this goal and to enable us to be positioned to benefit from market and industry changes. If we fail to accomplish these goals, our business, financial condition and
results of operations may be adversely affected and we may lose users and the advertisers that seek to reach those users.
A significant percentage
of our revenues are derived from activity-based fees generated when our users visit the content of our partners, and we might not be able to attract qualified users for which our partners are willing to pay us activity-based fees.
We earn fees when users search the content of our partners. There are currently many other businesses that offer similar services. In addition,
users may prefer to contact our partners directly rather than return to our sites. If we are unable to continue to attract users to our sites, to maintain the fees we charge our partners for these services or maintain the current or similar terms of
our relationships with our partners, then our business, operating results and financial condition may be adversely affected. Most of our agreements with merchants under which activity-based fees are earned are terminable by either party on ten to
thirty days notice.
Our failure to use third-party technologies or develop and maintain successful relationships with third parties may adversely
impact our traffic.
We depend in part on third parties for Internet traffic to our websites and changes to their operations or our failure to
develop and maintain relationships with them or use their technologies successfully could result in decreased traffic. Any reduction in users on our websites could negatively impact our ability to earn revenues. A significant portion of our users
visit our websites by conducting a search on a search engine, such as Google, MSN or Yahoo!, and following a link displayed in the search results. Changes in the methodologies used by these search engines to display results or our failure to
successfully optimize our sites for search engine ranking could result in our websites receiving less favorable placements, which could reduce the number of users who link to our sites from these search engines. In addition, we rely on the
cooperation of owners and operators of other Internet sites with whom we have syndication and other arrangements to generate traffic for our Internet sites. Our ability to maintain these relationships will continue to be critical to the success of
our Internet operations. If we are unable to develop and maintain satisfactory relationships with such third parties on acceptable commercial terms, or if our competitors are better able to capitalize on these relationships, we could see a reduction
in the numbers of users of our websites, which could adversely impact our revenues.
An inability to attract and retain key personnel could adversely
affect our operations.
Our success depends to a large extent on the continued services of our senior management team and qualified skilled
employees. We depend on our ability to identify, attract, develop, retain and motivate personnel in a competitive job environment. Our inability to attract and retain key executives and other employees or to retain and motivate existing executives
and employees may adversely
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affect our ability to operate our business. We do not maintain key person life insurance policies on any of our officers or other employees. As
the overall industry for interactive content and Internet advertising grows, our employees are increasingly sought after by competitors. In order to remain competitive in the employment market, we may need to increase compensation to retain or
attract qualified employees, which could have an adverse effect our financial condition or operating results. Our inability to attain shareholder approval of equity compensation plans may affect our ability to attract and retain key employees.
The matters relating to the Special Committees and Managements review of our past stock option granting practices and the restatement of
our consolidated financial statements may adversely impact our business.
On May 22, 2006, we announced that our Board of Directors had
appointed a Special Committee comprised of independent directors to conduct, with the assistance of legal counsel and outside accounting experts, an internal investigation relating to past option grants, the timing of such grants and related
accounting matters. The Special Committee reached a preliminary conclusion in July 2006, concluding that the actual measurement dates for certain stock options granted between 1998 and 2001 differed from the recorded measurement dates. Charges
related to the change in these stock option measurement dates were determined to be material and, as a result, on January 29, 2007, we filed restated financial statements for 2005, 2004 and 2003 and the first quarter of 2006.
As a result of our delayed filing of our Quarterly Reports on Form 10-Q for the quarters ended September 30, 2006 and September 30, 2006, we will be ineligible
to register our securities on Form S-3 for sale by us or resale by others until after November 2007. We may use Form S-1 to raise capital or complete acquisitions, but doing so could increase transaction costs and adversely impact our ability to
raise capital or complete acquisitions of other companies in a timely manner.
Employees who were awarded options that were granted at a discount from fair
market value and were all or partially unvested as of December 31, 2004, which we refer to as discount options, may be subject to income tax liability on the vesting date of those discount options in addition to a 20% excise tax under Internal
Revenue Code Section 409A (Section 409A) and parallel state taxes. In March 2007, CNET Networks notified the IRS of its intent to participate in the IRS 409A compliance relief program. In March of 2007, the Company also
elected to participate in a similar program offered by the California Franchise Tax Board. Under these programs, the Company paid state and federal income taxes incurred under Section 409A on behalf of employees for whom such taxes apply as a
result of their exercise of discount options during 2006. The Company has also made further tax reimbursement payments to such employees in order to defray the tax consequences of the Companys payment of Section 409A taxes on the
employees behalf. In order to assist current non-executive employees holding discount options to avoid future adverse tax consequences, we launched a tender offer in March. Under the terms of the offer, which closed in early April, employees
were given the opportunity to voluntarily increase the exercise price of their option to the appropriate fair value in exchange for a cash payment equal to the amount of the increase, which will be payable in January 2008. There is no guarantee that
these actions will effectively address employees adverse tax consequences as a result of having held discount options. Any unforeseen measures may cause the Company to incur additional cash or noncash compensation expense. Furthermore, such
measures, or the failure of such measures, may require the Company to incur substantial expenses for legal, accounting, tax and other professional services and may divert our managements attention from our business, which could in the future
harm our business, financial condition, results of operations and cash flows.
We have limited protection of our intellectual property and could be
subject to infringement claims that may result in costly litigation, the payment of damages or the need to revise the way we conduct our business.
Our success and ability to compete are dependent in part on the strength of our proprietary rights, on the goodwill associated with our trademarks, trade names, service marks, and on our ability to use United States and foreign laws to
protect them. Our intellectual property includes our original content, our editorial features, logos, brands, domain names, the technology that we use to deliver our products and services, the various databases of information that we maintain and
make available through our Internet sites or by license, and the appearance of our Internet sites. We claim common law protection on certain names and marks that we have used in connection with our business activities. While we have applied for and
obtained registration of many of our marks in countries outside of the United States where we do business, we have not been able to obtain registration of all of our key marks in such jurisdictions, in some cases due to opposition by people
employing similar marks. In addition to laws in the United States and foreign jurisdictions, we rely on confidentiality agreements with our employees and third parties, and protective contractual provisions to protect our intellectual property.
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Worldwide policing of our intellectual property rights is a difficult task and we might not be able to identify
infringers. Our content is widely distributed to third parties through licensing arrangements, and we cannot be certain our third party licensees will always take actions to protect the value of our proprietary rights and reputation. Intellectual
property laws, our agreements and our patents may not be sufficient to prevent others from copying or otherwise obtaining and using our content or technologies. Others may develop technologies that are similar or superior to ours, which could
negatively impact our business. In seeking to protect our trademarks, copyrights, patents and other proprietary rights, or defending ourselves against claims of infringement brought by others, with or without merit, we could face costly litigation
and the diversion of our managements attention and resources.
Notwithstanding the efforts that we have taken to ensure that we have sufficient
rights to the intellectual property that we use, we could still be subject to claims of infringement. For instance, there has been a recent increase in the granting and attempted enforcement of business process patents that cover practices that may
be widely employed in the Internet industry. We have, on occasion, been approached by holders of patents alleging that our services infringe their patents. Many companies that offer services similar to ours have been approached and, in some cases,
sued by other patent holders alleging patent infringement. We could be required to enter into costly royalty arrangements with the holders of these patents or to revise our services to ensure non-infringement or to avoid litigation. If we are
unsuccessful in avoiding litigation, we would incur significant expenses and could be subject to damage awards, including damages for past infringement and royalties for future use of the patented method or technology. If we are found to violate any
such patent, and we are unable to enter into a license agreement on reasonable terms, our ability to offer services could be materially and adversely affected. Even if we prevail against defending these claims, the fees and costs associated with the
defense of these matters could be significant. We have not historically procured insurance for patent infringement.
These claims could result in the need
to develop alternative trademarks, content or technology or to enter into costly royalty or licensing agreements, which could have a material adverse effect on our business, results of operations and financial condition.
Our business involves risks of liability claims for Internet and print content, which could result in significant costs.
As a publisher and a distributor of content through the Internet and print publications, we may face potential liability for:
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copyright, patent or trademark infringement; or
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other claims based on the nature and content of the materials published or distributed.
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These types of claims have been brought, sometimes successfully, against online services and publishers of print publications. In addition, we could be exposed to
liability in connection with material posted to our Internet sites by third parties. For example, many of our sites offer users an opportunity to post profiles, software, videos, photos, reviews and opinions. Some of this user-generated content, and
the content that appears in our indexes and directories, may infringe on third party intellectual property rights or privacy rights or may otherwise be subject to challenge under copyright laws. Although we do not believe that our listing of any
such material should expose us to liability, it is possible that such a claim may be successfully brought.
Our insurance may not cover potential claims of
defamation, libel, negligence and similar claims, and it may or may not apply to a particular claim or be adequate to reimburse us for all liability that may be imposed. Any imposition of liability that is not covered by insurance or is in excess of
insurance coverage could have a material adverse effect on our financial condition.
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Changes in regulations could adversely affect the way that we operate.
It is possible that new laws and regulations in the United States and elsewhere will be adopted covering issues affecting our business, including:
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privacy and use of personally identifiable information;
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copyrights, trademarks and domain names;
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obscene or indecent communications;
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pricing, characteristics and quality of Internet products and services;
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marketing practices, such as direct marketing or adware;
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the ability of children to access our services;
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taxation of Internet usage and transactions; and
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securities and tax regulations.
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Increased
government regulation, or the application of existing laws to online activities, could:
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decrease the growth rate of the Internet;
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increase our operating expenses; and
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expose us to significant liabilities.
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We cannot be
sure what effect any future material noncompliance by us with these laws and regulations or any material changes in these laws and regulations could have on our business, operating results and financial condition.
We may have difficulties with our acquisitions, investments and new product developments.
We intend to continue to pursue new business opportunities and ventures to expand our business, including acquisitions, investments and new product developments in a broad range of content areas and in various
domestic and international markets. During the first nine months of 2007, we completed seven acquisitions. Our decision to pursue these activities is accompanied by risks, including, among others:
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investment of a substantial amount of capital, which could have a material adverse effect on our financial condition and our ability to execute our existing
business strategy;
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issuance of additional equity interests, which would be dilutive to current stockholders;
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the need to incur borrowings, which would impact future cash flows for the repayment of principal and interest payments, and which borrowing may also have
restrictive covenants that could limit certain operating activities including our ability to make acquisitions;
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additional burdens on our management personnel and financial and operational systems;
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difficulty assimilating the operations, technology, corporate culture and personnel of the newly acquired businesses;
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potential disruption to our ongoing business;
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possible inability to retain key personnel;
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additional operating losses and expenses associated with the activities and expansion of acquired businesses; including expenses associated with amortization of
purchased intangible assets,
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possible impairment of relationships with existing employees and advertising customers;
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the impact of our recently completed stock option investigation and related litigations on our ability to attract business partners;
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potential undisclosed liabilities associated with new or acquired businesses; and
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for foreign acquisitions and investments, additional risks related to the integration of operations across different cultures and languages, currency risks, and the
particular economic, political, and regulatory risks associated with specific countries.
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In addition, both our current $250.0 million
credit facility as well as our recently retire $60.0 million revolving line of credit contain significant restrictions on additional further borrowings which could impact our ability to fund acquisitions or to pay for capital purchases.
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Changes in our tax rate and the outcomes of routine tax audits could affect our future results.
Our future effective tax rates could be affected by changes in the valuation of our deferred tax assets and liabilities, changes in the mix of earnings in countries
with differing statutory tax rates, or by changes in tax laws or their interpretations. In addition, we are subject to the continuous examination of our tax returns by the Internal Revenues Service and other tax authorities. We regularly assess the
likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. The outcomes from examinations may have an adverse effect on our business, operating results and financial condition.
We may be subject to system disruptions and other events that may impact use of our properties, which could adversely affect our revenues.
Our ability to attract and maintain relationships with users, advertisers, and strategic partners will depend on the satisfactory performance, reliability
and availability of our Internet infrastructure. Our Internet advertising revenues relate directly to the number of advertisements and other marketing opportunities delivered to our users. System interruptions or delays that result in the
unavailability of Internet sites or slower response times for users would reduce the number of impressions and leads delivered. This could reduce revenues as the attractiveness of our sites to users, strategic partners and advertisers decreases. Our
insurance policies provide only limited coverage for service interruptions and may not adequately compensate us for any losses that may occur due to any failures or interruptions in our systems. Further, we do not have multiple site capacity for all
of our services in the event of any such occurrence. We may experience service disruptions for the following reasons:
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occasional scheduled maintenance;
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an increase in traffic volumes to our sites beyond our infrastructures capacity;
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disruptions in the services provided to us by third parties; and
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natural disasters, telecommunications failures, power failures, other system failures, maintenance, viruses, hacking or other events.
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In addition, our business may be impacted by any event that decreases the amount of the time that users spend on our properties. During these times, our traffic and
revenues may decrease. Such events include, but are not limited to, geopolitical events and natural disasters.
There is no guarantee that our disaster
recovery plans will be effective in mitigating system disruptions caused by these and other events.
Our networks may be vulnerable to unauthorized
persons accessing our systems, which could disrupt our Internet operations and result in the theft of our proprietary information.
A party who is
able to circumvent our security measures could misappropriate either our proprietary information or the personal information of our users, customers and employees or cause interruptions or malfunctions in our Internet operations. We may be required
to expend significant capital and resources to protect against the threat of security breaches or to alleviate problems caused by breaches in security. For example, so-called spiders have and can be used in efforts to copy our databases,
including our database of technology products and prices. Our activities and the activities of third party contractors involve the storage and transmission of proprietary and personal information, such as computer software or credit card numbers.
Accordingly, security breaches could expose us to a risk of loss or litigation and possible liability. We cannot assure you that contractual provisions attempting to limit our liability in these areas will be successful or enforceable, or that other
parties will accept such contractual provisions as part of our agreements.
There are a number of risks associated with international operations that
could adversely affect our business.
We maintain an international presence through a variety of international structures and business operations.
We have wholly-owned operations in Australia, France, Germany, Japan, Russia, Singapore, Switzerland and the United Kingdom. We also have license arrangements in various other countries throughout the world. We operate our operations in China
through a variety of entities some
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of which are owned indirectly by us through local management in order to comply with local ownership and regulatory licensing requirements. We believe our
current ownership structure complies with all existing Chinese laws. It is possible, however, that the Chinese government may change the applicable laws or take a different interpretation of existing laws. If we were found to be in violation of any
existing or future Chinese laws or regulations, we could be subject to fines and other financial penalties, have our licenses revoked, or be forced to discontinue our business entirely.
There are additional risks inherent in doing business in international markets, such as the following:
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weak economic conditions in foreign markets, especially in the business sector;
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challenges caused by distance, language and cultural differences and in doing business with foreign entities and governments;
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uncertainty of product acceptance in different countries;
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longer collection cycles in some countries;
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current, and unforeseen changes in, legal and regulatory requirements;
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difficulties in staffing and managing multi-national operations;
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currency exchange rate fluctuations, which could reduce our revenues as determined under United States GAAP, increase our expenses, and dilute our operating
margins;
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difficulties in finding appropriate foreign licensees or joint venture partners;
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potential adverse tax requirements;
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foreign exchange controls that might prevent us from repatriating cash earned in countries outside the United States; and
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foreign political and economic uncertainty.
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Our debt obligations are restrictive and expose us to risks that could adversely affect our financial condition and prevent us from fulfilling our obligations.
We have a substantial level of debt and interest expense. At September 30, 2007 we had $66.1 million of outstanding indebtedness, of which $63.3 million was classified as a current liability, including $60.0
million outstanding on a line of credit that we repaid in October 2007 with borrowings under our new $250.0 million credit facility. In addition, the terms of our new $250.0 million credit facility limit the circumstances under which we can incur
additional debt and require that we maintain minimum consolidated leverage and fixed charge ratios relative to adjusted earnings before interest, taxes, depreciation and amortization. The level of our indebtedness and the associated covenants, among
other things, could:
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restrict our ability to make investments in the Company by requiring us to keep a minimum level of liquidity
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make it difficult for us to satisfy our obligations with respect to our indebtedness;
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make it difficult for us to obtain any necessary financing in the future for working capital, capital expenditures, debt service, acquisitions or general corporate
operating purposes;
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require us to dedicate a substantial portion of our cash flow from operations to service interest and principal payments on our debt;
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limit our flexibility in planning for or reacting to changes in our business;
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reduce funds available for use in our operations;
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place us at a possible competitive disadvantage relative to less leveraged competitors and competitors that have better access to capital resources;
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impair our ability to incur additional debt because of financial and other restrictive covenants; and
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make us more vulnerable in the event of a downturn in our business or an increase in interest rates.
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As of September 30, 2007, we had cash and investments of $71.4 million. We have prepared a forecast for 2007 which is based on our current expectations
regarding revenue growth and associated operating expense and capital spending levels. If our actual results should differ materially from our expectations, our liquidity may be adversely impacted. If that were to occur, we may take steps to adjust
our operating costs and capital expenditures to levels necessary to support our incoming business. We may also need to raise additional equity or borrow additional funds to achieve our longer-term business objectives.
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However, if we are unable to generate sufficient cash flow or otherwise obtain funds necessary to make required payments,
or if we fail to comply with the various covenants of our $250.0 million credit facility, we would be in default, which would permit our lender to accelerate the maturity of the indebtedness. Any default under our credit facility could have a
material adverse effect on our financial condition and adversely impact our business.
Our business, operating results and financial condition may be
impacted by certain contingencies related to our guarantee of certain lease obligations.
In conjunction with the ZDNet acquisition in 2000, we
assumed a guarantee of the obligations of Ziff Davis Media Inc., an unaffiliated company and primary lessee, under a New York City office lease for a total of 399,773 square feet. This lease expires in 2019. The annual average cost per square foot
is approximately thirty dollars over the remaining term of the lease. Ziff Davis Media Inc. currently occupies 144,682 square feet of this space. Ziff Davis Media Inc. subleases 205,951 square feet to various entities including The Bank of New York,
FOJP Risk Management and Softbank. In addition, we currently sublease and occupy 49,140 square feet of the office space from Ziff Davis Media Inc. These leases and subleases fully cover the current monthly lease payments.
As of September 30, 2007, the total lease payments remaining until the end of the lease term were $140.5 million, excluding the amounts attributable to our sublease
with respect to the floor we occupy. If the financial condition of any of the sublessees or Ziff Davis Media Inc. were to deteriorate and thereby result in their inability to make lease payments, we would be required to make their lease payments
under the guarantee. In addition, any expiration of any sublease, the potential resulting vacancy and the inability of Ziff Davis Media Inc. to make the primary lease payments could result in us being required to make lease payments on these
vacancies.
In connection with that guarantee, we have a letter of credit for $15.0 million outstanding as a security deposit. As there is no present
obligation to make any payments in connection with this guarantee, we have not recorded any liability for this guarantee in our financial statements.
We have generated significant losses in the past and cannot assure you that we will report positive net income in the future. If our revenues do not increase, we may not be able to adjust spending in a timely manner to maintain
positive net income.
In the past, we have generated operating losses, as well as net losses, as was the case in the three and nine months ended
September 30, 2007. Although we generated net income in 2006, our ability to generate positive net income in 2007 or subsequent periods may be negatively impacted by:
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an inability to decrease expenses in a timely manner to offset any revenues shortfalls or expenses associated with cost-reduction measures, such as severance, lease
termination payments, contract termination costs or impairment charges;
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an adverse outcome of an examination of our tax returns by tax authorities;
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payments associated with contingent liabilities, such as litigation or our guarantee of the New York lease of Ziff Davis Media Inc., as described in more detail in
a prior risk factor; or
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any transactions such as impairments or losses on investments.
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Changes in the interpretation of United States generally accepted accounting principles, or GAAP, may affect our reported results.
We prepare our financial statements in conformity with GAAP, which is subject to interpretation by the SEC and various bodies formed to interpret and create appropriate accounting policies. A change in these
principles could have a significant effect on our reported results and may affect the reporting of transactions completed prior to the announcement of a change.
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Accounting rules regarding goodwill could make our reported results more volatile.
Goodwill is tested for impairment annually or when an event occurs indicating the potential for impairment. The evaluation is prepared based on our current and projected
performance for our identified reporting units. The fair value of our reporting units is determined using a combination of the cash flow and market comparable approaches. If we conclude at any time that the carrying value of our goodwill and other
intangible assets for any of our reporting units exceeds its implied fair value, we will be required to recognize an impairment, which could materially reduce operating income and net income in the period in which such impairment is recognized.
In 2007, we changed our reporting units to reflect the change in the Companys internal management and reporting structure. This resulted in a change
from four reporting units to ten reporting units. As is required by SFAS 142, when an entity reorganizes its reporting structure in a manner that changes the composition of one or more of its reporting units, goodwill is reassigned to the affected
reporting units using a relative fair value allocation approach. Based on this evaluation, we determined that the fair value exceeded the carrying value of goodwill and other intangible assets for each of its reporting units as of August 31,
2007, except for the Webshots reporting unit. Therefore, an impairment of $19.0 million was recorded.
In the application of these methodologies, we are
required to make estimates of future operating trends and judgments on discount rates and other variables. Actual future results and other assumed variables could differ from these estimates, including changes in the economy, the business
environment in which we operate, and/or our own relative performance. Any differences in actual results compared to our estimates could result in further future impairments. Accordingly, our future earnings may be subject to significant volatility,
particularly on a period-to-period basis.
We will record substantial stock compensation expenses, which may have a material negative impact on our
operating results for the foreseeable future.
Effective January 1, 2006, we adopted SFAS 123(R),
Share-Based Payment
, for stock-based
employee compensation. Our stock compensation expense was $4.7 million in the quarter ended September 30, 2007 and is also expected to be significant in future periods, which will have an adverse impact on our operating income and net income.
Our option-pricing model requires the input of highly subjective assumptions, including the options expected life and the price volatility of the underlying stock. Changes in the subjective input assumptions can materially affect the amount of
our stock compensation expense. Our stock compensation expenses may also be greater than expected if the fair value of our stock increases. In addition, an increase in the competitiveness of the market for qualified employees could cause us to issue
more stock options or other securities than expected, which would increase our stock compensation expense.
A substantial number of shares of common
stock may be sold, which could affect the trading price of our common stock.
We have a substantial number of shares of common stock subject to
stock options. As of September 30, 2007, we had 7.1 million shares of common stock available for future grant under our stock option and employee stock purchase plans and 23.9 million issuable upon the future exercise of outstanding
stock options. In addition, as of September 30, 2007, we have approximately 250 million shares of authorized but unissued shares of our common stock that are available for future sale. We cannot predict the effect, if any, that future
sales of shares of our common stock, or the availability of shares of our common stock for future sale, will have on the market price of our common stock. Sales of substantial amounts of our common stock, including shares issued in connection with
acquisitions or upon the exercise of stock options or warrants or the conversion of debt securities that may be issued in the future, or the perception that such sales could occur, may adversely affect prevailing market prices for our common stock.
The trading value of our common stock may be volatile and decline substantially.
The trading price of our common stock is subject to wide fluctuations, which are a result of a number of events and factors, including:
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quarterly variations in operating results;
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announcements of innovations requiring significant expenditures;
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new products, strategic developments or business combinations by us or our competitors;
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changes in our financial estimates or that of securities analysts;
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announcements relating the appointment or resignation of a member of senior management;
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restatements of previously issued financial results;
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our sale of common stock or other securities in the future;
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changes in recommendations of securities analysts;
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developments in litigations or other governmental proceedings against us, or new litigations or governmental proceedings;
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the operating and securities price performance of other companies that investors may deem comparable to us; and
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news reports, including those relating to trends in the Internet.
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In addition, the stock market in general, and the market prices for Internet-related companies in particular, have experienced extreme volatility that often has been unrelated to the operating performance of these
companies. These broad market and industry fluctuations may adversely affect the trading price of our common stock. These fluctuations may make it more difficult to use stock as currency to make acquisitions that might otherwise be advantageous, or
to use stock options as a means to attract and retain employees.
Any shortfall in revenues or earnings compared to our or analysts or
investors expectations could cause, and has in the past caused an immediate and significant decline in the trading price of our common stock. In addition, we may not learn of such shortfalls or delays until late in the fiscal quarter, which
could result in an even more immediate and greater decline in the trading price of our common stock.
Provisions of our certificate of incorporation,
bylaws and Delaware law could deter takeover attempts.
Some provisions in our certificate of incorporation and bylaws could delay, prevent or make
more difficult a merger, tender offer, proxy contest or change of control. Our stockholders might view any transaction of this type as being in their best interest since the transaction could result in a higher stock price than the current market
price for our common stock. Among other things, our certificate of incorporation and bylaws:
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authorize our Board of Directors to issue preferred stock with the terms of each series to be fixed by our Board of Directors;
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divide our Board of Directors into three classes so that only approximately one-third of the total number of directors is elected each year;
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permit directors to be removed only for cause; and
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specify advance notice requirements for stockholder proposals and director nominations.
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In addition, with some exceptions, the Delaware General Corporation Law restricts or delays mergers and other business combinations between us and any stockholder that
acquires 15% or more of our voting stock.
Our business could be adversely impacted if we have deficiencies in our disclosure controls and procedures
or internal control over financial reporting.
The design and effectiveness of our disclosure controls and procedures and internal control over
financial reporting may not prevent all errors, misstatements or misrepresentations. While management will continue to review the effectiveness of our disclosure controls and procedures and internal control over financial reporting, we cannot assure
you that our disclosure controls and procedures or internal control over financial reporting will be effective in accomplishing all control objectives all of the time. Deficiencies, particularly a material weakness in internal control over financial
reporting, which may occur in the future, could result in misstatements of our results of operations, restatements of our financial statements, a decline in our stock price, or otherwise materially adversely affect our business, reputation, results
of operation, financial condition or liquidity.