e10vk
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
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(Mark One) |
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
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For the fiscal year ended December 31, 2005. |
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OR |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934. |
Commission File Number: 000-24643
DIGITAL RIVER, INC.
(Exact name of registrant as specified in its charter)
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DELAWARE
(State or other jurisdiction of
Incorporation or organization) |
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41-1901640
(I.R.S. Employer
Identification No.) |
9625 WEST 76TH STREET
EDEN PRAIRIE, MINNESOTA 55344
(Address of principal executive offices)
(952) 253-1234
(Registrants telephone number, including area code)
Securities registered pursuant to Section 12(b) of the
Act:
None
Securities registered pursuant to Section 12(g) of the
Act:
Common Stock $0.01 par value
Indicate by checkmark if the registrant is a well-known seasoned
issuer as defined in Rule 405 of the Securities
Act. Yes þ No o
Indicated by checkmark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the
Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been
subject to filing requirements for the past
90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K is
not contained herein, and will not be contained, to the best of
registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this
Form 10-K or any
amendment to this
Form 10-K. o
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer or a non-accelerated
filer (as defined in Exchange Act
Rule 12b-2)
Large accelerated
filer þ Accelerated
filer o Non-accelerated
filer o
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2 of the
Act). Yes o No þ
As of June 30, 2005, there were 34,208,165 shares of
Digital River, Inc. common stock, issued and outstanding. As of
such date, based on the closing sales price as quoted by The
NASDAQ Stock Market, 33,235,033 shares of common stock,
having an aggregate market value of approximately $1,055,212,000
were held by non-affiliates. For purposes of the above statement
only, all directors and executive officers of the registrant are
assumed to be affiliates.
The number of shares of common stock outstanding at
March 1, 2006 was 35,313,069 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Certain sections of the Registrants definitive Proxy
Statement for the 2006 Annual Meeting of Stockholders are
incorporated by reference in Part III of this
Form 10-K to the
extent stated herein.
TABLE OF CONTENTS
2
PART I
CAUTIONARY STATEMENT PURSUANT TO THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995
Certain statements set forth or incorporated by reference in
this Form 10-K, as
well as in our Annual Report to Stockholders for the year ended
December 31, 2005, constitute forward-looking
statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Words such as
believes, anticipates,
expects, intends, estimates,
and similar expressions are intended to identify forward-looking
statements, but are not the exclusive means of identifying such
statements. These statements involve known and unknown risks,
uncertainties and other factors that may cause our actual
results, performance or achievements, or industry results, to be
materially different from any future results, performance or
achievements, or industry results, expressed or implied by such
forward-looking statements. Such factors are set forth under
Risk Factors under Item 1A in this
Form 10-K. We
expressly disclaim any obligation to update or publicly release
any revision to these forward-looking statements after the date
of this Form 10-K.
Overview
We provide outsourced
e-commerce solutions
globally to a wide variety of companies primarily in the
software and high-tech products markets. We were incorporated in
1994 and began building and operating online stores for our
clients in 1996. We offer our clients a broad range of services
that enable them to effectively build, manage, and grow online
sales on a global basis. We focus on helping our clients
mitigate risk and grow their revenues. Our services include
online store design, development and hosting, store
merchandising and optimization, order management, fraud
prevention screening, export controls and management, tax
management, digital product delivery via download, physical
product fulfillment, multi-lingual customer service,
e-mail marketing,
website optimization, web analytics, and reporting.
Our products and services allow our clients to focus on
promoting and marketing their brands while leveraging the
investments we have made in technology and infrastructure that
facilitate the purchase of products from their online stores.
When shoppers visit the store on one of our clients
websites, they are seamlessly transferred to our
e-commerce platform.
Once on our platform, shoppers can browse for products and make
purchases online. After a purchase is made, we either deliver
the product digitally via download over the Internet or transmit
the order to a third party for physical fulfillment. We also
process the buyers payment, including collection and
remittance of applicable taxes, and provide customer service in
multiple languages to handle order-related questions.
In addition to the services we provide that facilitate the
completion of an online transaction, we also offer services
designed to increase traffic to our clients online stores
and to improve the sales effectiveness of those stores. Our
services include paid search advertising, search engine
optimization, affiliate marketing, store optimization, and
e-mail optimization.
All of our services are designed to help our clients acquire
customers more effectively, sell to those customers more often
and more efficiently, and increase the lifetime value of each
customer.
Our clients include many of the largest software and high-tech
products companies and major retailers of these products,
including Allume Systems, Inc., Autodesk, Inc., CompUSA, Inc.,
eBay, Inc., Hewlett Packard Company, Lexmark, Inc., McAfee,
Inc., Microsoft Corporation, OfficeMax Incorporated., Nuance
Communications Inc, Symantec Corporation, and Trend Micro, Inc.
General information about us can be found at
www.digitalriver.com under the Company/ Investor
Relations link. Our annual report on
Form 10-K,
quarterly reports on
Form 10-Q and
current reports on
Form 8-K, as well
as any amendments or exhibits to those reports, are available
free of charge through our website as soon as reasonably
practicable after we file them with the Securities and Exchange
Commission.
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Industry Background
Growth of the Internet and
E-Commerce.
E-Commerce sales continue to grow at a rapid rate. The
U.S. Commerce Department reported that
e-commerce sales in the
fourth quarter of 2005 rose 23.4% compared to the fourth quarter
of 2004, continuing a series of strong quarterly growth reports.
We believe there are a number of factors that are contributing
to the growth of
e-commerce:
(i) adoption of the Internet continues to increase
globally; (ii) broadband technology is becoming more widely
available and the adoption of broadband for Internet use is
increasing at a rapid rate; (iii) Internet users are
increasingly comfortable with the process of buying products
online; (iv) the functionality of online stores continues
to improve, a greater range of payment options are available,
and special offers and shipping discounts are making online
shopping more attractive; (v) businesses are placing more
emphasis on their online stores as they can reach a larger
audience at a comparatively lower cost than the methods used to
drive traffic to traditional bricks-and-mortar retail stores;
and (vi) concerns about conflicts between online and
traditional sales channels are continuing to subside. As a
result of these growth drivers, online businesses have begun to
build large, global customer bases that can be reached
cost-effectively, potentially resulting in higher sales and
profitability.
Opportunities for Outsourced
E-Commerce. We
believe there are advantages to outsourced
e-commerce that will
continue to make it an attractive alternative to building and
maintaining this capability in-house. These advantages include:
(i) eliminating the substantial up-front and ongoing costs
of computer hardware, network infrastructure and specialized
application software; (ii) reducing the time it takes to
get online stores live and productive; (iii) shifting the
ongoing technology, financial, regulatory and compliance risks
to a proven service provider; (iv) leveraging the expertise
of an e-commerce
service provider to accelerate growth of an online business; and
(v) allowing businesses to focus on their specific core
competencies.
We believe the market for outsourced
e-commerce will
continue to grow rapidly. The Internet is inherently global.
Once an online store is established, it is immediately
accessible to Internet users around the world. Web pages must be
presented and customer service inquires handled in diverse
languages, and a variety of currencies and payment options must
be accepted. The appropriate taxes must be collected and paid,
payment fraud risk mitigated, fulfillment provided, and
assurances made that products are not shipped to banned
locations. These and other requirements of a global
e-commerce system make
it a potentially expensive and risky undertaking for any
business. They also make a comprehensive outsourced offering,
such as that provided by Digital River, an attractive
alternative.
Shift from Physical to Electronic Delivery. Consumers
have grown increasingly comfortable with the electronic delivery
of digital products, such as music, video and software. This
shift from physical to electronic delivery is being driven by
benefits to both buyers and sellers of these products. For
buyers, downloaded products are immediately available for use
and a wider variety of products are available than can be found
in most retail stores. For sellers, electronic delivery avoids
inventory-stocking requirements and eliminates shipping,
handling, storage and inventory-carrying costs as well as the
risk of product obsolescence.
The Digital River Solution
Our solution combines a robust
e-commerce technology
platform and a suite of services to help businesses worldwide
grow their online revenues and avoid the costs and risks of
running a global
e-commerce operation
in-house. We offer a comprehensive
e-commerce solution
that operates seamlessly as part of a clients website. We
provide services that facilitate
e-commerce transactions
and services that help drive traffic to our clients online
stores and demand for their products. Our services include
e-commerce store design
and development, hosting, store merchandising, order management,
fraud prevention, export controls, tax management, digital
product delivery via download, physical product fulfillment,
multi-lingual customer service,
e-mail marketing, web
analytics, strategic marketing services and reporting. We also
provide our clients with increased product visibility and sales
opportunities through our large network of online channel
partners, including retailers and affiliates. We generate a
substantial
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majority of our revenue on a revenue-share basis, meaning that
we are paid a percentage of the selling price of each product
sold at a Digital River-managed
e-commerce store.
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Reduced Total Cost of Ownership and Risk |
Utilizing our solution, businesses can dramatically reduce or
eliminate upfront and ongoing hardware, software, maintenance
and support costs associated with developing, customizing,
deploying and upgrading an in-house
e-commerce solution.
They can have a global
e-commerce presence
without assuming the costs and risks of developing it themselves
and take immediate advantage of the investments we continually
make in our e-commerce
systems and associated services. In addition, we help mitigate
the risks of doing
e-commerce globally,
including risks associated with payment fraud, tax compliance,
export and denied parties compliance, among others. Our ongoing
investment in the latest technologies and
e-commerce
functionality helps ensure that our clients maintain pace with
industry advances.
We can assist our clients in growing their businesses by
(i) increasing the acquisition, retention and lifetime
value of new customers; (ii) extending their businesses
into international markets; and (iii) expanding the
visibility and sales of their products through new online sales
channels. We have developed substantial expertise in online
marketing and merchandising, which we apply to help our clients
increase traffic to their online stores, and improve order close
ratios, average order sizes and repeat purchases, all of which
result in higher revenues for our clients businesses and a
greater revenue share for Digital River.
We provide the technology and services necessary to establish,
grow and support international sales. Our technology platform
enables transactions to be completed in numerous currencies
using a variety of payment options. In addition, we provide
localized online content and offer customer service in a variety
of languages, extending our clients reach beyond their
home markets.
Through our large online marketplace, which we call Digital
River
oneNetworktm
(described in more detail in the section titled
Strategy), we provide our clients access to new
online sales channels, which can help grow their online
businesses. Clients can offer any part of their product catalogs
to our network of online channel partners, including online
retailers and affiliates. This increases the exposure these
products receive and can result in higher sales volumes. Our
channel partners benefit because we eliminate the need for each
of them to manage hundreds of relationships with product
developers while increasing the depth and breadth of products
they can sell, all without requiring the management of physical
product inventory.
Businesses can reduce the time required to develop an
e-commerce presence by
utilizing our outsourced business model. Typically, a new client
can have an online store live in a matter of days or weeks
compared with months or longer if they decide to build, test and
deploy the e-commerce
capability in-house. Once they are operational on our platform,
most clients can utilize our remote control toolset to make
real-time changes to their online store, allowing them to
address issues and take advantage of opportunities without
technical assistance.
By utilizing our outsourced
e-commerce services,
businesses can focus on developing, marketing and selling their
products rather than devoting time and resources to building and
maintaining an
e-commerce
infrastructure. Management can focus their time on what they
know best while ensuring they have access to the latest
technologies, tools and expertise for running a successful
e-commerce operation.
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Our solution emphasizes convenience as it enables products to be
purchased online from home or office at any time. In the case of
software and digital products, buyers can immediately download
their purchase and begin using it in a matter of minutes.
Sophisticated search technology allows shoppers to browse our
entire catalog to find the products they are looking for quickly
and easily. Our extended download service, which guarantees
replacement of products accidentally destroyed through computer
error or malfunction, and our 24/7 customer service provided on
behalf of our clients, offer shoppers additional assurance that
their e-commerce
experience will be a positive one. Our CD2Go service gives
buyers the ability to obtain, for a fee, a copy on CD of the
product they have purchased and downloaded, providing additional
assurances to buyers.
Strategy
Our objective is to be the global leader in outsourced
e-commerce services for
software and digital products developers, high-tech products
manufacturers and related online retailers. Our strategy for
achieving this objective includes the following key components:
Attract New Clients and Expand Relationships with Existing
Clients. We have focused our efforts on securing new clients
and expanding our relationships with existing clients primarily
in the software, digital products, high-tech products, and
consumer electronics markets. Our clients include software
publishers, other digital content providers, high-tech product
manufacturers, and online channel partners. In 2005, we entered
into contracts with more than 220 new clients.
We believe we can attract new clients and gain additional
business with existing clients by expanding the range of
services we offer, both in
e-commerce transaction
and marketing services. In addition, we believe that by
expanding the size and breadth of the catalog of products we
offer, we will attract additional online retailers and
affiliates seeking to offer their customers a wide range of
quality products. As of March 1, 2006, we were providing
e-commerce services for
more than 40,000 software and digital products publishers,
high-tech products manufacturers, online retailers and
affiliates.
Expand the Digital River oneNetwork Marketplace. During
the past two years, we have developed a global marketplace we
call Digital River oneNetwork. It enables our clients to
efficiently offer their products to a broad range of online
retailers and affiliates. Affiliates are entities (individuals,
organizations, companies, etc.) that generate visitor traffic to
e-commerce websites. On
those websites there are links, advertisements and other offers
to sell various products and services. If a visitor elects to
make a purchase, the affiliate generally receives a fixed fee or
a percentage of the selling price of the products purchased.
Affiliates are becoming an increasingly important source of
website traffic as they can target specific types of Internet
users.
We believe we have amassed the largest catalog of digital
software titles available anywhere online, and we offer these
titles to online retailers and affiliates. We generate revenue
when web traffic is directed to a site for which we provide
e-commerce services and
a purchase transaction occurs. We will continue to expand the
content available in our catalog, which we believe will make
that catalog increasingly attractive to online retailers,
affiliates and other online channel partners. For example, the
acquisition of Commerce5 in December 2005 will add approximately
100,000 new products to our catalog, bringing the total number
of products in our catalog to more than 200,000. We believe
Digital River oneNetwork is a unique marketplace and provides
opportunities to grow our revenues and strengthen our
relationships with clients and partners.
Expand International Sales. We believe there is a
substantial opportunity to grow our business by enabling our
clients to expand their sales through international online
stores. Internet adoption and broadband deployment continue to
increase rapidly in the European and Asia Pacific regions. We
have seen significant growth in sales for clients that have
created international online stores and we intend to continue to
enhance our technology platform, payment options and localized
service offerings to increase sales in international markets.
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Provide Clients with Strategic Marketing Services. We
proactively develop and deliver new products and services,
called strategic marketing services, that are designed to help
our clients improve customer acquisition and retention and
maximize the lifetime value of customers. These services include
paid search advertising, search engine optimization, affiliate
marketing, store optimization, and
e-mail marketing and
optimization. In general, we manage these programs for our
clients and have achieved significant increases in client
revenue,
return-on-investment or
both, compared to what the client experienced when running these
programs and supporting technologies in-house. We intend to
continue to develop and/or acquire new value-added strategic
marketing services to create additional sources of revenue for
our clients and for Digital River.
Maintain Technology Leadership. We believe our technology
platform and infrastructure afford us a competitive advantage in
the market for outsourced
e-commerce solutions.
We intend to continue to invest in and enhance our platform to
improve scalability, reliability, security and performance as
well as reduce costs. By leveraging our fixed cost structure, we
can improve our ability to provide low-cost, high-value services
while continuing to deploy the latest technologies.
Additionally, we plan to continue investing to allow our clients
to further penetrate international markets, enhance their
relationships with their customers, better manage their
return-on-investment
across all online marketing activities, and address new selling
models such as subscriptions, software-as-a-service,
try-before-you-buy and volume licensing.
Continue to Seek Strategic Acquisitions. Historically, we
have been an active acquirer of businesses, and we expect to
continue actively pursuing acquisitions that further our
business strategy. Some of the strategic factors we consider
when evaluating an acquisition opportunity include: expanding
the base of clients, improving the breadth and depth of our
product offering, improving the catalog of content for our
Digital River oneNetwork partners, extending our strategic
marketing and other services offerings, expanding our geographic
reach and diversifying our revenue stream into complementary or
adjacent market segments.
Services
We provide a broad range of services to our clients, including
online store development and hosting, merchandising, order
management, fraud prevention screening, denied parties
screening, export controls, tax management, digital and physical
product fulfillment, multi-lingual customer service, email
marketing, reporting and analytics, and a range of strategic
marketing services. Most of these services can be managed
through client-facing, remote control self-service tools
designed for business users. Since our clients utilize our
centralized system and processes, we can consistently offer best
practices across our entire client base.
Store Development and Hosting. We offer our clients
design services that utilize our experience and expertise to
create efficient and effective online stores. Our
e-commerce solutions
can be deployed quickly for our clients and implemented in a
variety of ways from fully-functioning shopping carts through
completely merchandised online stores. The online stores we
operate for our clients match their branding and design to
provide a seamless experience for shoppers. When a shopper
navigates from any one of our clients websites to its
store (hosted by us), it is a seamless transition to our
technology platform. We fully manage the order process through
payment processing, fraud screening, and fulfillment (either
digital or physical). We also notify the buyer via
e-mail once the
transaction is completed. Transaction information is captured
and stored in our data warehouse, an increasingly valuable
source of information used to create highly targeted
merchandising programs,
e-mail marketing
campaigns, product offers and test marketing programs.
For many of our clients, the solution we provide is critical to
their businesses and therefore we operate data centers that
perform and scale for continuous
e-commerce operation in
a high-demand environment. We operate multiple data centers
globally, which feature fully redundant high-speed connections
to the Internet, server capacity to handle unpredictable spikes
in traffic and transactions, 24/7 security and monitoring,
back-up electric
generators and dedicated power supplies.
Store Merchandising. Our technology platforms support a
wide range of merchandising activities. This enables our clients
to effectively execute promotional activities, up-sell,
cross-sell and feature specific
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products and services during any phase of the shopping process.
From the home page of our clients online stores through
the checkout and thank you pages, our solution
allows clients to deliver targeted offers designed to increase
close ratios and average order sizes.
Order Management and Fraud Screening. We manage all
phases of a shoppers order on our clients
e-commerce stores. We
process payment transactions for orders placed through our
technology platform and support a wide variety of payment types,
including credit cards, wire transfers, purchase orders, money
orders, direct debit cards and many other payment types popular
both in the United States and around the world. As part of the
payment process, we ensure that the correct taxes are displayed,
collected, remitted and reported.
The fraud screening component of our platform uses both
rules-based and heuristic scoring methods (which use
observations of known fraudulent activities) to make a
determination regarding the validity of the order, buyer and
payment information. As the order is entered, hundreds of data
reviews can be processed in real time. We also provide
denied-parties screening and export controls, which are designed
to ensure persons and/or organizations appearing on government
denied-parties lists are blocked from making purchases through
our system. Once a transaction is approved and the physical
product(s) ordered have been delivered or shipped, or digital
product has been delivered, we process the order for payment.
Digital and Physical Fulfillment Services. We provide
both digital and physical fulfillment services to our clients.
Digital delivery eliminates or reduces many of the costs
associated with the distribution of physical products, including
packaging, shipping, warehousing, handling, and
inventory-carrying and management costs. We offer our clients a
broad array of electronic delivery capabilities that enable
delivery of digital products directly to customers
computers via the Internet. Delivery is completed when a copy of
the purchased digital product is made from a master stored on
our technology platform and then securely downloaded to the
purchaser. Optionally, buyers can, for an additional fee,
request that a CD be created and shipped as a backup for their
order. Our digital distribution model reduces costs, resulting
in potentially higher margins for our software and digital
products publishing clients. In addition, our model helps to
address the shrinking supply of shelf space in retail stores,
which limits the number of software titles available for sale.
While the majority of our clients use our
e-commerce hosting
services, some publishers use only our digital delivery service,
which gives them online distribution through our extensive
network of online channel partners.
In addition to electronic fulfillment via download, we offer our
clients physical distribution services as well. We have
contracted with third-party fulfillment agents that maintain
inventories of physical products for shipment to buyers. These
products are held by the fulfillment agent on consignment from
our clients that make this option available to their customers.
We provide notification to buyers of product shipment as well as
shipment tracking, order status, and inventory information. We
also provide a service called Physical on Demand, which utilizes
robotic systems to create a client-branded product CD and
packaging materials after an order has been placed. This
eliminates the requirement for inventory to be stored in a
warehouse as the physical product is created only when needed.
We believe physical fulfillment services are important to
providing a complete
e-commerce solution to
our clients, particularly in the high-tech physical markets
where digital fulfillment is not possible.
Customer Service. We offer telephone, online chat and
e-mail customer support
for products sold through our platforms on behalf of our
clients. We provide assistance to buyers regarding ordering and
delivery questions on a 24/7 basis and in more than ten
different languages. We continue to invest in technology and
infrastructure to provide fast and efficient responses to
customer inquiries as well as provide online self-help options.
We provide extended download services for digital products for
an additional fee, which enables buyers to download the products
they have purchased more than once in the event of a computer
failure or other unexpected problem.
Advanced Reporting and Analytics. We capture and store,
in our data warehouse, detailed information about visitor
traffic to and sales on the online stores we manage for our
clients. We provide clients access to a large collection of
standard and customizable reports as well as our web analytics
technology. This enables our clients to track and analyze sales,
products, transactions, customer behavior
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and the results of marketing campaigns so they can optimize
their marketing efforts to increase traffic, close ratios and
average order values.
Strategic Marketing Services. We offer a wide range of
strategic marketing services designed to increase customer
acquisition, retention and lifetime value. Through a combination
of web analytics, analytics-based statistical testing,
optimization and proven direct marketing practices, our team of
strategic marketing experts develops, delivers and manages
programs such as paid search advertising, search engine
optimization, affiliate marketing, store optimization and
e-mail optimization on
behalf of our clients. Depending on the client contract, we
charge an incremental percentage of the selling price of
merchandise for sales driven by our strategic marketing services
activities. We believe our ability to capture and analyze
integrated traffic and commerce data enhances the value of our
strategic marketing services as we can precisely determine the
effectiveness of specific marketing activities, website changes,
and other actions taken by our clients.
Clients
We serve two distinct groups of clients: (1) product
developers and manufacturers; and (2) online retailers and
affiliates. We believe that the breadth of our catalog of
products is a competitive advantage in selling
e-commerce services to
online channel partners as they can access a huge volume of
products to sell without negotiating contract terms with every
product provider. At the same time, we believe the breadth of
our channel partner group is attractive to product manufacturers
as it gives them access to broad distribution through a single
source.
Sales and Marketing
We sell products and services to end consumers primarily through
the Internet. We sell and market our services for clients
through a direct sales force located in offices in the United
States, Europe and Asia Pacific. These offices include staff
dedicated to pre-sales, sales and sales support activities. Our
client sales organization sells to senior executives within
product, manufacturers and online retailers and online channel
partners who are looking to create or expand their
e-commerce businesses.
During the client sales process, our sales staff delivers
demonstrations, presentations, collateral material,
return-on-investment
analyses, proposals and contracts.
We also design, implement and manage marketing and merchandising
programs to help our clients drive traffic to their online
stores and increase close ratios, average order values and
repeat purchases at those stores. Our strategic
e-marketing team
delivers a range of marketing and merchandising programs such as
paid search advertising, search engine optimization, affiliate
marketing, site and store optimization,
e-mail marketing and
optimization and site merchandising, which includes promotions,
cross-sells and up-sells. This team combines their marketing
domain expertise with our suite of technology, including
reporting, analytics, optimization and
e-mail to drive
increased sales for our clients.
We market our products and services directly to clients and
prospective clients. We focus our efforts on generating
awareness of our brand and capabilities, establishing our
position as a global leader in
e-commerce outsourcing,
generating leads in our target markets, and providing sales
tools for our direct sales force. We conduct a variety of highly
integrated marketing programs to achieve these objectives in an
efficient and effective manner. We currently market our products
and services to clients and prospects via direct marketing,
print and electronic advertising, trade shows and events, public
relations, media events and speaking engagements. We intend to
increase our overall marketing expenditures on an absolute
dollar basis, but maintain approximately the current level on a
percentage of revenue basis.
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Technology
We deliver our outsourced
e-commerce solutions on
several platforms, each of which has been architected to solve
our clients multi-faceted
e-commerce needs. The
following is a brief description of our technology standards
utilized by the family of Digital River commerce platforms:
Architecture. Our platforms are highly scalable and
designed to handle tens of thousands of individual
e-commerce stores and
millions of products available for sale within those stores.
These platforms consist of proprietary software applications
running on multiple pods of Sun Microsystems and Dell servers
that serve dynamic web pages using Oracle, SQL server and MySQL
databases, and .net Microsoft IIS and Oracle 9iAS
application servers. We use Akamai and Mirror Images
worldwide caching technology to enable our platform engines to
serve web pages with consistent load times around the world. Our
platforms are designed to support growth by adding servers,
CPUs, memory and bandwidth without substantial changes to the
software applications. We believe this level of scalability is a
competitive advantage. The application software is written in
modular layers, enabling us to quickly respond to industry
changes, payment processing changes, changes to international
requirements for taxes and export screening, banking procedures,
encryption technologies, and new and emerging web technologies,
including DHTML, VRML, and web Caches.
The platforms include search capabilities that allow shoppers to
search for items across millions of products and thousands of
categories based on specific product characteristics or
specifications while maintaining page response times acceptable
to the user. We use sophisticated database indexing combined
with a dynamic cache system to provide flexibility and speed.
The platforms have been designed to index, retrieve and
manipulate all transaction data that flows through the system,
including detailed commerce transactions and end-user
interaction data. This enables us to create proprietary market
profiles of each shopper and groups of shoppers that can then be
used to create merchandising campaigns that are better targeted
and more successful. We also use our platforms internally for
fraud detection and prevention, management of physical shipping,
return authorizations, backorder processing, and transaction
auditing and reporting.
E-Commerce System Maintenance. Our platforms have a
centralized maintenance management system that we use to build
and manage our clients
e-commerce systems.
Changes that affect all of our clients
e-commerce sites or
groups of e-commerce
sites can be made centrally, dramatically reducing maintenance
time and complexity. Most of our clients
e-commerce sites
include a central store and many also have additional web pages
where highly targeted traffic is routed. Clients also may choose
to link specific locations on their
e-commerce stores to
detailed product or category information within their stores to
more effectively address their shoppers areas of interest.
Security. Continuous data center operations are crucial
to our success. We have security systems in place to control
access to our internal systems and commerce data. Log-ins and
passwords are required for all systems with additional levels of
log-in, password and IP security in place to control access on
an individual basis. Access only is granted to commerce areas
for which an individual is responsible. Multiple levels of
firewalls prevent unauthorized access from the outside or access
to confidential data from the inside. Our security system does
not allow direct access to any client or customer data. We
license certain encryption and authentication technology from
third parties to provide secure transmission of confidential
information such as credit card data. The security system is
designed not to interfere with the end-users experience on
our clients
e-commerce sites.
Data Center Operations. Continuous data center operations
are crucial to our success. We currently sustain major data
center operations in six facilities in California and Minnesota,
USA; and surrounding England; Germany; and Ireland. All major
data center locations are currently processing transactions and
serving downloads.
All data centers currently utilize multiple levels of redundant
systems, including load balancers fronting web and application
server farms, database servers, and enterprise disk storage
arrays. For the majority of these systems, we currently have
automatic failover procedures in place such that when a fault
10
is detected, a process automatically takes that portion of the
system offline and processing continues on the remaining
redundant portions of the system, or in an alternate datacenter.
In the event of an electrical power failure, we have redundant
power generators and uninterruptible power supplies that protect
our facilities. Fire suppression systems are present in each
data center.
Our network software constantly monitors our clients
e-commerce sites and
internal system functions, and notifies systems engineers if any
unexpected conditions arise. We lease multiple lines from
diverse Internet service providers and maintain a policy of
adding additional capacity if more than 40 percent of our
capacity is consistently utilized. Accordingly, if one line
fails, the other lines are able to assume the traffic load of
the failed line. We also utilize content distribution networks
operated by our vendors to serve appropriate types of traffic;
currently, the majority of our image traffic and a substantial
portion of our download traffic is served via the Akamai and
Mirror Image networks.
Product Research and Development
Our primary product research and development strategy is to
continually enhance the technology and feature set of our
commerce platforms and related technologies. To this end, we
continually have numerous development projects in process,
including ongoing enhancement of our commerce platforms,
improvements in our remote control capabilities, enhanced
international support, advanced product distribution
capabilities, and new marketing technologies. Product research
and development expenses were $20.6 million,
$14.1 million, and $10.0 million in 2005, 2004, and
2003 respectively.
We believe that the functionality and capabilities of our
commerce platforms are a competitive advantage and that we must
continue to invest in them to maintain our competitive position.
The Internet and
e-commerce, in
particular, are subject to rapid technological change, changes
in user and client requirements and expectations, new
technologies and evolving industry standards. To remain
successful, we must continually adapt to these and other
changes. We rely on internally developed, acquired and licensed
technologies to maintain the technological sufficiency of our
commerce platforms.
Competition
The market for
e-commerce solutions is
highly competitive. We compete with
e-commerce solutions
that our customers develop themselves or contract with third
parties to develop. We also compete with other outsourced
e-commerce providers.
The competition we encounter includes:
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In-house development of
e-commerce capabilities
using tools or applications from companies such as Art
Technology Group, Inc. and IBM Corporation; |
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E-Commerce capabilities custom-developed by companies such as
IBM Global Services, and Accenture, Inc.; |
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Other providers of outsourced
e-commerce solutions,
such as GSI Commerce, Inc., Macrovision Corporation, asknet Inc.
and eSellerate, Inc.; |
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Companies that provide technologies, services or products that
support a portion of the
e-commerce process,
such as payment processing, including CyberSource Corporation
and PayPal Corp.; |
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Companies that offer various online marketing services,
technologies and products, including ValueClick, Inc. and
aQuantive, Inc.; |
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High-traffic branded websites that generate a substantial
portion of their revenue from
e-commerce and may
offer or provide to others the means to offer their products for
sale, such as Amazon.com, Inc.; and |
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Web hosting, web services and infrastructure companies that
offer portions of our solution and are seeking to expand the
range of their offering, such as Network Solutions, LLC, Akamai
Technologies, Inc., Yahoo! Inc., eBay Inc. and Hostopia.com Inc. |
11
We believe that the principal competitive factors in our market
are the breadth of consumer products and services offered, the
number of clients and online channel partnerships, brand
recognition, system reliability and scalability, price, customer
service, ease of use, speed to market, convenience, and quality
of delivery. Some of the companies described above are clients
or potential clients, but they may choose to compete with us by
adopting a similar business model.
Intellectual Property
We believe the protection of our trademarks, copyrights, trade
secrets and other intellectual property is critical to our
success. We rely on patent, copyright and trademark enforcement,
contractual restrictions, and service mark and trade secret laws
to protect our proprietary rights. We have entered into
confidentiality and invention assignment agreements with our
employees and contractors, and nondisclosure agreements with
certain parties with whom we conduct business in order to limit
access to and disclosure of our proprietary information. We also
seek to protect our proprietary position by filing U.S. and
foreign patent applications related to our proprietary
technology, inventions and improvements that are important to
our business. We currently have nine U.S patents issued with
nine to seventeen years remaining prior to expiration. We also
have several patent applications pending. We pursue the
registration of our trademarks and service marks in the U.S. and
internationally. We have a number of registered trademarks in
the U.S., European Union and other countries.
Employees
As of March 3, 2006, we employed 948 people. We also employ
independent contractors and other temporary employees. None of
our employees are represented by a labor union, and we consider
our employee relations to be good. Competition for qualified
personnel in our industry is intense. We believe that our future
success will continue to depend, in part, on our continued
ability to attract, hire and retain qualified personnel.
Executive Officers
The following table sets forth information regarding our
executive officers at March 1, 2006:
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Name |
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Age | |
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Position | |
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Joel A. Ronning
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49 |
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Chief Executive Officer |
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Thomas M. Donnelly
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42 |
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Chief Financial Officer |
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Mr. Ronning founded Digital River in February 1994 and has
been our Chief Executive Officer and a director since that time.
From February 2001 through February 2004, Mr. Ronning also
was a member of the Office of the President. From February 1994
to July 1998, Mr. Ronning served as President of Digital
River. From May 1995 to December 1999, Mr. Ronning served
as Chairman of the Board of Directors of Tech Squared, Inc., a
direct catalog marketer of software and hardware products. From
May 1995 to July 1998, Mr. Ronning served as Chief
Executive Officer, Chief Financial Officer and Secretary of Tech
Squared. From May 1995 to August 1996, Mr. Ronning also
served as President of Tech Squared. Mr. Ronning founded
MacUSA, Inc., formerly a wholly-owned subsidiary of Tech
Squared, and served as a director of MacUSA, Inc. from April
1990 to December 1999. From April 1990 to July 1998,
Mr. Ronning also served as the Chief Executive Officer of
MacUSA, Inc.
Mr. Donnelly joined Digital River in February 2005 as Vice
President of Finance and Treasurer and was named Chief Financial
Officer and Secretary in July 2005. From March 1997 to May 2004,
he held various positions, including President, Chief Operating
Officer and Chief Financial Officer with Net Perceptions, Inc.,
a developer of software systems used to improve the
effectiveness of various customer interaction systems. From
March 1995 to March 1997, Mr. Donnelly served as a
financial and management consultant in the capacity of chief
financial officer or corporate controller for various public and
private companies and partnerships. Prior to 1995,
Mr. Donnelly served as an investment analyst for Marshall
Financial Group, a merchant banking company, Chief Financial
Officer of Medical Documenta-
12
tion Systems, Inc., a medical software company, and Controller
of Staats International, Inc., a defense subcontractor.
The risks described below are not the only ones facing our
company. Additional risks not presently known to us or that we
currently deem immaterial also may impair our business
operations. Our business, financial condition or results of
operations could be materially adversely affected by any of
these risks and the value of our common stock could decline due
to any of these risks. This annual report also contains
forward-looking statements that involve risks and uncertainties.
Our actual results could differ materially from those
anticipated in these forward-looking statements as a result of
certain factors, including the risks faced by us described below
and elsewhere in this report.
We have a limited profitable operating history.
Our limited profitable operating history, which we first
achieved in the quarter ended September 30, 2002, makes it
difficult to evaluate our ability to sustain profitability in
the future. The success of our business model depends upon our
success in generating sufficient transaction and service fees
from the use of our
e-commerce solutions by
existing and future clients. Accordingly, we must maintain our
existing relationships and develop new relationships with
software publishers, online retailers and physical goods
clients. To achieve this goal, we intend to continue to expend
significant financial and management resources on the
development of additional services, sales and marketing,
improved technology and expanded operations. If we are unable to
maintain existing, and develop new, client relationships, we
will not generate a profitable return on our investments and we
will be unable to gain meaningful market share to justify those
investments. Further, we may be unable to sustain profitability
if our revenues decrease or increase at a slower rate than
expected, or if operating expenses exceed our expectations and
cannot be adjusted to compensate for lower than expected
revenues.
A loss of any client that accounts for a large portion of our
revenue would cause our revenue to decline.
Sales of products for one software publisher client, Symantec
Corporation, accounted for approximately 29.7% of our revenue in
2005. In addition, in 2005, revenues derived from proprietary
Digital River services sold to Symantec end-users and dealer
network sales of Symantec products together amounted to
approximately $31.8 million, or approximately 14.4% of
total Digital River revenue. In addition, a limited number of
other software and physical goods clients contribute a large
portion of our annual revenue. Contracts with our clients are
generally one or two years in length. If any one of these key
contracts is not renewed or otherwise terminates, or if revenues
from these clients decline for any other reason (such as
competitive developments), our revenue would decline and our
ability to sustain profitability would be impaired. If our
contract with Symantec is not renewed or otherwise terminated,
or if revenues from Symantec and Symantec-related services
decline for any other reason, our revenue and our ability to
sustain profitability could be materially adversely impaired. It
is important to our ongoing success that we maintain our key
client relationships and, at the same time, develop new client
relationships.
Failure to properly manage and sustain our expansion efforts
could strain our management and other resources.
Through acquisitions and organic growth, we are rapidly and
significantly expanding our operations, both domestically and
internationally. We will continue to expand further to pursue
growth of our service offerings and customer base. This
expansion increases the complexity of our business and places a
significant strain on our management, operations, technical
performance, financial resources, and internal financial control
and reporting functions, and there can be no assurance that we
will be able to manage it effectively. Our personnel, systems,
procedures and controls may not be adequate to effectively
manage our future operations, especially as we employ personnel
in multiple domestic and international locations. We may not be
able to hire, train, retain and manage the personnel required to
address our growth. Failure to
13
effectively manage our growth opportunities could damage our
reputation, limit our future growth, negatively affect our
operating results and harm our business.
We intend to continue to expand our international operations
and these efforts may not be successful in generating additional
revenue.
We sell products and services to end-users outside the United
States and we intend to continue expanding our international
presence. In 2005, our international revenues represented
approximately 39% of our total revenues. Expansion into
international markets, particularly the European and
Asia-Pacific regions, requires significant resources that we may
fail to recover by generating additional revenue. Conducting
business outside of the United States is subject to risks,
including:
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Changes in regulatory requirements and tariffs; |
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Uncertainty of application of local commercial, tax, privacy and
other laws and regulations; |
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Reduced protection of intellectual property rights; |
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Difficulties in physical distribution for international sales; |
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Higher incidences of credit card fraud and difficulties in
accounts receivable collection; |
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The burden and cost of complying with a variety of foreign laws; |
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The possibility of unionization of our workforce outside the
United States, particularly in Europe; and |
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Political or economic constraints on international trade or
instability. |
These risks have grown with the acquisitions of element 5 and
SWReg, which have substantial operations outside the U.S., and
with our expansion into the Asia-Pacific region.
We may be unable to successfully and cost-effectively market,
sell and distribute our services in foreign markets. This may be
more difficult or take longer than anticipated especially due to
international challenges, such as language barriers, currency
exchange issues and the fact that the Internet infrastructure in
foreign countries may be less advanced than the
U.S. Internet infrastructure. If we are unable to
successfully expand our international operations, or manage this
expansion, our operating results and financial condition could
be harmed.
Our operating results are subject to fluctuations in demand
for products and services offered by us or our clients.
Our quarterly and annual operating results are subject to
fluctuations in demand for the products or services offered by
us or our clients, such as anti-virus software and anti-spyware
software. In particular, sales of anti-virus software
represented a significant portion of our revenues in recent
years, and continue to be very important to our business. Demand
for anti-virus software is subject to the unpredictable
introduction of significant computer viruses. In February 2006,
Microsoft Corporation announced plans to introduce products to
protect businesses and consumers from computer viruses and other
security risks. To the extent that Microsoft or others
successfully introduce products or services not sold through our
platform that are competitive with products and services sold by
current Digital River clients (including anti-virus products and
services), our revenues could be materially adversely affected.
New obligations to collect or pay transaction taxes could
substantially increase the cost to us of doing business.
Currently, we collect sales, use, value added tax (VAT) or
other similar transaction taxes with respect to electronic
software download and physical delivery of products in tax
jurisdictions where we believe we have taxable presences. The
application of transaction taxes to interstate and international
sales over the Internet is complex and evolving. We already are
required to collect and remit VAT in the European
14
Union, for example. Local, state or international jurisdictions
may seek to impose transaction tax collection obligations on
companies like ours that engage in
e-commerce, and they
may seek to impose taxes retroactively on past transactions that
we believed were exempt from transaction tax liability. A
successful assertion by one or more tax jurisdictions that we
should collect or were obligated to collect transaction taxes on
the products we sell could harm our results of operations.
We could be liable for fraudulent, improper or illegal uses
of our platforms.
In recent years revenues from our remote control
platforms have grown as a percentage of our overall business,
and we plan to continue to emphasize our self service
e-commerce solutions.
These platforms typically have an automated structure that
allows customers to use our
e-commerce services
without significant participation from Digital River personnel.
Despite our efforts to detect and contractually prohibit the
sale of inappropriate and illegal goods and services, the remote
control nature of these platforms makes it more likely that
transactions involving the sale of unlawful goods or services or
the violation of the proprietary rights of others may occur
before we become aware of them. Furthermore, unscrupulous
individuals may offer illegal products for sale via such
platforms under innocuous names, further frustrating attempts to
prevent inappropriate use of our services. Failure to detect
inappropriate or illegal uses of our platforms by third parties
could expose us to a number of risks, including fines, increased
fees or termination of services by payment processors or credit
card associations, risks of lawsuits, and civil and criminal
penalties.
Loss of our credit card acceptance privileges would seriously
hamper our ability to process the sale of merchandise.
The payment by end-users for the purchase of digital goods that
we process is typically made by credit card or similar payment
method. As a result, we must rely on banks or payment processors
to process transactions, and must pay a fee for this service.
From time to time, credit card associations may increase the
interchange fees that they charge for each transaction using one
of their cards. Any such increased fees will increase our
operating costs and reduce our profit margins. We also are
required by our processors to comply with credit card
association operating rules, and we have agreed to reimburse our
processors for any fines they are assessed by credit card
associations as a result of processing payments for us. The
credit card associations and their member banks set and
interpret the credit card rules. Visa, MasterCard, American
Express, or Discover could adopt new operating rules or
re-interpret existing rules that we or our processors might find
difficult to follow. We have had payment processing agreements
with certain of our payment processors terminated due to
violations of their rules, and although we have been able to
successfully migrate to new processors, such migrations require
significant attention from our personnel, and often result in
higher fees and customer dissatisfaction. Any disputes or
problems associated with our payment processors could impair our
ability to give customers the option of using credit cards to
fund their payments. If we were unable to accept credit cards,
our business would be seriously damaged. We also could be
subject to fines or increased fees from MasterCard and Visa if
we fail to detect that merchants are engaging in activities that
are illegal or activities that are considered high
risk, primarily the sale of certain types of digital
content. We may be required to expend significant capital and
other resources to monitor these activities.
Our failure to attract and retain software and digital
products publishers, manufacturers, online retailers and online
channel partners as clients would cause our revenue and
operating profits to decline.
We generate revenue by providing outsourced services to a wide
variety of companies, primarily in the software and high-tech
products markets. If we cannot develop and maintain satisfactory
relationships with software and digital products publishers,
manufacturers, online retailers and online channel partners on
acceptable commercial terms, we will likely experience a decline
in revenue and operating profit. We also depend on our software
and digital publisher clients creating and supporting software
and digital products that end-users will purchase. If we are
unable to obtain sufficient quantities of software and digital
products for any reason, or if the quality of service provided
by these software and digital products
15
publishers falls below a satisfactory level, we could also
experience a decline in revenue, operating profit and end-user
satisfaction, and our reputation could be harmed. Our contracts
with our software and digital products publisher clients are
generally one to two years in duration, with an automatic
renewal provision for additional one-year periods, unless we are
provided with a written notice at least 90 days before the
end of the contract. As is common in our industry, we have no
material long-term or exclusive contracts or arrangements with
any software or digital products publishers that guarantee the
availability of software or digital products. Software and
digital products publishers that currently supply software or
digital products to us may not continue to do so and we may be
unable to establish new relationships with software or digital
product publishers to supplement or replace existing
relationships.
Implementing our acquisition strategy could result in
dilution and operating difficulties leading to a decline in
revenue and operating profit.
We have acquired, and intend to continue engaging in strategic
acquisitions of businesses, technologies, services and products.
For example, in April 2004, we acquired element 5, and in
December 2005, we acquired Commerce5, each a provider of
outsourced e-commerce
solutions. The process of integrating an acquired business,
technology, service or product into our business and operations
may result in unforeseen operating difficulties and
expenditures. Integration of an acquired business also may
disrupt our ongoing business, distract management and make it
difficult to maintain standards, controls and procedures.
Moreover, the anticipated benefits of any acquisition may not be
realized. If a significant number of clients of the acquired
businesses cease doing business with us, we would experience
lost revenue and operating profit, and any synergies from the
acquisition may be lost. Future acquisitions could result in
potentially dilutive issuances of equity securities, the
incurrence of debt, contingent liabilities, amortization of
intangible assets or impairment of goodwill.
We may need to raise additional capital to achieve our
business objectives, which could result in dilution to existing
investors or increase our debt obligations.
We require substantial working capital to fund our business. In
January 2005, we filed a registration statement to increase our
available shelf registration amount from approximately
$55 million to $255 million. In addition, we filed an
acquisition shelf for up to approximately 1.5 million
shares. In February 2006, we filed a shelf registration that
would allow us to sell an undetermined amount of equity or debt
securities in accordance with the recently approved rules
applying to well-known seasoned issuers. If
additional funds are raised through the issuance of equity
securities, the percentage ownership of our stockholders will be
reduced and these equity securities may have rights, preferences
or privileges senior to those of our common stock. In June 2004,
we issued 1.25% convertible notes which require us to make
interest payments and will require us to pay principal when the
notes become due in 2024 or in the event of acceleration under
certain circumstances, unless the notes are converted into our
common stock prior to that. We may not have sufficient capital
to service this or any future debt securities that we may issue,
and the conversion of the notes into our common stock may result
in further dilution to our stockholders. Our capital
requirements depend on several factors, including the rate of
market acceptance of our products, the ability to expand our
client base, the growth of sales and marketing, and
opportunities for acquisitions of other businesses. We have had
significant operating losses and negative cash flow from
operations since inception. Additional financing may not be
available when needed, on terms favorable to us or at all. If
adequate funds are not available or are not available on
acceptable terms, we may be unable to develop or enhance our
services, take advantage of future opportunities or respond to
competitive pressures, which would harm our operating results
and adversely affect our ability to sustain profitability.
Our operating results have fluctuated in the past and are
likely to continue to do so, which could cause the price of our
common stock to be volatile.
Our quarterly and annual operating results have fluctuated
significantly in the past and are likely to continue to do so in
the future due to a variety of factors, some of which are
outside our control. As a result, we believe that
quarter-to-quarter and
year-to-year
comparisons of our revenue and operating results
16
are not necessarily meaningful, and that these comparisons may
not be accurate indicators of future performance. If our annual
or quarterly operating results fail to meet the guidance we
provide to securities analysts and investors or otherwise fail
to meet their expectations, the trading price of our common
stock will likely decline. Some of the factors that have or may
contribute to fluctuations in our quarterly and annual operating
results include:
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The addition of new clients or loss of current clients; |
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The introduction by us of new websites, web stores or services
that may require a substantial investment of our resources; |
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The introduction by others of competitive websites, web stores
or services or products; |
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Our ability to continue to upgrade and develop our systems and
infrastructure to meet emerging market needs and remain
competitive in our service offerings; |
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Economic conditions, particularly those affecting
e-commerce;
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Client decisions to delay new product launches or to invest in
e-commerce initiatives; |
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The performance of our newly acquired assets or companies; |
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Slower than anticipated growth of the online market as a vehicle
for the purchase of software products; |
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The cost of compliance with U.S. and foreign regulations
relating to our business; and |
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Our ability to retain and attract personnel commensurate with
our business needs. |
In addition, revenue generated by our software and digital
commerce services is likely to fluctuate on a seasonal basis
that is typical for the software publishing market in general.
We believe that our first and fourth quarters are generally
seasonally stronger than our second and third quarters due to
the timing of new product introductions, which generally do not
occur in the summer months, the holiday selling period, and the
post-holiday retail season.
Our operating expenses are based on our expectations of future
revenue. These expenses are relatively fixed in the short-term.
If our revenue for a quarter falls below our expectations and we
are unable to quickly reduce spending in response, our operating
results for that quarter would be harmed. In addition, the
operating results of companies in the electronic commerce
industry have, in the past, experienced significant
quarter-to-quarter
fluctuations that may adversely affect our stock price.
Security breaches could hinder our ability to securely
transmit confidential information.
A significant barrier to
e-commerce and
communications is the secure transmission of confidential
information over public networks. Any compromise or elimination
of our security could be costly to remedy, damage our reputation
and expose us to liability, and dissuade existing and new
clients from using our services. We rely on encryption and
authentication technology licensed from third parties to provide
the security and authentication necessary for secure
transmission of confidential information, such as
end-user credit card
numbers. A party who circumvents our security measures could
misappropriate proprietary information or interrupt our
operations.
We may be required to expend significant capital and other
resources to protect against security breaches or address
problems caused by breaches. Concerns over the security of the
Internet and other online transactions and the privacy of users
could deter people from using the Internet to conduct
transactions that involve transmitting confidential information,
thereby inhibiting the growth of our business. To the extent
that our activities or those of third-party contractors involve
the storage and transmission of proprietary information, such as
credit card numbers, security breaches could damage our
reputation and expose us to a risk of loss, fines or litigation
and possible liability. Our security measures may not prevent
security breaches, and failure to prevent security breaches
could lead to a loss of existing clients and also deter
potential clients away from our services.
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Claims of infringement of other parties intellectual
property rights could require us to expend significant
resources, enter into unfavorable licenses or require us to
change our business plans.
From time-to-time we
are named as a defendant in lawsuits claiming that we have, in
some way, violated the intellectual property rights of others.
Any assertions or prosecutions of claims like these, could
require us to expend significant financial and managerial
resources. The defense of any claims, with or without merit,
could be time-consuming, result in costly litigation and
diversion of technical and management personnel, cause product
enhancement delays or require that we develop non-infringing
technology or enter into royalty or licensing agreements.
Royalty or licensing agreements, if required, may be unavailable
on terms acceptable to us or at all. In the event of a
successful claim of infringement against us and our failure or
inability to develop non-infringing technology or license the
infringed or similar technology on a timely basis, we may be
unable to pursue our current business plan. We expect that we
will increasingly be subject to patent infringement claims as
our services expand in scope and complexity, and our results of
operation and financial condition could be materially adversely
affected.
Claims against us related to the software products that we
deliver electronically and the tangible goods that we deliver
physically could require us to expend significant resources.
We may become more vulnerable to third party claims as laws such
as the Digital Millennium Copyright Act, the Lanham Act and the
Communications Decency Act are interpreted by the courts. Claims
may be made against us for negligence, copyright or trademark
infringement, products liability or other theories based on the
nature and content of software products or tangible goods that
we deliver electronically and physically. Because we did not
create these products, we are generally not in a position to
know the quality or nature of the content of these products.
Although we carry general liability insurance and require that
our customers indemnify us against end-user claims, our
insurance and indemnification measures may not cover potential
claims of this type, may not adequately cover all costs incurred
in defense of potential claims, or may not reimburse us for all
liability that may be imposed. Any costs or imposition of
liability that are not covered by insurance or indemnification
measures could be expensive and time-consuming to address,
distract management and delay product deliveries, even if we are
ultimately successful in the defense of these claims.
The growth of the market for our services depends on the
development and maintenance of the Internet infrastructure.
Our business is based on highly reliable Internet delivery of
services. The success of our business therefore depends on the
development and maintenance of a sound Internet infrastructure.
This includes maintenance of a reliable network backbone with
the necessary speed, data capacity and security, as well as
timely development of complementary products, such as routers,
for providing reliable Internet access and services. Our ability
to increase the speed and scope of our services is limited by,
and depends upon, the speed and reliability of both the Internet
and our clients internal networks. Consequently, as
Internet usage increases, the growth of the market for our
services depends upon improvements made to the Internet as well
as to individual clients networking infrastructures to
alleviate overloading and congestion. In addition, any delays in
the adoption of new standards and protocols required to govern
increased levels of Internet activity or increased governmental
regulation may have a detrimental effect on the Internet
infrastructure.
Because the
e-commerce industry is
highly competitive and has low barriers to entry, we may be
unable to compete effectively.
The market for
e-commerce solutions is
extremely competitive and we may find ourselves unable to
compete effectively. Because there are relatively low barriers
to entry in the
e-commerce market, we
expect continued intense competition as current competitors
expand their product offerings and new competitors enter the
market. In addition, our clients may become competitors in the
future. Increased competition is likely to result in price
reductions, reduced margins, longer sales cycles and a decrease
or
18
loss of our market share, any of which could negatively impact
our revenue and earnings. We face competition from the following
sources:
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In-house development of
e-commerce capabilities
using tools or applications from companies, such as Art
Technology Group, Inc. and IBM Corporation; |
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E-Commerce capabilities custom-developed by companies, such as
IBM Global Services and Accenture, Inc.; |
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Other providers of outsourced
e-commerce solutions,
such as GSI Commerce, Inc., Macrovision Corporation, asknet Inc.
and eSellerate, Inc.; |
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Companies that provide technologies, services or products that
support a portion of the
e-commerce process,
such as payment processing, including CyberSource Corporation
and PayPal Corp.; |
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Companies that offer various online marketing services,
technologies and products, including ValueClick, Inc. and
aQuantive, Inc.; |
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High-traffic, branded websites that generate a substantial
portion of their revenue from
e-commerce and may
offer or provide to others the means to offer their products for
sale, such as Amazon.com, Inc.; and |
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Web hosting, web services and infrastructure companies that
offer portions of our solution and are seeking to expand the
range of their offering, such as Network Solutions, LLC, Akamai
Technologies, Inc., Yahoo! Inc., eBay Inc. and Hostopia.com Inc. |
We believe that the principal competitive factors in our market
are the breadth of products and services offered, the number of
clients and online channel partnerships, brand recognition,
system reliability and scalability, price, customer service,
ease of use, speed to market, convenience and quality of
delivery. The online channel partners and the other companies
described above may compete directly with us by adopting a
similar business model. Moreover, while some of these companies
also are clients or potential clients of ours, they may compete
with our e-commerce
outsourcing solution to the extent that they develop
e-commerce systems or
acquire such systems from other software vendors or service
providers.
Many of our competitors have, and new potential competitors may
have, more experience developing Internet-based software and
e-commerce solutions,
larger technical staffs, larger customer bases, more established
distribution channels and customer relationships, greater brand
recognition and greater financial, marketing and other resources
than we have. In addition, competitors may be able to develop
services that are superior to our services, achieve greater
customer acceptance or have significantly improved functionality
as compared to our existing and future products and services.
Our competitors may be able to respond more quickly to
technological developments and changes in customers needs.
Our inability to compete successfully against current and future
competitors could cause our revenue and earnings to decline.
Changes in government regulation could limit our Internet
activities or result in additional costs of doing business over
the Internet.
We are subject to the same international, federal, state and
local laws as other companies conducting business over the
Internet. Today, there are relatively few laws specifically
directed towards conducting business over the Internet. The
adoption or modification of laws related to the Internet could
harm our business, operating results and financial condition by
increasing our costs and administrative burdens. Due to the
increasing popularity and use of the Internet, many laws and
regulations relating to the Internet are being debated at the
international, federal and state levels. These laws and
regulations could cover issues such as:
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User privacy with respect to adults and minors; |
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Our ability to collect and/or share necessary information that
allows us to conduct business on the Internet; |
19
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Export compliance; |
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Pricing and taxation; |
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Fraud; |
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Advertising; |
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Intellectual property rights; |
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Information security; and |
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Quality of products and services. |
Applicability to the Internet of existing laws governing issues,
such as property ownership, copyrights and other intellectual
property issues, taxation, libel, obscenity and personal privacy
also could harm our operating results and substantially increase
the cost to us of doing business. For example, numerous state
legislatures have proposed that tax rules for Internet retailing
and catalog sales correspond to enacted tax rules for sales from
physical stores. Any requirement that we collect sales tax for
each online purchase and remit the tax to the appropriate state
authority would be a significant administrative burden to us,
and would likely depress online sales. This and any other change
in laws applicable to the Internet also might require
significant management resources to respond appropriately. The
vast majority of these laws were adopted prior to the advent of
the Internet, and do not contemplate or address the unique
issues raised thereby. Those laws that do reference the
Internet, such as the Digital Millennium Copyright Act, are only
beginning to be interpreted by the courts, and their
applicability and reach are therefore uncertain.
Failure to develop our technology to accommodate increased
traffic could reduce demand for our services and impair the
growth of our business.
We periodically enhance and expand our technology and
transaction-processing systems, network infrastructure and other
technologies to accommodate increases in the volume of traffic
on our technology platforms. Any inability to add software and
hardware or to develop and upgrade existing technology,
transaction-processing systems or network infrastructure to
manage increased traffic on this platform may cause
unanticipated systems disruptions, slower response times and
degradation in client services, including impaired quality and
speed of order fulfillment. Failure to manage increased traffic
could harm our reputation and significantly reduce demand for
our services, which would impair the growth of our business. We
may be unable to improve and increase the capacity of our
network infrastructure sufficiently or anticipate and react to
expected increases in the use of the platform to handle
increased volume. Further, additional network capacity may not
be available from third-party suppliers when we need it. Our
network and our suppliers networks may be unable to
maintain an acceptable data transmission capability, especially
if demands on the platform increase.
To remain competitive, we must continue to enhance and improve
the responsiveness, functionality and features of our
e-commerce platforms
and the underlying network infrastructure. If we incur
significant costs without adequate results, or are unable to
adapt rapidly to technological changes, we may fail to achieve
our business plan. The Internet and the
e-commerce industry are
characterized by rapid technological changes, changes in user
and client requirements and preferences, frequent new product
and service introductions embodying new technologies and the
emergence of new industry standards and practices that could
render our technology and systems obsolete. To be successful, we
must adapt to rapid technological changes by licensing and
internally developing leading technologies to enhance our
existing services, developing new products, services and
technologies that address the increasingly sophisticated and
varied needs of our clients, and responding to technological
advances and emerging industry standards and practices on a
cost-effective and timely basis. The development of our
proprietary technologies involves significant technical and
business risks. We may fail to use new technologies effectively
or fail to adapt our proprietary technology and systems to
client requirements or emerging industry standards.
20
System failures could reduce the attractiveness of our
service offerings.
We provide commerce, marketing and delivery services to our
clients and end-users through our proprietary technology
transaction processing and client management systems. These
systems also maintain an electronic inventory of products and
gather consumer marketing information. The satisfactory
performance, reliability and availability of the technology and
the underlying network infrastructure are critical to our
operations, level of client service, reputation and ability to
attract and retain clients. We have experienced periodic
interruptions, affecting all or a portion of our systems, which
we believe will continue to occur from
time-to-time. Any
systems damage or interruption that impairs our ability to
accept and fill client orders could result in an immediate loss
of revenue to us, and could cause some clients to purchase
services offered by our competitors. In addition, frequent
systems failures could harm our reputation.
Although we maintain system redundancies in multiple physical
locations, our systems and operations are vulnerable to damage
or interruption from:
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Fire, flood and other natural disasters; |
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Operator negligence, improper operation by, or supervision of,
employees, physical and electronic break-ins, misappropriation,
computer viruses and similar events; and |
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Power loss, computer systems failures, and Internet and
telecommunications failure. |
We do not carry sufficient business interruption insurance to
fully compensate us for losses that may occur.
We may become liable to clients who are dissatisfied with our
services.
We design, develop, implement and manage
e-commerce solutions
that are crucial to the operation of our clients
businesses. Defects in the solutions we develop could result in
delayed or lost revenue, adverse end-user reaction, and/or
negative publicity, which could require expensive corrections.
As a result, clients who experience these adverse consequences
either directly or indirectly by using our services could bring
claims against us for substantial damages. Any claims asserted
could exceed the level of any insurance coverage that may be
available to us. The successful assertion of one or more large
claims that are uninsured, that exceed insurance coverage or
that result in changes to insurance policies, including future
premium increases that could adversely affect our operating
results or financial condition.
We depend on key personnel.
Our future success significantly depends on the continued
services and performance of our senior management. Our
performance also depends on our ability to retain and motivate
our key technical employees who are skilled in maintaining our
proprietary technology platforms. The loss of the services of
any of our executive officers or key employees could harm our
business if we are unable to effectively replace that officer or
employee, or if that person should decide to join a competitor
or otherwise directly or indirectly compete with us. Further, we
may need to incur additional operating expenses and divert other
management time in order to search for a replacement.
Our future success depends on our ability to continue to
identify, attract, hire, train, retain and motivate highly
skilled personnel. Competition for these personnel is intense,
particularly in the Internet industry. We may be unable to
successfully attract, assimilate or retain sufficiently
qualified personnel. In making employment decisions,
particularly in the Internet and high-technology industries, job
candidates often consider the value of stock option grants they
are to receive in connection with their employment. Fluctuations
in our stock price may make it more difficult to retain and
motivate employees. Consequently, potential employees may
perceive our equity incentives as less attractive and current
employees whose equity incentives are no longer attractively
priced may choose not to remain with our organization. In that
case, our ability to attract employees will be adversely
affected. As a result, our ability to use stock options as
equity incentives will be adversely affected, which will make it
more difficult
21
to compete for and attract qualified personnel. Finally, should
our stock price substantially decline, the retention value of
stock options may weaken and employees who hold such options may
choose not to remain with our organization.
Protecting our intellectual property is critical to our
success.
We regard the protection of our trademarks, copyrights, trade
secrets and other intellectual property as critical to our
success. We rely on a combination of patent, copyright,
trademark, service mark and trade secret laws and contractual
restrictions to protect our proprietary rights. We have entered
into confidentiality and invention assignment agreements with
our employees and contractors, and nondisclosure agreements with
parties with whom we conduct business, in order to limit access
to and disclosure of our proprietary information. These
contractual arrangements and the other steps taken by us to
protect our intellectual property may not prevent
misappropriation of our technology or deter independent
third-party development of similar technologies. We also seek to
protect our proprietary position by filing U.S. patent
applications related to our proprietary technology, inventions
and improvements that are important to the development of our
business. Proprietary rights relating to our technologies will
be protected from unauthorized use by third parties only to the
extent they are covered by valid and enforceable patents or are
effectively maintained as trade secrets. We pursue the
registration of our trademarks and service marks in the U.S. and
internationally. Effective trademark, service mark, copyright
and trade secret protection may not be available in every
country in which our services are made available online.
The steps we have taken to protect our proprietary rights may be
inadequate and third parties may infringe or misappropriate our
trade secrets, trademarks and similar proprietary rights. Any
significant failure on our part to protect our intellectual
property could make it easier for our competitors to offer
similar services and thereby adversely affect our market
opportunities. In addition, litigation may be necessary in the
future to enforce our intellectual property rights, to protect
our trade secrets or to determine the validity and scope of the
proprietary rights of others. Litigation could result in
substantial costs and diversion of management and technical
resources.
Our clients sales cycles are lengthy, which may cause
us to incur substantial expenses and expend management time
without generating corresponding consumer revenue, which would
impair our cash flow.
We market our services directly to software publishers, online
retailers and other prospective customers outside of the
software industry. These relationships are typically complex and
take time to finalize. Due to operating procedures in many
organizations, a significant amount of time may pass between
selection of our products and services by key decision-makers
and the signing of a contract. The period between the initial
client sales call and the signing of a contract with significant
sales potential is difficult to predict and typically ranges
from six to twelve months. If at the end of a sales effort a
prospective client does not purchase our products or services,
we may have incurred substantial expenses and expended
management time that cannot be recovered and that will not
generate corresponding revenue. As a result, our cash flow and
our ability to fund expenditures incurred during the sales cycle
may be impaired.
The listing of our network addresses on anti-SPAM lists could
harm our ability to service our clients and deliver goods over
the Internet.
Certain privacy and anti-email proponents have engaged in a
practice of gathering, and publicly listing, network addresses
that they believe have been involved in sending unwanted,
unsolicited emails commonly known as SPAM. In response to user
complaints about SPAM, Internet service providers have from
time-to-time blocked
such network addresses from sending emails to their users. If
our network addresses mistakenly end up on these SPAM lists, our
ability to provide services for our clients and consummate the
sales of digital and physical goods over the Internet could be
harmed.
22
We are subject to regulations relating to consumer
privacy.
We collect and maintain end-user data for our clients, which
subjects us to increasing international, federal and state
regulations related to online privacy and the use of personal
user information. Congress has enacted anti-SPAM legislation
with which we must comply when providing email campaigns for our
clients. Legislation and regulations are pending in various
domestic and international governmental bodies that address
online privacy protections. Several governments have proposed,
and some have enacted, legislation that would limit the use of
personal user information or require online services to
establish privacy policies. In addition, the U.S. Federal
Trade Commission, or FTC, has urged Congress to adopt
legislation regarding the collection and use of personal
identifying information obtained from individuals when accessing
websites. In the past, the emphasis has been on information
obtained from minors. Focus has now shifted to include online
privacy protection for minors and adults.
Even in the absence of laws requiring companies to establish
these procedures, the FTC has settled several proceedings
resulting in consent decrees in which Internet companies have
been required to establish programs regarding the manner in
which personal information is collected from users and provided
to third parties. We could become a party to a similar
enforcement proceeding. These regulatory and enforcement efforts
could limit our collection of and/or ability to share with our
clients demographic and personal information from end-users,
which could adversely affect our ability to comprehensively
serve our clients.
The European Union has adopted a privacy directive that
regulates the collection and use of information that identifies
an individual person. These regulations may inhibit or prohibit
the collection and sharing of personal information in ways that
could harm our clients or us. The globalization of Internet
commerce may be harmed by these and similar regulations because
the European Union privacy directive prohibits transmission of
personal information outside the European Union. The United
States and the European Union have negotiated an agreement
providing a safe harbor for those companies who
agree to comply with the principles set forth by the
U.S. Department of Commerce and agreed to by the European
Union. Failure to comply with these principles may result in
fines, private lawsuits and enforcement actions. These
enforcement actions can include interruption or shutdown of
operations relating to the collection and sharing of information
pertaining to citizens of the European Union.
Compliance with future laws imposed on
e-commerce may
substantially increase our costs of doing business or otherwise
adversely affect our ability to offer our services.
Because our services are accessible worldwide, and we facilitate
sales of products to end-users worldwide, international
jurisdictions may claim that we are required to comply with
their laws. Laws regulating Internet companies outside of the
United States may be less favorable than those in the
United States, giving greater rights to consumers, content
owners and users. Compliance may be more costly or may require
us to change our business practices or restrict our service
offerings relative to those provided in the United States. Any
failure to comply with foreign laws could subject us to
penalties ranging from fines to bans on our ability to offer our
services.
As our services are available over the Internet in multiple
states and foreign countries, these jurisdictions may claim that
we are required to qualify to do business as a foreign
corporation in each state or foreign country. We and/or our
subsidiaries are qualified to do business only in certain
states. Failure to qualify as a foreign corporation in a
required jurisdiction could subject us to taxes and penalties
and could result in our inability to enforce contracts in these
jurisdictions.
In addition, we are subject to United States laws governing the
conduct of business with other countries, such as export control
laws, which prohibit or restrict the export of goods, services
and technology to designated countries, denied persons or denied
entities from the United States. Violation of these laws could
result in fines or other actions by regulatory agencies and
result in increased costs of doing business and reduced profits.
In addition, any significant changes in these laws, particularly
an expansion in export control laws, will increase our costs of
compliance and may further restrict our overseas client base.
23
We are exposed to foreign currency exchange risk.
Net revenues outside the United States accounted for
approximately 39% of our net revenues in 2005. The results of
operations of, and certain of our intercompany balances
associated with, our internationally-focused websites are
exposed to foreign exchange rate fluctuations. Upon translation,
net sales and other operating results from our international
operations may differ materially from expectations, and we may
record significant gains or losses on the remeasurement of
intercompany balances. If the U.S. dollar weakens against
foreign currencies, the translation of these
foreign-currency-denominated transactions will result in
increased net revenues and operating expenses. Similarly, our
net revenues and operating expenses will decrease if the
U.S. dollar strengthens against foreign currencies. As we
have expanded our international operations, our exposure to
exchange rate fluctuations has become more pronounced. We do not
currently have a currency hedging program to mitigate the effect
of fluctuations of currency prices on our financial results. See
Item 7A of Part II, for information demonstrating the
effect on our consolidated statements of operations from changes
in exchange rates versus the U.S. dollar.
Developments in accounting standards may cause us to increase
our recorded expenses, which in turn would jeopardize our
ability to demonstrate sustained profitability.
In January 2002, we adopted Statement of Financial Accounting
Standard No. 142, Goodwill and Other Intangible
Assets (SFAS No. 142). The statement generally
establishes that goodwill and intangible assets with indefinite
lives are not amortized, but are to be tested on an annual basis
for impairment and, if impaired, are recorded as an impairment
charge in income from operations. As of December 31, 2005,
we had goodwill with an indefinite life of $195.3 million
from our acquisitions. If our goodwill is determined for any
reason to be impaired, the subsequent accounting of the impaired
portion as an expense would lower our earnings and jeopardize
our ability to demonstrate sustained profitability.
In 2004, the Financial Accounting Standards Board adopted a
proposal to require that the fair value of stock options and
other share-based payments be reflected as an expense item in
the financial statements of public companies for annual periods
beginning after June 15, 2005. As a result of the adoption
of this proposal, our recorded non-cash expenses will
significantly increase in 2006, which could impair our ability
to maintain profitability.
Compliance with changing regulation of corporate governance
and public disclosure may result in additional expenses.
Keeping abreast of, and in compliance with, changing laws,
regulations and standards relating to corporate governance and
public disclosure, including the Sarbanes-Oxley Act of 2002, new
SEC regulations and the NASDAQ Stock Market rules, have required
an increased amount of management attention and external
resources. We intend to invest all reasonably necessary
resources to comply with evolving corporate governance and
public disclosure standards, and this investment may result in
increased general and administrative expenses and a diversion of
management time and attention from revenue-generating activities
to compliance activities.
Internet-related stock prices are especially volatile and
this volatility may depress our stock price or cause it to
fluctuate significantly.
The stock market, and the trading prices of Internet-related
companies in particular, have been notably volatile. This
volatility is likely to continue in the short-term and is not
necessarily related to the operating performance of affected
companies. This broad market and industry volatility could
significantly reduce the price of our common stock at any time,
without regard to our operating performance. Factors that could
cause our stock price in particular to fluctuate include, but
are not limited to:
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Actual or anticipated variations in quarterly operating results; |
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Announcements of technological innovations; |
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The ability to sign new clients and the retention of existing
clients; |
24
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New products or services that we offer; |
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Competitive developments, including new products or services, or
new relationships by our competitors; |
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Changes that affect our clients or the viability of their
product lines; |
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Changes in financial estimates by securities analysts; |
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Conditions or trends in the Internet and online commerce
industries; |
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Global unrest and terrorist activities; |
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Changes in the economic performance and/or market valuations of
other Internet or online
e-commerce companies; |
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Required changes in generally accepted accounting principles and
disclosures; |
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Our announcement of significant acquisitions, strategic
partnerships, joint ventures or capital commitments or results
of operations or other developments related to those
acquisitions; |
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Additions or departures of key personnel; and |
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Sales or other transactions involving our common stock or our
convertible notes. |
In addition, our stock price may be impacted by the short sales
and actions of other parties who may disseminate misleading
information about us in an effort to profit from fluctuations in
our stock price.
Provisions of our charter documents, other agreements and
Delaware law may inhibit potential acquisition bids for us.
Certain provisions of our amended and restated certificate of
incorporation, bylaws, other agreements and Delaware law could
make it more difficult for a third party to acquire us, even if
a change in control would be beneficial to our stockholders.
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ITEM 1B. |
UNRESOLVED STAFF COMMENTS |
None.
The following table summarizes the various facilities that we
lease for our business operations:
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Description of Use |
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Primary Locations |
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Square Footage(1) | |
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Lease Expirations | |
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Corporate Office Facilities
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Minnesota |
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133,000 |
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From 2006 to 2008 |
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Other U.S. Office Facilities
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California, Colorado, Illinois, Ohio, Utah, Washington |
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40,100 |
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From 2006 to 2010 |
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Non-U.S. Office Facilities
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Germany, Ireland, Japan, Korea, Taiwan, United Kingdom |
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47,600 |
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From 2006 to 2010 |
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Off Site U.S. Data Centers
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California, Minnesota |
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700 |
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From 2006 to 2007 |
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Off Site non U.S. Data Centers
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Germany, Ireland, United Kindom |
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200 |
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From 2006 to 2008 |
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(1) |
Includes sub-leased space. |
We believe our properties are suitable and adequate for our
present needs, and we periodically evaluate whether additional
facilities are necessary.
25
|
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ITEM 3. |
LEGAL PROCEEDINGS. |
We are subject to legal proceedings, claims and litigation
arising in the ordinary course of business. While the final
outcome of these matters is currently not determinable, we
believe there is no litigation pending against us that is likely
to have, individually or in the aggregate, a material adverse
effect on our consolidated financial position, results of
operation or cash flows. Because of the uncertainty inherent in
litigation, it is possible that unfavorable resolutions of these
lawsuits, proceedings and claims could exceed the amount we have
currently reserved for these matters.
Third parties have from
time-to-time claimed,
and others may claim in the future, that we have infringed their
intellectual property rights. We have been notified of several
potential patent disputes, and expect that we will increasingly
be subject to patent infringement claims as our services expand
in scope and complexity. We have in the past been forced to
litigate such claims. We also may become more vulnerable to
third-party claims as laws, such as the Digital Millennium
Copyright Act, the Lanham Act and the Communications Decency Act
are interpreted by the courts and as we expand geographically
into jurisdictions where the underlying laws with respect to the
potential liability of online intermediaries like ourselves are
either unclear or less favorable. These claims, whether
meritorious or not, could be time-consuming and costly to
resolve, cause service upgrade delays, require expensive changes
in our methods of doing business, or could require us to enter
into costly royalty or licensing agreements.
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ITEM 4. |
SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS. |
None.
PART II
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ITEM 5. |
MARKET FOR REGISTRANTS COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES. |
Price Range of Common Stock
Our common stock is traded on The NASDAQ Stock Market under the
symbol DRIV. The following table sets forth, for the
periods indicated, the high and low sale price per share of our
common stock on that market. These
over-the-counter market
quotations reflect inter-dealer prices, without retail mark-up,
markdown or commission, and may not necessarily represent actual
transactions.
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High | |
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Low | |
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2004
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First Quarter
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|
$ |
27.11 |
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$ |
19.38 |
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Second Quarter
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$ |
34.83 |
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$ |
22.44 |
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Third Quarter
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$ |
33.55 |
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$ |
22.75 |
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Fourth Quarter
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|
$ |
44.51 |
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$ |
28.83 |
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2005
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First Quarter
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|
$ |
41.82 |
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|
$ |
28.16 |
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Second Quarter
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$ |
33.73 |
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|
$ |
22.43 |
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Third Quarter
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$ |
41.75 |
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$ |
31.30 |
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Fourth Quarter
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$ |
39.39 |
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$ |
23.64 |
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As of March 1, 2006, there were approximately 392 holders
of record of our common stock. On March 1, 2006, the last
sale price reported on The NASDAQ Stock Market for our common
stock was $38.20 per share.
26
Dividend Policy
We have never declared or paid any cash dividends on our capital
stock. We intend to retain any future earnings to support
operations and to finance the growth and development of our
business and do not anticipate paying cash dividends for the
foreseeable future.
Issuer Purchases of Equity Securities
In April 2005, our Board of Directors authorized a new share
repurchase program of up to $50.0 million of our
outstanding shares of common stock. This new program superseded
and replaced the $5.0 million share repurchase program
adopted in 2001. Under the new program, the shares may be
repurchased in the open market or in privately negotiated
transactions. Repurchases are at our discretion based on ongoing
assessments of the capital needs of the business, the market
price of our common stock and general market conditions. No time
limit was set for the completion of the repurchase program.
Common stock repurchases in the fourth quarter of 2005 were as
follows:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Approximate Dollar | |
|
|
|
|
|
|
Total Number of | |
|
Value of Shares | |
|
|
|
|
Weighted Average | |
|
Shares Purchased as | |
|
That May yet be | |
|
|
Total Number of | |
|
Price Paid Per | |
|
Part of Publicly | |
|
Purchased Under the | |
Period |
|
Shares Purchased | |
|
Share | |
|
Announced Plan | |
|
Plan (In millions) | |
|
|
| |
|
| |
|
| |
|
| |
October 1 October 31, 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
46.5 |
|
November 1 November 30, 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
46.5 |
|
December 1 December 31, 2005
|
|
|
347,371 |
|
|
$ |
28.62 |
|
|
|
347,371 |
|
|
$ |
36.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
347,371 |
|
|
|
|
|
|
|
347,371 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities Authorized for Issuance under Equity Compensation
Plans
The information required in the table of Securities Authorized
for Issuance under Equity Compensation Plans is incorporated by
reference to our Proxy Statement in connection with our 2006
Annual Meeting to be filed in accordance with
Regulation 14A under the Securities Exchange Act of 1934,
as amended.
27
|
|
ITEM 6. |
SELECTED FINANCIAL DATA. |
The following selected financial data should be read in
conjunction with the Consolidated Financial Statements and
related notes and the MD&A appearing elsewhere in this
Form 10-K.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
2002 | |
|
2001 | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
(In thousands, except per share data) | |
Statement of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$ |
220,408 |
|
|
$ |
154,130 |
|
|
$ |
101,201 |
|
|
$ |
77,783 |
|
|
$ |
57,825 |
|
Costs and expenses (exclusive of depreciation and amortization
expense shown separately below) Direct cost of services
|
|
|
5,013 |
|
|
|
5,013 |
|
|
|
3,585 |
|
|
|
2,357 |
|
|
|
2,710 |
|
|
Network and infrastructure
|
|
|
19,814 |
|
|
|
15,143 |
|
|
|
12,253 |
|
|
|
11,405 |
|
|
|
10,200 |
|
|
Sales and marketing
|
|
|
69,256 |
|
|
|
51,749 |
|
|
|
37,220 |
|
|
|
32,437 |
|
|
|
27,489 |
|
|
Product research and development
|
|
|
20,575 |
|
|
|
14,097 |
|
|
|
9,962 |
|
|
|
11,454 |
|
|
|
11,192 |
|
|
General and administrative
|
|
|
21,474 |
|
|
|
16,894 |
|
|
|
9,228 |
|
|
|
9,299 |
|
|
|
4,701 |
|
|
Depreciation and amortization
|
|
|
8,833 |
|
|
|
8,203 |
|
|
|
7,275 |
|
|
|
6,009 |
|
|
|
4,627 |
|
|
Amortization of acquisition related intangibles(a)
|
|
|
8,730 |
|
|
|
8,269 |
|
|
|
5,380 |
|
|
|
5,738 |
|
|
|
17,009 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
|
153,695 |
|
|
|
119,368 |
|
|
|
84,903 |
|
|
|
78,699 |
|
|
|
77,928 |
|
Income (loss) from operations
|
|
|
66,713 |
|
|
|
34,762 |
|
|
|
16,298 |
|
|
|
(916 |
) |
|
|
(20,103 |
) |
Other income, net
|
|
|
4,967 |
|
|
|
1,641 |
|
|
|
838 |
|
|
|
406 |
|
|
|
881 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income tax expense
|
|
|
71,680 |
|
|
|
36,403 |
|
|
|
17,136 |
|
|
|
(510 |
) |
|
|
(19,222 |
) |
Income tax expense
|
|
|
17,337 |
|
|
|
1,079 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$ |
54,343 |
|
|
$ |
35,324 |
|
|
$ |
17,136 |
|
|
$ |
(510 |
) |
|
$ |
(19,222 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
|
|
Net income (loss) per share basic
|
|
$ |
1.57 |
|
|
|
1.09 |
|
|
$ |
0.58 |
|
|
$ |
(0.02 |
) |
|
$ |
(0.79 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
|
|
Net income (loss) per share diluted
|
|
$ |
1.36 |
|
|
|
0.96 |
|
|
$ |
0.52 |
|
|
$ |
(0.02 |
) |
|
$ |
(0.79 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares used in per-share calculation basic
|
|
|
34,536 |
|
|
|
32,328 |
|
|
|
29,398 |
|
|
|
26,791 |
|
|
|
24,285 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares used in per-share calculation diluted
|
|
|
41,448 |
|
|
|
38,532 |
|
|
|
33,051 |
|
|
|
26,791 |
|
|
|
24,285 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
2002 | |
|
2001 | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
(In thousands) | |
Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$ |
131,770 |
|
|
$ |
127,734 |
|
|
$ |
72,885 |
|
|
$ |
40,801 |
|
|
$ |
21,677 |
|
Short-term investments
|
|
|
220,569 |
|
|
|
164,402 |
|
|
|
59,037 |
|
|
|
|
|
|
|
9,978 |
|
Working capital
|
|
|
244,238 |
|
|
|
198,747 |
|
|
|
85,011 |
|
|
|
14,498 |
|
|
|
14,024 |
|
Total assets
|
|
|
669,140 |
|
|
|
504,521 |
|
|
|
189,658 |
|
|
|
96,534 |
|
|
|
78,780 |
|
Long-term obligations
|
|
|
195,022 |
|
|
|
195,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated deficit
|
|
|
(6,324 |
) |
|
|
(51,164 |
) |
|
|
(86,488 |
) |
|
|
(103,624 |
) |
|
|
(103,114 |
) |
Total stockholders equity
|
|
$ |
305,142 |
|
|
$ |
192,769 |
|
|
$ |
131,852 |
|
|
$ |
57,186 |
|
|
$ |
50,422 |
|
|
|
|
(a) |
|
In 2002, upon adoption of SFAS No. 142, Goodwill
and Other Intangible Assets, we discontinued the
amortization of goodwill. In 2001, prior to the adoption of
SFAS No. 142, we amortized $10.8 million of
goodwill. |
28
|
|
ITEM 7. |
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION. |
The discussion in this Annual Report contains forward-looking
statements that involve risks and uncertainties. Our actual
results could differ materially from those discussed below.
Additional factors that could cause or contribute to such
differences include, but are not limited to, those identified
below, and those discussed in the section entitled Risk
Factors, included elsewhere in this Annual Report. When
used in this document, the words believes,
expects, anticipates,
intends, plans, and similar expressions,
are intended to identify certain of these forward-looking
statements. However, these words are not the exclusive means of
identifying such statements. In addition, any statements that
refer to expectations, projections or other characterizations of
future events or circumstances are forward-looking statements.
The cautionary statements made in this document should be read
as being applicable to all related forward-looking statements
wherever they appear in this document.
Overview
We provide outsourced
e-commerce solutions
globally to a wide variety of companies primarily in the
software and high-tech products markets. We offer our clients a
broad range of services that enable them to effectively build,
manage, and grow online sales on a global basis. We focus on
helping our clients mitigate risk and grow their revenues. Our
services include online store design, development, and hosting,
store merchandising and optimization, order management, fraud
prevention screening, export controls and management, tax
management, digital product delivery via download, physical
product fulfillment, multi-lingual customer service,
e-mail marketing,
website optimization, web analytics and reporting.
|
|
|
Acquisitions and Comparability of Results. |
Our results of operations for the year ended December 31,
2005, include the results of acquisitions, including SWReg in
March 2005 and Commerce5, Inc. in December 2005. The results of
these acquisitions must be factored into any comparison of our
2005 results to the results for 2004 or 2003. See Note 4 of
our consolidated financial statements for the year ended
December 31, 2005, for pro forma financial information as
if these entities had been acquired on January 1, 2004.
Critical Accounting Policies
We prepare our consolidated financial statements in conformity
with accounting principles generally accepted in the United
States of America. As such, we are required to make certain
estimates, judgments and assumptions that we believe are
reasonable based upon the information available. These estimates
and assumptions affect the reported amounts of assets and
liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the periods
presented. The significant accounting policies that we believe
are the most critical in fully understanding and evaluating our
reported financial results are the following:
Revenue Recognition. We recognize revenue from services
rendered once all the following criteria for revenue recognition
have been met: (1) pervasive evidence of an agreement
exists; (2) the services have been rendered; (3) the
fee is fixed and determinable and not subject to refund or
adjustment; and (4) collection of the amounts due is
reasonably assured.
We evaluate the criteria outlined in Emerging Issues Task Force,
(EITF) Issues No. 99-19, Reporting Revenue
Gross as a Principal Versus Net as an Agent, in determining
whether it is appropriate to record the gross amount of product
sales and related costs or the net amount earned as net revenue.
We act as the merchant of record on most of the transactions
processed and have contractual relationships with our clients,
which obligate us to pay to the client a specified percentage of
each sale. We derive our revenue primarily from transaction fees
based on a percentage of the products sale price and fees from
services rendered associated with the
e-commerce and other
services provided to our clients and end customers. Our revenue
is recorded as net as generally our clients are subject to
inventory risks and control
29
customers product choices. Clients do not have the right
to take possession of the software applications used in the
delivery of services.
We also provide customers with various proprietary software
backup services. We recognize revenue for these backup services
upon delivery or based upon historical usage within the contract
period of the digital backup services when this information is
available. Digital backup services are recognized straight-line
over the life of the backup service when historical usage
information is unavailable. Shipping revenues are recorded net
of any associated costs.
We also, to a lesser extent, provide fee-based client services,
which include website design, custom development and
integration, analytical marketing and email marketing services.
If we receive payments for fee-based services in advance of
delivery, these amounts are deferred and recognized over the
service period.
Provisions for doubtful accounts and transaction losses and
authorized credits are made at the time of revenue recognition
based upon our historical experience. The provision for doubtful
accounts and transaction losses are recorded as charges to
operating expense, while the provision for authorized credits is
recognized as a reduction of net revenues.
Allowance for Doubtful Accounts. We must make estimates
and assumptions that can affect the amount of assets and
liabilities and the amounts of revenues and expenses we report
in any financial reporting period. We use estimates in
determining our allowance for doubtful accounts, which are based
on our historical experience and current trends. We must
estimate the collectability of our billed accounts receivable.
We analyze accounts receivable and consider our historical bad
debt experience, customer credit-worthiness, current economic
trends and changes in our customer payment terms when evaluating
the adequacy of the allowance for doubtful accounts. We must
make significant judgments and estimates in connection with the
allowance in any accounting period. There may be material
differences in our operating results for any period if we change
our estimates or if the estimates are not accurate.
Credit Card Chargeback Reserve. We use estimates based on
historical experience and current trends to determine accrued
chargeback expenses. Significant management judgments are used
and estimates made in connection with the accrued expenses in
any accounting period. There may be material differences in our
operating results for any period if we change our estimates or
if the estimates are not accurate.
Goodwill, Intangibles and Other Long-Lived Assets. We
depreciate property, plant and equipment, amortize certain
intangibles and certain other long-lived assets with definite
lives over their useful lives. Useful lives are based on our
estimates of the period of time over which the assets will
generate revenue or benefit our business. We review assets with
definite lives for impairment whenever events or changes in
circumstances indicate that the value we are carrying on our
financial statements for an asset may not be recoverable. Our
evaluation considers non-financial data such as changes in the
operating environment and business strategy, competitive
information, market trends and operating performance. If there
are indications that an impairment may be necessary, we use an
undiscounted cash flow analysis to determine the impairment
amount, if any. Assets with indefinite lives are reviewed for
impairment annually (or more frequently if there are indications
that an impairment may be necessary) utilizing the two-step
approach prescribed in Statement of Financial Accounting
Standards (SFAS) No. 142, Goodwill and Other
Intangible Assets. There have been no impairments of
goodwill and other intangible assets for the years 2005, 2004
and 2003.
Income Taxes and Deferred Taxes. We currently have
significant U.S. tax loss carryforwards resulting from the
tax deduction for exercise of stock options and acquired
operating tax loss carryforwards, and a lesser amount of
acquired foreign operating tax loss carryforwards. The benefit
of the loss carryforwards from exercise of stock options was
recognized as additional
paid-in-capital when
the deferred tax asset valuation allowance was removed in the
fourth quarter of 2005. The benefit of the acquired tax loss
carryforwards has been reserved by a valuation allowance
pursuant to GAAP. These valuation reserves of the deferred tax
asset will be removed if and when it is more likely than not
that the
30
deferred tax asset will be realized. We intend to evaluate the
need for a valuation allowance of the deferred tax asset on a
quarterly basis. If the benefit of these operating tax loss
carryforwards is recognized, we will not recognize the benefit
in the statement of income. Rather, the benefit will be
recognized as a reduction to goodwill. Deferred income taxes
reflect the tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes.
We may face challenges from domestic and foreign tax authorities
regarding the amount of tax due. These challenges may include
questions regarding the timing and amount of deductions and the
allocation of income among various tax jurisdictions. In
evaluating the exposure associated with various tax filing
positions, we record reserves for probable exposures. Based on
our evaluation of our tax position, we believe the amounts
related to these tax exposures are appropriately accrued and are
not material. To the extent we were to favorably resolve matters
for which accruals have been established or be required to pay
amounts in excess of the aforementioned reserves, our effective
tax rate in a given financial statement period may be impacted.
No provision has been made for federal income taxes on
approximately $9.0 million of our international
subsidiaries undistributed earnings as of December 31,
2005, since we plan to indefinitely reinvest all such earnings.
If these earnings were distributed to the U.S. in the form
of dividends or otherwise, then we would be subject to
U.S. income taxes on such earnings. The amount of
U.S. income taxes would be subject to adjustment for
foreign tax credits and for the impact of the
step-up basis resulting
from a Section 338 election made at the time of
acquisition. It is not practicable to determine the income tax
liability that might be incurred if these earnings were to be
distributed.
Results of Operations
The following table presents certain items from our consolidated
statements of operations as a percentage of total revenue for
the years indicated.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
Revenue
|
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
Costs and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct cost of services
|
|
|
2.3 |
|
|
|
3.3 |
|
|
|
3.6 |
|
|
Network and infrastructure
|
|
|
9.0 |
|
|
|
9.8 |
|
|
|
12.1 |
|
|
Sales and marketing
|
|
|
31.4 |
|
|
|
33.6 |
|
|
|
36.8 |
|
|
Product research and development
|
|
|
9.3 |
|
|
|
9.1 |
|
|
|
9.8 |
|
|
General and administrative
|
|
|
9.7 |
|
|
|
11.0 |
|
|
|
9.1 |
|
|
Depreciation and amortization
|
|
|
4.0 |
|
|
|
5.3 |
|
|
|
7.2 |
|
|
Amortization of acquisition-related costs
|
|
|
4.0 |
|
|
|
5.4 |
|
|
|
5.3 |
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
|
69.7 |
|
|
|
77.5 |
|
|
|
83.9 |
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
30.3 |
|
|
|
22.5 |
|
|
|
16.1 |
|
Other income, net
|
|
|
2.2 |
|
|
|
1.1 |
|
|
|
0.8 |
|
|
|
|
|
|
|
|
|
|
|
Income before income tax expense
|
|
|
32.5 |
|
|
|
23.6 |
|
|
|
16.9 |
|
Income tax expense
|
|
|
7.8 |
|
|
|
0.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
24.7 |
% |
|
|
22.9 |
% |
|
|
16.9 |
% |
|
|
|
|
|
|
|
|
|
|
Revenue. Our revenue increased to $220.4 million in
2005 from $154.1 million in 2004 and $101.2 million in
2003. The revenue increase in 2005 was primarily attributable to
higher online sales activity across our client base, growth in
the number of software publishers and online retailer clients we
served, increased sales from international sites, expanded
strategic marketing activities with a larger number of clients,
and acquisitions made during 2004 and 2005. Sales of security
software products for PCs represent the largest contributor to
our revenues. The revenue increase in 2004 as compared to 2003
31
resulted from higher online sales activity across the client
base, further expansion of our key client relationships,
marketing and merchandising activities that increased the size
of the average sale generated by our software publisher clients,
and acquisitions completed in 2004. Acquisitions made during
each of 2005, 2004 and 2003 generated approximately 2.0%, 16.1%
and 1.5% of our total revenue for those years, respectively.
International sales represented approximately 39%, 31% and 24%
of revenue in the years ended December 31, 2005, 2004 and
2003, respectively. That growth is attributable to a larger
number of international stores being operated for our clients as
well as the European outsourced
e-commerce providers we
acquired in 2004 and 2005. Sales of products for one software
publisher client, Symantec Corporation, accounted for
approximately 29.7% of our revenue in 2005, 27.2% in 2004 and
27.4% in 2003. In addition, revenues derived from proprietary
Digital River services sold to Symantec end-users and dealer
network sales of Symantec products amounted to approximately
14.4% of our total revenue in 2005, 10.8% in 2004 and 9.9% in
2003.
Direct Cost of Services. Our direct cost of services line
item primarily includes the personnel costs and costs related to
product fulfillment, physical on demand and our proprietary
back-up CD production.
Direct cost of service expense was $5.0 million in both
2005 and 2004, up from $3.6 million in 2003. The cost
remained flat in 2005 compared with 2004 as we were able to
leverage our installed infrastructure to support the higher
level of revenue. The increase in 2004 from 2003 resulted
primarily from personnel added to serve new clients, as well as
clients gained through acquisition of other businesses, and to
handle increased transaction volumes.
We currently believe that direct costs of services will increase
in absolute dollars in 2006 compared to 2005 as we continue to
expand our worldwide fulfillment capacity in order to meet
anticipated shipment volumes from sales and as we begin to
record expense related to stock-based compensation. See
Note 1 Nature of Operations and Summary
of Significant Accounting Policies in the consolidated
financial statements for a discussion of the impact of the
adoption of Financial Accounting Standards Board
(FASB) Statement No. 123R, Share Based
Payment, which became effective January 1, 2006.
Network and Infrastructure. Our network and
infrastructure expense line item primarily includes the
personnel costs and related expenses to operate and maintain our
technology platforms, customer service, data communication and
data center operations. Network and infrastructure expense was
$19.8 million in 2005, up from $15.1 million and
$12.3 million in 2004 and 2003, respectively. The increase
in 2005 from 2004, and in 2004 from 2003, resulted primarily
from personnel added to support our revenue growth as well as
those gained through acquisition of other businesses.
We currently believe that network and infrastructure expenses
will increase in absolute dollars in 2006 compared to 2005 as we
continue to expand our worldwide customer service capacity, as
we expand the number of operating global data centers, expected
increased network usage, which will drive higher Internet
connection charges, and as we begin to record expense related to
stock-based compensation. See Note 1
Nature of Operations and Summary of Significant Accounting
Policies in the consolidated financial statements for a
discussion of the impact of the adoption of FASB Statement
No. 123R, Share Based Payment, which became
effective January 1, 2006.
Sales and Marketing. Our sales and marketing expense line
item primarily includes personnel costs and related expenses,
advertising and promotional expenses, credit card transaction
and other payment processing fees, credit card chargebacks and
bad debt expense. Sales and marketing expense increased to
$69.3 million in 2005, from $51.7 million and
$37.2 million in 2004 and 2003, respectively. The increase
in 2005 from 2004 resulted primarily from increases in credit
card transaction fees of $11.9 million and an immaterial
amount of expenses of sales and marketing personnel added to
support our growth as well as those gained through acquisition
of other businesses. During 2005, we expanded the depth and
breadth of our strategic marketing programs that we manage on
behalf of our clients. These core programs include search engine
optimization, affiliate and email marketing and site
optimization. We also increased our marketing efforts to expand
our oneNetwork affiliate program. The increase in 2004 from 2003
resulted primarily from increases in credit card transaction
fees of $8.0 million and personnel related expenses,
including personnel of acquired businesses, of
$4.8 million. As a percentage of revenue, sales and
32
marketing expense decreased to 31.4% in 2005 from 33.6% in 2004
and 36.8% in 2003, primarily due to our revenue growing faster
than these expenses.
We currently believe that sales and marketing expenses will
increase in absolute dollars in 2006 compared to 2005, as we
continue to grow and expand our reach to clients, as we continue
to offer increased levels of strategic marketing services, as we
incur a full year of costs in 2006 related to acquisitions
completed in 2005, and as we begin to record expense related to
stock-based compensation. See Note 1
Nature of Operations and Summary of Significant Accounting
Policies in the consolidated financial statements for a
discussion of the impact of the adoption of FASB Statement
No. 123R, which became effective January 1, 2006.
Product Research and Development. Our product research
and development expense line item includes the costs of
personnel and related expenses associated with developing and
enhancing our technology platforms and other related systems.
Product research and development expense was $20.6 million
in 2005, compared to $14.1 million and $10.0 million
in 2004 and 2003, respectively. The increase in 2005 from 2004
resulted primarily from increases in personnel related expenses.
During 2005, we continued to advance our remote-control
technology, as well as the international and
e-marketing
capabilities. We capitalized approximately $0.4 million of
software development costs related to those efforts during 2005.
The increase in 2004 from 2003 resulted primarily from increases
in personnel related expenses, including personnel of acquired
businesses, of $3.9 million. In 2004, we also expanded and
redeployed our R&D team to advance our new self-service
remote control technology, and to develop the international and
e-marketing
capabilities. We capitalized approximately $2.7 million of
software development costs related to those efforts during 2004.
The amortization of capitalized development costs is included in
our depreciation expense line shown separately on our statement
of operations. As a percentage of revenue, product research and
development expense was 9.3% of sales in 2005 compared to 9.1%
in 2004 and 9.8% in 2003.
We currently believe that product research and development
expenses will increase in absolute dollars in 2006 compared to
2005, as we believe that continued investments in product
development are required to remain competitive, as we incur a
full year of costs in 2005 related to acquisitions completed in
2004 and as we begin to record expense related to stock-based
compensation. See Note 1 Nature of
Operations and Summary of Significant Accounting Policies
in the consolidated financial statements for a discussion of the
impact of the adoption of FASB Statement No. 123R, which
became effective January 1, 2006.
General and Administrative. Our general and
administrative expense line item primarily includes the costs of
executive, accounting, and administrative personnel and related
expenses, insurance expense, professional fees, including legal
and accounting, and shareholder and compliance expenses. General
and administrative expense increased to $21.5 million in
2005 from $16.9 million in 2004 and $9.2 million in
2003. The increase in 2005 from 2004 resulted primarily from the
addition of personnel and facilities to support our growth as
well as those gained through acquisition of other businesses.
The increase in 2004 from 2003 resulted primarily from increases
in personnel related expenses, legal and professional fees,
insurance charges and personnel of acquired businesses. As a
percentage of revenue, general and administrative expense
declined to 9.7% in 2005 from 11.0% in 2004 due to our ability
to spread administrative costs over the higher revenue base.
Between 2003 and 2004, general and administrative expense
increased from 9.1% to 11.0% as a percentage of revenue due to
the increase in professional, accounting, and legal fees
primarily associated with compliance with the Sarbanes-Oxley Act
and the growth of our international operations.
We currently believe that general and administrative expenses
will increase in absolute dollars in 2006 compared to 2005, as
we continue to invest in our infrastructure to support our
continued organic growth, as we incur a full year of costs in
2006 related to acquisitions completed in 2005 and as we begin
to record expense related to stock-based compensation. See
Note 1 Nature of Operations and Summary of
33
Significant Accounting Policies in the consolidated
financial statements for a discussion of the impact of the
adoption of FASB Statement No. 123R, which became effective
January 1, 2006.
Depreciation and Amortization. Our depreciation and
amortization expense line item includes the depreciation of
computer equipment and office furniture and the amortization of
purchased and internally developed software, leasehold
improvements made to our leased facilities, and debt financing
costs. Computer equipment, software and furniture are
depreciated under the straight-line method using three to seven
years lives, and leasehold improvements are amortized over the
shorter of the life of the asset or the remaining length of the
lease. Depreciation and amortization expense increased to
$8.8 million in 2005 from $8.2 million in 2004 and
$7.3 million in 2003. The increased expenses in 2005 and
2004 resulted primarily from increases in our assets, as gross
capitalized property and equipment increased to
$52.0 million on December 31, 2005, from
$41.1 million and $32.4 million on December 31,
2004 and 2003, respectively. We currently believe that
depreciation and amortization expenses will increase in absolute
dollars in 2006 compared to 2005 as we continue to expand our
worldwide customer support capacity and expand the number of
operating global data centers.
Amortization of Acquisition Related Intangibles. Our
amortization of acquisition-related intangibles line item
consists of the amortization of intangible assets recorded from
our 15 acquisitions in the past four years. Amortization of
acquisition related intangibles increased to $8.7 million
in 2005 from $8.3 million in 2004 and $5.4 million in
2003. The increase in 2005 from 2004 and 2003 reflects the
increased amortization of 2005 acquisitions partially offset by
full amortization of certain past acquisitions. We complete our
annual goodwill impairment test using a two-step approach in the
fourth quarter of each year. Our assessment has indicated that
there is no impairment of goodwill for the years ended
December 31, 2005, 2004 and 2003. We have purchased, and
expect to continue purchasing, assets or businesses, which may
include the purchase of intangible assets.
Income from Operations. Our income from operations in
2005 was $66.7 million, up from $34.8 million in 2004
and $16.3 million in 2003. As a percentage of revenue,
income from operations was 30.3% in 2005, 22.5% in 2004 and
16.1% in 2003. The increase in income from operations in 2005
and 2004 resulted primarily from growth in revenue while our
cost of revenue and operating expenses grew at a slower rate.
Other Income, Net. Our other income, net line item is the
total of interest income on our cash, cash equivalents, and
short-term investments, interest expense on our debt and foreign
currency transaction gains and losses. Interest income was
$9.7 million, $3.2 million and $0.8 million in
2005, 2004 and 2003, respectively. Interest expense was
$2.5 million in 2005 compared with $1.5 million in
2004 and no corresponding interest expense in 2003. Losses from
foreign currency were $2.2 million in 2005, and gains or
losses were immaterial in 2004 and 2003.
Income Taxes. In 2005, our tax expense was
$17.3 million, made up of approximately $28.5 million
of current tax expense and $11.2 million of deferred tax
benefit. In 2004, our tax expense was $1.1 million, made up
of international current tax expense. We had no tax expense in
2003.
As of December 31, 2005, we had net U.S. tax loss
carryforwards of approximately $117.2 million, and foreign
tax loss carryforwards of $8.0 million. The
U.S. amount consists of $75.2 million of deductions
resulting from exercise of stock options and $42.0 million
of acquired net operating losses. These tax loss carryforwards
expire in the years 2020 through 2024. The acquired net
operating losses expire in the years 2020 through 2025 and are
subject to other deductibility restrictions discussed below.
In prior years, there was uncertainty of future realization of
the deferred tax assets resulting from temporary differences and
from tax loss carryforwards from operations and stock option
deductions, therefore a valuation allowance equal to the
deferred tax assets was recorded. We have evaluated our deferred
tax assets related to tax loss carryforwards from stock option
deductions and concluded that the valuation allowance should be
reversed. We have met the requirements under GAAP as we believe
it is more likely than not that we will realize the benefit of
these deferred tax assets. This is based primarily on our
earnings history over the last three years as well as our
expected future taxable income. The impact on
34
U.S. taxable income of stock option deductions should not
reduce taxable income to a level that would jeopardize this
conclusion or unreasonably extend the period in which we may
recognize the tax benefit associated with these deferred tax
assets. We also have evaluated our deferred tax assets related
to acquired operating losses and we believe a full valuation
allowance for these assets is required under GAAP. This
valuation allowance is due to anticipated limitations, including
limitations under Section 382 of the Internal Revenue Code,
on acquired losses and any future release of this valuation
allowance will reduce goodwill.
Comprehensive Income. Comprehensive income includes
revenues, expenses, gains and losses that are excluded from net
earnings under GAAP. Items of comprehensive income are
unrealized gains and losses on short term investments and
foreign currency translation adjustments which are added to net
income to compute comprehensive income. Comprehensive income is
net of income tax benefits or expense.
In 2005, comprehensive income includes $1.3 million net of
the tax benefit of $0.8 million recorded for unrealized
foreign exchange losses on the revaluation of investments in
foreign subsidiaries; and $0.8 million net of
$0.5 million benefit for unrealized investment losses.
There was no tax benefit or expense for comprehensive income in
2004 and 2003 as we had no tax expense.
Liquidity and Capital Resources
As of December 31, 2005, we had $131.8 million of cash
and cash equivalents, $220.6 million of short-term
investments, and working capital of $244.2 million. The
major components of our working capital are cash and cash
equivalents, short-term investments and short-term receivables
net of client and merchant payables. Our primary source of
internal liquidity is our operating activities. Net cash
provided by operating activities in 2005, 2004 and 2003 was
$119.8 million, $85.1 million and $47.8 million,
respectively. Net cash provided by operating activities in 2005
was the result of net income, the tax benefit of stock-based
compensation and increases in accounts payable and other accrued
liabilities partially offset by increases in deferred and other
income taxes and accounts receivable. Net cash provided by
operating activities in 2004 was the result of net income and
increases in accounts payable and other accrued liabilities
partially offset by increases in accounts receivable. Net cash
provided by operating activities in 2003 was primarily due to an
increase in net income, declining accounts receivable, and
increases in accounts payable and other accrued liabilities.
Net cash used in investing activities was $125.4 million in
2005 and was the result of net purchases of investments of
$62.9 million, cash paid for acquisitions, net of cash
received, of $54.2 million, and purchases of capital
equipment of $8.3 million. Net cash used in investing
activities in 2004 was $241.4 million and was the result of
net purchases of investments of $105.6 million cash paid
for acquisitions, net of cash received, of $126.5 million
and purchases of capital equipment of $6.6 million and
capitalized internal-use software of $2.7 million. Net cash
used in investing activities was $72.2 million in 2003 and
was the result of purchases of investments of
$59.0 million, purchases of capital equipment of
$6.3 million and cash paid for acquisitions, net of cash
received, of $6.9 million.
In December 2005, we acquired all of the capital stock of
Commerce5, Inc., an outsourced
e-commerce provider to
high-tech and consumer electronics manufacturers. Under terms of
the agreement, we paid $45 million in cash. In March 2005,
we acquired SWReg, an operating business of Atlantic Coast plc,
a private limited UK company, for $8.8 million in cash. In
November 2004, we acquired all of the outstanding stock of
BlueHornet Networks, Inc. Under the terms of the agreement we
issued 160,185 shares of common stock to BlueHornet
shareholders and assumed debt obligations of BlueHornet totaling
approximately $0.7 million. In June 2004, we acquired
substantially all of the assets and assumed certain liabilities
of Fireclick, Inc. Under the terms of the agreement, we paid
$7.5 million in cash. In April 2004, we acquired element 5
AG, a privately held company based in Germany. Under the terms
of the acquisition, we paid $120 million in cash to acquire
all of the outstanding shares of capital stock of element 5.
35
Net cash provided by financing activities in 2005, 2004 and 2003
was $12.3 million, $209.0 million and
$56.5 million, respectively. Our external financing has
been provided primarily by the sale of our stock and convertible
notes in private and public offerings, and, to a lesser extent,
by sales to employees under our employee stock purchase plan and
by exercise of stock options. In June 2004, we sold and issued
$175 million in aggregate principal amount of
1.25% convertible senior notes due January 1, 2024, in
a private, unregistered offering. The notes were subsequently
registered for resale. The notes were sold at 100% of their
principal amount. The initial purchasers exercised in full their
option to purchase up to an additional $20 million in
aggregate principal amount of the notes, closing on July 6,
2004. Cash provided from the issuance of convertible senior
notes in 2004 totaled $188.4 million, net of financing
expense. In 2003, a secondary offering of our common stock
provided $43.4 million of cash. Proceeds from the exercise
of stock options provided cash of $23.2 million,
$19.7 million and $12.3 million in 2005, 2004 and
2003, respectively. In 2005, we repurchased $13.1 million
of common stock, which reduced our net cash provided by
financing activities. There were no stock repurchases in 2004
and 2003.
Liquidity and Capital Resource Requirements
We believe that existing sources of liquidity and the results of
our operations will provide adequate cash to fund our ongoing
operations for the foreseeable future, although we may seek to
raise additional capital during that period. In January 2005, we
filed a registration statement to increase our available shelf
registration amount from approximately $55 million to
approximately $255 million. In addition, we filed an
acquisition shelf for up to approximately 1.5 million
shares. In February 2006, we filed a shelf registration that
would allow us to sell an undetermined amount of equity or debt
securities in accordance with the recently approved rules
applying to well known seasoned issuers. These
filings were made to provide future flexibility for acquisition
and financing purposes. The sale of additional equity or
convertible debt securities could result in additional dilution
to our stockholders. There can be no assurances that financing
will be available in amounts or on terms acceptable to us, if at
all.
Contractual Obligations
At December 31, 2005, our principal commitments consisted
of interest and principal on our convertible senior notes and
long-term obligations outstanding under operating leases.
Although we have no material commitments for capital
expenditures, we anticipate continued capital expenditures
consistent with our anticipated growth in operations,
infrastructure and personnel. We expect that our operating
expenses will continue to grow as our overall business grows and
that they will be a material use of our cash resources.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payment Due by Period | |
|
|
| |
|
|
Total Amount | |
|
|
|
2011 and | |
Contractual Obligations |
|
Committed | |
|
2006 | |
|
2007-2008 | |
|
2009-2010 | |
|
Thereafter | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
(In thousands) | |
Operating Lease Obligations
|
|
$ |
7,761 |
|
|
$ |
2,921 |
|
|
$ |
3,999 |
|
|
$ |
841 |
|
|
$ |
0 |
|
Convertible Senior Notes
|
|
$ |
238,875 |
|
|
$ |
2,438 |
|
|
$ |
4,875 |
|
|
$ |
4,875 |
|
|
$ |
226,687 |
|
Total
|
|
$ |
246,636 |
|
|
$ |
5,359 |
|
|
$ |
8,874 |
|
|
$ |
5,716 |
|
|
$ |
226,687 |
|
With respect to our convertible senior notes, we are required to
pay interest on the notes on January 1 and July 1 of each
year. The notes bear interest at a rate of 1.25% and, if
specified conditions are met, are convertible into our common
stock at a conversion price of $44.063 per share. The notes
may be surrendered for conversion under certain circumstances,
including the satisfaction of a market price condition, such
that the price of our common stock reaches a specified
threshold; the satisfaction of a trading price condition, such
that the trading price of the notes falls below a specified
level; the redemption of the notes by us; the occurrence of
specified corporate transactions, as defined in the related
indenture; and the occurrence of a fundamental change, as
defined in the related indenture. The initial conversion price
is equivalent to a conversion rate of approximately
22.6948 shares per $1,000 of principal amount of the notes.
We will adjust the conversion price if certain events occur, as
specified in the related
36
indenture, such as the issuance of our common stock as a
dividend or distribution or the occurrence of a stock
subdivision or combination. If a fundamental change, such as a
change in our control, as defined in the related indenture,
occurs on or before January 1, 2009, we also may be
required to purchase the notes for cash and pay an additional
make-whole premium payable in our common stock, or in the same
form of consideration into which all, or substantially, all of
the shares of our common stock have been converted or exchanged
in connection with the fundamental change, upon the repurchase
or conversion of the notes in connection with the fundamental
change. Holders of the notes have the right to require us to
repurchase their notes prior to maturity on January 1,
2009, 2014 and 2019. We have the right to redeem the notes,
under certain circumstances, on or after July 1, 2007, and
prior to January 1, 2009, and we may redeem the notes at
any time on or after January 1, 2009.
2006 Outlook
We believe the outlook for our business remains positive for
2006. Total online sales continue to increase globally and
buyers appear increasingly comfortable shopping and purchasing
online. In our core market, trends continue to favor the
transition from packaged, physical delivery of software products
to electronic download. In addition, our strategic marketing
programs have been well received by our clients to date and we
believe we can expand adoption of these services by additional
clients as well as add new services. We anticipate making
additional investments to support existing client growth, new
client additions, development of other complementary vertical
markets, international expansion and improvements in our
technology platform.
New Accounting Standards
In December 2004, the FASB issued Statement No. 123
(revised 2004), Share-Based Payment
(SFAS 123(R)), which requires the measurement
and recognition of compensation expense for all stock-based
compensation payments and supersedes the accounting under
Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees
(APB 25). SFAS 123(R) is effective for all
annual periods beginning after June 15, 2005. In March
2005, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 107 (SAB 107)
relating to the adoption of SFAS 123(R).
We will adopt SFAS 123(R) in the first quarter of fiscal
2006 using the modified prospective method, which requires
measurement of compensation cost for all stock-based awards at
fair value on date of grant and recognition of compensation over
the service period for awards expected to vest. The fair value
of restricted stock and restricted stock units is determined
based on the number of shares granted and the quoted price of
our common stock, and the fair value of stock options will be
determined using the Black-Scholes valuation model. We will
continue to evaluate the impact of SFAS 123(R) on our
operating results and financial condition. As a result of the
provisions of SFAS 123(R) and SAB 107, we expect the
compensation charges under SFAS 123(R) to reduce diluted
net income per share by approximately $0.22 per share for
fiscal 2006. However, our assessment of the estimated
compensation charges will be affected by our stock price as well
as assumptions regarding a number of complex and subjective
variables and their related tax impacts. These variables
include, but are not limited to, the volatility of our stock
price and employee stock option exercise behaviors.
In November 2005, the FASB issued Staff Position
No. FAS 115-1, The Meaning of
Other-Than-Temporary Impairment and its Application to Certain
Investments (FSP 115-1). FSP 115-1 provides
accounting guidance for determining and measuring
other-than-temporary impairments of debt and equity securities,
and confirms the disclosure requirements for investments in
unrealized loss positions as outlined in EITF
issue 03-01,
The Meaning of Other-Than-Temporary Impairments and its
Application to Certain Investments. The accounting
requirements of FSP 115-1 are effective for us on
January 1, 2006, and are not expected to have a material
impact on our consolidated financial position, results of
operations or cash flows.
37
Off Balance Sheet Arrangements
None
|
|
ITEM 7A. |
QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET
RISK. |
Interest Rate Risk
Our portfolio of cash equivalents and short-term investments is
maintained in a variety of securities, including government
obligations and money market funds. Investments are classified
as available-for-sale securities and carried at their market
value with cumulative unrealized gains or losses recorded as a
component of accumulated other comprehensive
income/(loss) within stockholders equity. At
December 31, 2005 and 2004, all securities held had
maturities or reset dates of less than three years. A sharp rise
in interest rates could have an adverse impact on the market
value of certain securities in our portfolio. We do not
currently hedge our interest rate exposure and do not enter into
financial instruments for trading or speculative purposes or
utilize derivative financial instruments. A hypothetical and
immediate one percent (1%) increase in interest rates would
decrease the fair value in our investment portfolio held at
December 31, 2005 and 2004, by $1.77 million and by
$0.3 million, respectively. A hypothetical and immediate
one percent (1%) decrease in interest rates would increase the
fair value in our investment portfolio held at December 31,
2005 and 2004, by $1.77 million and by $0.4 million,
respectively. The approximate gains or losses in earnings are
estimates, and actual results could vary due to the assumptions
used. At December 31, 2005 and 2004, we had
$195.0 million of 1.25% fixed rate contingent convertible
debt outstanding. We presently believe there is minimal risk
that market interest rates will drop significantly below 1.25%.
Foreign Currency Risk
Our business has historically been transacted primarily in the
U.S. dollar and, as such, has not been subject to material
foreign currency exchange rate risk. However, the growth in our
international operations has increased our exposure to foreign
currency fluctuations as well as other risks typical of
international operations, including, but not limited to,
differing economic conditions, changes in political climate,
differing tax structures and other regulations and restrictions.
Accordingly, our future results could be materially adversely
impacted by changes in these or other factors.
Foreign exchange rate fluctuations may adversely impact our
consolidated results of operations as exchange rate fluctuations
on transactions denominated in currencies other than our
functional currencies result in gains and losses that are
reflected in our consolidated statement of income. To the extent
the U.S. dollar weakens against foreign currencies, the
translation of these foreign currency-denominated transactions
will result in increased net revenues and operating expenses.
Conversely, our net revenues and operating expenses will
decrease when the U.S. dollar strengthens against foreign
currencies. We do not currently have a currency hedging program
to mitigate the effect of fluctuations of currency prices on our
financial results. The following schedule summarizes revenue,
costs and expenses and income from operations that would have
resulted had exchange rates in the current period been the same
as those in effect in the comparable prior-year period for
operating results.
38
The effect on our consolidated statements of operations from
changes in exchange rates versus the U.S. Dollar is as
follows (in thousands):
|
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2005 | |
|
Year Ended December 31, 2004 | |
|
Year Ended December 31, 2003 | |
|
|
| |
|
| |
|
| |
|
|
At Prior | |
|
Exchange | |
|
|
|
At Prior | |
|
Exchange | |
|
|
|
At Prior | |
|
Exchange | |
|
|
|
|
Year | |
|
Rate | |
|
As | |
|
Year | |
|
Rate | |
|
As | |
|
Year | |
|
Rate | |
|
As | |
|
|
Rates(1) | |
|
Effect(2) | |
|
Reported | |
|
Rates(1) | |
|
Effect(2) | |
|
Reported | |
|
Rates(1) | |
|
Effect(2) | |
|
Reported | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Revenue
|
|
$ |
220,625 |
|
|
$ |
(217 |
) |
|
$ |
220,408 |
|
|
$ |
150,182 |
|
|
$ |
3,948 |
|
|
$ |
154,130 |
|
|
$ |
97,872 |
|
|
$ |
3,329 |
|
|
$ |
101,201 |
|
Costs and expenses
|
|
|
153,688 |
|
|
|
7 |
|
|
|
153,695 |
|
|
|
117,736 |
|
|
|
1,632 |
|
|
|
119,368 |
|
|
|
84,726 |
|
|
|
177 |
|
|
|
84,903 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
66,937 |
|
|
|
(224 |
) |
|
|
66,713 |
|
|
|
32,446 |
|
|
|
2,316 |
|
|
|
34,762 |
|
|
|
13,146 |
|
|
|
3,152 |
|
|
|
16,298 |
|
Other income, net
|
|
|
7,210 |
|
|
|
(2,243 |
) |
|
|
4,967 |
|
|
|
1,611 |
|
|
|
30 |
|
|
|
1,641 |
|
|
|
707 |
|
|
|
131 |
|
|
|
838 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income tax expense
|
|
|
74,147 |
|
|
|
(2,467 |
) |
|
|
71,680 |
|
|
|
34,057 |
|
|
|
2,346 |
|
|
|
36,403 |
|
|
|
13,853 |
|
|
|
3,283 |
|
|
|
17,136 |
|
Income tax expense
|
|
|
17,337 |
|
|
|
|
|
|
|
17,337 |
|
|
|
1,079 |
|
|
|
|
|
|
|
1,079 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$ |
56,810 |
|
|
$ |
(2,467 |
) |
|
$ |
54,343 |
|
|
$ |
32,978 |
|
|
$ |
2,346 |
|
|
$ |
35,324 |
|
|
$ |
13,853 |
|
|
$ |
3,283 |
|
|
$ |
17,136 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
Represents the outcome that would have resulted had exchange
rates in the current period been the same as those in effect in
the comparable prior-year period for operating results. |
|
(2) |
Represents the increase (decrease) in reported amounts resulting
from changes in exchange rates from those in effect in the
comparable prior-year period for operating results. |
Foreign exchange rate fluctuations may adversely impact our
consolidated financial position as well as our consolidated
results of operations. Foreign exchange rate fluctuations may
adversely impact our financial position as the assets and
liabilities of our foreign operations are translated into
U.S. dollars in preparing our consolidated balance sheet.
These gains or losses are recognized as an adjustment to
stockholders equity through accumulated other
comprehensive income/(loss) net of tax benefit or expense. The
potential loss in fair value resulting from a hypothetical 10%
adverse currency movement is $11.6 million and
$13.3 million for 2005 and 2004, respectively.
39
|
|
ITEM 8. |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. |
Our Financial Statements and Notes thereto appear beginning at
page 49 of this report.
QUARTERLY FINANCIAL DATA (UNAUDITED)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended | |
|
|
| |
|
|
March 31 | |
|
June 30 | |
|
September 30 | |
|
December 31 | |
|
|
| |
|
| |
|
| |
|
| |
|
|
(In thousands, except per share data) | |
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$ |
54,529 |
|
|
$ |
51,143 |
|
|
$ |
53,179 |
|
|
$ |
61,557 |
|
Income from operations(a)
|
|
|
17,782 |
|
|
|
14,565 |
|
|
|
15,532 |
|
|
|
18,834 |
|
Net income
|
|
|
14,037 |
|
|
|
10,226 |
|
|
|
12,358 |
|
|
|
17,722 |
|
Net income per share basic
|
|
$ |
0.41 |
|
|
$ |
0.30 |
|
|
$ |
0.35 |
|
|
$ |
0.50 |
|
Net income per share diluted(b)
|
|
$ |
0.35 |
|
|
$ |
0.26 |
|
|
$ |
0.31 |
|
|
$ |
0.44 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended | |
|
|
| |
|
|
March 31 | |
|
June 30 | |
|
September 30 | |
|
December 31 | |
|
|
| |
|
| |
|
| |
|
| |
|
|
(In thousands, except per share data) | |
2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$ |
31,855 |
|
|
$ |
34,877 |
|
|
$ |
39,439 |
|
|
$ |
47,959 |
|
Income from operations(a)
|
|
|
7,518 |
|
|
|
6,888 |
|
|
|
7,809 |
|
|
|
12,547 |
|
Net income
|
|
|
7,615 |
|
|
|
6,756 |
|
|
|
8,126 |
|
|
|
12,828 |
|
Net income per share basic
|
|
$ |
0.24 |
|
|
$ |
0.21 |
|
|
$ |
0.25 |
|
|
$ |
0.39 |
|
Net income per share diluted(b)
|
|
$ |
0.22 |
|
|
$ |
0.19 |
|
|
$ |
0.22 |
|
|
$ |
0.33 |
|
|
|
|
(a) |
|
Income from operations includes amortization of
acquisition-related intangibles of $2,396, $2,110, $2,089 and
$2,135 in the quarters ended March 31, June 30,
September 30, and December 31, 2005, respectively, and
$1,579, $2,267, $2,434, and $1,989 in the quarters ended
March 31, June 30, September 30, and
December 31, 2004, respectively. |
|
(b) |
|
In accordance with the Emerging Issues Task Force (EITF), Issue
No. 04-8, the unissued shares underlying contingent
convertible notes are treated as if such shares were issued and
outstanding for the purposes of calculating GAAP diluted
earnings per share beginning with the issuance of our
1.25% convertible senior notes on June 1, 2004. |
|
|
ITEM 9. |
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE. |
None.
|
|
ITEM 9A. |
CONTROLS AND PROCEDURES. |
|
|
(a) |
Disclosure Controls and Procedures |
Based on their evaluation of our disclosure controls and
procedures conducted as of December 31, 2005, our Chief
Executive Officer and Chief Financial Officer have concluded
that our disclosure controls and procedures (as defined in
Rules 13a-15(e)
and 15d-15(e)
promulgated under the Securities Exchange Act of 1934) were
effective at reasonable assurance levels to ensure that the
information required to be disclosed by us in this
Form 10-K was
recorded, processed, summarized and reported within the time
periods specified in the rules and instructions for
Form 10-K.
40
|
|
(b) |
Managements Annual Report on Internal Control Over
Financial Reporting |
Our management, including the Chief Executive Officer and Chief
Financial Officer, is responsible for establishing and
maintaining an adequate system of internal control over
financial reporting. This system of internal accounting controls
is designed to provide reasonable assurance that assets are
safeguarded, transactions are properly recorded and executed in
accordance with managements authorization and financial
statements are prepared in accordance with generally accepted
accounting principles. A control system, no matter how well
conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system
are met. Further, the design of a control system must reflect
the fact that there are resource constraints, and the benefits
of controls must be considered relative to their costs. Because
of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, within our
company have been detected. These inherent limitations include
the realities that judgments in decision-making can be faulty,
and that breakdowns can occur because of simple error or
mistake. Additionally, controls can be circumvented by the
individual acts of some persons, by collusion of two or more
people, or by management override of the control. The design of
any system of controls also is based in part upon certain
assumptions about the likelihood of future events, and there can
be no assurance that any design will succeed in achieving its
stated goals under all potential future conditions; over time,
control may become inadequate because of changes in conditions,
or the degree of compliance with the policies or procedures may
deteriorate. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or
fraud may occur and not be detected.
Management conducted an evaluation of the effectiveness of the
system of internal control over financial reporting based on the
framework in Internal Control Integrated Framework
issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). Based on this evaluation, management
concluded that our internal control over financial reporting was
effective as of December 31, 2005, to provide reasonable
assurance regarding the reliability of financial reporting and
the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. That
evaluation excluded the business operations of Commerce5, Inc.
and subsidiaries acquired on December 14, 2005. The
acquired business operations excluded from the evaluation
together constituted approximately seven percent of total assets
at December 31, 2005, and less than one percent of revenues
and net income, for the year then ended. Managements
assessment of the effectiveness of our internal control over
financial reporting has been audited by Ernst & Young
LLP, an independent registered public accounting firm, as stated
in their report in which they expressed an unqualified opinion,
which is included herein.
|
|
(c) |
Changes in Internal Control over Financial Reporting |
During the quarter ended December 31, 2005, there was no
change in our internal control over financial reporting that
materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.
41
|
|
(d) |
Report of Independent Registered Public Accounting Firm |
Board of Directors and Stockholders
Digital River, Inc.
We have audited managements assessment, included in the
accompanying Managements Annual Report on Internal Control
Over Financial Reporting, that Digital River, Inc. and
subsidiaries maintained effective internal control over
financial reporting as of December 31, 2005, based on
criteria established in Internal Control Integrated
Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission (the COSO criteria). Digital River,
Inc.s management is responsible for maintaining effective
internal control over financial reporting and for its assessment
of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on
managements assessment and an opinion on the effectiveness
of the companys internal control over financial reporting
based on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control
over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of
internal control over financial reporting, evaluating
managements assessment, testing and evaluating the design
and operating effectiveness of internal control, and performing
such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A companys internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
generally accepted accounting principles. A companys
internal control over financial reporting includes those
policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of
management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.
As indicated in the accompanying Managements Report on
Internal Control over Financial Reporting, managements
assessment of and conclusion on the effectiveness of internal
control over financial reporting did not include the internal
controls of Commerce5, Inc., which is included in the
December 31, 2005, consolidated financial statements of
Digital River, Inc. and constituted approximately seven percent
of total assets at December 31, 2005, and less than one
percent of revenue and net income for the year then ended.
Management did not assess the effectiveness of internal control
over financial reporting at Commerce5, Inc. as permitted by the
Securities and Exchange Commission for entities acquired within
the latest fiscal year. Our audit of internal control over
financial reporting of Digital River, Inc. also did not include
an evaluation of the internal control over financial reporting
of Commerce5, Inc.
In our opinion, managements assessment that Digital River,
Inc. maintained effective internal control over financial
reporting as of December 31, 2005, is fairly stated, in all
material respects, based on the COSO criteria. Also, in our
opinion, Digital River, Inc. maintained, in all material
respects, effective internal control over financial reporting as
of December 31, 2005, based on the COSO criteria.
42
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
consolidated balance sheets of Digital River, Inc. and
subsidiaries as of December 31, 2005 and 2004, and the
related consolidated statements of operations,
stockholders equity and cash flows for each of the three
years in the period ended December 31, 2005, and our report
dated March 14, 2006, expressed an unqualified opinion
thereon.
/s/ Ernst & Young LLP
Minneapolis, Minnesota
March 14, 2006
43
|
|
ITEM 9B. |
OTHER INFORMATION. |
None.
PART III
Certain information required in Part III of this report is
incorporated by reference to our Proxy Statement in connection
with our 2006 Annual Meeting to be filed in accordance with
Regulation 14A under the Securities Exchange Act of 1934,
as amended.
|
|
ITEM 10. |
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. |
Other than the identification of executive officers, which is
set forth in Part I, Item 1 hereof, the
information required in Item 10 of Part III of this
report is incorporated by reference to our Proxy Statement in
connection with our 2006 Annual Meeting to be filed in
accordance with Regulation 14A under the Securities
Exchange Act of 1934, as amended.
We have adopted a Code of Conduct and Ethics, a copy of which we
undertake to provide to any person, without charge, upon
request. Such requests can be made in writing to the attention
of Corporate Secretary at our principal executive offices
address. To the extent permitted by the rules promulgated by the
NASD, we intend to disclose any amendments to, or waivers from,
the Code provisions applicable to our principal executive
officer or senior financial officers, including our chief
financial officer and controller, or with respect to the
required elements of the Code, on our website,
www.digitalriver.com under the Investor
Relations link.
|
|
ITEM 11. |
EXECUTIVE COMPENSATION. |
The information required in Item 11 of Part III of
this report is incorporated by reference to our Proxy Statement
in connection with our 2006 Annual Meeting to be filed in
accordance with Regulation 14A under the Securities
Exchange Act of 1934, as amended.
|
|
ITEM 12. |
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS. |
The information required in Item 12 of Part III of
this report is incorporated by reference to our Proxy Statement
in connection with our 2006 Annual Meeting to be filed in
accordance with Regulation 14A under the Securities
Exchange Act of 1934, as amended.
|
|
ITEM 13. |
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. |
The information required in Item 13 of Part III of
this report is incorporated by reference to our Proxy Statement
in connection with our 2006 Annual Meeting to be filed in
accordance with Regulation 14A under the Securities
Exchange Act of 1934, as amended.
|
|
ITEM 14. |
PRINCIPAL ACCOUNTANT FEES AND SERVICES. |
The information required in Item 14 of Part III of
this report is incorporated by reference to our Proxy Statement
in connection with our 2006 Annual Meeting to be filed in
accordance with Regulation 14A under the Securities
Exchange Act of 1934, as amended.
44
PART IV
|
|
ITEM 15. |
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. |
(a) The following documents are filed as part of this
report:
|
|
|
(1) Financial Statements. |
|
|
|
The consolidated financial statements required by this item are
submitted in a separate section beginning on page 49 of
this report. |
|
|
|
(2) Financial Statement Schedules. |
|
|
|
All schedules for which provision is made in the applicable
accounting regulations of the SEC have been omitted as not
required or not applicable, or the information required has been
included elsewhere by reference in the financial statements and
related notes, except for Schedule II, which is included
with this
Form 10-K, as
filed with the SEC. |
|
|
|
|
|
Exhibit |
|
|
Number |
|
Description of Document |
|
|
|
|
2 |
.1(1) |
|
Stock Purchase Agreement, dated as of April 17, 2004, by
and among Digital River, Inc., Blitz F03-1424 GmbH, a company
organized under the laws of Germany and a wholly owned
subsidiary of Digital River, and the selling shareholders of
element 5 Informationstechnologien und
dienstleistungen Aktiengesellschaft, a company organized under
the laws of Germany. |
|
|
2 |
.2(2) |
|
Amended and Restated Asset Purchase Agreement dated
February 9, 2002, by and between the Registrant and
Beyond.com. |
|
|
2 |
.3(3) |
|
First Amendment to the Amended and Restated Asset Purchase
Agreement dated as of March 15, 2002, by and between the
Registrant and Beyond.com. |
|
|
2 |
.4(3) |
|
Post-Closing Amendment to the Amended and Restated Asset
Purchase Agreement dated as of March 31, 2002, by and
between the Registrant and Beyond.com. |
|
|
3 |
.1(4) |
|
Amended and Restated Certificate of Incorporation of the
Registrant, as currently in effect. |
|
|
3 |
.2(6) |
|
Amended and Restated Bylaws of the Registrant, as currently in
effect. |
|
|
3 |
.3(4) |
|
Certificate of Amendment of Amended and Restated Certificate of
Incorporation (amending Exhibit 3.1). |
|
|
4 |
.1(7) |
|
Specimen Stock Certificate. |
|
|
4 |
.2(4) |
|
Form of Senior Debt Indenture. |
|
|
4 |
.3(4) |
|
Form of Subordinated Debt Indenture. |
|
|
4 |
.4 |
|
References are hereby made to Exhibits 3.1, 3.2 and 3.3. |
|
|
4 |
.5(13) |
|
Indenture dated as of June 1, 2004, between Digital River,
Inc. and Wells Fargo Bank, N.A. as trustee, including therein
the form of the Note. |
|
|
10 |
.1(7) |
|
Form of Indemnity Agreement between Registrant and each of its
directors and executive officers. |
|
|
10 |
.3(7) |
|
Consent to Assignment and Assumption of Lease dated
April 22, 1998, by and between CSM Investors, Inc.,
IntraNet Integration Group, Inc. and Registrant. |
|
|
10 |
.4(5) |
|
Assignment of Lease dated April 21, 1998, by and between
Intranet Integration Group, Inc. and Registrant. |
45
|
|
|
|
|
Exhibit |
|
|
Number |
|
Description of Document |
|
|
|
|
|
10 |
.5(5) |
|
Lease Agreement dated January 18, 2000, between Property
Reserve, Inc. and Registrant. |
|
|
10 |
.6(6) |
|
First Amendment of Lease dated January 31, 2001, to that
certain Lease dated April 24, 1996, between CSM Investors,
Inc. and Registrant (as assignee of Intranet Integration Group,
Inc.). |
|
|
10 |
.7(8) |
|
1998 Stock Option Plan, as amended and superseded by
Exhibit 10.19.* |
|
|
10 |
.8(9) |
|
1999 Stock Option Plan, formerly known as the 1999 Non-Officer
Stock Option Plan, as amended and superseded by
Exhibit 10.19.* |
|
|
10 |
.9(8) |
|
2000 Employee Stock Purchase Plan, as amended, and offering.* |
|
|
10 |
.11(10) |
|
Second Amendment of Lease dated April 22, 2002, to that
certain Lease dated April 24, 1996, between CSM Investors,
Inc. and Registrant (as assignee of Intranet Integration Group,
Inc.) as amended. |
|
|
10 |
.12(10) |
|
Second Amendment of Lease dated April 28, 2003, to that
certain Lease dated January 18, 2000, between Property
Reserve Inc. and Registrant. |
|
|
10 |
.13(11) |
|
Employment Agreement with Jay Kerutis.* |
|
|
10 |
.14(12) |
|
Employment Agreement with Gary Howorka.* |
|
|
10 |
.15(13) |
|
Registration Rights Agreement dated as of June 1, 2004,
between Digital River, Inc. and the initial purchasers of Senior
Convertible Notes due January 1, 2024. |
|
|
10 |
.16(14) |
|
Supplemental Agreement and Settlement Agreement, by and among
Digital River, Inc., Digital River GmBH, element 5 AG,
Messrs. Clemens Roth, Christopher Reimold, Gerrit Schumann,
Stephan Naujoks and various other former element
5 shareholders, dated as of January 18, 2005. |
|
|
10 |
.17(15) |
|
Summary of Compensation Program for Non-Employee Directors. |
|
|
10 |
.18(16) |
|
Amended and Restated Authorized Symantec Electronic Reseller for
Shop Symantec Agreement by and among Symantec Corporation,
Symantec Limited and Digital River, Inc. dated as of
July 1, 2003, including Amendments 2 through 10
thereto. |
|
|
10 |
.19(17) |
|
1998 Equity Incentive Plan (formerly known as 1998 Stock Option
Plan).* |
|
|
10 |
.20(18) |
|
Employment Agreement between Digital River, Inc. and Carter D.
Hicks.* |
|
|
10 |
.21(18) |
|
Employment Offer Letter between Digital River, Inc. and Thomas
M. Donnelly.* |
|
|
10 |
.22(19) |
|
Amendment number 11 to the Amended and Restated Authorized
Symantec Electronic Reseller for Shop Symantec Agreement by and
among Symantec Corporation, Symantec Limited and Digital River,
Inc. dated as of June 15, 2005. |
|
|
10 |
.23(19) |
|
Employment Agreement between Digital River, Inc. and Joel A.
Ronning.* |
|
|
10 |
.24(19) |
|
Form of Amendment to Non-Qualified Stock Option Agreement.* |
|
|
10 |
.25(20) |
|
Inducement Equity Incentive Plan.* |
|
|
12 |
.1 |
|
Computation of Ratio of Earnings to Fixed Charges. |
|
|
21 |
.1 |
|
Subsidiaries of Digital River, Inc. |
|
|
23 |
.1 |
|
Consent of Independent Registered Public Accounting Firm, dated
March 14, 2006. |
|
|
24 |
.1 |
|
Power of Attorney, pursuant to which amendments to this Annual
Report on Form 10-K may be filed, is included on the
signature pages of this Annual Report on Form 10-K. |
|
|
31 |
.1 |
|
Certification of Digital River, Inc.s Chief Executive
Officer, pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002. |
|
|
31 |
.2 |
|
Certification of Digital River, Inc.s Chief Financial
Officer, pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002. |
|
|
32 |
|
|
Certification of Digital River, Inc.s Chief Executive
Officer and Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002. |
46
|
|
|
|
* |
Management contract or compensatory plan. |
|
|
|
|
|
Confidential treatment has been requested for portions of this
agreement, which portions have been filed separately with
the SEC. |
|
|
|
|
(1) |
Incorporated by reference from the Companys Current Report
on Form 8-K on
filed May 4, 2004. |
|
|
(2) |
Incorporated by reference from the Companys Current Report
on Form 8-K on
filed February 11, 2002. |
|
|
(3) |
Incorporated by reference from the Companys Current Report
on Form 8-K on
filed April 15, 2002. |
|
|
(4) |
Incorporated by reference from the Companys Registration
Statement on
Form S-3 (File
No. 333-81626),
declared effective on February 12, 2002. |
|
|
(5) |
Incorporated by reference from the Companys Annual Report
on Form 10-K for
the year ended December 31, 1999, filed on March 30,
2000. |
|
|
(6) |
Incorporated by reference from the Companys Annual Report
on Form 10-K for
the year ended December 31, 2000, filed on March 27,
2001. |
|
|
(7) |
Incorporated by reference from the Companys Registration
Statement on
Form S-1 (File
No. 333-56787),
declared effective on August 11, 1998. |
|
|
(8) |
Incorporated by reference from the Companys Registration
Statement on
Form S-8 (File
No. 333-105864)
filed on June 5, 2003. |
|
|
(9) |
Incorporated by reference from the Companys Quarterly
Report on
Form 10-Q for the
quarter ended June 30, 2003, filed on August 14, 2003. |
|
|
(10) |
Incorporated by reference from the Companys Quarterly
Report on
Form 10-Q for the
quarter ended March 31, 2003, filed on May 15, 2003. |
|
(11) |
Incorporated by reference from the Companys Quarterly
Report on
Form 10-Q for the
quarter ended September 30, 2003, filed on
November 13, 2003. |
|
(12) |
Incorporated by reference from the Companys Annual Report
on Form 10-K for
the year ended December 31, 2003, filed on March 15,
2004. |
|
(13) |
Incorporated by reference from the Companys Current Report
on Form 8-K filed
on July 13, 2004. |
|
(14) |
Incorporated by reference from the Companys Current Report
on Form 8-K filed
on January 20, 2005. |
|
(15) |
Incorporated by reference from the Companys Current Report
on Form 8-K filed
on February 15, 2005. |
|
(16) |
Incorporated by reference from the Companys Current Report
on Form 8-K filed
on June 15, 2005. |
|
(17) |
Incorporated by reference from the Companys Current Report
on Form 8-K filed
on May 31, 2005. |
|
(18) |
Incorporated by reference from the Companys Current Report
on Form 8-K filed
on July 5, 2005. |
|
(19) |
Incorporated by reference from the Companys Quarterly
Report on
Form 10-Q for the
quarter ended June 30, 2005, filed on August 9, 2005. |
|
(20) |
Incorporated by reference from the Companys Current Report
on Form 8-K filed
on December 20, 2005. |
47
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused
this report on
Form 10-K to be
signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Eden Prairie, State of Minnesota, on
the 14th of March 2006.
|
|
|
|
|
Joel A. Ronning |
|
Chief Executive Officer |
We, the undersigned, directors and officers of Digital River,
Inc., do hereby severally constitute and appoint Joel A. Ronning
and Thomas M. Donnelly and each or any of them, our true and
lawful attorneys and agents, with full power of substitution and
resubstitution, for him or her and in his or her name, place and
stead, in any and all capacities, to sign any and all amendments
to the Registrants Annual Report on
Form 10-K for the
fiscal year ended December 31, 2005, and to file the same
with all exhibits thereto, and all other documents in connection
therewith, with the Securities and Exchange Commission, granting
unto said attorneys and agents, and each or any of them, full
power and authority to do and perform each and every act and
thing requisite and necessary to be done, as fully to all
intents and purposes as he or she might or could do in person,
hereby ratifying and confirming all that said attorneys and
agents, and each of them, or his substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of
1934, this
Form 10-K has been
signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
|
|
|
|
|
|
|
Signature |
|
Title |
|
Date |
|
|
|
|
|
|
/s/ Joel A. Ronning
Joel A. Ronning |
|
Chief Executive Officer and Director (Principal Executive
Officer) |
|
March 14, 2006 |
|
/s/ Thomas M. Donnelly
Thomas M. Donnelly |
|
Chief Financial Officer and Treasurer (Principal Financial
and
Accounting Officer) |
|
March 14, 2006 |
|
/s/ Perry W. Steiner
Perry W. Steiner |
|
Director |
|
March 14, 2006 |
|
/s/ William Lansing
William Lansing |
|
Director |
|
March 14, 2006 |
|
/s/ Thomas F. Madison
Thomas F. Madison |
|
Director |
|
March 14, 2006 |
|
/s/ J. Paul Thorin
J. Paul Thorin |
|
Director |
|
March 14, 2006 |
|
/s/ Frederic Seegal
Frederic Seegal |
|
Director |
|
March 14, 2006 |
48
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Digital River, Inc.
We have audited the accompanying consolidated balance sheets of
Digital River, Inc. and subsidiaries as of December 31,
2005 and 2004, and the related consolidated statements of
operations, stockholders equity and cash flows for each of
the three years in the period ended December 31, 2005.
These financial statements are the responsibility of the
Companys management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards of
the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the consolidated
financial position of Digital River, Inc. and subsidiaries at
December 31, 2005 and 2004, and the consolidated results of
their operations and their cash flows for each of the three
years in the period ended December 31, 2005, in conformity
with U.S. generally accepted accounting principles.
We have also audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
effectiveness of Digital River, Inc.s internal control
over financial reporting as of December 31, 2005, based on
criteria established in Internal Control Integrated
Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission and our report dated March 14,
2006, expressed an unqualified opinion thereon.
Minneapolis, Minnesota
March 14, 2006
49
DIGITAL RIVER, INC.
Consolidated Balance Sheets as of December 31
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
|
| |
|
| |
ASSETS |
CURRENT ASSETS:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$ |
131,770 |
|
|
$ |
127,734 |
|
Short-term investments
|
|
|
220,569 |
|
|
|
164,402 |
|
Accounts receivable, net of allowance of $1,023 and $1,146
|
|
|
34,883 |
|
|
|
21,520 |
|
Deferred income taxes
|
|
|
22,251 |
|
|
|
|
|
Prepaid expenses and other
|
|
|
3,741 |
|
|
|
1,843 |
|
|
|
|
|
|
|
|
Total current assets
|
|
|
413,214 |
|
|
|
315,499 |
|
|
|
|
|
|
|
|
Property and equipment, net
|
|
|
17,955 |
|
|
|
17,367 |
|
Goodwill
|
|
|
195,299 |
|
|
|
148,086 |
|
Intangible assets, net of accumulated amortization of $36,798
and $28,245
|
|
|
20,054 |
|
|
|
17,297 |
|
Deferred income taxes
|
|
|
10,444 |
|
|
|
|
|
Other assets
|
|
|
12,174 |
|
|
|
6,272 |
|
|
|
|
|
|
|
|
TOTAL ASSETS
|
|
$ |
669,140 |
|
|
$ |
504,521 |
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS EQUITY |
CURRENT LIABILITIES
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$ |
127,846 |
|
|
$ |
88,052 |
|
Accrued payroll
|
|
|
8,866 |
|
|
|
5,332 |
|
Deferred revenue
|
|
|
5,403 |
|
|
|
3,901 |
|
Accrued acquisition costs
|
|
|
5,651 |
|
|
|
6,720 |
|
Other accrued liabilities
|
|
|
21,210 |
|
|
|
12,747 |
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
168,976 |
|
|
|
116,752 |
|
|
|
|
|
|
|
|
NON-CURRENT LIABILITIES
|
|
|
|
|
|
|
|
|
Convertible senior notes
|
|
|
195,000 |
|
|
|
195,000 |
|
Deferred income taxes
|
|
|
22 |
|
|
|
|
|
|
|
|
|
|
|
|
Total non-current liabilities
|
|
|
195,022 |
|
|
|
195,000 |
|
|
|
|
|
|
|
|
TOTAL LIABILITIES
|
|
|
363,998 |
|
|
|
311,752 |
|
|
|
|
|
|
|
|
COMMITMENTS AND CONTINGENCIES (NOTE 8)
|
|
|
|
|
|
|
|
|
STOCKHOLDERS EQUITY:
|
|
|
|
|
|
|
|
|
Preferred Stock, $.01 par value; 5,000,000 shares authorized; no
shares issued or outstanding
|
|
|
|
|
|
|
|
|
Common Stock, $.01 par value; 60,000,000 shares authorized;
35,033,741 and 33,652,149 shares issued and outstanding
|
|
|
350 |
|
|
|
337 |
|
Additional paid-in capital
|
|
|
315,489 |
|
|
|
243,926 |
|
Deferred compensation
|
|
|
(1,942 |
) |
|
|
|
|
Accumulated deficit
|
|
|
(6,324 |
) |
|
|
(51,164 |
) |
Accumulated other comprehensive loss
|
|
|
(2,431 |
) |
|
|
(330 |
) |
|
|
|
|
|
|
|
Total stockholders equity
|
|
|
305,142 |
|
|
|
192,769 |
|
|
|
|
|
|
|
|
TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
|
|
$ |
669,140 |
|
|
$ |
504,521 |
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
50
DIGITAL RIVER, INC.
Consolidated Statements of Operations for the Years Ended
December 31
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
(In thousands, except per share data) | |
Revenue
|
|
$ |
220,408 |
|
|
$ |
154,130 |
|
|
$ |
101,201 |
|
Costs and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct cost of services
|
|
|
5,013 |
|
|
|
5,013 |
|
|
|
3,585 |
|
|
Network and infrastructure
|
|
|
19,814 |
|
|
|
15,143 |
|
|
|
12,253 |
|
|
Sales and marketing
|
|
|
69,256 |
|
|
|
51,749 |
|
|
|
37,220 |
|
|
Product research and development
|
|
|
20,575 |
|
|
|
14,097 |
|
|
|
9,962 |
|
|
General and administrative
|
|
|
21,474 |
|
|
|
16,894 |
|
|
|
9,228 |
|
|
Depreciation and amortization
|
|
|
8,833 |
|
|
|
8,203 |
|
|
|
7,275 |
|
|
Amortization of acquisition-related intangibles
|
|
|
8,730 |
|
|
|
8,269 |
|
|
|
5,380 |
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
|
153,695 |
|
|
|
119,368 |
|
|
|
84,903 |
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
66,713 |
|
|
|
34,762 |
|
|
|
16,298 |
|
Other income, net
|
|
|
4,967 |
|
|
|
1,641 |
|
|
|
838 |
|
|
|
|
|
|
|
|
|
|
|
Income before income tax expense
|
|
|
71,680 |
|
|
|
36,403 |
|
|
|
17,136 |
|
Income tax expense
|
|
|
17,337 |
|
|
|
1,079 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$ |
54,343 |
|
|
$ |
35,324 |
|
|
$ |
17,136 |
|
|
|
|
|
|
|
|
|
|
|
Net income per share basic
|
|
$ |
1.57 |
|
|
$ |
1.09 |
|
|
$ |
0.58 |
|
|
|
|
|
|
|
|
|
|
|
Net income per share diluted
|
|
$ |
1.36 |
|
|
$ |
0.96 |
|
|
$ |
0.52 |
|
|
|
|
|
|
|
|
|
|
|
Shares used in per-share calculation basic
|
|
|
34,536 |
|
|
|
32,328 |
|
|
|
29,398 |
|
|
|
|
|
|
|
|
|
|
|
Shares used in per-share calculation diluted
|
|
|
41,448 |
|
|
|
38,532 |
|
|
|
33,051 |
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
51
DIGITAL RIVER, INC.
Consolidated Statements of Stockholders Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Stock | |
|
Additional | |
|
|
|
Accumulated | |
|
|
|
Total | |
|
|
|
|
| |
|
Paid-In | |
|
Deferred | |
|
Comprehensive | |
|
Accumulated | |
|
Stockholders | |
|
Comprehensive | |
|
|
Shares | |
|
Amount | |
|
Capital | |
|
Compensation | |
|
Income (Loss) | |
|
Deficit | |
|
Equity | |
|
Income (Loss) | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
BALANCE, December 31, 2002
|
|
|
27,537 |
|
|
$ |
275 |
|
|
$ |
160,535 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
(103,624 |
) |
|
$ |
57,186 |
|
|
$ |
(510 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
17,136 |
|
|
|
17,136 |
|
|
|
17,136 |
|
Unrealized gain on investments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
44 |
|
|
|
|
|
|
|
44 |
|
|
|
44 |
|
Sales of common stock
|
|
|
2,100 |
|
|
|
21 |
|
|
|
43,385 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
43,406 |
|
|
|
|
|
Common stock issued for acquisitions and earn-out arrangements
|
|
|
88 |
|
|
|
1 |
|
|
|
1,024 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,025 |
|
|
|
|
|
Exercise of stock options
|
|
|
1,680 |
|
|
|
17 |
|
|
|
12,238 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12,255 |
|
|
|
|
|
Common stock issued under the Employee Stock Purchase Plan
|
|
|
93 |
|
|
|
1 |
|
|
|
799 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
800 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCE, December 31, 2003
|
|
|
31,498 |
|
|
|
315 |
|
|
|
217,981 |
|
|
|
|
|
|
|
44 |
|
|
|
(86,488 |
) |
|
|
131,852 |
|
|
|
17,180 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
35,324 |
|
|
|
35,324 |
|
|
|
35,324 |
|
Unrealized (loss) on investments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(275 |
) |
|
|
|
|
|
|
(275 |
) |
|
|
(275 |
) |
Foreign currency translation (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(99 |
) |
|
|
|
|
|
|
(99 |
) |
|
|
(99 |
) |
Common stock issued for acquisitions
|
|
|
160 |
|
|
|
2 |
|
|
|
5,342 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,344 |
|
|
|
|
|
Exercise of stock options
|
|
|
1,943 |
|
|
|
19 |
|
|
|
19,700 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
19,719 |
|
|
|
|
|
Common stock issued under the Employee Stock Purchase Plan
|
|
|
51 |
|
|
|
1 |
|
|
|
903 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
904 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCE, December 31, 2004
|
|
|
33,652 |
|
|
|
337 |
|
|
|
243,926 |
|
|
|
|
|
|
|
(330 |
) |
|
|
(51,164 |
) |
|
|
192,769 |
|
|
|
34,950 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
54,343 |
|
|
|
54,343 |
|
|
|
54,343 |
|
Unrealized (loss) on investments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(776 |
) |
|
|
|
|
|
|
(776 |
) |
|
|
(776 |
) |
Foreign currency translation (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,325 |
) |
|
|
|
|
|
|
(1,325 |
) |
|
|
(1,325 |
) |
Repurchase of common stock
|
|
|
(483 |
) |
|
|
(5 |
) |
|
|
(3,637 |
) |
|
|
|
|
|
|
|
|
|
|
(9,503 |
) |
|
|
(13,145 |
) |
|
|
|
|
Exercise of stock options
|
|
|
1,718 |
|
|
|
17 |
|
|
|
23,182 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
23,199 |
|
|
|
|
|
Inducement Equity Incentive Plan
|
|
|
64 |
|
|
|
1 |
|
|
|
1,971 |
|
|
|
(1,942 |
) |
|
|
|
|
|
|
|
|
|
|
30 |
|
|
|
|
|
Tax benefit of stock-based compensation
|
|
|
|
|
|
|
|
|
|
|
47,848 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
47,848 |
|
|
|
|
|
Common stock issued under the Employee Stock Purchase Plan
|
|
|
83 |
|
|
|
|
|
|
|
2,199 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,199 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCE, December 31, 2005
|
|
|
35,034 |
|
|
$ |
350 |
|
|
$ |
315,489 |
|
|
$ |
(1,942 |
) |
|
$ |
(2,431 |
) |
|
$ |
(6,324 |
) |
|
$ |
305,142 |
|
|
$ |
52,242 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
52
DIGITAL RIVER, INC.
Consolidated Statements of Cash Flows For the Years Ended
December 31,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
(In thousands) | |
OPERATING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$ |
54,343 |
|
|
$ |
35,324 |
|
|
$ |
17,136 |
|
Adjustments to reconcile net income to net cash provided by
operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of acquisition-related intangibles
|
|
|
8,730 |
|
|
|
8,269 |
|
|
|
5,380 |
|
|
|
Change in accounts receivable allowance, net of acquisitions
|
|
|
(598 |
) |
|
|
709 |
|
|
|
(1,247 |
) |
|
|
Depreciation and amortization
|
|
|
8,833 |
|
|
|
8,203 |
|
|
|
7,275 |
|
|
|
Tax benefit of stock-based compensation
|
|
|
47,879 |
|
|
|
|
|
|
|
|
|
|
|
Deferred income taxes and other
|
|
|
(34,789 |
) |
|
|
|
|
|
|
|
|
|
|
Litigation and other charges
|
|
|
(739 |
) |
|
|
1,090 |
|
|
|
|
|
|
|
Change in operating assets and liabilities (net of acquisitions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(10,304 |
) |
|
|
(8,223 |
) |
|
|
3,558 |
|
|
|
|
Prepaid and other assets
|
|
|
(2,417 |
) |
|
|
1,037 |
|
|
|
132 |
|
|
|
|
Accounts payable
|
|
|
34,822 |
|
|
|
34,433 |
|
|
|
9,210 |
|
|
|
|
Deferred revenue
|
|
|
1,395 |
|
|
|
(230 |
) |
|
|
1,671 |
|
|
|
|
Income tax payable
|
|
|
2,740 |
|
|
|
143 |
|
|
|
|
|
|
|
|
Accrued payroll and other accrued liabilities
|
|
|
9,859 |
|
|
|
4,380 |
|
|
|
4,716 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
|
119,754 |
|
|
|
85,135 |
|
|
|
47,831 |
|
|
|
|
|
|
|
|
|
|
|
INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases of investments
|
|
|
(190,713 |
) |
|
|
(199,699 |
) |
|
|
(58,993 |
) |
|
Sales of investments
|
|
|
127,771 |
|
|
|
94,059 |
|
|
|
|
|
|
Cash paid for acquisitions, net of cash received
|
|
|
(54,177 |
) |
|
|
(126,457 |
) |
|
|
(6,944 |
) |
|
Purchases of equipment and capitalized software
|
|
|
(8,328 |
) |
|
|
(9,255 |
) |
|
|
(6,271 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
|
|
(125,447 |
) |
|
|
(241,352 |
) |
|
|
(72,208 |
) |
|
|
|
|
|
|
|
|
|
|
FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Principal amount on line of credit
|
|
|
|
|
|
|
45,000 |
|
|
|
|
|
|
Repayment of principal on line of credit
|
|
|
|
|
|
|
(45,000 |
) |
|
|
|
|
|
Proceeds from convertible senior notes
|
|
|
|
|
|
|
188,371 |
|
|
|
|
|
|
Proceeds from sales of common stock
|
|
|
|
|
|
|
|
|
|
|
43,406 |
|
|
Exercise of stock options and warrants
|
|
|
23,199 |
|
|
|
19,719 |
|
|
|
12,255 |
|
|
Sales of common stock under employee stock purchase plan
|
|
|
2,199 |
|
|
|
904 |
|
|
|
800 |
|
|
Repurchase of common stock
|
|
|
(13,145 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by financing activities
|
|
|
12,253 |
|
|
|
208,994 |
|
|
|
56,461 |
|
|
|
|
|
|
|
|
|
|
|
EFFECT OF EXCHANGE RATE CHANGES ON CASH
|
|
|
(2,524 |
) |
|
|
2,072 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET INCREASE IN CASH AND CASH EQUIVALENTS
|
|
|
4,036 |
|
|
|
54,849 |
|
|
|
32,084 |
|
CASH AND CASH EQUIVALENTS, beginning of period
|
|
|
127,734 |
|
|
|
72,885 |
|
|
|
40,801 |
|
CASH AND CASH EQUIVALENTS, end of period
|
|
$ |
131,770 |
|
|
$ |
127,734 |
|
|
$ |
72,885 |
|
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL DISCLOSURES:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid for interest on Convertible Senior Notes
|
|
$ |
2,641 |
|
|
$ |
|
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid for income taxes
|
|
$ |
193 |
|
|
$ |
|
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
Noncash investing and financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stock issued in acquisitions and earn-outs
|
|
$ |
|
|
|
$ |
5,344 |
|
|
$ |
1,025 |
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
53
DIGITAL RIVER, INC.
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
|
|
1. |
Nature of Operations and Summary of Significant Accounting
Policies: |
We provide outsourced
e-commerce solutions
globally to a wide variety of companies primarily in the
software and high-tech products markets. We were incorporated in
1994 and began building and operating online stores for our
clients in 1996. We generate revenue primarily based on the
sales of products made in those stores, and in addition, offer
services designed to increase traffic to our clients
online stores and to improve the sales effectiveness of those
stores.
|
|
|
Principles of Consolidation and Classification |
The consolidated financial statements include the accounts of
Digital River, Inc. and our wholly owned subsidiaries. All
intercompany balances and transactions have been eliminated in
consolidation. Certain reclassifications have been made to prior
year balances in order to conform to the current years
presentation.
|
|
|
Foreign Currency Translation |
Substantially all of our foreign subsidiaries use the local
currency of their respective countries as their functional
currency. Assets and liabilities are translated at exchange
rates prevailing at the balance sheet dates. Revenues, costs and
expenses are translated into U.S. dollars at average
exchange rates for the period. Gains and losses resulting from
translation are recorded as a component of equity. Gains and
losses resulting from foreign currency transactions are
recognized as other income, net.
|
|
|
Cash and Cash Equivalents |
We consider all short-term, highly liquid investments, primarily
high grade commercial paper and money market accounts, that are
readily convertible into known amounts of cash and that have
original or remaining maturities of three months or less at the
date of purchase to be cash equivalents. As of December 31,
2005 and 2004, cash balances of $12.9 million and
$2.8 million, respectively, were held by a credit card
processor to secure potential future credit card fees, fines and
chargebacks. In addition, at December 31, 2005 and 2004,
$0.4 million and $0.3 million was restricted by letter
of credit and agreements required by international tax
jurisdictions as security for potential tax liabilities.
Our short-term investments consist of debt securities that are
classified as available-for-sale and are carried on our balance
sheet at their market value with cumulative unrealized gains or
losses recorded as a component of accumulated other
comprehensive income within stockholders equity. As of
December 31, 2005 and 2004, all securities had dates to
maturity or reset dates of less than three years. We classify
all of our available-for-sale securities as current assets, as
these securities represent investments available for current
corporate purposes.
54
DIGITAL RIVER, INC.
Notes to Consolidated Financial
Statements (Continued)
Property and equipment is stated at historical cost. Computer
equipment, software and furniture are depreciated under the
straight-line method using estimated useful lives of three to
seven years and leasehold improvements are amortized over the
shorter of the asset life or remaining length of the lease.
Property and equipment at December 31 consisted of the
following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
|
| |
|
| |
Computer hardware and software
|
|
$ |
44,849 |
|
|
$ |
35,292 |
|
Furniture, fixtures and leasehold improvements
|
|
|
7,151 |
|
|
|
5,847 |
|
|
|
|
|
|
|
|
|
Total property and equipment
|
|
$ |
52,000 |
|
|
$ |
41,139 |
|
Accumulated depreciation
|
|
|
(34,045 |
) |
|
|
(23,772 |
) |
|
|
|
|
|
|
|
|
Net property and equipment
|
|
$ |
17,955 |
|
|
$ |
17,367 |
|
|
|
|
|
|
|
|
|
|
|
Purchased Intangible Assets |
Through both domestic and international acquisitions, we have
continued to expand our global online businesses. Tangible net
assets for our acquisitions were valued at their respective
carrying amounts as we believe that these amounts approximated
their current fair values at the respective acquisition dates.
The valuation of identifiable intangible assets acquired
reflects managements estimates based on, among other
factors, use of established valuation methods. Such assets
consist of customer lists and user base, trademarks and trade
names, developed technologies and other acquired intangible
assets, including contractual agreements. Identifiable
intangible assets are amortized using the straight-line method
over the estimated useful lives, generally three to five years.
We believe the straight-line method of amortization best
represents the distribution of the economic value of the
identifiable intangible assets acquired to date. Goodwill
represents the excess of the purchase price over the fair value
of the net tangible and identifiable intangible assets acquired
in each business combination. The purchase prices of the
acquisitions described in Note 4 below exceeded the
estimated fair value of the respective related identifiable
intangible and tangible assets because we believe these
acquisitions will assist with our strategy of establishing and
expanding our global online marketplace.
We review all long-lived assets, including intangible assets
with definite lives, for impairment in accordance with Statement
of Financial Accounting Standards No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets
(SFAS 144). Under SFAS 144, impairment
losses are recorded whenever events or changes in circumstances
indicate the carrying value of an asset may not be recoverable.
For long-lived assets used in operations, impairment losses are
only recorded if the assets carrying amount is not
recoverable through its undiscounted, probability-weighted cash
flows. We measure the impairment loss based on the difference
between the carrying amount and estimated fair value. An
impairment loss is recognized when estimated undiscounted cash
flows expected to result from the use of the asset plus net
proceeds expected from disposition of the asset (if any) are
less than the carrying value of the asset. As part of our
evaluation, we consider certain non-financial data as indicators
of impairment such as changes in the operating environment and
business strategy, competitive information, market trends and
operating performance. When an impairment loss is identified,
the carrying amount of the asset is reduced to its estimated
fair value. There were no significant impairments of long-lived
assets, including definite-lived intangible assets, recorded in
2005, 2004 or 2003.
55
DIGITAL RIVER, INC.
Notes to Consolidated Financial
Statements (Continued)
|
|
|
Fair Value of Financial Instruments |
The carrying amount of cash and cash equivalents, accounts
receivable, notes payable and accounts payable approximates fair
value because of the short maturity of these instruments. As of
December 31, 2005 and 2004, the fair value of our
$195 million 1.25% fixed rate convertible senior notes was
valued at $189 million and $230 million, respectively.
The following table summarizes our other assets as of
December 31, 2005 and 2004 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
|
| |
|
| |
Unamortized debt financing costs
|
|
$ |
5,960 |
|
|
$ |
6,258 |
|
Cost of investment
|
|
|
6,000 |
|
|
|
|
|
Other
|
|
|
214 |
|
|
|
14 |
|
|
|
|
|
|
|
|
Total other assets
|
|
$ |
12,174 |
|
|
$ |
6,272 |
|
|
|
|
|
|
|
|
During 2005, we purchased $6 million of the Series B
Convertible Preferred stock of Intraware, Inc., a provider of
enterprise digital license management and other services. We
account for this investment using the cost method. Through this
investment, we intend to establish a strategic partnership with
Intraware that will enhance our access to the enterprise segment
of the software and digital products market.
|
|
|
Other Accrued Liabilities |
The following table summarizes our other accrued liabilities as
of December 31, 2005 and 2004 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
|
| |
|
| |
Accrued expenses
|
|
$ |
12,451 |
|
|
$ |
9,444 |
|
Sales, value-added and transaction taxes
|
|
|
5,479 |
|
|
|
3,160 |
|
Current and deferred income taxes
|
|
|
3,280 |
|
|
|
143 |
|
|
|
|
|
|
|
|
Total other accrued liabilities
|
|
$ |
21,210 |
|
|
$ |
12,747 |
|
|
|
|
|
|
|
|
Comprehensive income includes revenues, expenses, gains and
losses that are excluded from net earnings under GAAP. Items of
our comprehensive income are unrealized gains and losses on
short term investments and foreign currency translation
adjustments which are added to net income to compute
comprehensive income. Comprehensive income is net of income tax
benefits or expense.
As of December 31, 2005, comprehensive income is net of the
tax benefit of $0.8 million recorded for unrealized foreign
exchange losses on the revaluation of investments in foreign
subsidiaries and $0.5 million benefit for unrealized
investment losses. There was no tax benefit or expense for
comprehensive income in 2004 and 2003 as we had no tax expense.
We recognize revenue from services rendered once all the
following criteria for revenue recognition have been met:
(1) pervasive evidence of an agreement exists;
(2) the services have been rendered;
56
DIGITAL RIVER, INC.
Notes to Consolidated Financial
Statements (Continued)
(3) the fee is fixed and determinable and not subject to
refund or adjustment; and (4) collection of the amounts due
is reasonably assured.
We evaluate the criteria outlined in Emerging Issues Task Force,
(EITF) Issues No. 99-19, Reporting Revenue
Gross as a Principal Versus Net as an Agent, in determining
whether it is appropriate to record the gross amount of product
sales and related costs or the net amount earned as net revenue.
We act as the merchant of record on most of the transactions
processed and have contractual relationships with our clients,
which obligate us to pay to the client a specified percentage of
each sale. We derive our revenue primarily from transaction fees
based on a percentage of the products sale price and fees from
services rendered associated with the
e-commerce and other
services provided to our clients and end customers. Our revenue
is recorded at net as generally our clients are subject to
inventory risks and control customers product choices.
Clients do not have the right to take possession of the software
applications used in the delivery of services.
We also provide customers with various proprietary software
backup services. We recognize revenue for these back up services
upon delivery or based upon historical usage within the contract
period of the digital backup services when this information is
available. Digital backup services are recognized straight-line
over the life of the backup service when historical usage
information is unavailable. Shipping revenues are recorded net
of any associated costs.
We also, to a lesser extent, provide fee-based client services,
which include website design, custom development and
integration, analytical marketing and email marketing services.
If we receive payments for fee-based services in advance of
delivery, these amounts are deferred and recognized over the
service period.
Provisions for doubtful accounts and transaction losses and
authorized credits are made at the time of revenue recognition
based upon our historical experience. The provision for doubtful
accounts and transaction losses are recorded as charges to
operating expense, while the provision for authorized credits is
recognized as a reduction of net revenues.
Deferred revenue is recorded when service payment is received in
advance of performing our service obligation. Revenue is
recognized over either the estimated usage period when usage
information is available, or ratably over the service period
when usage information is not available.
The costs of advertising are charged to sales and marketing
expense as incurred. We incurred advertising expense of
$0.1 million, $1.0 million and $0.6 million in
2005, 2004 and 2003, respectively.
We currently have significant U.S. tax loss carryforwards
resulting from the tax deduction for exercise of stock options
and acquired operating tax loss carryforwards. The benefit of
the loss carryforwards from exercise of stock options was
recognized as additional paid in capital when the deferred tax
asset valuation allowance was reversed in the fourth quarter of
2005. The benefit of the acquired tax loss carryforwards has
been reserved by a valuation allowance pursuant to United States
generally accepted accounting principles. These valuation
reserves of the deferred tax asset will be reversed if and when
it is more likely than not that the deferred tax asset will be
realized. We evaluate the need for a valuation allowance of the
deferred tax asset on a quarterly basis. Deferred income taxes
reflect the tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes.
57
DIGITAL RIVER, INC.
Notes to Consolidated Financial
Statements (Continued)
Our other income, net line item is the total of interest income
on our cash, cash equivalents, and short-term investments,
interest expense on our debt and foreign currency transaction
gains and losses. Interest income was $9.7 million,
$3.2 million and $0.8 million in 2005, 2004 and 2003,
respectively. Interest expense was $2.5 million in 2005
compared with $1.5 million in 2004 and no corresponding
interest expense in 2003. Losses related to foreign currency
transactions were $2.2 million in 2005, and gains or losses
were immaterial in 2004 and 2003.
The preparation of financial statements in accordance with the
United States generally accepted accounting principles requires
management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from
those estimates.
|
|
|
Research and Development and Software Development |
Research and development expenses consist primarily of
development personnel and non-employee contractor costs related
to the development of new products and services, enhancement of
existing products and services, quality assurance, and testing.
We follow AICPA Statement of Position No. 98-1,
Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use, in accounting for internally
developed software. During 2005 and 2004, we capitalized
$0.4 million and $2.7 million, respectively, of
software development costs. During 2003, capitalizable software
development costs were immaterial.
|
|
|
Recent Accounting Pronouncements |
We will adopt SFAS 123(R) in the first quarter of fiscal
2006 using the modified prospective method, which requires
measurement of compensation cost for all stock-based awards at
fair value on date of grant and recognition of compensation over
the service period for awards expected to vest. The fair value
of restricted stock and restricted stock units is determined
based on the number of shares granted and the quoted price of
our common stock, and the fair value of stock options will be
determined using the Black-Scholes valuation model. We will
continue to evaluate the impact of SFAS 123(R) on our
operating results and financial condition. Our assessment of the
estimated compensation charges will be affected by our stock
price as well as assumptions regarding a number of complex and
subjective variables and the related tax impact. These variables
include, but are not limited to, the volatility of our stock
price and employee stock option exercise behaviors.
In November 2005, the FASB issued Staff Position
No. FAS 115-1, The Meaning of
Other-Than-Temporary Impairment and its Application to Certain
Investments (FSP 115-1). FSP 115-1 provides
accounting guidance for determining and measuring
other-than-temporary impairments of debt and equity securities,
and confirms the disclosure requirements for investments in
unrealized loss positions as outlined in EITF
issue 03-01,
The Meaning of Other-Than-Temporary Impairments and its
Application to Certain Investments. The accounting
requirements of FSP 115-1 are effective for us on
January 1, 2006, and are not expected to have a material
impact on our consolidated financial position, results of
operations or cash flows.
58
DIGITAL RIVER, INC.
Notes to Consolidated Financial
Statements (Continued)
Basic income per common share is computed by dividing net income
by the weighted average number of shares of common stock
outstanding during the period. Diluted earnings per common share
is calculated by dividing net income, adjusted to exclude
interest expense and financing cost amortization related to
potentially dilutive securities, by the weighted average number
of common shares related to potentially dilutive securities
outstanding during the period, plus any additional common shares
that would have been outstanding if potentially dilutive common
shares had been issued during the period.
The following table summarizes the computation of basic and
diluted earnings per share (in thousands, except per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
Earnings per share basic
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income basic
|
|
$ |
54,343 |
|
|
$ |
35,324 |
|
|
$ |
17,136 |
|
Weighted average shares outstanding basic
|
|
|
34,536 |
|
|
|
32,328 |
|
|
|
29,398 |
|
|
|
|
|
|
|
|
|
|
|
Earnings per share basic
|
|
$ |
1.57 |
|
|
$ |
1.09 |
|
|
$ |
0.58 |
|
|
|
|
|
|
|
|
|
|
|
Earnings per share diluted
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income basic
|
|
$ |
54,343 |
|
|
$ |
35,324 |
|
|
$ |
17,136 |
|
Exclude: Interest expense and amortized financing cost of
convertible senior notes, net of tax benefit
|
|
|
2,099 |
|
|
|
1,772 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income diluted
|
|
$ |
56,442 |
|
|
$ |
37,096 |
|
|
$ |
17,136 |
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding basic
|
|
|
34,536 |
|
|
|
32,328 |
|
|
|
29,398 |
|
Dilutive impact of non-vested stock and options outstanding
|
|
|
2,487 |
|
|
|
3,626 |
|
|
|
3,653 |
|
Dilutive impact of convertible senior notes
|
|
|
4,425 |
|
|
|
2,578 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding diluted
|
|
|
41,448 |
|
|
|
38,532 |
|
|
|
33,051 |
|
|
|
|
|
|
|
|
|
|
|
Earnings per share diluted
|
|
$ |
1.36 |
|
|
$ |
0.96 |
|
|
$ |
0.52 |
|
|
|
|
|
|
|
|
|
|
|
In accordance with the Emerging Issues Task Force (EITF), Issue
No. 04-8, the unissued shares underlying contingent
convertible notes are treated as if such shares were issued and
outstanding for the purposes of calculating GAAP diluted
earnings per share beginning with the issuance of our
1.25% convertible senior notes on June 1, 2004.
59
DIGITAL RIVER, INC.
Notes to Consolidated Financial
Statements (Continued)
|
|
3. |
Short-Term Investments: |
As of December 31, 2005 and 2004, our available-for-sale
securities consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized Gain/(Loss) | |
|
Maturities/Reset Dates | |
|
|
| |
|
| |
|
|
|
|
Less Than | |
|
Greater Than | |
|
Fair | |
|
Less Than | |
|
1 to 3 | |
|
|
Cost | |
|
12 Months | |
|
12 Months | |
|
Value | |
|
12 Months | |
|
Years | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. government agencies
|
|
|
147,982 |
|
|
|
(1,277 |
) |
|
|
(189 |
) |
|
|
146,516 |
|
|
|
64,003 |
|
|
|
82,513 |
|
Student loan bonds
|
|
|
60,000 |
|
|
|
|
|
|
|
|
|
|
|
60,000 |
|
|
|
60,000 |
|
|
|
|
|
Other
|
|
|
14,053 |
|
|
|
|
|
|
|
|
|
|
|
14,053 |
|
|
|
14,053 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total available-for-sale securities
|
|
$ |
222,035 |
|
|
$ |
(1,277 |
) |
|
$ |
(189 |
) |
|
$ |
220,569 |
|
|
$ |
138,056 |
|
|
$ |
82,513 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. government agencies
|
|
|
79,133 |
|
|
|
(234 |
) |
|
|
|
|
|
|
78,899 |
|
|
|
4,660 |
|
|
|
74,239 |
|
Student loan bonds
|
|
|
85,500 |
|
|
|
3 |
|
|
|
|
|
|
|
85,503 |
|
|
|
85,503 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total available-for-sale securities
|
|
$ |
164,633 |
|
|
$ |
(231 |
) |
|
$ |
|
|
|
$ |
164,402 |
|
|
$ |
90,163 |
|
|
$ |
74,239 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized gains or losses on investments are recorded on our
statement of operations within other income, net. Realized
losses on sales of investments were immaterial in 2005, 2004 and
2003. Interest income of $9.7 million, $3.2 million
and $0.8 million was recorded in 2005, 2004 and 2003,
respectively.
60
DIGITAL RIVER, INC.
Notes to Consolidated Financial
Statements (Continued)
|
|
4. |
Business Combinations, Goodwill and Intangible Assets: |
The following table summarizes the purchase acquisitions
completed during the three years in the period ended
December 31, 2005 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Intangible Assets | |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
Initial | |
|
Initial | |
|
|
|
|
|
|
|
|
|
Non- | |
|
|
Shares | |
|
Purchase | |
|
Acquired | |
|
Assumed | |
|
|
|
Technology/ | |
|
Customer | |
|
Compete | |
Acquisition |
|
Issued | |
|
Consideration | |
|
Assets | |
|
Liabilities | |
|
Goodwill | |
|
Tradenames | |
|
Relationships | |
|
Agreements | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commerce5, Inc.(1)
|
|
|
|
|
|
$ |
45,000 |
|
|
$ |
3,321 |
|
|
$ |
(5,501 |
) |
|
$ |
38,737 |
|
|
$ |
1,607 |
|
|
$ |
7,639 |
|
|
$ |
|
|
SWReg
|
|
|
|
|
|
|
8,800 |
|
|
|
5,373 |
|
|
|
(6,464 |
) |
|
|
9,090 |
|
|
|
589 |
|
|
|
1,747 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
$ |
53,800 |
|
|
$ |
8,694 |
|
|
$ |
(11,965 |
) |
|
$ |
47,827 |
|
|
$ |
2,196 |
|
|
$ |
9,386 |
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
element 5, AG
|
|
|
|
|
|
$ |
120,000 |
|
|
$ |
14,662 |
|
|
$ |
(16,673 |
) |
|
$ |
110,775 |
|
|
$ |
5,654 |
|
|
$ |
7,814 |
|
|
$ |
784 |
|
Fireclick, Inc.
|
|
|
|
|
|
|
7,500 |
|
|
|
451 |
|
|
|
(111 |
) |
|
|
7,512 |
|
|
|
701 |
|
|
|
|
|
|
|
250 |
|
BlueHornet Networks, Inc.
|
|
|
160 |
|
|
|
1,176 |
|
|
|
756 |
|
|
|
(280 |
) |
|
|
4,280 |
|
|
|
836 |
|
|
|
1,104 |
|
|
|
250 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
160 |
|
|
$ |
128,676 |
|
|
$ |
15,869 |
|
|
$ |
(17,064 |
) |
|
$ |
122,567 |
|
|
$ |
7,191 |
|
|
$ |
8,918 |
|
|
$ |
1,284 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Metatec International
|
|
|
|
|
|
$ |
1,300 |
|
|
$ |
121 |
|
|
|
|
|
|
$ |
789 |
|
|
$ |
300 |
|
|
$ |
|
|
|
$ |
75 |
|
Infocon America Corporation
|
|
|
|
|
|
|
1,100 |
|
|
|
78 |
|
|
|
(232 |
) |
|
|
953 |
|
|
|
207 |
|
|
|
|
|
|
|
75 |
|
The Registration Network
|
|
|
|
|
|
|
2,500 |
|
|
|
71 |
|
|
|
(1,320 |
) |
|
|
934 |
|
|
|
600 |
|
|
|
1,011 |
|
|
|
150 |
|
Emetrix, Inc.
|
|
|
|
|
|
|
2,600 |
|
|
|
132 |
|
|
|
(1,107 |
) |
|
|
601 |
|
|
|
600 |
|
|
|
1,360 |
|
|
|
150 |
|
GameZone, Inc.
|
|
|
|
|
|
|
1,100 |
|
|
|
|
|
|
|
(194 |
) |
|
|
821 |
|
|
|
208 |
|
|
|
|
|
|
|
100 |
|
Other
|
|
|
|
|
|
|
416 |
|
|
|
|
|
|
|
(9 |
) |
|
|
100 |
|
|
|
220 |
|
|
|
|
|
|
|
150 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
|
|
$ |
9,016 |
|
|
$ |
402 |
|
|
$ |
(2,862 |
) |
|
$ |
4,198 |
|
|
$ |
2,135 |
|
|
$ |
2,371 |
|
|
$ |
700 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
The Commerce5, Inc. purchase price allocation is preliminary and
subject to adjustment. |
|
|
|
Acquisitions completed in 2005 |
In March 2005, we acquired certain assets and assumed certain
liabilities, vendor contracts and intellectual property of
SWReg, an operating business of Atlantic Coast plc, a private
limited UK company, for $8.8 million in cash. SWReg is a
provider of e-commerce
services for software authors. We also may make additional
earn-out payments in cash based on achieving specific revenue
and development goals over the first 12 months following
the closing of the acquisition. Earn-outs totaling
$0.3 million were recorded as goodwill in 2005 as they were
considered incremental to the purchase price.
In December 2005, we acquired all of the capital stock of
Commerce5, Inc., an outsourced
e-commerce provider to
high-tech and consumer electronics manufacturers. The allocation
of the purchase price of Commerce5 will be finalized upon
completion of the analysis of the fair value of Commerce5s
assets. The result of the allocation of the purchase price
between amortizable costs and goodwill could have an impact on
our future operating results.
|
|
|
Acquisitions completed in 2004 |
In April 2004, we acquired element 5 AG, a privately held
company based in Germany and a leading European
e-commerce solution
provider for software publishers. Under the terms of the
acquisition, we paid $120 million in cash to acquire all of
the outstanding shares of capital stock of element 5. We also
61
DIGITAL RIVER, INC.
Notes to Consolidated Financial
Statements (Continued)
agreed to pay up to an additional $2.5 million in cash
based on element 5s operating performance over the first
24 months following the closing of the acquisition.
On January 18, 2005, we entered into an agreement with
senior employees of element 5 AG, pursuant to which these
employees agreed to cease providing services to element 5 sixty
days after the date of the agreement. Pursuant to the agreement,
we also agreed to resolve a $12 million escrow associated
with our acquisition of element 5 by distributing
$10 million to the former element 5 shareholders, and
$2 million to us. Certain adjustments also were made to our
earn-out obligations under the April 2004 acquisition agreement.
Under the restructured earn-out, $1.25 million in cash was
paid to the former element 5 shareholders on March 1,
2005 and an additional $1.25 million was due on
March 1, 2006 and is expected to be paid upon receipt of
certain contractual documentation. These earn-out amounts have
been recorded as additional goodwill as they were incremental to
the purchase price. We have recorded a net of $5.4 million
as part of the acquisition cost of element 5 related to these
acquisition restructuring plans of which $2.2 million
remained as of December 31, 2005. The following table
provides detail on the activity and our remaining accrual
balance by category as of December 31, 2005 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accrual | |
|
|
|
|
|
Accrual | |
|
|
|
|
|
Accrual | |
|
|
April 16, | |
|
Net | |
|
|
|
December 31, | |
|
|
|
|
|
December 31, | |
|
|
2004 | |
|
Additions | |
|
Charges | |
|
2004 | |
|
Adjustments | |
|
Charges | |
|
2005 | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Shareholder escrow
|
|
$ |
|
|
|
$ |
2,500 |
|
|
$ |
|
|
|
$ |
2,500 |
|
|
$ |
|
|
|
$ |
(1,250 |
) |
|
$ |
1,250 |
|
Employee severance costs
|
|
|
700 |
|
|
|
2,100 |
|
|
|
(400 |
) |
|
|
2,400 |
|
|
|
(200 |
) |
|
|
(1,250 |
) |
|
|
950 |
|
Facilities consolidation
|
|
|
200 |
|
|
|
100 |
|
|
|
(300 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
900 |
|
|
$ |
4,700 |
|
|
$ |
(700 |
) |
|
$ |
4,900 |
|
|
$ |
(200 |
) |
|
$ |
(2,500 |
) |
|
$ |
2,200 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In June 2004, we acquired substantially all of the assets and
assumed certain liabilities of Fireclick, Inc., a leading
provider of web-analysis solutions for online retailers,
providing website site owners with the tools necessary to
measure campaign
return-on-investment,
track user path analysis and enhance website site user
experience. Under the terms of the agreement, we paid
$7.5 million in cash and an additional $0.3 million in
cash upon the completion of certain integration milestones. The
agreement also provides Fireclick the opportunity for an
earn-out based on our achieving certain revenue and
profitability targets attributable to Fireclick over the course
of the 36 months following the closing of the acquisition.
Earn-outs totaling $0.5 million were recorded as goodwill
in 2005 as they were considered part of the purchase price.
In November 2004, we acquired all of the outstanding capital
stock of BlueHornet Networks, Inc. BlueHornet is a leading
provider of e-mail
marketing campaign management services and related customer
relationship management (CRM) tools. As consideration for
the acquisition, we issued a total of 160,185 shares of our
common stock to the BlueHornet stockholders, valued at
approximately $5.3 million, paid off $0.7 million of
BlueHornet debt obligations at closing and agreed to pay an
additional $0.5 million in cash to the former BlueHornet
stockholders following the transition of certain BlueHornet
assets to our facilities in Eden Prairie, Minnesota. In
addition, the former BlueHornet stockholders may receive
additional earn-out payments of cash or our common stock, at our
discretion, based on BlueHornets operating performance
over the first 36 months following the closing of the
acquisition. Earn-outs totaling $0.5 million, tax
adjustments totaling $0.5 million and acquisition costs
totaling $0.1 million were recorded as goodwill in 2005 as
they were considered part of the purchase price.
As of December 31, 2005, there was an estimated maximum
potential for future earn-outs of approximately
$2.4 million in excess of the $3.3 million in
earn-outs included in accrued acquisition costs. Any of the
estimated maximum potential future earn-out beyond the
$3.3 million accrued will result in additional goodwill.
62
DIGITAL RIVER, INC.
Notes to Consolidated Financial
Statements (Continued)
|
|
|
Pro Forma Operating Results (Unaudited) |
The consolidated financial statements include the operating
results of each business acquired from the date of acquisition.
The following unaudited pro forma condensed results of
operations for 2005, 2004 and 2003 have been prepared as if each
of the acquisitions in 2005 had occurred on January 1,
2004, and as if each of the 2004 acquisitions had occurred on
January 1, 2003 (in thousands except per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
Revenue
|
|
$ |
230,975 |
|
|
$ |
178,814 |
|
|
$ |
121,025 |
|
Income from operations
|
|
|
64,119 |
|
|
|
25,649 |
|
|
|
6,488 |
|
Net income
|
|
|
51,771 |
|
|
|
26,411 |
|
|
|
6,786 |
|
Diluted income per share
|
|
$ |
1.30 |
|
|
$ |
0.71 |
|
|
$ |
0.21 |
|
This pro forma financial information does not purport to
represent results that would actually have been obtained if the
transactions had been in effect on January 1, 2004 or 2003,
as applicable, or any future results that may be realized.
We account for our goodwill in accordance with
SFAS No. 142, Goodwill and Other Intangible
Assets. SFAS No. 142 precludes the amortization
of goodwill and intangible assets with indefinite lives, but
these assets are reviewed annually (or more frequently if
impairment indicators arise) for impairment.
We complete our annual impairment test using a two-step approach
based in the fourth quarter of each fiscal year and reassess any
intangible assets, including goodwill, recorded in connection
with earlier acquisitions. Our assessment has indicated that
there is no impairment of goodwill for the years ended
December 31, 2005, 2004 and 2003.
The changes in the net carrying amount of goodwill for the years
ended December 31, 2005 and 2004, are as follows (in
thousands):
|
|
|
|
|
|
|
Total | |
|
|
| |
Balance as of December 31, 2003
|
|
$ |
23,921 |
|
Goodwill from acquisitions and earn-outs
|
|
|
124,165 |
|
|
|
|
|
Balance as of December 31, 2004
|
|
$ |
148,086 |
|
Goodwill from acquisitions and earn-outs
|
|
|
49,096 |
|
Adjustments(1)
|
|
|
(1,883 |
) |
|
|
|
|
Balance as of December 31, 2005
|
|
$ |
195,299 |
|
|
|
|
|
|
|
(1) |
Adjustments to goodwill during the year ended December 31,
2005, resulted primarily from foreign currency translation
adjustments relating to goodwill associated with our current and
prior period acquisitions. |
63
DIGITAL RIVER, INC.
Notes to Consolidated Financial
Statements (Continued)
Information regarding our other intangible assets is as follows
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2005 | |
|
|
| |
|
|
Carrying | |
|
|
|
Carrying | |
|
|
Amount | |
|
Accumulated | |
|
Amount | |
|
|
Gross | |
|
Amortization | |
|
Net | |
|
|
| |
|
| |
|
| |
Customer relationships
|
|
$ |
34,666 |
|
|
$ |
21,103 |
|
|
$ |
13,563 |
|
Non-compete agreements
|
|
|
5,121 |
|
|
|
4,300 |
|
|
|
821 |
|
Technology/tradename
|
|
|
17,065 |
|
|
|
11,395 |
|
|
|
5,670 |
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
56,852 |
|
|
$ |
36,798 |
|
|
$ |
20,054 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2004 | |
|
|
| |
|
|
Carrying | |
|
|
|
Carrying | |
|
|
Amount | |
|
Accumulated | |
|
Amount | |
|
|
Gross | |
|
Amortization | |
|
Net | |
|
|
| |
|
| |
|
| |
Customer relationships
|
|
$ |
25,406 |
|
|
$ |
14,784 |
|
|
$ |
10,622 |
|
Non-compete agreements
|
|
|
5,134 |
|
|
|
3,549 |
|
|
|
1,585 |
|
Technology/tradename
|
|
|
15,002 |
|
|
|
9,912 |
|
|
|
5,090 |
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
45,542 |
|
|
$ |
28,245 |
|
|
$ |
17,297 |
|
|
|
|
|
|
|
|
|
|
|
The components of intangible assets acquired during the years
ended December 31, 2005, 2004 and 2003, are as follows (in
thousands). No significant residual value is estimated for these
assets.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005(1) | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
|
|
Weighted | |
|
|
|
Weighted | |
|
|
|
Weighted | |
|
|
|
|
Average | |
|
|
|
Average | |
|
|
|
Average | |
|
|
Amount | |
|
Life | |
|
Amount | |
|
Life | |
|
Amount | |
|
Life | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Customer Relationships
|
|
$ |
9,386 |
|
|
|
4 years |
|
|
$ |
8,918 |
|
|
|
3 years |
|
|
$ |
2,371 |
|
|
|
3 years |
|
Non-compete agreements
|
|
|
|
|
|
|
|
|
|
|
1,284 |
|
|
|
3 years |
|
|
|
700 |
|
|
|
3 years |
|
Technology/tradename
|
|
|
2,196 |
|
|
|
4 years |
|
|
|
7,191 |
|
|
|
3 years |
|
|
|
2,135 |
|
|
|
3 years |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
11,582 |
|
|
|
4 years |
|
|
$ |
17,393 |
|
|
|
3 years |
|
|
$ |
5,206 |
|
|
|
3 years |
|
|
|
(1) |
The Commerce5, Inc. purchase price allocation is preliminary and
subject to adjustment. |
Estimated amortization expense for the remaining life of the
intangible assets, based on intangible assets as of
December 31, 2005, is as follows (in thousands):
|
|
|
|
|
Year |
|
Amount | |
|
|
| |
2006
|
|
$ |
10,226 |
|
2007
|
|
|
5,377 |
|
2008
|
|
|
3,133 |
|
2009
|
|
|
1,313 |
|
2010
|
|
|
5 |
|
|
|
|
|
Total
|
|
$ |
20,054 |
|
|
|
|
|
64
DIGITAL RIVER, INC.
Notes to Consolidated Financial
Statements (Continued)
Following is an allocation of the net assets acquired from the
acquisitions consummated and amounts paid under earn-out
arrangements in 2005 and 2004 (in thousands) which includes
subsequent year activity for 2004 acquisitions:
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
|
| |
|
| |
Tangible assets
|
|
$ |
8,694 |
|
|
$ |
15,869 |
|
Liabilities assumed
|
|
|
(11,965 |
) |
|
|
(17,064 |
) |
Customer relationships
|
|
|
9,386 |
|
|
|
8,918 |
|
Non-compete agreements
|
|
|
|
|
|
|
1,284 |
|
Technology/tradename
|
|
|
2,196 |
|
|
|
7,191 |
|
Goodwill
|
|
|
47,827 |
|
|
|
123,481 |
|
|
|
|
|
|
|
|
Net assets acquired
|
|
$ |
56,138 |
|
|
$ |
139,679 |
|
|
|
|
|
|
|
|
|
|
5. |
Stock-Based Compensation: |
Prior to the annual stockholders meeting held in May 2005,
we had two stock-based employee compensation plans. At the
annual stockholders meeting held in May 2005, our
stockholders approved an amendment and restatement of our 1998
Stock Option Plan that combined the 1998 plan with our 1999
Stock Option Plan and gave us the flexibility to grant
restricted stock awards, restricted stock unit awards and
performance shares, in addition to incentive and nonstatutory
stock options, to our directors, employees, and consultants
under the combined plan. We account for these plans under the
recognition and measurement principles of Accounting Principles
Board (APB) Opinion No. 25, Accounting for Stock
Issued to Employees, and related interpretations. No
stock-based employee compensation cost is reflected in net
income, as all options granted under these plans had an exercise
price equal to the market value of the underlying common stock
on the date of the grant. Our current plan is described more
fully in Note 10.
The following table illustrates the effect on net income and net
income per share if we had applied the fair value recognition
provision of Financial Accounting Standards Board Statement
No. 123, Accounting for Stock-Based
Compensation, to stock-based employee compensation (in
thousands, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
Net income, as reported
|
|
$ |
54,343 |
|
|
$ |
35,324 |
|
|
$ |
17,136 |
|
Add: Stock-based compensation, as reported
|
|
|
|
|
|
|
|
|
|
|
|
|
Deduct: Total stock-based compensation determined under fair
value based method for all awards:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation expense
|
|
|
(13,018 |
) |
|
|
(26,426 |
) |
|
|
(14,540 |
) |
|
Tax benefit
|
|
|
4,531 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted net income, fair value method for all stock-based awards
|
|
$ |
45,856 |
|
|
$ |
8,898 |
|
|
$ |
2,596 |
|
|
|
|
|
|
|
|
|
|
|
Basic income per share as reported
|
|
$ |
1.57 |
|
|
$ |
1.09 |
|
|
$ |
0.58 |
|
Diluted income per share as reported
|
|
$ |
1.36 |
|
|
$ |
0.96 |
|
|
$ |
0.52 |
|
Basic income per share SFAS No. 123 adjusted
|
|
$ |
1.33 |
|
|
$ |
0.28 |
|
|
$ |
0.09 |
|
Diluted income per share SFAS No. 123 adjusted
|
|
$ |
1.19 |
|
|
$ |
0.29 |
|
|
$ |
0.08 |
|
65
DIGITAL RIVER, INC.
Notes to Consolidated Financial
Statements (Continued)
The fair value of each option grant is estimated on the date of
grant using the Black-Scholes option pricing model with the
following weighted average assumptions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
Risk-free interest rate
|
|
|
4 |
% |
|
|
4 |
% |
|
|
4 |
% |
Expected life (years)
|
|
|
3.14 |
|
|
|
1-4 |
|
|
|
4 |
|
Volatility factor
|
|
|
0.68 |
|
|
|
1.3 |
|
|
|
1.3 |
|
Expected dividends
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average fair value of options granted
|
|
|
13.75 |
|
|
|
13.14 |
|
|
|
13.46 |
|
The components of pretax income are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
United States
|
|
$ |
65,347 |
|
|
$ |
33,778 |
|
|
$ |
17,136 |
|
International
|
|
|
6,333 |
|
|
|
2,625 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
71,680 |
|
|
$ |
36,403 |
|
|
$ |
17,136 |
|
|
|
|
|
|
|
|
|
|
|
The provision (benefit) for income taxes is composed of the
following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
|
|
|
|
2005 | |
|
2004 | |
|
2003 |
|
|
| |
|
| |
|
|
Current tax expense (benefit):
|
|
|
|
|
|
|
|
|
|
|
|
|
United States federal
|
|
$ |
23,161 |
|
|
$ |
|
|
|
$ |
|
|
State and local
|
|
|
1,610 |
|
|
|
|
|
|
|
|
|
International
|
|
|
3,825 |
|
|
|
1,079 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current provision for income taxes
|
|
|
28,596 |
|
|
|
1,079 |
|
|
|
|
|
Deferred tax expense (benefit):
|
|
|
|
|
|
|
|
|
|
|
|
|
United States federal
|
|
|
(10,288 |
) |
|
|
|
|
|
|
|
|
State and local
|
|
|
(647 |
) |
|
|
|
|
|
|
|
|
International
|
|
|
(324 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total deferred provision (benefit) for income taxes
|
|
|
(11,259 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for income taxes
|
|
$ |
17,337 |
|
|
$ |
1,079 |
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
66
DIGITAL RIVER, INC.
Notes to Consolidated Financial
Statements (Continued)
The following is a reconciliation of the difference between the
actual provision for income taxes and the provision computed by
applying the federal statutory rate of 35% to income before
income taxes (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
Tax expense at statutory rate
|
|
$ |
25,102 |
|
|
$ |
12,740 |
|
|
$ |
5,998 |
|
State taxes, net of federal benefit
|
|
|
1,359 |
|
|
|
1,484 |
|
|
|
725 |
|
International rate differential
|
|
|
(1,561 |
) |
|
|
128 |
|
|
|
|
|
Non-deductible goodwill
|
|
|
|
|
|
|
183 |
|
|
|
314 |
|
Other
|
|
|
1,801 |
|
|
|
1,012 |
|
|
|
35 |
|
Change in valuation allowance
|
|
|
(9,364 |
) |
|
|
(14,468 |
) |
|
|
(7,072 |
) |
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
17,337 |
|
|
$ |
1,079 |
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
Deferred income taxes reflect the tax effects of temporary
differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts
used for income tax purposes. Significant components of deferred
income taxes are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
|
| |
|
| |
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Net operating loss and credit carryforwards
|
|
$ |
47,944 |
|
|
$ |
40,809 |
|
Nondeductible reserves and accruals
|
|
|
2,854 |
|
|
|
1,761 |
|
Depreciation and amortization
|
|
|
5,475 |
|
|
|
5,718 |
|
Valuation allowance
|
|
|
(17,504 |
) |
|
|
(42,973 |
) |
|
|
|
|
|
|
|
Total
|
|
|
38,769 |
|
|
|
5,315 |
|
|
|
|
|
|
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
(788 |
) |
|
|
|
|
Other intangibles
|
|
|
(5,706 |
) |
|
|
(5,315 |
) |
|
|
|
|
|
|
|
Total deferred tax liabilities
|
|
|
(6,494 |
) |
|
|
(5,315 |
) |
|
|
|
|
|
|
|
Net deferred tax assets
|
|
$ |
32,275 |
|
|
$ |
|
|
|
|
|
|
|
|
|
As of December 31, 2005, we had net U.S. tax loss
carryforwards of approximately $117.2 million, and foreign
tax loss carryforwards of $8.0 million. The
U.S. amount consists of $75.2 million of deductions
resulting from exercise of stock options and $42.0 million
of acquired net operating losses. As of December 31, 2004,
we had net U.S. operating loss carryforwards of
approximately $96.7 million, and foreign tax loss
carryforwards of $7.8 million. Included in the
U.S. amount were approximately $88.3 million of
deductions resulting from exercise of stock options. When the
deductions from stock option exercises are realized for
financial statement purposes they will not result in a reduction
in income tax expense, rather the benefit will be recorded as
additional
paid-in-capital. These
tax loss carryforwards expire in the years 2020 through 2024.
The acquired net operating losses expire in the years 2020
through 2025 and are subject to other deductibility restrictions
discussed below.
In prior years, there was uncertainty of future realization of
the deferred tax assets resulting from temporary differences and
from tax loss carryforwards from operations and stock option
deductions, therefore a valuation allowance equal to the
deferred tax assets was recorded. We have evaluated these
deferred tax assets and have concluded that the valuation
allowance should be removed. We have met the
67
DIGITAL RIVER, INC.
Notes to Consolidated Financial
Statements (Continued)
requirements under GAAP as we believe it is more likely than not
that we will realize the benefit of these deferred tax assets.
This is based primarily on our earnings history over the last
three years as well as our expected future taxable income. The
impact on U.S. taxable income of stock option deductions
should not reduce taxable income to a level that would
jeopardize this conclusion or unreasonably extend the period in
which we may recognize the tax benefit associated with these
deferred tax assets. In the fourth quarter of 2005, the
valuation allowance related to deferred tax assets from tax loss
carryforwards from stock options was removed, increasing
additional
paid-in-capital by
approximately $28.0 million. Also during the fourth quarter
of 2005, the valuation allowance related to deferred tax assets
from temporary differences was removed, decreasing income tax
expense by approximately $6.7 million.
As of December 31, 2005, approximately $16.3 million
of the deferred tax asset balance relates to net operating
losses and credit carryforwards acquired in U.S. business
combinations. Another $1.2 million of the deferred tax
asset balance relates to acquired foreign net operating losses.
As of December 31, 2004, we had a full valuation allowance
and therefore no deferred tax asset for tax loss carryforwards.
These deferred tax assets are subject to a full valuation
allowance due to anticipated limitations, including limitations
under Section 382 of the Internal Revenue Code. Should a
valuation allowance no longer be required, the release of the
valuation allowance will be reflected as a reduction to goodwill.
No provision has been made for federal income taxes on
approximately $9.0 million and $2.6 million of our
foreign subsidiaries undistributed earnings as of
December 31, 2005, and December 31, 2004,
respectively, since we plan to indefinitely reinvest all such
earnings. If these earnings were distributed to the U.S. in
the form of dividends or otherwise, then we would be subject to
U.S. income taxes on such earnings. The amount of
U.S. income taxes would be subject to adjustment for
foreign tax credits and for the impact of the
step-up basis resulting
from a Section 338 election made at the time of
acquisition. It is not practicable to determine the income tax
liability that might be incurred if these earnings were to be
distributed.
|
|
7. |
Commitments and Contingencies: |
We currently have twenty seven facility leases in addition to
leasing certain computer equipment under non-cancelable
operating leases. Total rent expense, including common area
maintenance charges, recognized under all leases was
$3.0 million, $2.4 million and $1.9 million for
the years ended December 31, 2005, 2004 and 2003,
respectively. The minimum annual rents under long-term leases at
December 31, 2005, were as follows (in thousands):
|
|
|
|
|
Year Ending December 31, |
|
Lease Obligations | |
|
|
| |
2006
|
|
$ |
2,921 |
|
2007
|
|
$ |
2,270 |
|
2008
|
|
$ |
1,729 |
|
2009
|
|
$ |
612 |
|
2010-2011
|
|
$ |
229 |
|
|
|
|
|
Total future minimum obligations
|
|
$ |
7,761 |
|
|
|
|
|
We are subject to legal proceedings, claims and litigation
arising in the ordinary course of business. While the final
outcome of these matters is currently not determinable, we
believe there is no litigation pending against us that is likely
to have, individually or in the aggregate, a material adverse
effect on our
68
DIGITAL RIVER, INC.
Notes to Consolidated Financial
Statements (Continued)
consolidated financial position, results of operation or cash
flows. Because of the uncertainty inherent in litigation, it is
possible that unfavorable resolutions of these lawsuits,
proceedings and claims could exceed the amount we have currently
reserved for these matters.
Third parties have from
time-to-time claimed,
and others may claim in the future, that we have infringed their
intellectual property rights. We have been notified of several
potential patent disputes, and expect that we will increasingly
be subject to patent infringement claims as our services expand
in scope and complexity. We have in the past been forced to
litigate such claims. We may also become more vulnerable to
third-party claims as laws, such as the Digital Millennium
Copyright Act, the Lanham Act and the Communications Decency Act
are interpreted by the courts and as we expand geographically
into jurisdictions where the underlying laws with respect to the
potential liability of online intermediaries like ourselves are
either unclear or less favorable. These claims, whether
meritorious or not, could be time consuming and costly to
resolve, cause service upgrade delays, require expensive changes
in our methods of doing business, or could require us to enter
into costly royalty or licensing agreements.
|
|
|
Indemnification Provisions |
In the ordinary course of business we have included limited
indemnification provisions in certain of our agreements with
parties with whom we have commercial relations. Under these
contracts, we generally indemnify, hold harmless and agree to
reimburse the indemnified party for losses suffered or incurred
by the indemnified party in connection with claims by any third
party with respect to our domain names, trademarks, logos and
other branding elements to the extent that such marks are
applicable to our performance under the subject agreement. In a
limited number of agreements, including agreements under which
we have developed technology for certain commercial parties, we
have provided an indemnity for other types of third-party
claims. To date, no significant costs have been incurred, either
individually or collectively, in connection with our
indemnification provisions.
In addition, we are required by our processors to comply with
credit card association operating rules, and we have agreed to
indemnify our processors for any fines they are assessed by
credit card associations as a result of processing payments for
us. The credit card associations and their member banks set and
interpret the credit card rules. Visa, MasterCard, American
Express, or Discover could adopt new operating rules or
re-interpret existing rules that we or our processors might find
difficult to follow. We have had payment processing agreements
with certain of our payment processors terminated due to
violations of their rules. We also could be subject to fines or
increased fees from MasterCard and Visa.
On April 16, 2004, in connection with our acquisition of
element 5, we established a $45 million secured
revolving credit facility with Harris Trust and Savings Bank.
This facility was repaid in full and terminated in connection
with the sale and issuance of our 1.25% convertible senior
notes on June 1, 2004.
On June 1, 2004, we sold and issued $175 million in
aggregate principal amount of 1.25% convertible senior
notes due January 1, 2024, in a private, unregistered
offering. The notes were subsequently registered for resale. The
notes were sold at 100% of their principal amount. The initial
purchasers exercised in full their option to purchase up to an
additional $20 million in aggregate principal amount of the
notes on June 30, 2004, which purchase transaction closed
on July 6, 2004.
We are required to pay interest on the notes on January 1 and
July 1 of each year beginning January 1, 2005. The
notes bear interest at a rate of 1.25% and, if specified
conditions are met, are convertible into our common stock at a
conversion price of $44.063 per share. The notes may be
surrendered for conversion under certain circumstances,
including the satisfaction of a market price condition, such
that the price of our common stock reaches a specified
threshold; the satisfaction of a
69
DIGITAL RIVER, INC.
Notes to Consolidated Financial
Statements (Continued)
trading price condition, such that the trading price of the
notes falls below a specified level; the redemption of the notes
by us, the occurrence of specified corporate transactions, as
defined in the related indenture; and the occurrence of a
fundamental change, as defined in the related indenture. The
initial conversion price is equivalent to a conversion rate of
approximately 22.6948 shares per $1,000 of principal amount
of the notes. We will adjust the conversion price if certain
events occur, as specified in the related indenture, such as the
issuance of our common stock as a dividend or distribution or
the occurrence of a stock subdivision or combination. If a
fundamental change, such as a change in our control, as defined
in the related indenture, occurs on or before January 1,
2009, we also may be required to purchase the notes for cash and
pay an additional make-whole premium payable in our common
stock, or in the same form of consideration into which all, or
substantially all, of the shares of our common stock have been
converted or exchanged in connection with the fundamental
change, upon the repurchase or conversion of the notes in
connection with the fundamental change. Holders of the notes
have the right to require us to repurchase their notes prior to
maturity on January 1, 2009, 2014 and 2019. We have the
right to redeem the notes, under certain circumstances, on or
after July 1, 2007, and prior to January 1, 2009, and
we may redeem the notes at anytime on or after January 1,
2009.
A portion of the net proceeds of the offering was used to repay
our senior secured revolving credit facility with Harris Trust
and Savings Bank. The balance is being used for general
corporate purposes, including working capital, capital
expenditures, potential future acquisitions, investments, and
the potential repurchase of shares of our common stock.
We incurred interest expense of $2.5 million in 2005 and
made interest payments of $2.6 million. We incurred
interest expense of $1.5 million in 2004 and made no
interest payments. No interest expense was incurred in 2003.
In April 2005, our Board of Directors authorized a new share
repurchase program of up to $50.0 million of our
outstanding shares of common stock. This new program superseded
and replaced the $5.0 million share repurchase program
adopted in 2001. Under the new program, the shares may be
repurchased in the open market or in privately negotiated
transactions. Repurchases are at our discretion based on ongoing
assessments of the capital needs of the business, the market
price of our common stock and general market conditions. No time
limit was set for the completion of the repurchase program.
During 2005, we repurchased a total of 483,371 shares at a
weighted average price per share of $27.20. No shares were
repurchased during 2004 and 2003.
|
|
10. |
Employee Benefit Plans: |
Prior to the annual stockholders meeting held in May 2005,
we had two stock-based employee compensation plans. At the
annual stockholders meeting held in May 2005, our
stockholders approved an amendment and restatement of our 1998
Stock Option Plan that combined the 1998 Plan with our 1999
Stock Option Plan and gave us the flexibility to grant
restricted stock awards, restricted stock unit awards and
performance shares, in addition to incentive and nonstatutory
stock options, to our directors, employees, and consultants
under the combined plan. We call our new amended and restated
plan our 1998 Equity Incentive Plan (the 1998 Plan).
As of December 31, 2005, there were 1,928,584 shares
available for future awards under our 1998 Plan. The number of
shares available will be reduced by three shares for every two
shares granted under the stock award plan that does not provide
for full payment by the participant.
70
DIGITAL RIVER, INC.
Notes to Consolidated Financial
Statements (Continued)
Options granted to employees typically expire no later than ten
years after the date of grant. Incentive stock option grants
must have an exercise price of at least 100% of the fair market
value of a share of common stock on the grant date. Incentive
stock options granted to employees who, immediately before such
grant, owned stock directly or indirectly representing more than
10% of the voting power of our stock will have an exercise price
of 110% of the fair market value of a share of common stock on
the grant date and will expire no later than five years from the
date of grant. The 1998 Plan also provides for other stock-based
awards as may be established by the Board of Directors or the
Compensation Committee.
A Summary of the changes in outstanding options is as follows:
|
|
|
|
|
|
|
|
|
|
|
Options | |
|
Options Price | |
|
|
Outstanding | |
|
per Share | |
|
|
| |
|
| |
Balance, December 31, 2002
|
|
|
6,054,283 |
|
|
|
$ 1.69 - $31.13 |
|
Grants
|
|
|
2,858,651 |
|
|
|
8.98 - 27.40 |
|
Exercised
|
|
|
(1,678,761 |
) |
|
|
1.69 - 26.88 |
|
Cancelled
|
|
|
(568,027 |
) |
|
|
2.59 - 31.13 |
|
|
|
|
|
|
|
|
Balance, December 31, 2003
|
|
|
6,666,146 |
|
|
|
1.69 - 31.13 |
|
Grants
|
|
|
1,603,600 |
|
|
|
20.60 - 24.86 |
|
Exercised
|
|
|
(1,942,212 |
) |
|
|
2.59 - 31.13 |
|
Cancelled
|
|
|
(612,794 |
) |
|
|
2.59 - 31.13 |
|
|
|
|
|
|
|
|
Balance, December 31, 2004
|
|
|
5,714,740 |
|
|
|
1.69 - 31.13 |
|
Grants
|
|
|
846,678 |
|
|
|
23.90 - 30.69 |
|
Exercised
|
|
|
(1,719,114 |
) |
|
|
1.69 - 30.69 |
|
Cancelled
|
|
|
(318,919 |
) |
|
|
3.88 - 27.40 |
|
|
|
|
|
|
|
|
Balance, December 31, 2005
|
|
|
4,523,385 |
|
|
|
$ 1.69 - $31.13 |
|
|
|
|
|
|
|
|
A summary of information about total stock options outstanding
at December 31, 2005, is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding | |
|
Options Exercisable | |
|
|
| |
|
| |
|
|
Number | |
|
Weighted Average | |
|
Weighted | |
|
Number | |
|
Weighted | |
Exercise Price |
|
Outstanding | |
|
Life Remaining | |
|
Average Price | |
|
Exercisable | |
|
Average Price | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
$ 1.69 - $ 3.88
|
|
|
141,004 |
|
|
|
3.1 years |
|
|
$ |
3.04 |
|
|
|
141,004 |
|
|
$ |
3.04 |
|
4.56 - 7.55
|
|
|
1,062,616 |
|
|
|
5.4 years |
|
|
|
5.41 |
|
|
|
947,685 |
|
|
|
5.35 |
|
9.13 - 13.92
|
|
|
967,156 |
|
|
|
6.8 years |
|
|
|
11.42 |
|
|
|
538,100 |
|
|
|
11.92 |
|
16.72 - 22.98
|
|
|
1,036,174 |
|
|
|
7.7 years |
|
|
|
22.00 |
|
|
|
634,531 |
|
|
|
22.34 |
|
23.01 - 31.13
|
|
|
1,316,435 |
|
|
|
8.8 years |
|
|
|
26.94 |
|
|
|
219,141 |
|
|
|
25.73 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ 1.69 - $31.13
|
|
|
4,523,385 |
|
|
|
7.1 years |
|
|
$ |
16.69 |
|
|
|
2,480,461 |
|
|
$ |
12.79 |
|
|
|
|
Employee Stock Purchase Plan |
We also sponsor an employee stock purchase plan under which
1,200,000 shares have been reserved for purchase by
employees. The purchase price of the shares under the plan is
the lesser of 85% of the fair market value on the first or last
day of the offering period. Offering periods are currently every
six months ending on June 30 and December 31.
Employees may designate up to ten percent of their compensation
for the purchase of shares under the plan. Total shares
purchased by employees under the plan were 83,000, 51,000 and
93,000 in the years ended December 31, 2005, 2004 and 2003,
respectively. There are 628,036 shares still reserved under
the plan as of December 31, 2005.
71
DIGITAL RIVER, INC.
Notes to Consolidated Financial
Statements (Continued)
|
|
|
Inducement Equity Incentive Plan |
Effective on December 14, 2005, in connection with our
acquisition of Commerce5, Inc., we adopted an Inducement Equity
Incentive Plan (the Inducement Plan) initially for
Commerce5 executives who joined Digital River as a result of the
acquisition, or other personnel who join us after the date of
the Inducement Plan adoption. A total of 87,500 restricted
shares of Digital River stock may be issued under the Inducement
Plan, subject to vesting. In December 2005, we issued
63,750 shares under the plan. In January 2006, we issued
the remaining 23,750 shares. In accordance with the NASDAQ
rules, no stockholder approval was required for the Inducement
Plan.
We have a defined contribution 401(k) retirement plan for
eligible employees. Employees may contribute up to 15% of their
pretax compensation to the plan, with us providing a
discretionary match of up to 50% of the total employee
contribution. Amounts charged to expense related to our matching
contributions were $1.1 million in 2005, and
$0.7 million in both 2004 and 2003.
We view our operations and manage our business as one reportable
segment, providing outsourced
e-commerce solutions
globally to a variety of companies, primarily in the software
and high-tech products markets. Factors used to identify our
single operating segment include the financial information
available for evaluation by the chief operating decision maker
in making decisions about how to allocate resources and assess
performance. We market our products and services through our
offices in the United States and our wholly-owned branches and
subsidiaries operating in the United Kingdom, Germany, Japan and
Taiwan.
Prior to January 1, 2004, we managed our physical goods
clients through a division (formerly our
E-Business Services
Division) that was separate from our Software and Digital
Commerce Services Division. Beginning in January 2004, this
divisional structure was consolidated, and we announced that we
would no longer report our activities as separate business
segments.
Sales to international customers accounted for 39%, 31% and 24%
of revenue for 2005, 2004 and 2003, respectively. Sales are
attributed to a geographic region based on the ordering location
of the customer. Summarized revenue information by region for
fiscal 2005, 2004 and 2003 is as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
United States
|
|
$ |
135,110 |
|
|
$ |
106,350 |
|
|
$ |
76,913 |
|
Europe
|
|
|
59,951 |
|
|
|
35,450 |
|
|
|
16,192 |
|
Other
|
|
|
25,347 |
|
|
|
12,330 |
|
|
|
8,096 |
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
220,408 |
|
|
$ |
154,130 |
|
|
$ |
101,201 |
|
|
|
|
|
|
|
|
|
|
|
Revenue derived from sales of product from one software
publisher, Symantec Corporation, accounted for approximately
29.7%, 27.2% and 27.4% of our total revenue in 2005, 2004 and
2003, respectively. In addition, revenues derived from
proprietary Digital River services sold to Symantec end-users
and dealer network sales of Symantec products amounted to
approximately 14.4% of total Digital River revenue in 2005,
10.8% in 2004 and 9.9% in 2003.
72
DIGITAL RIVER, INC.
Notes to Consolidated Financial
Statements (Continued)
The following table presents selected asset information by
geographic area based on the physical location of the assets (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
|
| |
|
| |
|
|
United States | |
|
Europe | |
|
United States | |
|
Europe | |
|
|
| |
|
| |
|
| |
|
| |
Total property and equipment
|
|
$ |
46,694 |
|
|
$ |
5,306 |
|
|
$ |
37,588 |
|
|
$ |
3,551 |
|
Accumulated depreciation
|
|
|
(30,691 |
) |
|
|
(3,354 |
) |
|
|
(21,406 |
) |
|
|
(2,366 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net property and equipment
|
|
$ |
16,003 |
|
|
$ |
1,952 |
|
|
$ |
16,182 |
|
|
$ |
1,185 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total intangible assets
|
|
$ |
42,871 |
|
|
$ |
13,981 |
|
|
$ |
31,290 |
|
|
$ |
14,252 |
|
Accumulated amortization
|
|
|
(28,995 |
) |
|
|
(7,803 |
) |
|
|
(25,192 |
) |
|
|
(3,053 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net intangible assets
|
|
$ |
13,876 |
|
|
$ |
6,178 |
|
|
$ |
6,098 |
|
|
$ |
11,199 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total goodwill
|
|
$ |
109,374 |
|
|
$ |
108,380 |
|
|
$ |
59,766 |
|
|
$ |
110,775 |
|
Accumulated amortization
|
|
|
(22,455 |
) |
|
|
|
|
|
|
(22,455 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net goodwill
|
|
$ |
86,919 |
|
|
$ |
108,380 |
|
|
$ |
37,311 |
|
|
$ |
110,775 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In January 2006, we acquired the stock of Direct Response
Technologies, Inc. for approximately $15 million in cash.
Direct Response, a provider of tools for managing affiliate
networks, is a privately held company based in Pittsburgh, PA.
The agreement also provides Direct Response shareholders with an
earn-out opportunity based on Digital River and Direct Response
achieving certain revenue and earnings targets during the first
three years subsequent to the acquisition.
73
DIGITAL RIVER, INC.
Notes to Consolidated Financial
Statements (Continued)
Digital River, Inc.
Schedule II
For Years Ended December 31, 2005, 2004 and 2003
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Charges to | |
|
|
|
|
|
|
Balance at | |
|
Costs and | |
|
|
|
Balance at | |
2005 |
|
Beginning of Year | |
|
Expenses | |
|
Deductions | |
|
End of Year | |
|
|
| |
|
| |
|
| |
|
| |
Allowance for doubtful accounts
|
|
$ |
1,146 |
|
|
$ |
468 |
|
|
$ |
(591 |
) |
|
$ |
1,023 |
|
Accrued chargeback reserve
|
|
|
2,246 |
|
|
|
3,031 |
|
|
|
(3,832 |
) |
|
|
1,445 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Charges to | |
|
|
|
|
|
|
Balance at | |
|
Costs and | |
|
|
|
Balance at | |
2004 |
|
Beginning of Year | |
|
Expenses | |
|
Deductions | |
|
End of Year | |
|
|
| |
|
| |
|
| |
|
| |
Allowance for doubtful accounts
|
|
$ |
319 |
|
|
$ |
1,061 |
|
|
$ |
(234 |
) |
|
$ |
1,146 |
|
Accrued chargeback reserve
|
|
|
1,774 |
|
|
|
3,008 |
|
|
|
(2,536 |
) |
|
|
2,246 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Charges to | |
|
|
|
|
|
|
Balance at | |
|
Costs and | |
|
|
|
Balance at | |
2003 |
|
Beginning of Year | |
|
Expenses | |
|
Deductions | |
|
End of Year | |
|
|
| |
|
| |
|
| |
|
| |
Allowance for doubtful accounts
|
|
$ |
905 |
|
|
$ |
820 |
|
|
$ |
(1,406 |
) |
|
$ |
319 |
|
Accrued chargeback reserve
|
|
|
841 |
|
|
|
3,005 |
|
|
|
(2,072 |
) |
|
|
1,774 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Charged/ | |
|
|
|
|
|
|
Charged/ | |
|
(Credited) to | |
|
|
Deferred Income Tax Asset |
|
Balance at | |
|
(Credited) to | |
|
Other | |
|
Balance at | |
Valuation Allowance |
|
Beginning of Year | |
|
Expenses | |
|
Accounts (1) | |
|
End of Year | |
|
|
| |
|
| |
|
| |
|
| |
2005
|
|
$ |
42,973 |
|
|
$ |
(9,364 |
) |
|
|
(16,105 |
) |
|
$ |
17,504 |
|
2004
|
|
|
42,944 |
|
|
|
(14,468 |
) |
|
|
14,497 |
|
|
|
42,973 |
|
2003
|
|
|
38,965 |
|
|
|
(7,072 |
) |
|
|
11,051 |
|
|
|
42,944 |
|
|
|
(1) |
Amounts not charged (credited) to expenses were charged
(credited) to equity or goodwill |
74
INDEX TO EXHIBITS
|
|
|
|
|
Exhibit |
|
|
Number |
|
Description of Document |
|
|
|
|
2 |
.1(1) |
|
Stock Purchase Agreement, dated as of April 17, 2004, by
and among Digital River, Inc., Blitz F03-1424 GmbH, a company
organized under the laws of Germany and a wholly owned
subsidiary of Digital River, and the selling shareholders of
element 5 Informationstechnologien und
dienstleistungen Aktiengesellschaft, a company organized under
the laws of Germany. |
|
|
2 |
.2(2) |
|
Amended and Restated Asset Purchase Agreement dated
February 9, 2002, by and between the Registrant and
Beyond.com. |
|
|
2 |
.3(3) |
|
First Amendment to the Amended and Restated Asset Purchase
Agreement dated as of March 15, 2002, by and between the
Registrant and Beyond.com. |
|
|
2 |
.4(3) |
|
Post-Closing Amendment to the Amended and Restated Asset
Purchase Agreement dated as of March 31, 2002, by and
between the Registrant and Beyond.com. |
|
|
3 |
.1(4) |
|
Amended and Restated Certificate of Incorporation of the
Registrant, as currently in effect. |
|
|
3 |
.2(6) |
|
Amended and Restated Bylaws of the Registrant, as currently in
effect. |
|
|
3 |
.3(4) |
|
Certificate of Amendment of Amended and Restated Certificate of
Incorporation (amending Exhibit 3.1). |
|
|
4 |
.1(7) |
|
Specimen Stock Certificate. |
|
|
4 |
.2(4) |
|
Form of Senior Debt Indenture. |
|
|
4 |
.3(4) |
|
Form of Subordinated Debt Indenture. |
|
|
4 |
.4 |
|
References are hereby made to Exhibits 3.1, 3.2 and 3.3. |
|
|
4 |
.5(13) |
|
Indenture dated as of June 1, 2004, between Digital River,
Inc. and Wells Fargo Bank, N.A. as trustee, including therein
the form of the Note. |
|
|
10 |
.1(7) |
|
Form of Indemnity Agreement between Registrant and each of its
directors and executive officers. |
|
|
10 |
.3(7) |
|
Consent to Assignment and Assumption of Lease dated
April 22, 1998, by and between CSM Investors, Inc.,
IntraNet Integration Group, Inc. and Registrant. |
|
|
10 |
.4(5) |
|
Assignment of Lease dated April 21, 1998, by and between
Intranet Integration Group, Inc. and Registrant. |
|
|
10 |
.5(5) |
|
Lease Agreement dated January 18, 2000, between Property
Reserve, Inc. and Registrant. |
|
|
10 |
.6(6) |
|
First Amendment of Lease dated January 31, 2001, to that
certain Lease dated April 24, 1996, between CSM Investors,
Inc. and Registrant (as assignee of Intranet Integration Group,
Inc.). |
|
|
10 |
.7(8) |
|
1998 Stock Option Plan, as amended and superseded by
Exhibit 10.19.* |
|
|
10 |
.8(9) |
|
1999 Stock Option Plan, formerly known as the 1999 Non-Officer
Stock Option Plan, as amended and superseded by
Exhibit 10.19.* |
|
|
10 |
.9(8) |
|
2000 Employee Stock Purchase Plan, as amended and offering.* |
|
|
10 |
.11(10) |
|
Second Amendment of Lease dated April 22, 2002, to that
certain Lease dated April 24, 1996, between CSM Investors,
Inc. and Registrant (as assignee of Intranet Integration Group,
Inc.) as amended. |
|
|
10 |
.12(10) |
|
Second Amendment of Lease dated April 28, 2003, to that
certain Lease dated January 18, 2000, between Property
Reserve Inc. and Registrant. |
|
|
10 |
.13(11) |
|
Employment Agreement with Jay Kerutis.* |
|
|
10 |
.14(12) |
|
Employment Agreement with Gary Howorka.* |
|
|
10 |
.15(13) |
|
Registration Rights Agreement dated as of June 1, 2004,
between Digital River, Inc. and the initial purchasers of Senior
Convertible Notes due January 1, 2024. |
|
|
10 |
.16(14) |
|
Supplemental Agreement and Settlement Agreement, by and among
Digital River, Inc., Digital River GmBH, element 5 AG,
Messrs. Clemens Roth, Christopher Reimold, Gerrit Schumann,
Stephan Naujoks and various other former element
5 shareholders, dated as of January 18, 2005. |
75
|
|
|
|
|
Exhibit |
|
|
Number |
|
Description of Document |
|
|
|
|
10 |
.17(15) |
|
Summary of Compensation Program for Non-Employee Directors. |
|
|
10 |
.18(16) |
|
Amended and Restated Authorized Symantec Electronic Reseller for
Shop Symantec Agreement by and among Symantec Corporation,
Symantec Limited and Digital River, Inc. dated as of
July 1, 2003, including Amendments 2 through 10
thereto. |
|
|
10 |
.19(17) |
|
1998 Equity Incentive Plan (formerly known as 1998 Stock Option
Plan).* |
|
|
10 |
.20(18) |
|
Employment Agreement between Digital River, Inc. and Carter D.
Hicks.* |
|
|
10 |
.21(18) |
|
Employment Offer Letter between Digital River, Inc. and Thomas
M. Donnelly.* |
|
|
10 |
.22(19) |
|
Amendment number 11 to the Amended and Restated Authorized
Symantec Electronic Reseller for Shop Symantec Agreement by and
among Symantec Corporation, Symantec Limited and Digital River,
Inc. dated as of June 15, 2005. |
|
|
10 |
.23(19) |
|
Employment Agreement between Digital River, Inc. and Joel A.
Ronning.* |
|
|
10 |
.24(19) |
|
Form of Amendment to Non-Qualified Stock Option Agreement.* |
|
|
10 |
.25(20) |
|
Inducement Equity Incentive Plan.* |
|
|
12 |
.1 |
|
Computation of Ratio of Earnings to Fixed Charges. |
|
|
21 |
.1 |
|
Subsidiaries of Digital River, Inc. |
|
|
23 |
.1 |
|
Consent of Independent Registered Public Accounting Firm, dated
March 14, 2006. |
|
|
24 |
.1 |
|
Power of Attorney, pursuant to which amendments to this Annual
Report on Form 10-K may be filed, is included on the
signature pages of this Annual Report on Form 10-K. |
|
|
31 |
.1 |
|
Certification of Digital River, Inc.s Chief Executive
Officer, pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002. |
|
|
31 |
.2 |
|
Certification of Digital River, Inc.s Chief Financial
Officer, pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002. |
|
|
32 |
|
|
Certification of Digital River, Inc.s Chief Executive
Officer and Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002. |
|
|
* |
|
|
Management contract or compensatory plan. |
|
|
|
|
|
Confidential treatment has been requested for portions of this
agreement, which portions have been filed separately with the
SEC. |
|
|
|
|
(1) |
Incorporated by reference from the Companys Current Report
on Form 8-K on
filed May 4, 2004. |
|
|
(2) |
Incorporated by reference from the Companys Current Report
on Form 8-K on
filed February 11, 2002. |
|
|
(3) |
Incorporated by reference from the Companys Current Report
on Form 8-K on
filed April 15, 2002. |
|
|
(4) |
Incorporated by reference from the Companys Registration
Statement on
Form S-3 (File
No. 333-81626),
declared effective on February 12, 2002. |
|
|
(5) |
Incorporated by reference from the Companys Annual Report
on Form 10-K for
the year ended December 31, 1999, filed on March 30,
2000. |
|
|
(6) |
Incorporated by reference from the Companys Annual Report
on Form 10-K for
the year ended December 31, 2000, filed on March 27,
2001. |
|
|
(7) |
Incorporated by reference from the Companys Registration
Statement on
Form S-1 (File
No. 333-56787),
declared effective on August 11, 1998. |
|
|
(8) |
Incorporated by reference from the Companys Registration
Statement on
Form S-8 (File
No. 333-105864)
filed on June 5, 2003. |
|
|
(9) |
Incorporated by reference from the Companys Quarterly
Report on
Form 10-Q for the
quarter ended June 30, 2003, filed on August 14, 2003. |
|
|
(10) |
Incorporated by reference from the Companys Quarterly
Report on
Form 10-Q for the
quarter ended March 31, 2003, filed on May 15, 2003. |
76
|
|
(11) |
Incorporated by reference from the Companys Quarterly
Report on
Form 10-Q for the
quarter ended September 30, 2003, filed on
November 13, 2003. |
|
(12) |
Incorporated by reference from the Companys Annual Report
on Form 10-K for
the year ended December 31, 2003, filed on March 15,
2004. |
|
(13) |
Incorporated by reference from the Companys Current Report
on Form 8-K filed
on July 13, 2004. |
|
(14) |
Incorporated by reference from the Companys Current Report
on Form 8-K filed
on January 20, 2005. |
|
(15) |
Incorporated by reference from the Companys Current Report
on Form 8-K filed
on February 15, 2005. |
|
(16) |
Incorporated by reference from the Companys Current Report
on Form 8-K filed
on June 15, 2005. |
|
(17) |
Incorporated by reference from the Companys Current Report
on Form 8-K filed
on May 31, 2005. |
|
(18) |
Incorporated by reference from the Companys Current Report
on Form 8-K filed
on July 5, 2005. |
|
(19) |
Incorporated by reference from the Companys Quarterly
Report on
Form 10-Q for the
quarter ended June 30, 2005, filed on August 9, 2005. |
|
(20) |
Incorporated by reference from the Companys Current Report
on Form 8-K filed
on December 20, 2005. |
77