|
|
 | | | |
- close
- close
- close
- close
Digital River 10-K 2008 Documents found in this filing:
Table of Contents
UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission File Number:
000-24643
DIGITAL RIVER, INC.
9625 WEST 76TH STREET
EDEN PRAIRIE, MINNESOTA 55344 (Address of principal executive offices)
(952) 253-1234
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the
Act:
Name of each Exchange on which registered:
Common Stock $0.01 par value Nasdaq Global Select
Market
Securities registered pursuant to Section 12(g) of the
Act:
None
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 registrant’s 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, a non-accelerated
filer, or a smaller reporting company. See the definitions of
“large accelerated filer,” “accelerated
filer” and “smaller reporting company” in Rule
12b-2 of the
Exchange Act. (Check one):
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, 2007, there were 41,489,018 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, 40,191,937 shares of common stock,
having an aggregate market value of approximately $1,818,685,000
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
February 1, 2008 was 40,580,644 shares.
Certain sections of the Registrant’s definitive Proxy
Statement for the 2008 Annual Meeting of Stockholders are
incorporated by reference in Part III of this
Form 10-K
to the extent stated herein.
Table of Contents
This Annual Report on
Form 10-K
contains certain forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as
amended. All statements, other than statements of historical
fact, regarding our strategy, future operations, financial
position, estimated revenue, projected costs, projected savings,
prospects, plans, opportunities and objectives constitute
“forward-looking statements.” The words
“may,” “will,” “expect,”
“plan,” “anticipate,” “believe,”
“estimate,” “potential,” or
“continue” and similar types of expressions identify
forward-looking statements, although not all such statements
contain these identifying words. These forward-looking
statements are based upon information that is currently
available to us
and/or
management’s current expectations, speak only as of the
date hereof, and are subject to risks and uncertainties. We
expressly disclaim any obligation, except as required by law, or
undertaking to update or revise any forward-looking statements
contained or incorporated by reference herein to reflect any
change or expectations with regard thereto or to reflect any
change in events, conditions, or circumstances on which any such
forward-looking statement is based, in whole or in part. Our
actual results may differ materially from the results discussed
in or implied by such forward-looking statements. We are subject
to a number of risks, some of which may be similar to those of
other companies of similar size in our industry, including
pre-tax losses, rapid technological changes, competition,
limited number of suppliers, customer concentration, failure to
successfully integrate acquisitions, adverse government
regulations, failure to manage international activities, and
loss of key individuals. Risks that may affect our operating
results include, but are not limited to, those discussed in
Part I Item 1A, titled “Risk Factors.”
Readers should carefully review the risk factors described in
this document and in other documents that we file from time to
time with the Securities and Exchange Commission.
PART I
We provide end-to-end global
e-commerce
solutions to a wide variety of companies in software, consumer
electronics, computer and video games, and other 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 quickly and cost
effectively establish an online sales channel capability and to
subsequently manage and grow online sales on a global basis. Our
offerings help our clients mitigate risk and grow their online
revenues. Our services include design, development and hosting
of online stores, store merchandising and optimization, order
management, denied parties screening, export controls and
management, tax compliance and management, digital product
delivery via download, physical product fulfillment,
subscription management, multi-lingual customer service, online
marketing including
e-mail
marketing, management of paid search programs, website
optimization, web analytics and reporting.
Our products and services allow our clients to focus on
promoting and marketing their brands while leveraging our
investments in technology and infrastructure to facilitate the
purchase of products from their online stores. When shoppers
visit the store on one of our clients’ websites, they are
transferred to our
e-commerce
platform. Once on our system, 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 instructions to a third party for physical fulfillment
of the order. We also process the buyer’s payment,
including collection and remittance of applicable taxes, and can
provide customer service in multiple languages to handle
order-related questions. We believe we are an example of an
emerging trend known as “Software as a Service”
(SaaS). We have invested substantial resources to develop our
e-commerce
software platform and we provide access and use of it to our
clients as a service as opposed to selling the software to be
operated on their own in-house computer hardware.
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 improve the sales productivity of those
Table of Contents
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, consumer
electronics, and computer and video game companies and major
retailers of these products, including Allume Systems, Inc.,
Autodesk, Inc., CompUSA, Inc., Computer Associates, Canon Inc.,
Electronic Arts, Inc., Hewlett Packard Company, Lexmark, Inc.,
Microsoft Corporation, 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.
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 2007 rose 18.0% compared to the
fourth quarter of 2006, continuing a series of strong quarterly
growth reports. We believe there are a number of factors that
are contributing to the continued growth of
e-commerce:
(i) adoption of the Internet continues to increase
globally; (ii) broadband technology is increasingly being
used to deliver Internet service enabling the delivery of richer
content as well as larger files to consumers;
(iii) Internet users are becoming increasingly comfortable
with the process of buying products online; (iv) the
functionality of online stores continues to improve, offering a
broader assortment of payment options with more promotion
alternatives; (v) businesses are placing more emphasis on
their online channel, reaching a larger audience at
comparatively lower costs 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 continue to subside.
Growing Interest in Direct Sales of Products to
Consumers. Increasingly, companies are selling
their products directly to consumers via online sales channels.
This is due to increased competition for shelf space in the
traditional retail channels as well as recognition that direct
sales channels can co-exist with traditional sales channels.
Opportunities for Outsourced
E-Commerce. We
believe the market for outsourced
e-commerce
will continue to grow as 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, specialized application software and training
and support costs; (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 direct
marketing 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.
Once an online store is established, it is immediately
accessible to Internet users around the world. Web pages must be
presented and customer service inquiries handled in multiple
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 an expensive and potentially risky undertaking
for any business. These factors also make a comprehensive
outsourced offering, such as that provided by Digital River, an
attractive alternative.
Shift from Physical to Electronic Delivery of
Software. Consumers have grown increasingly
comfortable with the electronic delivery of digital products,
such as software, computer and video games, music, and video.
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
eliminates
Table of Contents
inventory-stocking requirements, shipping, handling, storage and
inventory-carrying costs as well as the risk of product
obsolescence.
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 client’s
website. We provide services that facilitate
e-commerce
transactions and drive traffic to our clients’ online
stores. Our services include design, development and hosting of
online stores, store merchandising, order management, fraud
prevention, popular online payment methods, export controls, tax
compliance and management, digital product delivery via
download, physical product fulfillment, multi-lingual customer
service, subscription management, online marketing services
including
e-mail
marketing, management of paid search programs, web analytics 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 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 clients’ online
store that is being managed by Digital River. We believe this
revenue share model aligns our interests with those of our
clients.
Benefits
to Clients
Utilizing the Digital River solution, businesses can
dramatically reduce or eliminate upfront and ongoing hardware,
software, maintenance and support costs associated with
developing, customizing, deploying, maintaining and upgrading an
in-house global
e-commerce
solution. They can have a global
e-commerce
presence without assuming the costs and risks of internal
development and leverage the investments we make in our
e-commerce
system. In addition, we help mitigate the risks of global
e-commerce,
including risks associated with payment fraud, tax compliance,
and regulatory compliance. Our ongoing investments in the latest
technologies and
e-commerce
functionality help ensure our clients maintain pace with
industry advances.
We can assist our clients in growing their online businesses by
(i) facilitating the acquisition of new customers,
improving the retention of existing customers, and increasing
the lifetime value of each customer; (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’ and
Digital River.
We provide the technology and services required to establish,
grow and support international sales, both for U.S-based clients
seeking to reach customers overseas, and
non-U.S.-based
clients looking to access the U.S. and other markets. Our
technology platform enables transactions to be completed in
numerous currencies using a variety of payment methods. 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.
Table of Contents
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 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 from Digital River.
By utilizing our outsourced
e-commerce
services, clients can focus on developing, marketing and selling
their products rather than devoting time and resources to
building and maintaining an
e-commerce
infrastructure. This allows client management time to focus on
what they know best while ensuring they have access to the
latest technologies, tools and expertise for running a
successful
e-commerce
operation.
Our solution emphasizes convenience as it enables products to be
purchased online at anytime from anywhere in the world via a
connection to the Internet. In the case of software, PC games
and other digital products, buyers can immediately download
their purchase and, depending on file size, begin using it in a
matter of minutes. 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.
Our objective is to be the global leader in outsourced
e-commerce
services for software and digital products developers, high-tech
product manufacturers, computer and video games, 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, consumer electronics, and computer and video game
markets. Our clients include software publishers, other digital
content providers, high-tech product manufacturers, and online
channel partners such as retailers. In 2007, we entered into
more than 100 new contracts with new and existing clients.
We believe we can attract new clients and gain additional
business with existing clients by expanding the range of
services we offer. This includes services to enhance the
e-commerce
transaction as well as additional online marketing services. 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 February 1, 2008, we were providing
e-commerce
services for thousands of software and digital products
publishers, high-tech products manufacturers, online retailers
and affiliates.
We believe we have amassed the largest catalog of digital
software titles available anywhere online, which we offer 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. We
believe the Digital River oneNetwork is a unique marketplace and
provides opportunities to grow our revenues and strengthen our
relationships with clients and partners.
Table of Contents
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, especially in the European and Asia Pacific
regions. We have seen significant growth in sales for clients
that have created international online stores. We intend to
continue to enhance our technology platform, payment options and
localized service offerings to increase sales in international
markets.
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 currently 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 clients 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 and
technologies 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, efficiency, 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
in our infrastructure to enable our clients to further penetrate
international markets, enhance their relationships with their
customers, better manage the
return-on-investment
across all their online marketing activities, successfully adopt
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 our
base of clients, improving the breadth and depth of our product
offering, improving the catalog of content, extending our
strategic marketing and other services offerings, expanding our
geographic reach and diversifying our revenue stream into
complementary or adjacent market segments.
Expand the Digital River oneNetwork
Marketplace. We have developed a global
marketplace we call Digital River oneNetwork which 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
online traffic to specific websites. On those websites, there
are links, advertisements and other offers to sell various
products and services. If a visitor clicks one of the links or
advertisements and subsequently makes a purchase, the affiliate
receives a commission in the form of a fixed fee or a percentage
of the selling price of the product(s) purchased. Affiliates are
an increasingly important source of website traffic as they can
target specific types of Internet users.
We provide a broad range of services to our clients, including
design, development and hosting of online stores, merchandising,
order management, fraud prevention screening, popular online
payment methods, denied parties screening, tax compliance and
management, digital and physical product fulfillment,
multi-lingual customer service, subscription management, online
marketing services including email marketing and paid search
program management, and analytics and reporting. Most of these
offerings can be managed through client-facing, remote control
self-service tools that are easily used by business users
without specialized training. Since clients utilize our
centralized system and processes, we can consistently offer best
practices across our entire client base.
Store Design, Development and Hosting. We
offer our clients website design services utilizing our
experience and expertise to create efficient and effective
online stores. Our
e-commerce
solutions can be
Table of Contents
deployed quickly 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 website design to provide a seamless
experience for shoppers. When a shopper navigates from a
client’s website (operated by them) to their store
(operated by us), the transition is seamless and the customer is
unaware they are then being served by our technology platform.
We manage the order process through payment processing, fraud
screening, and fulfillment (either digital or physical) and
notify the buyer via
e-mail once
the transaction is completed. Transaction information is
captured and stored in our database systems, 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 global 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 promotions, up-sell, and
cross-sell activities and to feature specific 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 order close ratios
and average order sizes.
Order Management and Fraud Screening. We
manage all phases of a shopper’s 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
methods 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 that 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 digital product has been
delivered via download or the physical product(s) has been
shipped, we submit the transaction for payment.
Digital and Physical Fulfillment Services. We
provide both digital and physical fulfillment services to our
clients. 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 generally 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.
In addition to electronic fulfillment via download, we offer
physical distribution services to our clients 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. We provide notification of product shipment to the
buyer as well as shipment tracking, order status, and inventory
information. We also provide a service called “Physical on
Demand” (POD), which utilizes robotic systems to create a
client-branded product CD and packaging materials after a POD
order has been placed. This eliminates the requirement for
inventory to be stored in a warehouse as physical product is
created only when needed. 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. We
believe physical fulfillment services are important to providing
a complete
e-commerce
solution to our clients, particularly for non-digital products
market where digital fulfillment is not possible.
Table of Contents
Customer Service. At our client’s option
and for an additional fee, we provide telephone and
e-mail
customer support for products sold through our platforms. We
provide assistance to buyers regarding ordering and delivery
questions on a 24/7 basis in multiple 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.
Advanced Reporting and Analytics. We capture
and store detailed information about visitor traffic, for sales
in the online stores we manage for our clients. This information
is stored in our database systems where it is available for
analysis and reporting. 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 and the
results of marketing campaigns so they can optimize their
marketing efforts to increase traffic, order close ratios and
average order values.
Strategic Marketing Services. We offer a range
of strategic marketing services designed to increase customer
acquisition, improve customer retention and enhance the lifetime
value of each customer. 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. We generally 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
e-commerce
sales 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.
We serve distinct groups of clients: (1) software, consumer
electronics, and computer and video game product manufacturers;
and (2) online channel partners including 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
developers and manufacturers as it gives them access to broad
distribution through a single source.
We sell products and services primarily to consumers 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 executives within software
companies, consumer electronics and high-tech product
manufacturers, game manufacturers and online channel partners
who are looking to create or expand their
e-commerce
businesses. During the 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 order 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,
Table of Contents
print and electronic advertising, trade shows and events, public
relations, media events and speaking engagements.
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 the 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 Digital River developed
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, .net Microsoft IIS
and Oracle 9iAS application servers. We use Akamai, Limelight
and Mirror Image’s 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 AJAX, Web
Services, DHTML, 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 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, 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 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 a shopper’s specific
areas of interest.
Security. 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 Internet Protocol
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-user’s experience on our
clients’
e-commerce
sites.
Data Center Operations. Continuous data center
operations are crucial to our success. We currently maintain
major data center operations in eight facilities: California and
Minnesota, USA; and Germany, Ireland and Sweden. All major data
center locations are currently processing transactions and
serving downloads.
Table of Contents
All data centers currently utilize multiple levels of redundant
systems, including load balancers managing traffic volumes
across web and application server farms, database servers, and
enterprise disk storage arrays. For the majority of these
systems, we have automatic failover procedures in place such
that when a fault 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, Limelight and Mirror Image networks.
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, sophisticated reporting functionality and new
marketing technologies. Product research and development
expenses were $39.2 million, $32.3 million, and
$20.7 million, in 2007, 2006, and 2005 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
e-commerce
platforms.
The market for
e-commerce
solutions is highly competitive. We compete with
e-commerce
solutions that our customers develop internally or contract with
third parties to develop on their behalf. We also compete with
other outsourced
e-commerce
providers. The competition we encounter includes:
Table of Contents
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.
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, 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 sixteen U.S patents issued with
seven to sixteen years remaining prior to expiration. We also
have over seventy U.S. and foreign 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.
As of February 1, 2008, we employed 1265 associates. 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.
The following table sets forth information regarding our
executive officers at February 1, 2008:
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 Documentation Systems, Inc., a medical
software company, and Controller of Staats International, Inc.,
a defense subcontractor.
Table of Contents
Mr. Crudden joined Digital River in January 2006 as
Vice President and General Counsel. For more than five years
prior to joining Digital River, Mr. Crudden was a partner
in the law firm of Robins, Kaplan, Miller & Ciresi
L.L.P., Minneapolis, Minnesota, practicing in the areas of
corporate finance, mergers and acquisitions, and corporate
governance.
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.
Sales of products for one software publisher client, Symantec
Corporation, accounted for approximately 26.2% of our revenue in
2007. In addition, revenues derived from proprietary Digital
River services sold to Symantec end-users and sales of Symantec
products through our oneNetwork retail and affiliate channel
together accounted for approximately 13.2% 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.
Compared to certain of our current and potential competitors, we
have a relatively short operating history. In addition, the
nature of our business and the
e-commerce
industry in which we operate has undergone rapid development and
change. Accordingly, it is difficult to predict whether we will
be successful. Thus, our chances of financial and operational
success should be evaluated in light of the risks,
uncertainties, expenses, delays and difficulties associated with
operating a business with limited history in a relatively
rapidly changing industry. If we are unable to address these
issues, we may not be financially or operationally successful.
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 effectively manage our growth
opportunities could damage our reputation, limit our future
growth, negatively affect our operating results and harm our
business.
Table of Contents
We sell products and services to end-users outside the United
States and we intend to continue expanding our international
presence. In 2007, our sales to international consumers
represented approximately 43.2% of our total sales. 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:
Any of the factors described above may have a material adverse
effect on our ability to increase or maintain foreign sales.
These risks have grown with the acquisitions of Digital River
GmbH, which has substantial operations outside the U.S. and
with our expansion into the Asia-Pacific region. More recently,
we acquired NetGiro Systems which is based in Stockholm, Sweden.
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. In addition, a significant portion of our cash and
marketable securities are held in
non-U.S. domiciled
countries.
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. To the extent that
software publishers 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.
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
Table of Contents
complex and evolving. We already are required to collect and
remit VAT in the European 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.
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.
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, Discover, or other card associations 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.
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 publishers falls below a
satisfactory level, we could also experience a decline in
revenue, operating profit and end-user satisfaction,
Table of Contents
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 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.
In February 2007, we announced that an internal review had
discovered irregularities related to the issuance of certain
stock option grants primarily made between 1998 and 2002. As a
result of the internal review, the Special Committee concluded,
and the Audit Committee and Board of Directors agreed, that we
used incorrect measurement dates for financial accounting
purposes for certain stock option grants in prior periods.
Therefore, we have recorded additional non-cash stock-based
compensation expense and related tax effect with regard to
certain past stock option grants, and we have restated
previously filed financial statements in our
Form 10-K
for the year ended December 31, 2006. The full year
adjustment to 2006 was recorded in the fourth quarter of 2006
due to its insignificance.
Activities
related to our internal review of historical stock option
practices have required us to incur substantial expenses for
legal, accounting, tax and other professional services, have
diverted management’s attention from our business, and
could, in the future, harm our business, financial condition,
results of operations and cash flows.
While we believe we have made appropriate judgments in
determining the correct measurement dates for our stock option
grants, the SEC may disagree with the manner in which we have
accounted for and reported, or not reported, the financial
impact. Accordingly, there is a risk we may have to further
restate our prior financial statements, amend prior filings with
the SEC, or take other actions not currently contemplated.
Our past stock option granting practices and the restatement of
prior financial statements have exposed us to greater risks
associated with litigation, regulatory proceedings and
government enforcement actions. In December 2006, the SEC
initiated an informal inquiry into our historical stock option
practices. We have provided the results of our internal review
together with supporting documentation to the SEC. We intend to
continue to fully cooperate with the SEC’s inquiry. No
assurance can be given regarding the outcomes from litigation,
regulatory proceedings or government enforcement actions
relating to our past stock option practices. The resolution of
these matters could be time consuming, expensive, and may
distract management from the conduct of our business.
Furthermore, if we are subject to adverse findings in
litigation, regulatory proceedings or government enforcement
actions, we could be required to pay damages or penalties or
have other remedies imposed, which could harm our business,
financial condition, results of operations and cash flows.
As a result of our investigation into our historical stock
option granting practices, we have determined that a number of
our outstanding stock option awards were granted at exercise
prices below the fair market value of our stock on the
appropriate accounting measurement date. The primary adverse tax
consequence is that the re-measured options vesting after
December 31, 2005 are potentially subject to option holder
excise tax under Section 409A of the Internal Revenue Code
(and, as applicable, similar excise taxes under state law or
foreign law). Our employees who have exercised or will exercise
options which are determined to have been granted with exercise
prices below the fair market value of the underlying shares of
common stock on
Table of Contents
the appropriate measurement date and do not meet one of the
exceptions under 409A may be subject to an increase in taxes
imposed by 409A, penalties and interest.
A key element of our business strategy involves expansion
through the acquisitions of businesses, assets, products or
technologies that allow us to complement our existing product
offerings, expand our market coverage, increase our engineering
workforce or enhance our technological capabilities. Between
January 1, 1999 and December 31, 2007, we acquired
27 companies. We continually evaluate and explore strategic
opportunities as they arise, including business combination
transactions, strategic partnerships, and the purchase or sale
of assets, including tangible and intangible assets such as
intellectual property. We have acquired, and intend to continue
engaging in strategic acquisitions of businesses, technologies,
services and products. Since December 2006, we have acquired
three businesses, NetGiro Systems AB, DigitalSwift Corporation
and CustomCD, Inc.
Acquisitions may require significant capital infusions,
typically entail many risks, and could result in difficulties in
assimilating and integrating the operations, personnel,
technologies, products and information systems of acquired
companies or businesses. We have in the past and may in the
future experience delays in the timing and successful
integration of an acquired company’s technologies and
product development, unanticipated costs and expenditures,
changing relationships with customers, suppliers and strategic
partners, or contractual, intellectual property or employment
issues. In addition, key personnel of an acquired company may
decide not to work for us. The acquisition of another company or
its products and technologies may also require us to enter into
a geographic or business market in which we have little or no
prior experience.
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. These challenges are
magnified as the size of the acquisition increases. Furthermore,
these challenges would be even greater if we acquired a business
or entered into a business combination transaction with a
company that was larger and more difficult to integrate than the
companies we have historically acquired. 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 require substantial working capital to fund our business. In
January 2005, we filed a registration statement to increase our
available shelf registration amount and we have $82 million
available for future use. 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. For a thirty day period ending
January 1, 2009, the note holders have the right to have
the debt redeemed at 100.25% of principal face amount. In light
of current market conditions for interest rates and our stock
price relative to the conversion price for the notes, it is
likely that some of the note holders will seek repayment on
January 1, 2009. We may not have sufficient capital to
service this or any future debt securities that we may issue,
further, the conversion of the notes into our common stock would
result in further dilution to our stockholders.
Table of Contents
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 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 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 may be impacted. Some of the
factors that have contributed or may contribute to fluctuations
in our quarterly and annual operating results include:
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, consumer
electronics, and computer and video games markets.
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.
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
Table of Contents
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.
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. 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. 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
operations and financial condition could be materially adversely
affected.
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.
If our
internal control over financial reporting or disclosure controls
and procedures are not effective, there may be errors in our
financial statements that could require a restatement or our
filings may not be timely and investors may lose confidence in
our reported financial information, which could lead to a
decline in our stock price.
Section 404 of the Sarbanes-Oxley Act of 2002 requires us
to evaluate the effectiveness of our internal control over
financial reporting as of the end of each year, and to include a
management report assessing the effectiveness of our internal
control over financial reporting in each Annual Report on
Form 10-K.
Section 404
Table of Contents
also requires our independent registered public accounting firm
to attest to, and report on, management’s assessment of our
internal control over financial reporting.
Our management, including our Chief Executive Officer and Chief
Financial Officer, does not expect that our internal control
over financial reporting will prevent all error and all fraud. A
control system, no matter how well designed and operated, can
provide only reasonable, not absolute, assurance that the
control system’s objectives will be 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. Controls can be circumvented
by the individual acts of some persons, by collusion of two or
more people, or by management override of the controls. Over
time, controls may become inadequate because changes in
conditions or deterioration in the degree of compliance with
policies or procedures may occur. Because of the inherent
limitations in a cost-effective control system, misstatements
due to error or fraud may occur and not be detected.
As a result, we cannot assure you that significant deficiencies
or material weaknesses in our internal control over financial
reporting will not be identified in the future. Any failure to
maintain or implement required new or improved controls, or any
difficulties we encounter in their implementation, could result
in significant deficiencies or material weaknesses, cause us to
fail to timely meet our periodic reporting obligations, or
result in material misstatements in our financial statements.
Any such failure could also adversely affect the results of
periodic management evaluations and annual auditor attestation
reports regarding disclosure controls and the effectiveness of
our internal control over financial reporting required under
Section 404 of the Sarbanes-Oxley Act of 2002 and the rules
proclaimed after that. The existence of a material weakness
could result in errors in our financial statements that could
result in a restatement of financial statements, cause us to
fail to timely meet our reporting obligations and cause
investors to lose confidence in our reported financial
information, leading to a decline in our stock price.
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 loss of our market share, any of which could
negatively impact our revenue and earnings. We face competition
from the following sources:
Table of Contents
We believe that the principal competitive factors for a
participant in our market are the breadth of products and
services offered, proven global platforms, the number of clients
and online channel partnerships a participant has, 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.
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:
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 was adopted prior to the advent of
the Internet, and do not contemplate or address the unique
issues raised thereby. Those laws that do
Table of Contents
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.
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.
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:
We may not carry sufficient business interruption insurance to
fully compensate us for losses that may occur.
Table of Contents
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, could adversely affect our operating results
or financial condition.
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.
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.
Table of Contents
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. We can incur substantial front-end cost to
launch client sites and it may require a substantial time before
those costs are recouped by us.
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.
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.
Table of Contents
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.
Sales outside the United States accounted for approximately
43.2% of our total sales in 2007. 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 may
enter into short-term currency forward contracts to offset the
foreign exchange gains and losses generated by the
re-measurement of certain assets and liabilities recorded in
non-functional currencies. The use of such hedging activities
may not offset more than a portion of the adverse financial
impact resulting from unfavorable movements in foreign exchange
rates. See Item 7A of Part II, for information
demonstrating the effect on our consolidated statements of
income from changes in exchange rates versus the
U.S. dollar.
Our future effective tax rates could be favorably or unfavorably
affected by changes in the mix of earnings in countries with
differing statutory tax rates, changes in the valuation of our
deferred tax assets and liabilities, or by changes in tax laws
or their interpretation. In addition, we are subject to the
continuous examination of our income tax returns by the Internal
Revenue Service and other tax authorities. We regularly assess
the likelihood of adverse outcomes resulting from these
examinations to determine the adequacy of our provision for
income taxes. There can be no assurance that the outcomes from
these continuous examinations will not have an adverse effect on
our results of operations and financial condition.
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
Table of Contents
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, 2007, we had goodwill with an indefinite life
of $261.9 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. On January 1, 2006, we adopted
SFAS 123(R) which requires the measurement and recognition
of compensation expense for all stock-based compensation based
on estimated fair values. Our operating results for 2007
contain, and our operating results for future periods will
contain, a charge for stock-based compensation related to stock
options, restricted stock grants and employee stock purchases.
The stock market and the trading prices of Internet-related
companies in particular, have been notably volatile. This
volatility is likely to continue 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:
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.
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.
Table of Contents
At January 31, 2008, we held approximately
$117.5 million of municipal debt, classified as current
assets, with an auction reset feature (“auction rate
securities”) whose underlying assets are generally student
loans which are FFELP (Federal Family Education Loan Program)
back, over-collateralized, insured and backed by the Department
of Education. In February 2008 auctions failed for
$40.0 million of our auction rate securities and there is
no assurance that currently successful auctions on the other
auction rate securities in our investment portfolio will
continue to succeed and as a result our ability to liquidate our
investment and fully recover the carrying value of our
investment in the near term may be limited or not exist. A
failed auction will occur if there is more selling than buying
in a given auction. All of our auction rate securities,
including those subject to the failure, are currently rated AAA,
the highest rating, by a rating agency. If the issuers are
unable to successfully close future auctions and their credit
ratings deteriorate, we may in the future be required to record
an impairment charge on these investments. We believe we will be
able to liquidate our investment without significant loss within
the next year, and we currently believe these securities are not
significantly impaired, primarily due to the government
guarantee of the underlying securities; however, it could take
until the final maturity of the underlying notes (up to
30 years) to realize our investments’ recorded value.
Based on our expected operating cash flows, and our other
sources of cash, we do not anticipate the potential lack of
liquidity on these investments will affect our ability to
execute our current business plan.
None.
The following table summarizes the various facilities that we
lease for our business operations:
We believe our properties are suitable and adequate for our
present needs We periodically evaluate whether additional
facilities are necessary.
DDR Holdings, LLC has brought a claim against us and several
other defendants regarding US Patents No. 6,629,135 and
6,993,572, which are owned by DDR Holdings. These patents claim
e-commerce
outsourcing systems and methods relating to the provision of
outsourced
e-commerce
support pages having a common look and feel with a host’s
website. The case was filed in the U.S. District Court for
the Eastern District of Texas on January 31, 2006. The
complaint seeks injunctive relief, declaratory relief, damages
and attorneys’ fees. We have denied infringement of any
valid claim of the
patents-in-suit,
and have asserted counter-claims which seek a judicial
declaration that the patents are invalid and not infringed. In
September 2006, DDR Holdings filed an application for
reexamination of its patents based upon the prior art produced
by us and the other defendants in the case. As part of that
application, DDR Holdings asserted that this prior art raised a
substantial question as to the patentability of the inventions
claimed in the patents. In December 2006,
Table of Contents
the Court stayed the litigation pending a decision on the
reexamination application. In February 2007, the US Patent and
Trademark Office ordered reexamination of DDR’s patents. We
intend to vigorously defend ourselves in this matter.
NetRatings, Inc. has brought a claim against us regarding US
Patents Nos. 5,675,510, 6,115,680, 6,108,637, 6,138,155 and
6,763,386, which are owned by NetRatings. These patents claim
web analytic and reporting systems. The case was filed in the
U.S. District Court for the District of Minnesota on
October 5, 2006. The complaint seeks injunctive relief,
declaratory relief, damages and attorney’s fees. We have
denied the allegations of infringement. Discovery in this matter
is ongoing. In December 2007, the parties submitted briefs to
the Court in connection with the Markman claim construction. No
trial date is currently set for this case. We intend to continue
our vigorous defense of this matter.
In December 2006, we announced that we had received an informal
inquiry from the SEC relating to our historical stock option
grant practices. We have cooperated with the SEC regarding this
matter and intend to continue to do so.
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
operations 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.
None.
Table of Contents
Our common stock is traded on NASDAQ Global Select 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.
As of February 1, 2008, there were approximately 350
holders of record of our common stock. On February 1, 2008,
the last sale price reported on The NASDAQ Stock Market for our
common stock was $30.68 per share.
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.
In June 2007, the Board of Directors authorized a new share
repurchase program of up to $200.0 million of our
outstanding shares of common stock. This new program supersedes
and replaces the $50.0 million share repurchase program
adopted in 2005. 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. We
did not repurchase any of our common stock during the three
months ended December 31, 2007. During 2007, we repurchased
1,372,185 shares for $63.0 million. None of the
repurchased shares have been retired.
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 2008
Annual Meeting to be filed in accordance with
Regulation 14A under the Securities Exchange Act of 1934,
as amended.
Table of Contents
The SEC requires a comparison on an indexed basis of cumulative
total stockholder return for the Company, a relevant broad
equity market index and a published industry line-of-business
index. The following graph shows a total stockholder return of
an investment of $100 in cash on December 31, 2002 for
(i) the Company’s Common Stock; (ii) the CRSP
Total Return Index for the Nasdaq Stock Market
(U.S. companies) (the “Nasdaq Composite Index”);
and (iii) the RDG Technology Composite Index. The RDG
Technology Composite Index is composed of approximately 500
technology companies in the semiconductor, electronics, medical
and related technology industries. Historic stock price
performance is not necessarily indicative of future stock price
performance. All values assume reinvestment of the full amount
of all dividends.
Fiscal year ending December 31.
1 This
Section is not “soliciting material,” is not deemed
“filed” with the SEC and is not to be incorporated by
reference in any filing of the Company under the Securities Act
or the Exchange Act whether made before or after the date hereof
and irrespective of any general incorporation language in any
such filing.
Table of Contents
The information set forth below is not necessarily indicative of
results of future operations, and should be read in conjunction
with Item 7, “Management’s Discussion and
Analysis-Financial Condition and Results of Operations” and
the consolidated financial statements and related notes thereto
included in Item 8 of this
Form 10-K
to fully understand factors that may affect the comparability of
the information presented below.
The financial information that has been previously filed or
otherwise reported for these periods is superseded by the
information in this Annual Report on
Form 10-K,
and the financial statements and related financial information
contained in previously-filed reports should no longer be relied
upon.
Table of Contents
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.
We provide outsourced
e-commerce
solutions globally to a wide variety of companies primarily in
the software and high-tech products, consumer electronics, and
computer and video games 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, hosting, store
merchandising and optimization, order management, subscription
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.
We acquired SWReg in March 2005, Commerce5, Inc. (now DR
globalTech, Inc.) in December 2005, Direct Response
Technologies, Inc. (now DR Marketing Solutions, Inc.) in January
2006, MindVision, Inc. in June 2006 and NetGiro Systems AB in
September 2007. The results of these acquisitions must be
factored into any comparison of our 2007 results to the results
for 2006 or 2005. See Note 4 of our consolidated financial
statements for the year ended December 31, 2007, for pro
forma financial information as if these entities had been
acquired on January 1, 2006.
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.
Table of Contents
Our revenue is recorded as 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 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.
In June 2006, the EITF reached a consensus on EITF Issue
No. 06-3,
“How Taxes Collected from Customers and Remitted to
Governmental Authorities Should Be Presented in the Income
Statement (That is, Gross versus Net Presentation)”
(“EIFT
06-3”).
EITF 06-3
provides that the presentation of taxes assessed by a
governmental authority that is directly imposed on a
revenue-producing transaction between a seller and a customer on
either a gross basis (included in revenues and costs) or on a
net basis (excluded from revenues) is an accounting policy
decision that should be disclosed. The Company presents these
taxes on a net basis.
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 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
Table of Contents
Intangible Assets.” There have been no impairments of
goodwill and other intangible assets for the years 2007, 2006
and 2005.
Income Taxes and Deferred Taxes. 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 record deferred tax assets for favorable tax
attributes, including tax loss carryforwards. We currently have
significant U.S. tax loss carryforwards consisting solely
of acquired operating tax loss carryforwards, and a lesser
amount of acquired foreign operating tax loss carryforwards. A
portion of 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. If the benefit of these
acquired 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.
On January 1, 2007, we adopted FASB Interpretation
No. 48 (FIN 48), Accounting for Uncertainty in
Income Taxes — an interpretation of FASB Statement
No. 109. FIN 48 clarifies the accounting for
uncertainty in income taxes recognized under
SFAS No. 109, Accounting for Income Taxes.
FIN 48 prescribes a recognition threshold and measurement
attribute for financial statement recognition and measurement of
a tax position taken or expected to be taken in a tax return and
also provides guidance on various related matters such as
derecognition, interest and penalties, and disclosure. As a
result of the implementation of FIN 48, we recognized no
material adjustment in the liability for unrecognized income tax
benefits.
No provision has been made for federal income taxes on
approximately $48.9 million of our foreign subsidiaries
undistributed earnings as of December 31, 2007 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, 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 in
the basis of assets 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.
Stock-Based Compensation Expense. On
January 1, 2006, we adopted Statement of Financial
Accounting Standards No. 123 (Revised 2004),
“Share-Based Payment,” (“SFAS 123(R)”)
which requires the measurement and recognition of compensation
expense for all share-based payments made to employees and
directors including stock options, restricted stock grants and
employee stock purchases made through our Employee Stock
Purchase Plan based on estimated fair values. SFAS 123(R)
supersedes our previous accounting under Accounting Principles
Board Opinion No. 25 (“APB 25”), “Accounting
for Stock Issued to Employees,” for periods beginning in
2006.
Prior to the adoption of SFAS 123(R), we had elected to
apply the disclosure-only provision of SFAS No. 123,
“Accounting for Stock-Based Compensation” as amended
by SFAS No. 148. Accordingly, we accounted for
stock-based compensation using the intrinsic value method
prescribed in APB 25 and related interpretations. Compensation
expense for stock options was measured as the excess, if any, of
the fair value of our common stock at the date of grant over the
stock option exercise price.
We have adopted SFAS 123(R) using the modified prospective
transition method under which prior periods are not revised.
Stock-based compensation expense recognized during the period is
based on the value of the portion of share-based awards that are
ultimately expected to vest during the period. Stock-based
compensation expense recognized in our Consolidated Statement of
Income in 2006 and 2007 includes compensation expense for
share-based awards granted prior to, but not yet vested, as of
December 31, 2005, as well as compensation expense for the
share-based payment awards granted subsequent to
December 31, 2005. The fair value of each stock option
grant is estimated on the date of grant using the Black-Scholes
option pricing model. The fair value of restricted stock is
determined based on the number of shares granted and the closing
price of our common stock on the date of grant. Compensation
expense for all share-based payment awards is recognized using
the straight-line amortization method over the vesting period.
Stock-based
Table of Contents
compensation expense of $13.7 million was charged to
operating expenses during 2007. The related tax benefit of
$3.7 million resulted in a net after-tax stock-based
compensation expense of $10.0 million for 2007.
As stock-based compensation expense recognized in our
Consolidated Statement of Income for 2007 is based on awards
ultimately expected to vest, it has been reduced for estimated
forfeitures. SFAS 123(R) requires forfeitures to be
estimated at the time of grant and revised, if necessary, in
subsequent periods if actual forfeitures differ from those
estimates. Our pro forma information required under
SFAS 123, for periods prior to 2006, accounted for
forfeitures as they occurred. In March 2005 the Securities and
Exchange Commission issued Staff Accounting
Bulletin No. 107 (“SAB 107”), which
provides supplemental implementation guidance for
SFAS 123(R). We have applied the provision of SAB 107
in our adoption of SFAS 123(R).
SFAS 123(R) also requires the benefits of tax deductions in
excess of recognized stock-based compensation expense be
reported as a financing cash flow, rather than an operating cash
flow as required prior to adoption of SFAS 123(R) in our
Consolidated Statement of Cash Flows. On November 10, 2005,
the Financial Accounting Standards Board (FASB) issued FASB
Staff Position No. FAS 123(R)-3 “Transition
Election Related to Accounting for Tax Effects of Share-based
Payment Awards.” We have elected not to adopt the
alternative transition method provided in the FASB Staff
Position for calculating the tax effects of stock-based
compensation pursuant to SFAS 123(R).
See Note 5 in the Consolidated Financial Statements in this
Form 10-K
for further information regarding the impact of our adoption of
SFAS 123(R) and the assumptions we use to calculate the
fair value of share-based compensation.
Results
of Operations
The following table presents certain items from our consolidated
statements of income as a percentage of total revenue for the
years indicated.
Revenue. Our revenue increased to
$349.3 million in 2007 from $307.6 million in 2006 and
$220.4 million in 2005. The revenue increases were
primarily attributable to increased traffic, increase in average
order value offset by a reduction in close ratio, growth in the
number of online game and consumer electronic clients we served,
increased sales from international sites, expanded strategic
marketing activities with a larger number of clients, and
acquisitions. Sales of security software products for PCs
represent the largest contributor to our revenues. Acquisitions
made during each of 2007, 2006 and 2005 generated approximately
Table of Contents
1.3%, 3.5% and 2.0% of our total revenue for those years,
respectively. International sales represented approximately
43.2%, 41.2% and 38.7% of revenue in the years ended
December 31, 2007, 2006 and 2005, respectively. That growth
is attributable to a larger number of international stores being
operated for our clients. Sales of products for one software
publisher client, Symantec Corporation, accounted for
approximately 26.2% of our revenue in 2007, 30.2% in 2006 and
29.7% in 2005. In addition, revenues derived from proprietary
Digital River services sold to Symantec end-users and dealer
network sales of Symantec products amounted to approximately
13.2% of our total revenue in 2007, 16.6% in 2006 and 14.4% in
2005.
Direct Cost of Services. Our direct cost of
services primarily include costs related to personnel, product
fulfillment, physical on demand, our proprietary
back-up CD
production and client-specific costs. Direct cost of service
expense was $10.2 million, $7.7 million, and
$5.1 million, in 2007, 2006 and 2005, respectively. The
increase in 2007 compared with 2006 was primarily due to
approximately $1.6 million in increased CD supply costs
associated with higher gross sales and $0.8 million in
additional personnel costs to support our largest clients and
handle increased sales volume. The increase in 2006 compared
with 2005 was attributable to personnel added to support new
clients and increased transaction volumes, recent acquisitions
and stock-based compensation expense related to employee stock
options and employee stock purchases recognized under
SFAS 123(R). As a percentage of revenue, direct cost of
services increased to 2.9% in 2007 from 2.5% and 2.3% in 2006
and 2005, respectively.
We currently believe direct costs of services will increase in
absolute dollars in 2008 compared to 2007 as we continue to
expand our worldwide fulfillment capacity to meet anticipated
shipment volumes.
Network and Infrastructure. Our network and
infrastructure expenses primarily include personnel related
expenses and costs to operate and maintain our technology
platforms, customer service, data communication and data center
operations. Network and infrastructure expenses were
$32.3 million in 2007, up from $29.3 million and
$19.8 million in 2006 and 2005, respectively. The increase
in 2007 from 2006 was primarily due to approximately
$1.8 million in additional software license amortization
expense, $1.3 million in increased data telecommunication
and data center operations costs and $1.0 million of
network and infrastructure costs related to recent acquisition,
NetGiro Systems. These increases supported our revenue growth
and were partially offset by $1.9 million lower personnel
costs due primarily to Symantec Corporation bringing certain
customer service activities in-house and the absence of
workforce reduction related costs incurred in connection with
the 2006 consolidation of our International customer service
center located in Ireland. The increase in 2006 expenses from
2005 resulted primarily from Information Services personnel
added to support our revenue growth as well as those gained
through acquisition of other businesses and costs related to
operating new international data centers. As a percentage of
revenue, network and infrastructure costs declined to 9.3% from
9.5% in 2006 and were 9.0% in 2005.
We currently believe network and infrastructure expenses will
increase in absolute dollars in 2008 compared to 2007 as we
continue to expand our worldwide global data center and customer
service capacity.
Sales and Marketing. Our sales and marketing
expenses mainly include credit card transaction and other
payment processing fees, personnel and related costs,
advertising, promotional and product marketing expenses, credit
card chargeback’s and bad debt expense. Sales and marketing
expenses were $134.4 million, $113.5 million and
$69.4 million in 2007, 2006 and 2005, respectively. The
increase in 2007 from 2006 was driven by an additional
$9.2 million in personnel and related costs to support our
global growth initiatives in strategic and product marketing,
$5.7 million in promotional and product marketing expenses
associated with MarketForce services, particularly paid search
and a $5.5 million increase in credit card and other
payment processing fees directly related to incremental gross
revenue and the addition of new international payment methods.
During 2007, we continued to strengthen our presence in the
global and the consumer electronics markets. We increased the
value of existing client relationships through our strategic
marketing and oneNetwork affiliate program. In addition, we
expanded our relationships with two of our major partners,
Symantec and Microsoft. The increase in sales and marketing
expenses in 2006 from 2005 resulted primarily from credit card
fees directly associated with increased revenue, new
international payment methods, marketing personnel and related
expenses, costs from recent acquisitions, and stock-based
compensation expense related to employee stock options and
employee stock purchases recognized under SFAS 123(R). As a
Table of Contents
percentage of revenue, sales and marketing expense increased to
38.5% in 2007 from 36.9% and 31.5% in 2006 and 2005,
respectively.
We currently believe sales and marketing expenses will increase
in absolute dollars in 2008 compared to 2007, to support the
expansion of our client relationships through increased
investments in subscriptions, international payment processing
and strategic marketing services. We also plan to invest in key
vertical markets, in particular consumer electronics and games.
Product Research and Development. Our product
research and development expenses include the costs of personnel
and related expenses associated with developing and enhancing
our technology platforms and related systems. Product research
and development expense was $39.2 million in 2007, compared
to $32.3 million and $20.7 million in 2006 and 2005,
respectively. The increase in 2007 from 2006 was primarily due
to strategic investments of an additional $4.8 million in
professional consulting fees and $2.4 million additional
personnel related expenses mainly in software development and
quality assurance. These investments supported on-going
initiatives in our
e-commerce
infrastructure to advance global system scalability, our
e-marketing
capabilities and client reporting. We expect these investments
to drive long-term operational efficiencies across the
organization and provide further competitive differentiation.
Our 2007 network and infrastructure costs also included new
acquisition NetGiro Systems and software development expenses
related to our new relationship with Electronic Arts, a leading
interactive entertainment software company. We did not
capitalize any internal software development costs in 2007. The
increase in 2006 from 2005 resulted primarily from increases in
personnel related expenses to support our growth initiatives,
costs from recent acquisitions, development related to our
expanded relationship with Microsoft and stock-based
compensation expense related to employee stock options and
employee stock purchases recognized under SFAF 123(R). As a
percentage of revenue, product research and development expense
increased to 11.2% in 2007 from 10.5% in 2006 and 9.4% in 2005.
We currently believe that product research and development
expenses will increase in absolute dollars in 2008 compared to
2007, as a result of continued investments in product
development required to remain competitive.
General and Administrative. Our general and
administrative expenses primarily include the costs of
executive, accounting and administrative personnel and related
expenses, professional fees for legal, tax and audit services,
bank fees and insurance. General and administrative expenses
increased to $38.9 million in 2007 from $34.2 million
and $21.5 million in 2006 and 2005, respectively. The
increase in 2007 from 2006 resulted primarily from expenses
required to support our global expansion and infrastructure
investments including approximately $2.3 million of
additional professional consulting fees, $1.7 million in
additional personnel related costs and $0.9 million of
additional bank fees mainly incurred by our new acquisition,
NetGiro Systems. NetGiro Systems is an international payment
service provider headquartered in Stockholm, Sweden. The
increase expenses in 2006 from 2005 resulted primarily from the
addition of personnel and facilities to support our global
expansion, such as our offices in Ireland and Luxembourg, as
well as those gained through acquisition of other businesses,
from stock-based compensation expense related to employee stock
options and employee stock purchases recognized under
SFAS 123(R) and costs incurred for activities related to
our internal review of historical stock option practices. As a
percentage of revenue, general and administrative expenses were
11.1% in both 2007 and 2006 and increased from 9.7% in 2005.
We currently believe that general and administrative expenses
will increase in absolute dollars in 2008 compared to 2007, as
we continue to invest in our infrastructure to support continued
organic growth and expenses related to new acquisitions.
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
$12.7 million in 2007 from $11.0 million in 2006 and
$8.8 million in 2005. The increased expenses in 2007 and
2006 resulted primarily
Table of Contents
from increases in our assets, as gross capitalized property and
equipment increased to $74.1 million on December 31,
2007, from $56.4 million and $52.0 million on
December 31, 2006 and 2005, respectively.
We currently believe that depreciation and amortization expenses
will increase in absolute dollars in 2008 compared to 2007 as we
have and will 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 9
acquisitions in the past four years. Amortization of acquisition
related intangibles decreased to $7.6 million in 2007 from
$12.1 million in 2006 and $8.7 million in 2005. The
decrease in 2007 from 2006 and 2005 reflects the full
amortization of certain past acquisitions partially offset by
the increased amortization of 2007 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, 2007, 2006 and 2005. 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 2007 was $73.9 million, up from
$67.6 million in 2006 and $66.4 million in 2005. As a
percentage of revenue, income from operations was 21.2% in 2007,
22.0% in 2006 and 30.1% in 2005. Income from operations
decreased during 2007 from 2006 and 2005 as a percentage of
revenue as expenses grew faster than revenues primarily due to
higher spending on global growth initiatives.
Interest Income. Our interest income line item
is the total of interest income on our cash, cash equivalents,
and short-term investments. Interest income was
$32.2 million, $22.8 million and $9.7 million in
2007, 2006 and 2005, respectively. The increases in interest
income were primarily due to higher cash balances and slightly
higher interest rates.
Other Income (Expense), Net. Our other income
(expense), net line item is the total of interest expense on our
debt and foreign currency transaction gains and losses. Interest
expense was $2.4 million in 2007, 2006 and 2005 and is
related primarily to our contingent convertible notes. Our loss
from foreign currency remeasurement was $0.6 million in
2007 compared to a gain of $1.5 million in 2006 and a loss
of $2.2 million in 2005.
Income Taxes. In 2007, our tax expense was
$32.3 million, made up of approximately $37.0 million
of current tax expense and $4.7 million of deferred tax
benefit. In 2006, our tax expense was $28.7 million, made
up of approximately $39.4 million of current tax expense
and $10.8 million of deferred tax benefit. In 2005, our tax
expense was $14.9 million, made up of approximately
$26.1 million of current tax expense and $11.2 million
of deferred tax benefit. Our effective tax rate for 2007 was
31.3% compared to 32.0% in 2006 and 20.8% in 2005. In 2007 and
2006, our effective tax rate differed from statutory rates
mainly because of the impact of the international tax structure
that we implemented in early 2006. In 2005, our effective tax
was impacted by the reversal of a previously established
valuation allowance.
As of December 31, 2007, we had U.S. tax loss
carryforwards of approximately $21.5 million and foreign
tax loss carryforwards of $1.2 million. These tax loss
carryforwards consist solely of acquired net operating losses.
The U.S. tax loss carryforwards expire in the years 2021
through 2025.
In prior years, there was uncertainty of future realization of
the deferred tax assets resulting from acquired U.S. tax
loss carryforwards due to anticipated limitations, including
limitations under Section 382 of the Internal Revenue Code
(IRC). Therefore, a valuation allowance was recorded against the
tax effect of such tax loss carryforwards. We have evaluated
these deferred tax assets and concluded it is now more likely
than not that we will realize $11.6 million of these
deferred tax assets. This is based on conclusions of an IRC
Section 382 analysis completed during this year as well as
our expected future taxable income. The release of the valuation
allowance was recorded in the second quarter of 2007 and was
reflected as a reduction to goodwill. A valuation allowance
remains on approximately $1.4 million of deferred tax
assets related to acquired operating losses and other tax
attributes as we believe it is not more likely than not that
these
Table of Contents
deferred tax assets will be realized. This valuation allowance
is due to anticipated limitations 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 2007, comprehensive income included $18.3 million
recorded for unrealized foreign exchange gains on the
revaluation of investments in foreign subsidiaries; and
$1.0 million net of $0.6 million tax expense for
unrealized investment gains. In 2006, comprehensive income
included $13.5 million recorded for unrealized foreign
exchange gains on the revaluation of investments in foreign
subsidiaries; and $0.6 million net of $0.2 million tax
expense for unrealized investment gains. In 2005, comprehensive
income included $1.3 million recorded for unrealized
foreign exchange losses on the revaluation of investments in
foreign subsidiaries; and $0.8 million net of
$0.5 million tax benefit for unrealized investment losses.
As of December 31, 2007, we had $381.8 million of cash
and cash equivalents, $315.6 million of short-term
investments, and working capital of $529.7 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 2007, 2006 and 2005 was
$146.4 million, $117.5 million and
$119.8 million, respectively. Net cash provided by
operating activities in 2007 was primarily the result of net
income adjusted for non-cash expenses, and increases in accrued
liabilities and accounts payable partially offset by decreases
in accounts receivable and income tax payable. Net cash provided
by operating activities in 2006 and 2005 was primarily the
result of net income adjusted for non-cash expenses, increases
in accrued liabilities, accounts payable and income tax payable
partially offset by an increase in accounts receivable. Due to
our adoption of SFAS 123(R), as of January 1, 2006,
the impact of the excess tax benefits of stock-based
compensation, defined as the benefits of a tax deduction for
share-based payment expenses that exceeds the recognized
compensation expenses, is now reported under financing
activities with a corresponding deduction from operating
activities in our Consolidated Statements of Cash Flows.
Net cash used in investing activities was $128.7 million in
2007 and was the result of net purchases of investments of
$78.3 million, cash paid for acquisitions, net of cash
received, of $31.6 million, and purchases of capital
equipment of $18.7 million. Net cash used in investing
activities was $68.0 million in 2006 and was the result of
net purchases of investments of $14.3 million, cash paid
for acquisitions, net of cash received, of $37.8 million,
and purchases of capital equipment of $15.9 million. 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.
In September 2007, we acquired all of the capital stock of
NetGiro Systems AB, for approximately $27.4 million in
cash. In January 2006, we acquired Direct Response Technologies,
Inc. (now DR Marketing Solutions, Inc.) for approximately
$15.0 million in cash, and in June 2006, we acquired
MindVision for approximately $21.2 million in cash payments
to stockholders plus the assumption of certain liabilities. 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 for
$45.1 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.
Net cash used by financing activities in 2007 was
$35.5 million, net cash provided by financing activities in
2006 and 2005 was $204.6 million and $12.3 million,
respectively. In 2007 our cash used in financing is mostly due
to our stock repurchase which equaled $63.0 million and has
been offset by sales to employees under our employee stock
purchase plan and by exercise of stock options. In 2006 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 March 2006, we sold 4.0 million shares of our common
stock. The offering provided net proceeds
Table of Contents
of $172.8 million, and was made pursuant to a shelf
registration statement previously filed with the Securities and
Exchange Commission. During 2007, proceeds from the exercise of
stock options provided cash of $13.5 million, and proceeds
of $12.0 million were provided by the excess tax benefit
from stock-based compensation. During 2006, proceeds from the
exercise of stock options provided cash of $21.1 million,
and proceeds of $9.0 million were provided by the excess
tax benefit from stock-based compensation. During 2005, proceeds
from the exercise of stock options provided cash of
$23.2 million, and we repurchased $13.1 million of
common stock, which reduced our net cash provided by financing
activities.
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. In January 2005, we filed a
registration statement to increase our available shelf
registration amount and we have approximately $82 million
for future use. 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.
At December 31, 2007, 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.
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 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.
Table of Contents
We believe the outlook for our business remains positive for
2008. Global online sales continue to increase and buyers appear
to be increasingly comfortable shopping online. In our core
market, trends continue to favor the transition away from
packaged, physical delivery of software to electronic download.
Additionally, we see opportunities to grow our share of business
in adjacent and complementary vertical markets such as consumer
electronics and computer and video games. We also see
opportunities to expand our core service offerings in areas such
as payment processing, subscriptions management and strategic
marketing. We anticipate making incremental investments in our
people and technology in support of our strategic growth
initiatives in 2008. We believe the initiatives outlined in our
strategic plan will enable us to; 1) continue to be a
leader in the software delivery market, 2) strengthen our
product and service offering by investing in our core business,
3) expand into new vertical markets such as consumer
electronics, and computer and video games and 4) supplement
our growth through strategic acquisitions.
In December 2007, the FASB issued SFAS No. 141
(Revised 2007), “Business Combinations.” This revised
Statement, which we refer to as SFAS No. 141R, is
intended to simplify existing guidance and converge rulemaking
under U.S. GAAP with international accounting rules.
SFAS No. 141R will significantly change the accounting
for business combinations in a number of areas, including the
treatment of contingent consideration, contingencies,
acquisition costs and restructuring costs. Also under this
Statement, changes in deferred tax asset valuation allowances
and acquired income tax uncertainties in a business combination
after the measurement period will impact income tax expense.
SFAS No. 141R is effective for fiscal years beginning
after December 15, 2008. Adoption of this Statement is not
expected to have a material effect on our financial condition
and results of operations or cash flows.
In September 2006, the FASB issued statement No. 157,
“Fair Value Measurements”, (SFAS 157).
SFAS 157 defines fair value, establishes a framework for
measuring fair value in accordance with accounting principles
generally accepted in the United States, and expands disclosures
about fair value measurements. SFAS 157 is effective for
fiscal years beginning after November 15, 2007, with
earlier application encouraged. Any amounts recognized upon
adoption as a cumulative effect adjustment will be recorded to
the opening balance of retained earnings in the year of
adoption. The Company has not yet determined the impact of this
Statement on its financial condition and results of operations
or cash flows.
None
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, 2007 and 2006, 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, 2007 and 2006, by $1.48 million and by
$1.38 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,
2007 and 2006, by $1.48 million and by $1.38 million,
respectively. The approximate gains or losses in earnings are
estimates, and actual results could vary due to the assumptions
used. At December 31, 2007 and 2006, we had
Table of Contents
$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%.
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.
Further, we recently acquired NetGiro Systems, a payment
processor based in Stockholm, Sweden that processes
international transactions, and the anticipated growth of this
company will increase our exposure to foreign currency
fluctuations. 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. 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.
The effect on our consolidated statements of income from changes
in exchange rates versus the U.S. Dollar is as follows (in
thousands):
The Company enters into short term foreign currency forward
contracts to offset the foreign exchange gains and losses
generated by the re-measurement of certain assets and
liabilities recorded in non-functional currencies. Changes in
the fair value of these derivatives, as well as re-measurement
gains and losses, are recognized in current earnings in other
income (expense), net. Foreign currency transaction gains and
losses were a loss of $0.6 million in 2007, a gain of
$1.5 million in 2006 and a loss of $2.2 million in
2005.
Foreign exchange rate fluctuations may adversely impact our
consolidated 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
$22.9 million and $16.0 million for 2007 and 2006,
respectively.
Table of Contents
QUARTERLY
FINANCIAL DATA (UNAUDITED)
Our Financial Statements and Notes thereto appear beginning at
page 52 of this report.
None.
Based on their evaluation of our disclosure controls and
procedures conducted as of December 31, 2007, 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.
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 management’s 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
Table of Contents
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, 2007, 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 NetGiro Systems
AB on September 1, 2007. The acquired business operations
excluded from the evaluation together constituted less than four
percent of total assets at December 31, 2007, and
approximately one percent of revenues and net income, for the
year then ended. Ernst & Young LLP, an independent
registered public accounting firm, has audited the effectiveness
of our internal control over financial reporting as of
December 31, 2007, as stated in their report in which they
expressed an unqualified opinion, which is included herein.
During the quarter ended December 31, 2007, 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.
The Board of Directors and Stockholders
Digital River, Inc.
We have audited Digital River, Inc.’s internal control over
financial reporting as of December 31, 2007, 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 included in the accompanying
Management’s Annual Report on Internal Control over
Financial Reporting. Our responsibility is to express an opinion
on Digital River, Inc.’s 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, assessing the risk
that a material weakness exists, testing and evaluating the
design and operating effectiveness of internal control based on
the assessed risk, 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 company’s 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 company’s
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
Table of Contents
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
company’s 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 Management’s Annual Report
on Internal Control over Financial Reporting, management’s
assessment of and conclusion on the effectiveness of internal
control over financial reporting did not include the internal
controls of NetGiro Systems AB, which is included in the
December 31, 2007, consolidated financial statements of
Digital River Inc. and constituted less than 4% of total assets
at December 31, 2007, and less than 2% of revenue and net
income for the year then ended. 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 NetGiro Systems AB.
In our opinion, Digital River, Inc. maintained, in all material
respects, effective internal control over financial reporting as
of December 31, 2007, based on the COSO criteria.
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, 2007 and 2006, and the
related consolidated statements of income, stockholders’
equity, and cash flows for each of the three years in the period
ended December 31, 2007 of Digital River, Inc. and our
report dated February 29, 2007 expressed an unqualified
opinion thereon.
/s/ Ernst &
Young LLP
Minneapolis, Minnesota
February 29, 2008
None.
Table of Contents
Certain information required in Part III of this report is
incorporated by reference to our Proxy Statement in connection
with our 2008 Annual Meeting to be filed in accordance with
Regulation 14A under the Securities Exchange Act of 1934,
as amended.
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 2008 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.
The information required in Item 11 of Part III of
this report is incorporated by reference to our Proxy Statement
in connection with our 2008 Annual Meeting to be filed in
accordance with Regulation 14A under the Securities
Exchange Act of 1934, as amended.
The information required in Item 12 of Part III of
this report is incorporated by reference to our Proxy Statement
in connection with our 2008 Annual Meeting to be filed in
accordance with Regulation 14A under the Securities
Exchange Act of 1934, as amended.
The information required in Item 13 of Part III of
this report is incorporated by reference to our Proxy Statement
in connection with our 2008 Annual Meeting to be filed in
accordance with Regulation 14A under the Securities
Exchange Act of 1934, as amended.
The information required in Item 14 of Part III of
this report is incorporated by reference to our Proxy Statement
in connection with our 2008 Annual Meeting to be filed in
accordance with Regulation 14A under the Securities
Exchange Act of 1934, as amended.
Table of Contents
(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 52 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.
(3) Exhibits.
Table of Contents
48
Table of Contents
Table of Contents
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
February 29, 2008.
DIGITAL RIVER, INC.
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 Registrant’s Annual Report on
Form 10-K
for the fiscal year ended December 31, 2007, 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:
Table of Contents
The 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,
2007 and 2006, and the related consolidated statements of
income, stockholders’ equity, and cash flows for each of
the three years in the period ended December 31, 2007. Our
audit also included the financial statement schedule listed in
Item 15(a)(2). These financial statements and schedule are
the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial
statements and schedule based on our audits.
We conducted our audits 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 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, 2007 and 2006, and the consolidated results of
their operations and their cash flows for each of the three
years in the period ended December 31, 2007, in conformity
with U.S. generally accepted accounting principles. Also,
in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken
as a whole, presents fairly, in all material respects, the
information set forth herein.
As discussed in Note 1 to the consolidated financial
statements, effective January 1, 2006, the Company adopted
the provisions of Statement of Financial Accounting Standards
No. 123 (Revised 2004), Share Based Payment, using
the modified prospective approach.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States),
Digital River, Inc.’s internal control over financial
reporting as of December 31, 2007, based on criteria
established in Internal Control-Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated February 29, 2008 expressed
an unqualified opinion thereon.
/s/ Ernst &
Young LLP
Minneapolis, Minnesota
February 29, 2008
Table of Contents
DIGITAL
RIVER, INC.
The accompanying notes are an integral part of these
consolidated financial statements.
Table of Contents
DIGITAL
RIVER, INC.
The accompanying notes are an integral part of these
consolidated financial statements.
Table of Contents
DIGITAL
RIVER, INC.
The accompanying notes are an integral part of these
consolidated financial statements.
Table of Contents
DIGITAL
RIVER, INC.
The accompanying notes are an integral part of these
consolidated financial statements.
Table of Contents
DIGITAL
RIVER, INC.
December 31,
2007 and 2006
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.
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.
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.
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 (expense), net.”
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,
2007 and 2006, cash balances of $1.5 million and
$2.9 million, respectively, were held by banks or credit
card processors to secure potential future credit card fees,
fines and chargebacks or for other payments. In addition, at
December 31, 2007 and 2006, $0.4 million and
$0.6 million were 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, 2007 and 2006, 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.
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
Table of Contents
DIGITAL
RIVER, INC.
Notes to
Consolidated Financial
Statements — (Continued)
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):
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 management’s 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 ten 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 asset’s 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
2007, 2006 or 2005.
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, 2007 and 2006, the fair value of our
$195 million 1.25% fixed rate convertible senior notes was
valued at $246 million and $270 million, respectively,
based on the quoted fair market value of the debt.
Table of Contents
DIGITAL
RIVER, INC.
Notes to
Consolidated Financial
Statements — (Continued)
The following table summarizes our other assets as of December
31 (in thousands):
The following table summarizes our other accrued liabilities as
of December 31 (in thousands):
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 2007, comprehensive income included $18.3 million
recorded for unrealized foreign exchange gains on the
revaluation of investments in foreign subsidiaries, and
$1.0 million net of $0.6 million tax expense for
unrealized investment gains. In 2006, comprehensive income
included $13.5 million recorded for unrealized foreign
exchange gains on the revaluation of investments in foreign
subsidiaries, and $0.6 million net of $0.2 million tax
expense for unrealized investment gains. In 2005, comprehensive
income included $1.3 million recorded for unrealized
foreign exchange losses on the revaluation of investments in
foreign subsidiaries, and $0.8 million net of
$0.5 million tax benefit for unrealized investment losses.
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 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.
Table of Contents
DIGITAL
RIVER, INC.
Notes to
Consolidated Financial
Statements — (Continued)
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.
In June 2006, the EITF reached a consensus on EITF Issue
No. 06-3,
“How Taxes Collected from Customers and Remitted to
Governmental Authorities Should Be Presented in the Income
Statement (That is, Gross versus Net Presentation)”
(“EIFT
06-3”).
EITF 06-3
provides that the presentation of taxes assessed by a
governmental authority that is directly imposed on a
revenue-producing transaction between a seller and a customer on
either a gross basis (included in revenues and costs) or on a
net basis (excluded from revenues) is an accounting policy
decision that should be disclosed. The Company presents these
taxes on a net basis.
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, $1.5 million and $0.1 million in
2007, 2006 and 2005, respectively.
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 record deferred tax assets for
favorable tax attributes, including tax loss carryforwards. We
currently have significant U.S. tax loss carryforwards
consisting solely of acquired operating tax loss carryforwards.
A portion of 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.
Our interest income line item is the total of interest income on
our cash, cash equivalents, and short-term investments. Interest
income was $32.2 million, $22.8 million and
$9.7 million in 2007, 2006 and 2005, respectively. The
increases in interest income were primarily due to higher cash
balances.
Table of Contents
DIGITAL
RIVER, INC.
Notes to
Consolidated Financial
Statements — (Continued)
Our other (expense), net line item is the total of interest
expense on our debt and foreign currency transaction gains and
losses. Interest expense was $2.4 million in 2007, 2006 and
2005. Our loss from foreign currency remeasurement was
$0.6 million in 2007 compared to a gain of
$1.5 million in 2006 and a loss of $2.2 million in
2005.
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 2007 we didn’t capitalize any
software development cost; in 2006 and 2005, we capitalized
$0.1 million and $0.4 million, respectively, of
software development costs.
On January 1, 2006, we adopted Statement of Financial
Accounting Standards No. 123 (Revised 2004),
“Share-Based Payment,” (“SFAS 123(R)”)
which requires the measurement and recognition of compensation
expense for all share-based payments made to employees and
directors including stock options, restricted stock grants and
employee stock purchases made through our Employee Stock
Purchase Plan based on estimated fair values. SFAS 123(R)
supersedes our previous accounting under Accounting Principles
Board Opinion No. 25 (“APB 25”), “Accounting
for Stock Issued to Employees,” for periods beginning in
2006.
Prior to the adoption of SFAS 123(R), we had elected to
apply the disclosure-only provision of SFAS No. 123,
“Accounting for Stock-Based Compensation” as amended
by SFAS No. 148. Accordingly, we accounted for
stock-based compensation using the intrinsic value method
prescribed in APB 25 and related interpretations. Compensation
expense for stock options was measured as the excess, if any, of
the fair value of our common stock at the date of grant over the
stock option exercise price.
We have adopted SFAS 123(R) using the modified prospective
transition method under which prior periods are not revised.
Stock-based compensation expense recognized during the period is
based on the value of the portion of share-based awards that are
ultimately expected to vest during the period. Stock-based
compensation expense recognized in our Consolidated Statement of
Income in 2006 and 2007 includes compensation expense for
share-based awards granted prior to, but not yet vested, as of
December 31, 2005, as well as compensation expense for the
share-based payment awards granted subsequent to
December 31, 2005. The fair value of each stock option
grant is estimated on the date of grant using the Black-Scholes
option pricing model. The fair value of restricted stock is
determined based on the number of shares granted and the closing
price of our common stock on the date of grant. Compensation
expense for all share-based payment awards is recognized using
the straight-line amortization method over the vesting period.
Stock-based compensation expense of $13.7 million was
charged to operating expenses during 2007. The related tax
benefit of $3.7 million resulted in a net after-tax
stock-based compensation expense of $10.0 million for 2007.
As stock-based compensation expense recognized in our
Consolidated Statement of Income for 2007 is based on awards
ultimately expected to vest, it has been reduced for estimated
forfeitures. SFAS 123(R) requires forfeitures to be
estimated at the time of grant and revised, if necessary, in
subsequent periods if actual forfeitures differ from those
estimates. Our pro forma information required under
SFAS 123, for periods prior to 2006, accounted for
forfeitures as they occurred. In March 2005 the Securities and
Exchange Commission issued Staff Accounting
Bulletin No. 107 (“SAB 107”), which
provides supplemental implementation guidance for
SFAS 123(R). We have applied the provision of SAB 107
in our adoption of SFAS 123(R).
Table of Contents
DIGITAL
RIVER, INC.
Notes to
Consolidated Financial
Statements — (Continued)
SFAS 123(R) also requires the benefits of tax deductions in
excess of recognized stock-based compensation expense be
reported as a financing cash flow, rather than an operating cash
flow as required prior to adoption of SFAS 123(R) in our
Consolidated Statement of Cash Flows. On November 10, 2005,
the Financial Accounting Standards Board (FASB) issued FASB
Staff Position No. FAS 123(R)-3 “Transition
Election Related to Accounting for Tax Effects of Share-based
Payment Awards.” We have elected not to adopt the
alternative transition method provided in the FASB Staff
Position for calculating the tax effects of stock-based
compensation pursuant to SFAS 123(R).
See Note 5 for further information regarding the impact of
our adoption of SFAS 123(R) and the assumptions we use to
calculate the fair value of share-based compensation.
In December 2007, the FASB issued SFAS No. 141
(Revised 2007), “Business Combinations.” This revised
Statement, which we refer to as SFAS No. 141R, is
intended to simplify existing guidance and converge rulemaking
under U.S. GAAP with international accounting rules.
SFAS No. 141R will significantly change the accounting
for business combinations in a number of areas, including the
treatment of contingent consideration, contingencies,
acquisition costs and restructuring costs. Also under this
Statement, changes in deferred tax asset valuation allowances
and acquired income tax uncertainties in a business combination
after the measurement period will impact income tax expense.
SFAS No. 141R is effective for fiscal years beginning
after December 15, 2008. Adoption of this Statement is not
expected to have a material effect on our financial condition
and results of operations or cash flows.
In September 2006, the FASB issued statement No. 157,
“Fair Value Measurements” (SFAS 157).
SFAS 157 defines fair value, establishes a framework for
measuring fair value in accordance with accounting principles
generally accepted in the United States, and expands disclosures
about fair value measurements. SFAS 157 is effective for
fiscal years beginning after November 15, 2007, with
earlier application encouraged. Any amounts recognized upon
adoption as a cumulative effect adjustment will be recorded to
the opening balance of retained earnings in the year of
adoption. We have not yet determined the impact of this
Statement on our financial condition and results of operations.
2. Net
Income per Share:
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.
Table of Contents
DIGITAL
RIVER, INC.
Notes to
Consolidated Financial
Statements — (Continued)
The following table summarizes the computation of basic and
diluted earnings per share (in thousands, except per share data):
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.
As of December 31, 2007 and 2006, our available-for-sale
securities consisted of the following (in thousands):
Table of Contents
DIGITAL
RIVER, INC.
Notes to
Consolidated Financial
Statements — (Continued)
Realized gains or losses on investments are recorded in our
statement of income within other income (expense), net. Realized
losses on sales of investments were immaterial in 2007, 2006 and
2005. Interest income of $32.2 million, $22.8 million
and $9.7 million was recorded in 2007, 2006 and 2005,
respectively.
The following table summarizes the purchase acquisitions
completed during the three years in the period ended
December 31, 2007 (in thousands):
Note: Balances as of acquisition date and do not
reflect subsequent earn-outs, adjustments or currency
translation.
On September 1, 2007, we acquired all of the capital stock
of NetGiro Systems AB (NetGiro), a privately held company based
in Stockholm, Sweden, for approximately $27.4 million in
cash. NetGiro is a payment service provider. The agreement also
provides NetGiro shareholders with an earn-out opportunity based
on NetGiro achieving certain revenue and earnings targets during
the first year subsequent to the acquisition. Any future
earn-out will result in additional goodwill.
In June 2006, we acquired all of the capital stock of
MindVision, Inc., a privately held
e-commerce
company based in Lincoln, Nebraska, for approximately
$25.0 million comprised of payments to stockholders of
$21.2 million plus the assumption of certain liabilities
totaling approximately $3.7 million. In November 2006, we
recorded $0.2 million as acquisition cost related to a
restructuring plan for employee severance to be paid out over a
six month period.
In January 2006, we acquired all of the capital stock of Direct
Response Technologies, Inc. (Direct Response), a privately held
company based in Pittsburgh, Pennsylvania, for approximately
$15.0 million in cash. Direct Response, a provider of tools
for managing affiliate networks, is now named DR Marketing
Solutions, Inc. The agreement also provided Direct Response
shareholders with an earn-out opportunity based on DR Marketing
Solutions, Inc. achieving certain revenue and earnings targets
during the first three years
Table of Contents
DIGITAL
RIVER, INC.
Notes to
Consolidated Financial
Statements — (Continued)
subsequent to the acquisition. In 2006, we accrued
$3.5 million for future earn-out payments. In 2007,
pursuant to the January 2006 acquisition agreement, certain
adjustments were made to the earn-out obligations under this
agreement. Under the restructured earn-out agreement a final
earn-out of $3.5 million was accrued and paid in 2007.
These earn-outs have been recorded as goodwill in 2006 and 2007
as they were considered incremental to the purchase price.
In December 2005, we acquired all of the capital stock of
Commerce5, Inc. (Commerce5) for approximately $45.1 million
in cash comprised of payments to stockholders of
$32.4 million plus assumption of $12.7 million in
liabilities. Commerce5, now named DR globalTech, Inc., is an
outsourced
e-commerce
provider to high-tech and consumer electronics manufacturers
headquartered in Aliso Viejo, California.
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
for services for software authors. The agreement also provided
an opportunity for earn-out based on achieving specific revenue
and development goals over the first 12 months following
the closing of the acquisition. Earn-outs totaling
$0.5 million have been recorded as goodwill as of
December 31, 2007 as they were considered incremental to
the purchase price.
As of December 31, 2007, there were no future earn-outs in
accrued acquisition liabilities.
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 2007, 2006 and 2005 have been prepared as if each
of the acquisitions in 2007 had occurred on January 1,
2006, and as if each of the 2006 acquisitions had occurred on
January 1, 2005 (in thousands except per share data):
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, 2006 or 2005,
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, 2007, 2006 and 2005.
Table of Contents
DIGITAL
RIVER, INC.
Notes to
Consolidated Financial
Statements — (Continued)
The changes in the net carrying amount of goodwill for the years
ended December 31, 2007 and 2006 are as follows (in
thousands):
Intangible
Assets
Information regarding our other intangible assets is as follows
(in thousands):
The components of intangible assets acquired during the years
ended December 31, 2007, 2006 and 2005, are as follows (in
thousands). No significant residual value is estimated for these
assets.
Table of Contents
DIGITAL
RIVER, INC.
Notes to
Consolidated Financial
Statements — (Continued)
Estimated amortization expense for the remaining life of the
intangible assets, based on intangible assets as of
December 31, 2007, is as follows (in thousands):
Following is an allocation of the net assets acquired from the
acquisitions consummated and amounts paid under earn-out
arrangements in 2007 and 2006 (in thousands) which includes
subsequent year activity for 2006 acquisitions:
Our stockholders approved the Digital River, Inc. 2007 Equity
Incentive Plan (the “2007 Plan”) at the Company’s
annual stockholder meeting held on May 31, 2007. The number
of shares issuable under the 2007 Plan equals
2,000,000 shares of our common stock. In addition, shares
not issued under the 1998 Plan shall become available for
issuance under the 2007 Plan to the extent a stock option or
other stock award under the 1998 Plan expires or terminates
before shares of common stock are issued under the award. Under
our 2007 Equity Incentive Plan we have the flexibility to grant
incentive and non-statutory stock options, restricted stock
awards, restricted stock unit awards and performance shares to
our directors, employees, and consultants.
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 non-statutory
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”).
Our current plan is described more fully in Note 11.
Prior to the adoption of SFAS 123(R), we presented deferred
compensation as a separate component of shareholders’
equity. In 2006, in accordance with the provisions of SFAS(R),
we reclassified the balance in deferred compensation to
additional paid-in capital on our balance sheet.
Table of Contents
DIGITAL
RIVER, INC.
Notes to
Consolidated Financial
Statements — (Continued)
On January 1, 2006, we adopted SFAS 123(R) which
requires measurement and recognition of compensation expense for
all stock-based payments made to employees and directors
including stock options, restricted stock grants and employee
stock purchases made through our Employee Stock Purchase Plan
based on estimated fair values. The following table summarizes
stock-based compensation expense, net of tax, related to our
stock-based compensations plans recognized under
SFAS 123(R):
The following table reflects net income and basic and diluted
net income per share for 2007 and 2006 compared with the pro
forma information for 2005 as if the Company had applied the
fair value recognition provisions SFAS No. 123 to
stock-based compensation during 2005 (in thousands, except per
share amounts):
| |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||