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Digital River 10-K 2010 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 checkmark 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 whether the registrant has submitted
electronically and posted on its corporate Website, if any,
every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of
Regulation S-T
during the preceding 12 months (or for such shorter period
that the Registrant was required to submit to post such
files). Yes o 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, 2009, there were 38,588,928 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 Global Select Market, 37,783,401 shares of common
stock, having an aggregate market value of approximately
$1,372,293,000 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, 2010 was 38,653,851 shares.
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Certain sections of the Registrant’s definitive Proxy
Statement for the 2010 Annual Meeting of Stockholders are
incorporated by reference in Part III of this
Form 10-K
to the extent stated herein.
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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
and marketing solutions to a wide variety of companies in
software, consumer electronics, computer games, video games, and
other markets. 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 while mitigating risks. Our
services include design, development and hosting of online
stores and shopping carts, store merchandising and optimization,
order management, denied parties screening, export controls and
management, tax compliance and management, fraud management,
digital product delivery via download, physical product
fulfillment, subscription management, online marketing including
e-mail
marketing, management of affiliate programs, paid search
programs, payment processing services, website optimization, web
analytics and reporting, and CD production and delivery.
Our products and services allow our clients to focus on
promoting and marketing their products and brands while
leveraging our investments in technology and infrastructure to
facilitate the purchase of products through their online
websites. When shoppers visit one of our clients’ branded
websites and purchase goods, they are transferred to an
e-commerce
store and/or
shopping cart operated by us on our
e-commerce
platforms. Once on our system, shoppers can browse for products
and make purchases online. We typically are the seller of record
for transactions through our client branded stores. 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 as the merchant of record, including
collection and remittance of applicable taxes. We have invested
substantial resources to develop our
e-commerce
and marketing platforms and we provide access and use of our
platforms to our clients as a service as opposed to selling the
software to be operated on their own in-house computer hardware.
Our
e-commerce
store solutions range from simple remote control models to more
comprehensive online store models.
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’ websites and
the associated online stores and to improve the sales
productivity of those stores. Our services include paid search
advertising, search engine optimization,
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affiliate marketing, store optimization, multi-variant testing,
web analytic services 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, computer and video game companies, including
Absolute Software Corporation, Adobe Systems, Inc., Aspyr Media,
Inc., Autodesk, Inc., Canon Europa N.V., Computer Associates,
Cyber Patrol, LLC, Eastman Kodak Company, Electronic Arts, Inc.,
Lexmark, Inc., Microsoft Corporation, Nuance Communications,
Inc., SanDisk Corporation, Smith Micro Software, Inc., Symantec
Corporation, and Trend Micro, Inc.
As announced on October 12, 2009, Symantec Corporation has
informed us that it has elected not to renew its
e-commerce
agreement with us, which will result in the termination of the
e-commerce
agreement on June 30, 2010. We expect a material decrease
in revenue and operating income as a result of Symantec’s
decision to not renew its
e-commerce
agreement with us as Symantec migrates its stores from our
e-commerce
infrastructure to their internally developed
e-commerce
platform. However, as Symantec has not yet informed us of its
migration plans or the nature of the support Symantec will
require from us during the transition period, we are currently
unable to predict the magnitude or timing of the revenue impact
on our business, our future revenues and our operating results.
Our intention is to moderate the impact on our consolidated
financial results of the expected reduction in revenue through
acquisition of new clients, organic growth within existing
clients, new product and service introductions, cost-saving
initiatives and acquisition activities. Unless and until we
generate sufficient new business to offset the loss of Symantec,
our 2009 financial results will be difficult or impossible to
duplicate in 2010.
We view our operations and manage our business as one reportable
segment, providing outsourced
e-commerce
solutions globally to a variety of companies, primarily in the
software and high-tech products markets. See Item 15 of
Part IV, Exhibits and Financial Statement Schedules,
Note 12 Segment Information for additional information.
We were incorporated in Delaware in February 1994. Our
headquarters are located at 9625 West 76th Street, Eden
Prairie, Minnesota and our telephone number is
952-253-1234.
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. The U.S. Commerce Department
reported that
e-commerce
sales in 2009 rose 2.0% compared to 2008. 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 other methods; and
(vi) concerns about conflicts between online and
traditional sales channels continue to subside. Additionally, we
believe that current economic conditions have led to increased
retail store closings which should drive more shoppers online as
they shift to other channels, filling the void created by retail
downsizings and bankruptcies.
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.
There is also a growing recognition of the value inherent in
developing behavioral or personalized marketing campaigns
relevant to a consumer’s interests.
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
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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, personal information security
protections, 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,
e-books,
computer games, 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
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 an integrated 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, merchandising, order management, fraud prevention
screening, popular online payment methods, export controls and
management, denied parties screening, tax compliance and
management, digital product delivery via download, physical
product fulfillment, CD production, multi-lingual customer
service, subscription management, online marketing services
including email marketing, paid search program management,
website optimization, 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
significant proportion 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, data security,
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;
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(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 payment
methods, and offer customer service in a variety of languages,
extending our clients’ reach beyond their home markets.
Through our large online affiliate network marketplace, which we
call
oneNetworkDirecttm,
we provide our clients access to a new sales channel which can
help grow their online businesses. Clients can offer any part of
their product catalogs to our network of online channel
partners, including online retailers and affiliates. This
increases the exposure these products receive and can result in
higher sales volumes. Our channel partners benefit because we
eliminate the need for each of them to manage hundreds of
relationships with product developers, while increasing the
depth and breadth of products they can sell, all without
requiring the management of physical product inventory.
Businesses can reduce the time required to develop an
e-commerce
presence by utilizing our outsourced business model. Typically,
a new client can have an online store live in a matter of weeks
compared with months or longer if they decide to build, test
deploy and integrate 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 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, video 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 of the product
they have purchased and downloaded on a CD.
Our objective is to be the global leader in outsourced
e-commerce
activities for software and digital products developers,
high-tech product and computer manufacturers, and video game
publishers. 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, consumer electronics,
computer game and video game markets. Our clients include
software publishers, other digital content providers, high-tech
product manufacturers and online channel partners.
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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 and payment
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. We currently provide
e-commerce
services for thousands of software and digital products
publishers, high-tech products manufacturers, game publishers
and affiliates.
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
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, web analytics, 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 or through other
service providers. 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. By leveraging our infrastructure, 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
(SaaS), trial programs and volume licensing programs.
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.
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 localized
online payment methods, export controls and management, denied
parties screening, tax compliance and management, digital
product delivery via download, physical product fulfillment, CD
production, multi-lingual customer service, subscription
management, online marketing services including email marketing,
paid search program management, website optimization, web
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 deployed quickly and implemented in a variety
of ways from fully-functioning shopping carts through
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completely merchandised online stores. The online stores we
operate for our clients often 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.
In connection with the sales of consumer electronic goods, we
offer management services relating to regulatory matters such as
the Waste Electronics and Electrical Equipment laws.
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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 via 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. We also believe this information is
valuable in establishing a metric for the lifetime value of the
customer.
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.
Payment Services. We offer full service
payment provider solutions for online merchants around the
world. We connect businesses to the local payment methods that
their customers prefer and support businesses to expand into new
markets through enabling the acceptance and processing of a
diverse range of payment methods and options. We offer a broad
range of back office payment reconciliation services that result
in a highly cost efficient and secure program for
e-payments.
We sell and market these services through a direct sales channel
located in offices in the United States and Europe. Our
technology platform provides for high transaction throughput in
a highly secure and data sensitive environment. These services
are provided either via a direct interface between the
client’s commerce system and our payment services platform
or via a Payment Card Industry (PCI) compliant wrapped secure
web based payment page that is served to the client’s
commerce system on a transaction by transaction basis.
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
manufacturers since it provides access to 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, consumer
electronics, computer and game manufacturers and online channel
partners who are looking to create or expand their online
businesses. During the sales process, our sales staff deliver
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
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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
integrates their marketing domain expertise with our suite of
technology, including reporting, analytics, optimization and
e-mail to
drive increased sales for our clients.
We market our products and services directly to clients and
prospective clients. We focus our efforts on generating
awareness of our brand and capabilities, establishing our
position as a global leader in
e-commerce
outsourcing, generating leads in our target markets, and
providing sales tools for our direct sales force. We conduct a
variety of highly integrated marketing programs to achieve these
objectives in an efficient and effective manner. We currently
market our products and services to clients and prospects via
direct marketing, print and electronic advertising, trade shows
and events, public relations, media events and speaking
engagements.
Technology
We deliver our outsourced
e-commerce
solutions on several platforms, each of which has been
architected to solve our clients multi-faceted
e-commerce
needs. The following is a brief description of the technology
standards utilized by the family of Digital River
e-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. 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 manage all transaction
data that flows through the system, including detailed commerce
transactions and consumer 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 relevant to the end consumer 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
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security system is designed not to interfere with the
consumer’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 six facilities: California,
Minnesota and Utah, USA; and Germany, Ireland and Sweden. All
major data center locations are currently processing
transactions and serving downloads.
All data centers currently utilize multiple levels of redundant
systems, including load balancers 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
maintain our technology and feature set for 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.
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:
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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 also 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 twenty-one U.S. patents issued
with five to fourteen years remaining prior to expiration. We
also have over sixty-eight 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.
We are subject to a number of foreign and domestic laws and
regulations that affect companies conducting business on the
internet. In addition, laws and regulations relating to user
privacy, information security and intellectual property rights
are being debated and considered for adoption by many countries
throughout the world. We face risks from some of the proposed
legislation that could be passed in the future.
A range of laws and new interpretations of existing laws could
have an impact on our business. For example, the Digital
Millennium Copyright Act has provisions that limit, but do not
necessarily eliminate, our liability for listing, linking or
hosting third-party content that includes materials that
infringe copyrights. The Child Online Protection Act and the
Children’s Online Privacy Protection Act restrict the
distribution of materials considered harmful to children and
impose additional restrictions on the ability of online services
to collect information from children under 13. In the area of
data protection, many states have passed laws requiring
notification to users when there is a security breach for
personal data, such as California’s Information Practices
Act. The costs of compliance with these laws may increase in the
future as a result of changes in interpretation. Furthermore,
any failure on our part to comply with these laws may subject us
to significant liabilities.
We are also subject to federal, state and foreign laws regarding
privacy and protection of user data. We post on our web site our
privacy policies and practices concerning the use and disclosure
of user data. Any failure by us to comply with our posted
privacy policies or privacy-related laws and regulations could
result in proceedings against us by governmental authorities or
others, which could potentially harm our business. In addition,
the interpretation of data protection laws, and their
application to the internet, in Europe and other foreign
jurisdictions is unclear and in a state of flux. There is a risk
that these laws may be interpreted and applied in conflicting
ways from country to country and in a manner that is not
consistent with our current data protection practices. Complying
with these varying international requirements could cause us to
incur additional costs. Further, any failure by us to protect
our users’ privacy and data could result in a loss of user
confidence in our services.
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As of February 1, 2010, we employed 1,239 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, 2010:
Mr. Ronning founded Digital River in February 1994
and has been our Chief Executive Officer and a director since
that time. From February 1994 to July 1998, Mr. Ronning
served as President of Digital River.
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.
Mr. Crudden joined Digital River in January 2006 as
Vice President, General Counsel and Corporate Secretary. From
1987 until joining Digital River, Mr. Crudden was with the
law firm of Robins, Kaplan, Miller & Ciresi L.L.P.,
Minneapolis, Minnesota, and served as a partner 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, and you could lose all or part of the
money you paid to buy our common stock. The following discussion
of our risk factors should be read in conjunction with the
consolidated financial statements and related notes thereto, and
management’s discussion and analysis, contained in this
report. These risks are current as of the date of this
Form 10-K,
and will be updated in subsequent
Form 10-Qs
to the extent required by law. Our business is also subject to
general risks and uncertainties that affect many other
companies.
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.
Company
Risk Factors
Our quarterly and annual revenues, operating results, and growth
rate have fluctuated significantly in the past and are likely 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.
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Factors that may affect our revenues, operating results,
continued growth, and our stock price include the risks
described elsewhere in this Item 1A, as well as the
following:
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The following risks may also have a material adverse impact on
our business, financial condition, results of operations and
stock price:
Our
stock price may be volatile.
The stock market as a whole and the trading prices of companies
in the electronic commerce industry in particular, has been
notably volatile. The operating results of companies in the
electronic commerce industry have experienced significant
quarter-to-quarter
fluctuations. This broad market and industry volatility could
significantly reduce the price of our common stock at any time,
without regard to our own operating performance. 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. Our stock price also may experience significant
volatility unrelated to the overall market or our industry
segment.
Further, our stock price may be impacted by the announcement of
the financial results or other decisions by our larger clients
whose products represent a significant portion of our sales. For
example, our stock price experienced a significant decline on
October 12, 2009 in connection with the announcement by us
that Symantec had informed us that it has elected not to renew
its
e-commerce
agreement with us.
A material decline in our stock price may result in the
assertion of certain claims against us,
and/or the
commencement of inquiries
and/or
investigations against us. A prolonged decline in the price of
our common stock could result in a reduction in the liquidity of
our common stock and a reduction in our ability to raise
capital, and the inability for you to obtain a favorable selling
price for our shares. Any reduction in our ability to raise
equity capital in the future may force us to reallocate funds
from other planned uses and could have a significant negative
effect on our business plans and operations.
The
termination of our
e-commerce
agreement with Symantec may materially adversely affect our
business, financial condition or results of operations and stock
price.
Sales of products for one client, Symantec Corporation,
accounted for approximately 21.5% of our revenue in 2009. In
addition, revenues derived from proprietary Digital River
services sold to Symantec consumers and sales of Symantec
products through our
oneNetworkDirecttm
retail and affiliate channel together accounted for
approximately 6.9% of total Digital River revenue in 2009. As
announced on October 12, 2009, Symantec has informed us
that it has elected not to renew its
e-commerce
agreement with
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us, which will result in the termination of the
e-commerce
agreement on June 30, 2010. While Symantec has migrated
portions of business from Digital River to its new
e-commerce
platform in certain geographic regions as of the date of this
Form 10-K,
Symantec has not yet informed us of the balance of its migration
plans, or the nature of the support Symantec will require from
us during the remainder of the transition period. As a result,
we are currently unable to predict the impact of the remainder
of the transition on our business, our future revenues and our
operating results, which may result in continued volatility in
our stock price. Until we are able to determine Symantec’s
final migration plans and the nature of the support Symantec
will require from us during the transition assistance period, it
will be difficult for us to implement additional steps to
moderate the impact of this event to our business. Unless and
until we generate sufficient new business to offset the loss of
Symantec, our 2009 financial results will be difficult or
impossible to duplicate in 2010.
The payment by consumers for the purchase of goods and services
through our
e-commerce
systems is typically made by credit card or similar payment
method. As a result, we must rely on banks and payment
processors to process transactions, and must pay a fee for this
service. From time to time, credit card associations may
increase the per-transaction fees that they charge. In addition,
reductions in the volume of transactions processed by us may
result in increased per-transaction processing fees. 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, and other card associations whose cards we
accept could adopt new operating rules or re-interpret existing
rules that we, or our processors, might find difficult to
follow. Although we have been able to successfully switch to new
payment processors in the past, such migrations require
significant attention from our personnel, and may not achieve
the anticipated cost savings or other desired results. Any
disputes or problems associated with our payment processors
could impair our ability to give customers the option of using
credit or debit cards to fund their payments. If we were unable
to accept credit or debit cards or other widely accepted forms
of payment, our business would be seriously damaged. We also
could be subject to fines or increased fees from Visa and
MasterCard if we fail to detect that our clients are engaging in
activities that are illegal or activities that are considered
“high risk,” primarily the sale of certain types of
digital content, or if the percentage of our sales transactions
subject to chargeback increases as an absolute percentage of our
overall transaction volume. We may be required to expend
significant capital and other resources to monitor these
activities.
Our business depends in large part on the secure transmission of
confidential information over public networks, including
customers’ credit card and other payment account
information, and the secure storage of confidential information.
We rely on encryption and authentication technology licensed
from third parties to provide the security and authentication
necessary for secure transmission of confidential information,
such as customer credit and debit card numbers. While we take
significant steps to protect the security of confidential
information in our possession, we cannot guarantee our security
measures will prevent security breaches, or that future advances
in computer and software capabilities and encryption technology,
new cryptography tools and discoveries, and other events will
enable us to prevent the breach or compromise of our security
even if implemented by us. Further, the technology utilized in
credit and debit cards, and the systems used for the
transmission of payment card transactions, are controlled by the
payment card industry, and vulnerabilities in these systems and
technology can place payment card data at risk.
Any breach or compromise of our security could have a material
adverse effect on our reputation, business, operating results
and financial condition, dissuade existing and new clients from
using our services, dissuade customers from transacting business
through our systems, and expose us to significant costs, fines,
losses, litigation, governmental investigations and liabilities.
A party who circumvents our security measures
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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 such breaches. Security breaches could expose
us to lawsuits from affected persons and companies, and to
governmental inquiries. 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 personally identifiable
and other confidential information, inhibiting the growth of our
business.
Sales outside the United States accounted for approximately
41.1% of our total sales in 2009. A significant portion of our
cash and marketable securities are held in non-U.S. domiciled
countries, primarily Ireland and Germany. 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 re-measurement 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.
Failure
to enhance and expand our technology, systems and business
offerings to accommodate increased traffic and to remain
competitive could reduce demand for our services and impair the
growth of our business.
We periodically enhance and expand our technology and
transaction-processing systems, network infrastructure and other
technologies to accommodate increases and spikes in the volume
of traffic on our technology platforms due to factors including
launches of new products and new commerce websites on our
technology platforms, and seasonal fluctuations in consumer
demand. 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, and develop
and introduce new business offerings and programs. Any inability
to enhance and expand our existing technology,
transaction-processing systems or network infrastructure to
manage such increased traffic and traffic spikes 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
and traffic spikes or an inability to maintain our
competitiveness could harm our reputation and significantly
reduce demand for our services, which would impair the growth of
our business. 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. 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,
or to obtain needed related services from third party suppliers.
Our network and our suppliers’ networks may be unable to
maintain an acceptable data transmission capability, especially
if demands on the platform increase. We may fail to use new
technologies effectively or fail to adapt our proprietary
technology and systems to client requirements or emerging
industry standards.
If we
are unable to enter into, achieve desired results from, or
maintain our marketing and promotional agreements with third
party marketing or technology providers to generate sales
traffic and sales for our clients, our ability to generate
revenue and our business could be adversely
affected.
We have entered into multiple marketing and promotional
agreements and operate certain affiliate networks and programs
which are designed to increase both traffic to the
e-commerce
stores we operate and the number of customers purchasing
products through such stores, including agreements with search
engine providers, display advertising networks, comparison
shopping engines, affiliate networks, operators of websites
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and marketing technology providers. Our ability to attract new
clients and retain existing clients is based in part on our
ability to generate increased traffic or better conversion rates
resulting in increased online sales of their products through
these agreements and programs. If we are unable to enter into
such agreements on favorable terms, are unable to achieve the
desired results under these agreements and programs, are unable
to maintain these relationships, or fail to generate sufficient
traffic or generate sufficient revenue from purchases pursuant
to these agreements and programs, our ability to generate sales
and our ability to attract and retain our clients may be
impacted, negatively affecting our business and operating
results.
Many of the laws and regulations regarding the application of
sales tax, use tax, value added tax (VAT) or other similar
transaction taxes predate the growth of the Internet and online
commerce. The application of transaction taxes to interstate and
international sales over the Internet is complex and evolving.
We currently collect taxes on certain product and service
offerings in tax jurisdictions where we have taxable presence. 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. The
imposition by state and local governments of various taxes upon
Internet commerce and related
e-commerce
activities could create administrative burdens for us, put us at
a competitive disadvantage if they do not impose similar
obligations on all of our online competitors, and decrease our
future sales.
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.
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.
We sell products and services to consumers outside the United
States and we intend to continue expanding our international
presence. In 2009, our sales to international consumers
represented approximately 41.1% of our total sales. Continued
expansion into international markets, particularly the European
and Asia-Pacific regions, requires significant resources that we
may fail to recover through generating additional revenue.
Conducting business internationally is subject to risks that may
have a material adverse effect on our ability to increase or
maintain foreign sales, including:
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We may be unable to successfully and cost-effectively market,
sell and distribute our services in foreign markets. Doing so
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 some 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.
Implementing
our acquisition and strategic partnership strategy could result
in dilution and operating difficulties leading to a decline in
revenue and operating profit.
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, 2009, we acquired or
invested in 33 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.
In December 2009, we entered into a strategic business
relationship with and acquired a minority stake in Softonic
International S.L. and Intershare S.L.
Acquisitions, strategic investments and strategic partnership
agreements may require significant capital infusions, typically
entail many risks, and could result in unforeseen difficulties,
disruptions, distractions, and expenditures in assimilating and
integrating with 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 completion of such
activities. 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 or strategic investment 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. 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. 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. Acquisitions could
also result in a dilutive impact to our earnings.
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We market our services directly to software publishers, online
retailers, consumer electronics companies and other prospective
customers. 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,
the signing of a contract, and the launch of a
revenue-generating commerce store. 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, and completion of
the implementation process typically ranges from one to four
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 and implementation process 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, if at all.
We may
become liable for fraudulent, improper or illegal uses of our
platforms and services.
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 sign up for and use our
e-commerce
services without significant participation from Digital River
personnel. Despite our efforts to contractually prohibit the
sale of inappropriate and illegal goods and services and our
efforts to detect the same, the remote control nature of these
platforms increases the risk 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 for sale,
or attempt to purchase, illegal products via such platforms
under innocuous names, further frustrating our 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.
Compliance
with and changes to applicable laws, rules, regulations, and
certification requirements, may substantially increase our costs
of doing business, limit our activities, or otherwise adversely
affect our ability to offer our services.
We are subject to the same international, federal, state and
local laws as other companies conducting business over the
Internet. Because our services are accessible worldwide, and we
facilitate sales of products to customers worldwide,
international jurisdictions may claim that we are required to
comply with their laws, rules and regulations. 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 with
international, federal, state and local laws may be costly or
may require us to change our business practices or restrict our
service offerings relative to those provided in the United
States. 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. 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. Laws,
rules and regulations applicable to our business cover issues
such as:
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Our acceptance of credit cards and similar payment methods
requires us to maintain certain certifications, most notably
Payment Card Industry (PCI) Level 1 compliance. Maintaining
this certification requires an annual audit by a qualified third
party auditor and a review and assessment of our security
controls and a significant commitment of internal resources. Our
loss of such certification may result in our inability to
process credit card transactions and have a material adverse
affect on our ability to do business.
Violation of any laws, rules or regulations applicable to our
business could result in fines or other actions by regulatory
agencies, increased costs of doing business, reduced profits, or
restrictions on our ability to conduct business such as our
ability to export products or bans on our ability to offer
certain services. In addition, any significant changes,
developments, or new interpretations of laws, rules, and
regulations applicable to our business will increase our costs
of compliance and may further restrict our overseas client base,
may require significant management and other resources to
respond appropriately, and may harm our operating results.
Failure
to protect our intellectual property may jeopardize our
competitive position and require us to incur significant
expenses to enforce our rights.
We rely on a combination of patent, copyright, trademark,
service mark and trade secret laws, and contractual restrictions
with our employees and other parties with which we do business,
to protect our proprietary rights and to limit access to and
disclosure of our proprietary information. 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, and the registration of our trademarks and service
marks in the U.S. and internationally.
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. Our
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 may not be
able to successfully obtain patents or trademarks for our
technologies or brands. Effective protection of our intellectual
property rights may not be available in every country in which
our services are made available online, or cost-effective for us
to obtain on a worldwide basis. 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.
Claims
against us related to infringement of other parties’
intellectual property rights, or the products we resell or
deliver, could require us to expend significant resources, enter
into unfavorable licenses, prevent us from using certain
technology, or require us to change our business
plans.
From time to time, we are named as a defendant in lawsuits
claiming that we have, in some way, violated the intellectual
property rights of others. From time to time we are notified of
several potential patent disputes, and expect that we will
increasingly be subject to the assertion of patent infringement
claims against us as our services expand in scope and
complexity. 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. Any assertions or prosecutions of claims like
these could require us to expend significant financial,
managerial and personnel resources. Although we carry general
liability insurance and require that our customers
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indemnify us against consumer 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. We may elect to self-insure against certain
claims. 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 continue 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 collect and maintain customer data from our customers, 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 and transfer of personal user
information or require online service providers to establish
privacy policies. In addition, the U.S. Federal Trade
Commission (FTC) has urged Congress to adopt legislation
regarding the collection and use of personal identifying
information obtained from individuals when accessing websites,
including both adults and minors.
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 customers, 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. Failure to comply with member
state implementations of these directives 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. Other countries may introduce
or expand their existing data privacy laws, rules and
regulations, which could require us to expend significant
resources to implement procedures and processes to ensure our
compliance.
System
failures, outages or errors could reduce the attractiveness of
our service offerings.
We provide commerce, marketing and delivery services to our
clients and consumers 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 and have identified errors, affecting all or a
portion of our systems, which we believe will continue to occur
from
time-to-time.
While we attempt to correct every system error we identify, not
all errors may be identified or corrected. Any systems damage,
errors, 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.
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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.
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.
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.
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. Implementation of new
technology related to the control system, such as our current
ongoing implementation of an SAP Enterprise Resource Planning,
or “ERP,” system, may result in misstatements due to
errors that are not detected and corrected during testing.
Because of the inherent limitations in a cost-effective control
system, misstatements due to error or fraud may occur and may
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 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.
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In January 2002, we adopted new Financial Accounting Standards
Board (FASB) guidance that establishes that goodwill and
intangible assets with indefinite lives are not amortized, but
are to be tested on an annual basis for impairment and, if
impaired, are recorded as an impairment charge in income from
operations. As of December 31, 2009, we had goodwill with
an indefinite life of $280.0 million from our acquisitions.
If our goodwill is determined for any reason to be impaired, the
subsequent accounting of the impaired portion as an expense
would lower our earnings and jeopardize our ability to
demonstrate sustained profitability. In January 2008, we adopted
new FASB guidance that requires the reporting of assets at fair
value as the price that would be received to sell an asset or
paid to transfer a liability in an orderly transaction between
market participants at the measurement date. The fair value of
assets can shift significantly and can cause a permanent or
temporary impairment.
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.
Industry
Risk Factors
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 and partners 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:
The online channel partners and the other companies described
above may compete directly with us by adopting a business model
similar to ours. Many of our competitors have, and new potential
competitors may
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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. Some of our clients may also
compete with us. In addition, competitors or our clients 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, which could result in the loss of
existing clients
and/or our
inability to pursue and sign new clients. 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.
The
global recession, and political and economic conditions, may
adversely affect our revenue and results of operations and stock
price.
The U.S. and other global economies are currently
experiencing a recession that has affected the economy as a
whole, resulting in stagnation or declines in economic growth,
loss of consumer confidence and uncertainty about economic
stability, and increased unemployment. U.S. and foreign
credit and financial markets continue to experience instability,
resulting in increased volatility in the stock market and
reduced availability of credit. Our revenue and growth is
dependent on the continued growth in demand for our
clients’ products and the continued growth of Internet
commerce, and depends significantly on geopolitical economic and
business conditions. The effect of this recession and the
instability in the credit and financial markets may continue to
negatively impact our business and our clients, demand for our
clients products, and consumer spending, such as causing delays
in new product introductions, changes in client’s
outsourcing behavior, increasing our difficulty in collecting
client receivables, and increasing the risk of client
bankruptcies
and/or
interruption or cessation of business, which may have a negative
impact on our business, operating results and financial
condition. Instability in the credit and equity markets
increases the risk that the actual amounts realized in the
future on our financial instruments and investments may
significantly differ from the fair values currently assigned to
them. If macroeconomic and market conditions affecting us or our
clients remain uncertain, weaken further, or otherwise fail to
improve, they may have a material adverse effect on our
business, operating results and financial condition.
Securities
Risk Factors
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. 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 experienced significant operating losses and
negative cash flow from operations during our operating history
and may do so in the future. 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.
The investment of our substantial cash balance and our
investments in marketable debt securities are subject to risks
which may cause losses and affect the liquidity of these
investments.
As of December 31, 2009, we held $99.1 million of
investments at par value, $92.8 million fair value, in
auction-rate securities (ARS), all are AAA/Aaa rated and
105%-115% over collateralized by student loans guaranteed by the
U.S. government with the exception of one security which is
rated AAA/A3 and one
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security which is rated AAA/Aa1. All the securities are 100%
guaranteed by the Department of Education or the Federal Family
Education Loan Program (FFELP) with the exception of two
securities which are 82.5% and 99% guaranteed by FFELP. Almost
all of these securities continue to fail at auction due to
illiquid market conditions.
The Company determined a market value discount, due to current
illiquid market conditions, was required and recorded a
temporary fair value reduction of $16.3 million (14.9% of
par value) recorded to “Accumulated other comprehensive
income” on the December 31, 2008 balance sheet. In
2009, $10.4 million of our ARS were successfully liquidated
at par. As of December 31, 2009, the Company adjusted the
market value discount to $6.3 million (6.4% of par value)
through “Accumulated other comprehensive income”.
The investment principal associated with failed auctions will
not be accessible until successful auctions occur, a buyer is
found outside of the auction process, the issuers establish a
different form of financing to replace these securities, or
final payments come due according to the contractual maturities
of the debt issues. If none of these events occur or if the
credit markets deteriorate, we may in the future be required to
take a larger fair value discount and may be required to take a
permanent impairment resulting in a reduction of earnings and
liquidity. We intend to hold our auction-rate securities until
we can recover the full principal amount and have the ability to
do so based on our other sources of liquidity. 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 (DDR Holdings) has brought a claim against us
and several other defendants regarding U.S. Patents
No. 6,629,135 (the “’135 patent”) and
6,993,572 (the “’572 patent”), 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
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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, the Court stayed the litigation
pending a decision on the reexamination application. In February
2007, the U.S. Patent and Trademark Office ordered
reexamination of DDR Holdings’ patents. On January 5,
2009, the U.S. Patent and Trademark Office issued a final
office action rejecting the claims in the ’135 patent which
were subject to reexamination. On January 14, 2009, the
U.S. Patent and Trademark Office issued a final office
action rejecting all but two of the claims in the ’572
patent which were subject to reexamination. Should the stay of
litigation be lifted, we intend to vigorously defend ourselves
in this matter.
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, or that certain
products and services we resell infringed their intellectual
property rights. We have been notified of several potential
intellectual property disputes, and expect that we will
increasingly be subject to intellectual property infringement
claims as our services expand in scope and complexity. We have
in the past been forced to litigate such claims in some
instances. We also may become more vulnerable to third-party
claims as laws, such as the Digital Millennium Copyright Act,
the Lanham Act and the Communications Decency Act are
interpreted by the courts and as we expand geographically into
jurisdictions where the underlying laws with respect to the
potential liability of online intermediaries like ourselves are
either unclear or less favorable. These claims, whether
meritorious or not, could be time-consuming and costly to
resolve, cause service upgrade delays, require expensive changes
in our methods of doing business, or could require us to enter
into costly royalty or licensing agreements.
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Our common stock is traded on the 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, 2010, there were approximately 307
holders of record of our common stock. On February 1, 2010,
the last sale price reported on The Nasdaq Global Select Market
for our common stock was $24.84 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 our Board of Directors authorized a new stock
buyback program to repurchase up to an aggregate of
$200 million of our common stock. This buyback program
superseded the prior buyback program.
No shares were repurchased during 2009.
During 2008, 4,239,312 shares were repurchased under the
2007 Repurchase Program, including 3,876,612 shares
repurchased pursuant to the accelerated share repurchase
program. None of the repurchased shares have been retired.
The Accelerated Share Repurchase (ASR) agreement was entered
into with Goldman Sachs (GS) on February 7, 2008 and called
for GS to repurchase $127 million of Digital River, Inc.
stock between February 7, 2008 and June 20, 2008.
Based on the agreement, Digital River received a final share
count based on a discount of the Volume Weighted Average Price
of Digital River stock from February 21, 2008, through the
end of the contract. On June 20, 2008, GS had concluded the
ASR program with a final share delivery of 327,767 shares.
The aggregate number of shares repurchased pursuant to the ASR
program was 3,876,612 shares at an average price of $32.76
per share. The ASR agreement terminated upon completion of the
ASR program on June 20, 2008 in accordance with its terms.
With the conclusion of the ASR program, we have completed the
2007 Repurchase Program.
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The information required in the table of Securities Authorized
for Issuance under Equity Compensation Plans will be
incorporated by reference to our Proxy Statement in connection
with our 2010 Annual Meeting to be filed in accordance with
Regulation 14A under the Securities Exchange Act of 1934,
as amended.
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, 2004 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.
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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.
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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
end-to-end
global
e-commerce
and marketing solutions to a wide variety of companies in
software, consumer electronics, computer games, video games, and
other markets. 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 while mitigating risks. Our
services include design, development and hosting of online
stores and shopping carts, store merchandising and optimization,
order management, denied parties screening, export controls and
management, tax compliance and management, fraud management,
digital product delivery via download, physical product
fulfillment, subscription management, online marketing including
e-mail
marketing, management of affiliate programs, paid search
programs, payment processing services, website optimization, web
analytics and reporting, and CD production and delivery.
Our products and services allow our clients to focus on
promoting and marketing their products and brands while
leveraging our investments in technology and infrastructure to
facilitate the purchase of products through their online
websites. When shoppers visit one of our clients’ branded
websites and purchase goods, they are transferred to an
e-commerce
store and / or shopping cart operated by us on our
e-commerce
platforms. Once on our system, shoppers can browse for products
and make purchases online. We typically are the seller of record
for transactions through our client branded stores. 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 as the merchant of record, including
collection and remittance of applicable taxes. We have invested
substantial resources to develop our
e-commerce
and marketing platforms and we provide access and use of our
platforms to our clients as a service as opposed to selling the
software to be operated on their own in-house computer hardware.
Our
e-commerce
store solutions range from simple remote control models to more
comprehensive online store models.
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’ websites and
the associated online stores and to improve the sales
productivity of those stores. Our services include paid search
advertising, search engine optimization, affiliate marketing,
store optimization, multi-variant testing, web analytic services
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, computer and video game companies, including
Absolute Software Corporation, Adobe Systems, Inc., Aspyr Media,
Inc., Autodesk, Inc., Canon Europa N.V., Computer Associates,
Cyber Patrol, LLC, Eastman Kodak Company, Electronic Arts, Inc.,
Lexmark, Inc., Microsoft Corporation, Nuance Communications,
Inc., SanDisk Corporation, Smith Micro Software, Inc., Symantec
Corporation, and Trend Micro, Inc.
As announced on October 12, 2009, Symantec Corporation has
informed us that it has elected not to renew its
e-commerce
agreement with us, which will result in the termination of the
e-commerce
agreement on June 30, 2010. We expect a material decrease
in revenue and operating income as a result of Symantec’s
decision to not renew its
e-commerce
agreement with us as Symantec migrates its stores from our
e-commerce
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infrastructure to their internally developed
e-commerce
platform. However, as Symantec has not yet informed us of its
migration plans or the nature of the support Symantec will
require from us during the transition period, we are currently
unable to predict the magnitude or timing of the revenue impact
on our business, our future revenues and our operating results.
Our intention is to moderate the impact on our consolidated
financial results of the expected reduction in revenue through
acquisition of new clients, organic growth within existing
clients, new product and service introductions, cost-saving
initiatives and acquisition activities. Unless and until we
generate sufficient new business to offset the loss of Symantec,
our 2009 financial results will be difficult or impossible to
duplicate in 2010.
We were incorporated in Delaware in February 1994. Our
headquarters are located at 9625 West 76th Street, Eden
Prairie, Minnesota and our telephone number is
952-253-1234.
General information about us can be found at
www.digitalriver.com under the “Company/Investor
Relations” link. Our annual report on
Forms 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.
Current
Year Results
The Company reported net income of $49.8 million, or $1.32
per diluted share for the year ended December 31, 2009.
This compared with net income of $63.6 million, or $1.55
per diluted share for the year ended December 31, 2008. Net
income was approximately $3.3 million less and basic and
diluted earnings per share were $0.08 and $0.09 less,
respectively, than initially reported in the Company’s
earnings press release and
Form 8-K,
both dated January 28, 2010. In performing its detailed
review of the financial statements and notes at year end,
management identified an additional adjustment associated with
its January 2, 2009, convertible note repurchase. After the
Company filed its year end 2009 press release it determined that
a $5.2 million non-cash expense for debt financing costs
($3.3 million net of tax), previously deferred and
amortized over the period of the note, was to be written off to
earnings in conjunction with the note repurchase.
We acquired NetGiro Systems AB in September 2007, IA Users Club,
Inc. d.b.a. CustomCD and DigitalSwift Corporation in January
2008 and THINK Subscription, Inc. in September 2008. The results
of these acquisitions must be factored into any comparison of
our 2009 results to the results for 2008 or 2007. See
Note 5 of our consolidated financial statements for the
year ended December 31, 2009, for pro forma financial
information as if these entities had been acquired on
January 1, 2008.
We prepare our consolidated financial statements in conformity
with accounting principles generally accepted in the United
States of America (U.S. GAAP). 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) persuasive evidence
of an agreement exists; (2) the services have been
rendered; (3) the fee is fixed and determinable; and
(4) collection of the amounts due is reasonably assured.
We determine 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 net as generally our
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clients are subject to inventory risks and control
customers’ product choices. We sell both physical and
digital products. Revenue is recognized upon fulfillment and
based upon when products are shipped and title and significant
risk of ownership passes to the customer.
We also provide customers with various proprietary software
backup services. We recognize revenue for these backup services
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, affiliate marketing and email
marketing services. If we receive payments for fee-based
services in advance of delivery, these amounts, if significant,
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.
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 these
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 a two-step approach. There have been no material
impairments of goodwill and other intangible assets for the
years 2009, 2008 and 2007.
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
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
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portion of the benefit of the acquired tax loss carryforwards
has been reserved by a valuation allowance pursuant to
U.S. GAAP. These valuation allowances 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. Any future release of valuation allowance will
reduce income tax expense.
As of December 31, 2009, we had U.S. tax loss
carryforwards of approximately $15.7 million and foreign
tax loss carryforwards of $3.4 million. These tax loss
carryforwards consist solely of acquired net operating losses.
The U.S. tax loss carryforwards expire in the years 2021
through 2028. However, we anticipate most U.S. tax loss
carryforwards will be utilized in the next few years.
There is uncertainty of future realization of the deferred tax
assets resulting from acquired tax loss carryforwards due to
anticipated limitations. Therefore, a valuation allowance was
recorded against the tax effect of such tax loss carryforwards.
At December 31, 2009, the Company has a valuation allowance
on approximately $1.1 million of deferred tax assets
related to acquired operating losses and other tax attributes as
we believe it is more likely than not that these deferred tax
assets will not be realized. Any future release of this
valuation allowance will reduce income tax expense.
No provision has been made for federal income taxes on
approximately $113.1 million of our foreign subsidiaries
undistributed earnings as of December 31, 2009 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 an election made at the time
of acquisition. If these earnings were to be distributed, the
income tax liability would be approximately $26.9 million.
Stock-Based Compensation Expense. We account
for share-based payments made to our 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 under the provisions of ASC 718.
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. 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.
As stock-based compensation expense recognized in our
Consolidated Statements of Income is based on awards ultimately
expected to vest, it has been reduced for estimated forfeitures.
ASC 718 requires forfeitures to be estimated at the time of
grant and revised, if necessary, in subsequent periods if actual
forfeitures differ from those estimates.
ASC 718 also requires the benefits of tax deductions in excess
of recognized stock-based compensation expense be reported as a
financing cash flow.
Stock-based compensation expense of $18.3 million,
$12.5 million and $13.7 million was charged to
operating expenses during 2009, 2008 and 2007, respectively.
See Note 6 for further information regarding the accounting
for share-based compensation.
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Results
of Operations
The following table sets forth certain items from our
consolidated statements of income as a percentage of total
revenue for the years indicated.
Revenue. Our revenue increased to
$403.8 million in 2009 from $394.2 million in 2008 and
$349.3 million in 2007. The revenue increases were
primarily attributable to growth with existing clients, the
addition of consumer electronics clients, expanded strategic
marketing activities with a larger number of clients which is
offset by a reduction in revenue with our largest client
Symantec who is migrating to an in house solution. Sales of
security software products for PCs represent the largest
contributor to our revenues. No acquisitions were made in 2009.
Acquisitions made during 2008 and 2007 generated approximately
2.6% and 1.3% of our total revenue for those years,
respectively. International
e-commerce
sales are approximately 41.1%, 42.8% and 43.2% of revenue in the
years ended December 31, 2009, 2008 and 2007, respectively.
The decrease in international sales during 2009 has been
attributed to foreign currency fluctuation during 2008. Sales of
products for one software publisher client, Symantec
Corporation, accounted for approximately 21.5% of our revenue in
2009, 24.3% in 2008 and 26.2% in 2007. In addition, revenues
derived from proprietary Digital River services sold to Symantec
consumers and
oneNetworkDirecttm
sales of Symantec products amounted to approximately 6.9% of our
total revenue in 2009, 9.4% in 2008 and 13.2% in 2007. Microsoft
Corporation accounted for approximately 11.8% of our revenue in
2009, 7.1% in 2008 and 3.5% in 2007.
Direct Cost of Services. Direct cost of
services expenses primarily include costs related to personnel,
product fulfillment,
back-up CD
production and delivery solutions and certain client-specific
costs. Direct cost of service expense was $17.6 million,
$16.4 million and $10.2 million in 2009, 2008 and
2007, respectively. The increase in 2009 compared with 2008 was
primarily driven by revenue growth and increased CD supply. The
increase in 2008 compared with 2007 was primarily driven by
revenue growth and increased CD supply and personnel costs
incurred through the DigitalSwift and CustomCD acquisitions in
January 2008.
As a percentage of revenue, direct cost of services increased to
4.4% in 2009 from 4.2% and 2.9% in 2008 and 2007, respectively.
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
$46.0 million in 2009, up from $41.0 million and
$32.3 million in 2008 and 2007, respectively. The increase
in 2009 from 2008 was due to
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an increase in data telecommunication expenses, increased global
data center operations costs and increased workforce related
costs. The increase in 2008 from 2007 was due to increased
workforce related costs, software licenses and data
telecommunication expenses to support our global data center
operations and increased revenue growth. In addition,
$2.7 million of the increase in 2008 compared to 2007 was
due to network and infrastructure costs related to NetGiro
Systems which was acquired in September 2007.
As a percentage of revenue, network and infrastructure costs
increased to 11.4% in 2009 from 10.4% and 9.3% in 2008 and 2007,
respectively.
Sales and Marketing. Our sales and marketing
expenses include credit card transaction and other payment
processing fees, personnel and related costs, advertising,
promotional and product marketing expenses, credit card
chargebacks and bad debt expense. Sales and marketing expenses
were $157.5 million, $150.1 million and
$134.4 million in 2009, 2008 and 2007, respectively. The
increase in sales and marketing in 2009 compared to 2008 was due
to additional workforce related costs to support our global
growth initiatives and higher marketing and advertising costs
due to new or expanded client paid search marketing programs.
The increase in 2008 from 2007 was due to additional workforce
related costs to support our global growth initiatives,
increased credit card and other payment processing fees related
to higher revenue and the addition of new payment methods and
increased marketing and advertising costs to strengthen our
presence in the video game and consumer electronics markets.
Also, an additional $3.3 million in sales and marketing
expenses were incurred in 2008 by NetGiro Systems, our global
payment service provider which was acquired in September 2007.
In addition, $1.0 million of sales and marketing expenses
were incurred through our January 2008 CustomCD, Inc. and
Digital Swift acquisitions.
As a percentage of revenue, sales and marketing expense was
39.0% in 2009 from 38.1% and 38.5% in 2008 and 2007,
respectively.
Product Research and Development. Our product
research and development expenses include personnel and related
expenses associated with developing, maintaining and enhancing
our technology platforms and related systems. Product research
and development expenses were $54.5 million in 2009,
compared to $51.2 million and $39.2 million in 2008
and 2007, respectively. The increases in 2009 compared to 2008
were due to higher research and development workforce related
costs to support increased investment in technologies to
strengthen our leadership position in software and unlock
opportunities in markets such as consumer electronics, games,
subscriptions, and
business-to-business
software. The higher research and development workforce related
expenses were offset by the benefit of foreign currency
translation and increased capitalization of internal and
consulting labor to support on-going initiatives in our
e-commerce
infrastructure. These investments advance global system
scalability, our
e-marketing
capabilities, data management and client reporting. Recent
acquisitions NetGiro, CustomCD, DigtalSwift and THINK
Subscriptions comprised a total of approximately
$5.4 million of the increase in research and development
costs in 2008 compared to 2007. Our research and development
investments supported on-going initiatives in our
e-commerce
infrastructure to advance global system scalability, our
e-marketing
capabilities, data management and client reporting. Our 2007
research and development costs included the impact of our
September 2007 NetGiro Systems acquisition as well as software
development expenses related to our relationship with Electronic
Arts, a leading interactive entertainment software company.
As a percentage of revenue, product research and development
expenses increased to 13.5% in 2009 from 13.0% in 2008 and 11.2%
in 2007.
General and Administrative. Our general and
administrative expenses primarily include executive, accounting
and administrative personnel and related expenses, professional
fees for legal, tax and audit services, bank fees and insurance.
General and administrative expenses were $37.7 million in
2009 compared to $39.5 million and $38.9 million in
2008 and 2007, respectively. The decrease in 2009 compared to
2008 was primarily due to lower total personnel related costs as
a result of targeted cost control measures. The increase in 2008
compared to 2007 was primarily due to $1.4 million higher
workforce related costs related to our September 2007 NetGiro
Systems acquisition.
As a percentage of revenue, general and administrative expenses
decreased to 9.3% in 2009 from 10.0% in 2008 and 11.1% in 2007.
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Depreciation and Amortization. Our
depreciation and amortization expenses include 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
year lives and leasehold improvements are amortized over the
shorter of the asset life or the remaining length of the lease.
Depreciation and amortization expense increased to
$19.4 million in 2009 from $16.0 million and
$12.7 million in 2008 and 2007, respectively. The increased
expenses in 2009 resulted primarily due to the amortization of
our new enterprise resource planning system and a new data
management and reporting infrastructure. The increase in 2008
resulted primarily from increases in our capital equipment, as
gross capitalized property and equipment increased to
$94.1 million on December 31, 2008, from
$74.1 million on December 31, 2007.
Amortization of Acquisition-Related
Intangibles. In 2009, our amortization of
acquisition-related intangibles line item consists of the
amortization of intangible assets recorded from our eight
acquisitions in the past five years. Amortization of acquisition
related intangibles was $7.6 million in 2009 compared to
$8.4 million and $7.6 million in 2008 and 2007,
respectively. The decrease in 2009 reflects the full
amortization of several past acquisitions and is the benefit of
foreign currency translation. The increase in 2008 from 2007
reflects the expenses associated with our acquisitions of
CustomCD, DigitalSwift and THINK Subscription which were
partially offset by the full amortization of prior 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, 2009, 2008 and 2007. 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 2009 was $63.5 million, down from
$71.6 million in 2008 and down from $73.9 million in
2007. As a percentage of revenue, income from operations was
15.7% in 2009, 18.2% in 2008 and 21.2% in 2007. Income from
operations decreased during 2009 from 2008 mainly due to
maintaining our resource levels, re-allocating people where
possible to projects designed to replace anticipated lost
revenue. The decrease from 2008 to 2007 was mainly due to higher
spending on global growth and operational efficiency initiatives.
Interest Income. Our interest income
represents the total of interest income on our cash, cash
equivalents, short-term investments and certain long-term
investments. Interest income was $3.2 million,
$18.0 million and $32.2 million in 2009, 2008 and
2007, respectively. The decrease in interest income in 2009
compared to 2008 was due to the use of approximately
$188 million of cash in January 2009 to satisfy the
majority of holders of our 1.25% Convertible Senior Notes
due 2024 who exercised their put option to require the company
to repurchase their notes. Also, interest income declined in
2009 due to significantly lower market yields on our portfolio.
The decrease in interest income in 2008 compared to 2007 was
primarily due to the use of $138 million in cash for our
share repurchase program during the first quarter of 2008.
Other Expense, Net. Our other expense, net
line item includes the total of interest expense on our debt,
foreign currency transaction gains and losses and asset disposal
gains and losses. Interest expense was $5.3 million, which
included the write-off of $5.2 million in debt financing
costs, in 2009 compared to $2.5 million in 2008 and
$2.4 million in 2007 and was related primarily to our
Convertible Senior Notes. We reported a $0.4 million gain
from foreign currency remeasurement in 2009 compared to a
$0.3 million gain in 2008 and a $0.6 million loss on
foreign currency remeasurement in 2007. The disposals of assets
in 2009 were immaterial. The loss on asset disposals was
$1.1 million in 2008, and included one-time charges of
approximately $0.5 million each for a settlement of patent
litigation and a write-down of intangible assets related to our
2007 Bitpass asset acquisition. Disposals of assets were
immaterial in 2007.
Income Tax Expense. In 2009, our tax expense
was $12.0 million, consisting of approximately
$17.2 million of current tax expense offset by
approximately $5.2 million of deferred tax benefit. In
2008, our tax expense was $22.7 million, consisting of
approximately $26.9 million of current tax expense offset
by $4.2 million of deferred tax benefit. In 2007, our tax
expense was $32.3 million, consisting of approximately
$37.0 million of current tax expense offset by
$4.7 million of deferred tax benefit. Our effective tax
rate for 2009 was 19.5% compared to 26.3% in 2008 and 31.3% in
2007. Differences in our effective tax rate from the US
statutory rate are primarily due to our mix of earnings from
international operations and the differences in statutory rates
in these countries from the US rate.
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As of December 31, 2009, we had U.S. tax loss
carryforwards of approximately $15.7 million and foreign
tax loss carryforwards of $3.4 million. These tax loss
carryforwards consist solely of acquired net operating losses.
The U.S. tax loss carryforwards expire in the years 2021
through 2028. However, we anticipate most U.S. tax loss
carryforwards will be utilized in the next few years.
There is uncertainty of future realization of the deferred tax
assets resulting from acquired tax loss carryforwards due to
anticipated limitations. Therefore, a valuation allowance was
recorded against the tax effect of such tax loss carryforwards.
During 2009, the valuation allowance decreased $0.3 million
due to utilization of net operating losses. At December 31,
2009, the Company has a valuation allowance on approximately
$1.1 million of deferred tax assets related to acquired
operating losses and other tax attributes as we believe it is
more likely than not that these deferred tax assets will not be
realized. Any future release of this valuation allowance will
reduce expense.
As of December 31, 2009, we had $392.7 million of cash
and cash equivalents and $15.2 million of short-term
investments. As discussed below, on January 2, 2009 we paid
approximately $186.7 million of principal and
$1.2 million in interest in connection with the repurchase
of our Notes. The major components of our working capital are
cash and cash equivalents, short-term investments and short-term
receivables net of client payables. Our primary source of
internal liquidity is our operating activities. Net cash
provided by operating activities in 2009, 2008 and 2007 was
$137.1 million, $95.2 million and $146.4 million,
respectively. Net cash provided by operating activities in 2009
was primarily the result of net income adjusted for non-cash
expenses, decreases in prepaid and other assets, and increases
in accounts payable. Net cash provided by operating activities
in 2008 was primarily the result of net income adjusted for
non-cash expenses, and decreases in accounts receivable
partially offset by increases in prepaid and other assets. Net
cash provided by operating activities in 2007 was primarily the
result of net income adjusted for non-cash expenses, increases
in accrued liabilities, accounts payable, and accounts
receivable.
Net cash used in investing activities was $62.2 million in
2009 and was the result of net sales of investments of
$1.5 million, cash paid for cost-method investments of
$26.8 million, cash paid for earn-outs related to prior
year acquisitions of $4.9 million, and purchases of capital
equipment of $31.9 million. Net cash provided by investing
activities was $144.8 million in 2008 and was the result of
net sales of investments of $195.2 million, cash paid for
acquisitions, net of cash received, of $23.5 million, and
purchases of capital equipment of $26.9 million. Net cash
used for 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 financing activities in 2009 was
$174.1 million, net cash used in financing activities in
2008 was $124.2 million, net cash used in financing
activities in 2007 was $35.5 million. In 2009 our cash used
in financing is mostly due to $186.7 million paid for
convertible senior notes and has been offset by sales to
employees under our employee stock purchase plan and by exercise
of stock options. In 2008 our cash used in financing is mostly
due to our stock repurchase which equaled $137.9 million
and has been offset by sales to employees under our employee
stock purchase plan and by exercise of stock options. 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. During 2009, proceeds of $10.1 million
were provided by the exercise of stock options, proceeds of
$2.5 million were provided by the sale of stock under the
employee stock purchase plan, cash used in the repurchase of
restricted stock to satisfy tax withholding obligation was
$0.7 million and proceeds of $0.7 million were
provided by the excess tax benefit from stock-based
compensation. During 2008, proceeds of $7.2 million were
provided by the exercise of stock options, proceeds of
$2.7 million were provided by the sale of stock under the
employee stock purchase plan, cash used in the repurchase of
restricted stock to satisfy tax withholding obligation was
$0.6 million, and proceeds of $4.4 million were
provided by the excess tax benefit from stock-based
compensation. During 2007, proceeds of $13.5 million were
provided by the exercise of stock options, proceeds of
$2.5 million were provided by the sale of stock under the
employee stock purchase plan, cash used in the repurchase of
restricted stock to satisfy tax withholding obligation was
$0.5 million, and proceeds of $12.0 million were
provided by the excess tax benefit from stock-based compensation.
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As announced on October 12, 2009, Symantec Corporation has
informed us that it has elected not to renew its
e-commerce
agreement with us, which will result in the termination of the
e-commerce
agreement on June 30, 2010. We expect a material decrease
in revenue and operating profit as a result of Symantec’s
decision to not renew its
e-commerce
agreement with us. However, as Symantec has not yet informed us
of its migration plans or the nature of the support Symantec
will require from us during the transition period, we are
currently unable to predict the magnitude or timing of the
revenue impact on our future revenues and our internal liquidity.
As of December 31, 2009, we held $99.1 million of
investments at par value, $92.8 million fair value, in
auction-rate securities (ARS), all are AAA/Aaa-rated and
105%-115% over collateralized by student loans guaranteed by the
U.S. government with the exception of one security which is
rated AAA/A3 and one security which is rated AAA/Aa1. All the
securities are 100% guaranteed by the Department of Education or
the Federal Family Education Loan Program (FFELP) with the
exception of two securities which are 82.5% and 99% guaranteed
by FFELP. Almost all of these securities continue to fail at
auction due to illiquid market conditions.
The Company determined a market value discount, due to current
illiquid market conditions, was required and recorded a
temporary fair value reduction of $16.3 million (14.9% of
par value) recorded to “Accumulated other comprehensive
income” on the December 31, 2008 balance sheet. In
2009, $10.4 million of our ARS were successfully liquidated
at par. As of December 31, 2009, the Company adjusted the
market value discount to $6.3 million (6.4% of par value)
through “Accumulated other comprehensive income”.
The determination of fair value required management to make
estimates and assumptions about the securities. The discounted
cash flow model we used to value the securities included the
following assumptions:
In aggregate the ARS portfolio is yielding 1.8% and we continue
to receive 100% of the contractually required interest payments.
We continue to believe that we will be able to liquidate at par
over time. We do not intend to sell the investments prior to
recovery of their amortized cost basis nor do we believe it is
more likely than not we may be required to sell the investments
prior to recovery of their amortized cost basis. Accordingly, we
treated the fair value decline as temporary. We anticipate we
will have sufficient cash flow from operations to execute our
business strategy and fund our operational needs. We believe
that capital markets are also available if we need to finance
other investing alternatives. See Note 3 for further
information.
Our principal commitments consist 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 operating expenses will be a material use of our
cash resources.
The following table summarizes our principal contractual
commitments as of December 31, 2009:
With respect to our 1.25% convertible senior notes due
January 1, 2024 (the “Notes”), we are required to
pay interest on the Notes on January 1 and July 1 of each year
so long as the Notes are outstanding. On January 4, 2010,
we paid $0.1 million in interest for the period July 1
through December 31, 2009. The Notes
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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.
Holders of the Notes have the right to require us to repurchase
their Notes prior to maturity on January 1, 2014 and 2019.
We have the right to redeem the Notes at any time on or after
January 1, 2009. On January 5, 2009, we announced that
holders of 95.5% of the Notes exercised the option to require us
to repurchase those Notes on January 2, 2009 at a purchase
price of 100.25% of the principal amount of each tendered Note.
Notes with an aggregate principal amount of approximately
$8.8 million remain outstanding. In light of the right of
holders to require us to redeem the Notes on January 1,
2009, on January 1, 2008, we reclassified the Notes as
short-term debt. As such right has expired and the exercise of
the next right to require us to redeem the Notes will not occur
until January 1, 2014, we have reclassified the remaining
Notes as long-term debt.
We believe that existing sources of liquidity and the results of
our operations will provide adequate cash to fund our operations
and to repurchase the remaining Notes, if necessary, 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
available for future use. In addition, we filed an acquisition
shelf registration statement 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.
We believe the outlook for our business remains positive for
2010. Global online sales continue to strengthen across most
categories and buyers appear to be increasingly comfortable
shopping online. In our core markets, software, consumer
electronics and games, trends continue to favor the migration
toward online shopping. Additionally, we see opportunities to
grow our share of business in adjacent and complementary markets
such as
business-to-business
software and subscriptions management. We also see opportunities
to expand our core service offerings in areas such as payment
processing and strategic marketing. We anticipate that we will
continue to reallocate resources in the first half of 2010 in
support of our strategic growth initiatives and plan to
implement cost savings initiatives by the end of the second
quarter of 2010 which should begin to benefit the expense
structure in the back half of the year. 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) continue to expand into new
vertical markets such as consumer electronics, and computer and
video games and 4) supplement our growth through strategic
acquisitions.
Accounting Standards Codification (ASC): In
June 2009, the Financial Accounting Standards Board (FASB)
issued new guidance now codified in ASC Topic No. 105. The
guidance establishes the FASB ASC as the single source of
authoritative U.S. GAAP, with exception to rules and
interpretive releases from the SEC, which continue to be sources
of authoritative U.S. GAAP for SEC registrants. We have
adopted the new guidance for the period ending
September 30, 2009. As the new standard did not change
U.S. GAAP, there was no change in the Company’s
Consolidated Financial Statements other than conforming
U.S. GAAP references into the ASC format.
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Interim Disclosures about Fair Value of Financial
Instruments: In April 2009, the FASB issued
additional guidance related to ASC Topic No. 825,
“Financial Instruments” (ASC 825). ASC 825 establishes
additional disclosure requirements of fair values for certain
financial instruments in the interim financial statements. We
adopted the new guidance for the period ending June 30,
2009. The required disclosures are included in Note 3,
“Fair Value Measurements”.
Other-than-temporary
Impairments: In April 2009, the FASB issued new
investment impairment guidance now codified in ASC Topic
No. 320, “Investments — Debt and Equity
Securities” (ASC 320). The guidance requires companies to
provide greater clarity to investors about the credit and
noncredit component of an
other-than-temporary
impairment event and to communicate more effectively when an
other-than-temporary
impairment event has occurred. The new guidance improves the
presentation and disclosure of
other-than-temporary
impairment on investment securities and changes the calculation
of the
other-than-temporary
impairment recognized in earnings in the financial statements.
The new guidance does not amend existing recognition and
measurement guidance related to
other-than-temporary
impairment of equity securities.
For debt securities, the new guidance requires an entity to
assess whether (a) it has the intent to sell the debt
security, or (b) it is more likely than not that it will be
required to sell the debt security before its anticipated
recovery. If either of these conditions is met, an
other-than-temporary
impairment on the security must be recognized.
In instances in which a determination is made that a credit loss
(defined as the difference between the present value of the cash
flows expected to be collected and the amortized cost basis)
exists but the entity does not intend to sell the debt security
and it is not more likely than not that the entity will be
required to sell the debt security before the anticipated
recovery of its remaining amortized cost basis (i.e., the
amortized cost basis less any current-period credit loss), the
new guidance changes the presentation and amount of the
other-than-temporary
impairment recognized in the income statement.
When adopting the additional guidance related to ASC 320, an
entity is required to record a cumulative-effect adjustment as
of the beginning of the period of adoption to reclassify the
noncredit component of a previously recognized
other-than-temporary
impairment from retained earnings to “Accumulated other
comprehensive income” if the entity does not intend to sell
the security and it is not more likely than not that the entity
will be required to sell the security before the anticipated
recovery of its amortized cost basis. We have adopted the
additional guidance related to ASC 320 for the period ending
June 30, 2009, and it did not have a material impact on the
Company’s Consolidated Financial Statements.
Fair Value Measurements and Disclosures: In
April 2009, the FASB issued additional guidance related to ASC
Topic No. 820, “Fair Value Measurements and
Disclosures” (ASC 820). ASC 820 provisions define fair
value, establish a framework for measuring fair value and expand
disclosure requirements. The new guidance emphasizes that even
if there has been a significant decrease in the volume and level
of activity, the objective of a fair value measurement remains
the same. Fair value is the price that would be received to sell
an asset or paid to transfer a liability in an orderly
transaction (that is, not a forced liquidation or distressed
sale) between market participants. The guidance provides a
number of factors to consider when evaluating whether there has
been a significant decrease in the volume and level of activity
for an asset or liability in relation to normal market activity.
In addition, when transactions or quoted prices are not
considered orderly, adjustments to those prices based on the
weight of available information may be needed to determine the
appropriate fair value. The guidance also requires increased
disclosures. We adopted the new guidance for the period ending
June 30, 2009, and it did not have a material impact on the
Company’s Consolidated Financial Statements. The required
disclosures are included in Note 3, “Fair Value
Measurements”.
Subsequent Events: In May 2009, the FASB
issued additional guidance related to ASC Topic No. 855,
“Subsequent Events” (ASC 855). ASC 855 establishes
that management must evaluate, as of each reporting period,
events or transactions that occur for potential recognition or
disclosure in the financial statements and the circumstances
under which an entity should recognize events or transactions
occurring after the balance sheet date through the date that the
financial statements are issued or available to be issued. It
also requires the disclosure of the date through which an entity
has evaluated subsequent events. We adopted ASC 855 for the
period ending June 30, 2009. The required disclosures are
included in Note 13, “Subsequent Events”.
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Consolidation of Variable Interest
Entities: In June 2009, FASB issued additional
guidance related to ASC Topic No. 810,
“Consolidation” (ASC 810). ASC 810 requires an
analysis to determine whether a variable interest gives the
entity a controlling financial interest in a variable interest
entity. This guidance requires an ongoing reassessment and
eliminates the quantitative approach previously required for
determining whether an entity is the primary beneficiary. This
statement is effective for fiscal years beginning after
Nov. 15, 2009. Accordingly, we will adopt this guidance at
the beginning of 2010. The Company is currently evaluating and
has not yet determined the impact, if any, its adoption will
have on the Company’s Consolidated Financial Statements.
None
Our portfolio of cash equivalents and investments is maintained
in a variety of securities, including government agency
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” within
stockholders’ equity. 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. A hypothetical and immediate one
percent (1%) increase in interest rates would decrease the fair
value in our investment portfolio held at December 31, 2009
and 2008, by $0.3 million and by $0.2 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, 2009 and 2008, by
$0.3 million and by $0.2 million, respectively. The
approximate gains or losses in earnings are estimates, and
actual results could vary due to the assumptions used. At
December 31, 2009 and 2008, we had $8.8 million and
$195 million, respectively, of 1.25% fixed rate contingent
convertible debt outstanding.
Growth in our international operations will incrementally
increase 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.
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 effect on our consolidated statements of income from changes
in exchange rates versus the U.S. Dollar is as follows (in
thousands):
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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 expense, net”. Foreign currency transaction
gains and losses were a gain of $0.4 million in 2009, a
gain of $0.3 million in 2008 and a loss of
$0.6 million in 2007.
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”. The
potential loss in fair value resulting from a hypothetical 10%
adverse currency movement is $12.4 million and
$24.7 million for 2009 and 2008, respectively.
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QUARTERLY
FINANCIAL DATA (UNAUDITED)
Our Financial Statements and Notes thereto appear beginning at
page 56 of this report.
None.
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We are committed to maintaining disclosure controls and
procedures designed to ensure that information required to be
disclosed in our periodic reports filed under the Securities
Exchange Act of 1934, as amended, is recorded, processed,
summarized and reported within the time periods specified in the
SEC’s rules and forms, and that such information is
accumulated and communicated to our management, including our
Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow for timely decisions regarding required
disclosure. Our management, with the participation of our Chief
Executive Officer and Chief Financial Officer, evaluated the
effectiveness of our disclosure controls and procedures (as
defined in Rules 13a-15(e) and
15d-15(e)
under the Exchange Act) as of December 31, 2009. The term
“disclosure controls and procedures” means controls
and other procedures that are designed to ensure that
information required to be disclosed by a company in the reports
that it files or submits under the Exchange Act is recorded,
processed, summarized and reported, within the time periods
specified in the SEC’s rules and forms. Disclosure controls
and procedures include, without limitation, controls and
procedures designed to ensure that such information is
accumulated and communicated to the company’s management,
including its principal executive and principal financial
officers, as appropriate, to allow timely decisions regarding
required disclosure. Management recognizes that any controls and
procedures, no matter how well designed and operated, can
provide only reasonable assurance of achieving their objectives,
and management necessarily applies its judgment in evaluating
the cost-benefit relationship of possible controls and
procedures. Based on their evaluation of our disclosure controls
and procedures as of December 31, 2009, our Chief Executive
officer and our Chief Financial Officer concluded that as of
that date, our disclosure controls were effective at the
reasonable assurance level.
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 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, under the supervision and
with the participation of the Chief Executive Officer and Chief
Financial Officer, 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, 2009, 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.
Ernst & Young LLP, an independent registered public
accounting firm, has audited the effectiveness of our internal
control over financial reporting as of December 31, 2009,
as stated in their report in which they expressed an unqualified
opinion, which is included herein.
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We are in the process of converting to a new enterprise resource
planning (ERP) system. Implementation of the new ERP system is
scheduled to occur in phases. During the year ended
December 31, 2009, the majority of the Company’s US
entities and certain non-US entities implemented the new ERP
system which resulted in some changes in internal controls. This
ERP system, along with the internal controls over financial
reporting included in the related phases of implementation, were
appropriately tested for effectiveness prior to implementation.
There were no other changes in the Company’s internal
control over financial reporting (as defined in
Rule 13a-15(f) and 15d-15(f) under the Exchange Act) during
the quarter ended December 31, 2009 that have materially
affected, or are reasonably likely to materially affect, the
Company’s 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, 2009, 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
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.
In our opinion, Digital River, Inc. maintained, in all material
respects, effective internal control over financial reporting as
of December 31, 2009, based on the COSO criteria.
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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, 2009 and 2008, and the
related consolidated statements of income, stockholders’
equity, and cash flows for each of the three years in the period
ended December 31, 2009 of Digital River, Inc. and our
report dated February 23, 2010 expressed an unqualified
opinion thereon.
/s/ Ernst &
Young LLP
Minneapolis, Minnesota
February 23, 2010
None.
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Certain information required in Part III of this report is
incorporated by reference to our Proxy Statement in connection
with our 2010 Annual Meeting to be filed in accordance with
Regulation 14A under the Securities Exchange Act of 1934,
as amended.
Directors
The information relating to directors and the Audit Committee of
the Board of Directors required by this item will be contained
under the captions Proposal 1. “Election of
Directors” and “Board Committees and Meetings” in
a definitive proxy statement involving the election of
directors, by reference to the Proxy Statement for the 2010
Annual Meeting of Stockholders to be filed within 120 days
after the end of the company’s fiscal year.
The information required by Items 405, 407(d)(4) and
407(d)(5) of
Regulation S-K
will be included under the captions “Section 16(a)
Beneficial Ownership Reporting Compliance” and “Board
Committees and Meetings” in the 2010 Proxy Statement, and
that information is incorporated by reference herein.
The information relating to executive officers required by this
item is included herein in Part I under the caption
“Executive Officers.”
Code of
Conduct
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
NASDAQ, 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.
Other
Disclosures
Other disclosures required by this Item will be incorporated
herein by reference to the Proxy Statement for the 2010 Annual
Meeting of Stockholders to be filed within 120 days after
the end of the company’s fiscal year.
Information concerning “Executive Compensation,”
including information concerning “Compensation Committee
Interlocks” and “Compensation Committee Report,”
will be incorporated herein by reference to the Proxy Statement
for the 2010 Annual Meeting of Stockholders to be filed within
120 days after the end of the company’s fiscal year.
The information as to “Securities Authorized for Issuance
under Equity Compensation Plans” and “Security
Ownership of Certain Beneficial Owners and Management” will
be incorporated herein by reference to the Proxy Statement for
the 2010 Annual Meeting of Stockholders to be filed within
120 days after the end of the company’s fiscal year.
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The information as to “Certain Relationships and Related
Transactions,” and “Director Independence” will
be incorporated herein by reference to the Proxy Statement for
the 2010 Annual Meeting of Stockholders to be filed within
120 days after the end of the company’s fiscal year.
The information as to principal accountant fees and services
will be incorporated herein by reference to the Proxy Statement
for the 2010 Annual Meeting of Shareholders to be filed within
120 days after the end of the company’s fiscal year.
(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 56 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.
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52
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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 23, 2010.
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 and in his 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, 2009, 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 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:
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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,
2009 and 2008, and the related consolidated statements of
income, stockholders’ equity, and cash flows for each of
the three years in the period ended December 31, 2009. Our
audits 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, 2009 and 2008, and the consolidated results of
their operations and their cash flows for each of the three
years in the period ended December 31, 2009, 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.
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, 2009, 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 23, 2010 expressed an unqualified opinion thereon.
/s/ Ernst &
Young LLP
Minneapolis, Minnesota
February 23, 2010
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DIGITAL
RIVER, INC.
Consolidated Balance Sheets
The accompanying notes are an integral part of these
consolidated financial statements.
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DIGITAL
RIVER, INC.
Consolidated Statements of Income for the Years Ended December 31,
The accompanying notes are an integral part of these
consolidated financial statements.
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DIGITAL
RIVER, INC.
Consolidated Statements of Stockholders’ Equity
The accompanying notes are an integral part of these
consolidated financial statements.
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DIGITAL
RIVER, INC.
Consolidated Statements of Cash Flows For the Years Ended December 31,
The accompanying notes are an integral part of these
consolidated financial statements.
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DIGITAL
RIVER, INC.
December 31,
2009 and 2008
We provide outsourced
e-commerce
solutions globally to a wide variety of companies primarily in
the software, consumer electronics, computer game and video game
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
(U.S. GAAP) 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 at the average exchange rates for the
reported period. Gains and losses resulting from translation are
recorded as a component of “Accumulated other comprehensive
income” within stockholders’ equity. Gains and losses
resulting from foreign currency transactions are recognized as
“Other expense, net”.
We are exposed to market risk from changes in foreign currency
exchange rates. Our primary risk is the effect of foreign
currency exchange rate fluctuations on the U.S. dollar
value of foreign currency denominated operating sales and
expenses. At December 31, 2009, these exposures were
mitigated by the use of foreign exchange forward contracts with
maturities of approximately one week. Our derivatives are not
designated as hedges and are adjusted to fair value through
income each period. The principal exposures mitigated were euro
and pound sterling currencies. For the years ended
December 31, 2009 and 2008, derivative exposures were
immaterial. The notional amounts held and the underlying
gain/loss were determined to be immaterial when compared to our
overall cash and cash equivalents and the net income reported
for the respective periods.
Our foreign currency contracts contain credit risk to the extent
that our bank counterparties may be unable to meet the terms of
the agreements. We minimize such risk by limiting our
counterparties to major financial institutions of high credit
quality.
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,
2009 and 2008, cash balances of $0.1 million and
$0.0 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, 2009 and 2008, $0.3 million and
$0.3 million were restricted by letter of credit and
agreements required by international tax jurisdictions as
security for potential tax liabilities.
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DIGITAL
RIVER, INC.
Notes to
Consolidated Financial
Statements — (Continued)
Short-Term Investments
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 net of tax as a
component of “Accumulated other comprehensive income”
within stockholders’ equity. We classify all of our
available-for-sale
securities, except for our auction-rate securities, as current
assets, as these securities represent investments available for
current corporate purposes. Upon the sale of a security
classified as available for sale, the amount reclassified out of
“Accumulated other comprehensive income” into earnings
is based on the average cost method.
Long-Term Investments
Our long-term investments consist of cost-based investments and
auction-rate debt securities. The auction-rate debt securities
are classified as
available-for-sale
and are carried on our balance sheet at their market value with
cumulative unrealized gains or losses recorded net of tax as a
component of “Accumulated other comprehensive income”
within stockholders’ equity. Upon the sale of a security
classified as available for sale, the amount reclassified out of
“Accumulated other comprehensive income” into earnings
is based on the average cost method.
We also have equity investments that are accounted for under the
cost method included in long-term investments. We review the key
characteristic of our other investments and their classification
in accordance with U.S. GAAP on an annual basis, or when
indications of potential impairment exist. If a decline in the
fair value of a security is deemed by management to be
other-than-temporary,
we write down the cost basis of the investment to fair value,
and the amount of the write-down is included in net earnings.
Computer equipment, software and furniture are depreciated under
the straight-line method using estimated useful lives of three
to seven years and leasehold improvements are amortized over the
shorter of the asset life or remaining length of the lease.
Property and equipment at December 31 consisted of the following
(in thousands):
Depreciation expense was $19.4 million, $15.6 million
and $12.1 million in 2009, 2008 and 2007, respectively.
Repairs and maintenance costs are charged directly to expense as
incurred. Major renewals or replacements that substantially
extend the useful life of an asset are capitalized and
depreciated.
Software
Development
Costs to develop software for internal use are required to be
capitalized and amortized over the estimated useful life of the
software. We capitalized $16.9 million and
$5.3 million related to software development during 2009
and 2008, respectively. This capitalization is primarily related
to the development of our new ERP system and new data management
and reporting infrastructure. We expect these investments to
drive long-term operational efficiencies across the organization
and provide further competitive differentiation. In 2007, we
capitalized an immaterial amount of software development costs.
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DIGITAL
RIVER, INC.
Notes to
Consolidated Financial
Statements — (Continued)
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 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. 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.
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. 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. There have been no
material impairments of goodwill and other intangible assets for
the years 2009, 2008 and 2007.
Impairment
of Long-Lived Assets and Costs Associated with Exit
Activities
We review all long-lived assets, including intangible assets
with definite lives, for impairment. 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 2009,
2008 or 2007.
The present value of costs associated with facility closings,
primarily future lease costs (net of expected sublease income),
are charged to earnings when a location is vacated. We
accelerate depreciation on property, equipment and leasehold
improvements we expect to retire when a decision is made to
abandon a location.
The following table summarizes our other assets as of December
31 (in thousands):
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DIGITAL
RIVER, INC.
Notes to
Consolidated Financial
Statements — (Continued)
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 U.S. GAAP.
Items of comprehensive income are unrealized gains and losses on
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.
The components of comprehensive income are (in thousands):
We recognize revenue from services rendered once all the
following criteria for revenue recognition have been met:
(1) persuasive evidence of an agreement exists;
(2) the services have been rendered; (3) the fee is
fixed and determinable; and (4) collection of the amounts
due is reasonably assured.
We determine 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 net as generally our clients are subject
to inventory risks and control customers’ product choices.
We sell both physical and digital products. Revenue is
recognized upon fulfillment and based upon when products are
shipped and title and significant risk of ownership passes to
the customer.
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DIGITAL
RIVER, INC.
Notes to
Consolidated Financial
Statements — (Continued)
We also provide customers with various proprietary software
backup services. We recognize revenue for these backup services
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, affiliate marketing and email
marketing services. If we receive payments for fee-based
services in advance of delivery, these amounts, if significant,
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.
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.
We account for share-based payments made to our 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 under the
provisions of ASC 718.
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. 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.
As stock-based compensation expense recognized in our
Consolidated Statement of Income is based on awards ultimately
expected to vest, it has been reduced for estimated forfeitures.
ASC 718 requires forfeitures to be estimated at the time of
grant and revised, if necessary, in subsequent periods if actual
forfeitures differ from those estimates.
ASC 718 also requires the benefits of tax deductions in excess
of recognized stock-based compensation expense be reported as a
financing cash flow.
Stock-based compensation expense of $18.3 million,
$12.5 million and $13.7 million was charged to
operating expenses during 2009, 2008 and 2007, respectively.
See Note 6 for further information regarding the accounting
for share-based compensation.
The costs of advertising are charged to sales and marketing
expense as incurred. We incurred advertising expense of
$1.0 million, $0.7 million and $0.1 million in
2009, 2008 and 2007, respectively.
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DIGITAL
RIVER, INC.
Notes to
Consolidated Financial
Statements — (Continued)
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 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 U.S. GAAP. These valuation allowances 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 investments. Interest income was
$3.2 million, $18.0 million and $32.2 million in
2009, 2008 and 2007, respectively. The significant decrease in
interest income in 2009 compared to 2008 was due to the use of
approximately $188 million of cash in January 2009, to
satisfy the majority of holders of our 1.25% Convertible
Senior Notes due 2024 who exercised their put option to require
the company to repurchase their notes. Additionally, the
weighted average yield on the investment portfolio has declined
substantially from 2008. The decrease in interest income from
2007 to 2008 was due to the use of $138 million in cash for
our share repurchase program during the first quarter of 2008.
Interest income also declined due to lower yields on our
portfolio during 2008.
Our other expense, net line item is the total of interest
expense on our debt and foreign currency transaction gains and
losses and disposals of asset gains and losses. Interest expense
was $5.3 million in 2009 compared to $2.5 million in
2008 and $2.4 million in 2007. In 2009, $5.2 million
of interest expense was due to the write-off of debt financing
costs related to the repurchase of 95.5% of our Convertible
Senior Notes in January 2009. Our gain from foreign currency
remeasurement was $0.4 million in 2009 compared to a gain
of $0.3 million in 2008 and a loss of $0.6 million in
2007. Disposals of assets were immaterial in 2009. The loss on
disposals of assets was $1.1 million in 2008. Disposals of
assets were immaterial in 2007.
Accounting Standards Codification (ASC): In
June 2009, the Financial Accounting Standards Board (FASB)
issued new guidance now codified in ASC Topic No. 105. The
guidance establishes the FASB ASC as the single source of
authoritative U.S. GAAP, with exception to rules and
interpretive releases from the SEC, which continue to be sources
of authoritative U.S. GAAP for SEC registrants. We adopted
the new guidance for the period ending September 30, 2009.
As the new standard did not change U.S. GAAP, there was no
change in the Company’s Consolidated Financial Statements
other than conforming U.S. GAAP references into the ASC
format.
Interim Disclosures about Fair Value of Financial
Instruments: In April 2009, the FASB issued
additional guidance related to ASC Topic No. 825,
“Financial Instruments” (ASC 825). ASC 825 establishes
additional disclosure requirements of fair values for certain
financial instruments in the interim financial statements. We
adopted the new guidance for the period ending June 30,
2009. The required disclosures are included in Note 3,
“Fair Value Measurements”.
Other-than-temporary
Impairments: In April 2009, the FASB issued new
investment impairment guidance now codified in ASC Topic
No. 320, “Investments — Debt and Equity
Securities” (ASC 320). The guidance requires companies to
provide greater clarity to investors about the credit and
noncredit component of an
other-than-temporary
impairment event and to communicate more effectively when an
other-than-temporary
impairment event has occurred. The new guidance improves the
presentation and disclosure of
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DIGITAL
RIVER, INC.
Notes to
Consolidated Financial
Statements — (Continued)
other-than-temporary
impairment on investment securities and changes the calculation
of the
other-than-temporary
impairment recognized in earnings in the financial statements.
The new guidance does not amend existing recognition and
measurement guidance related to
other-than-temporary
impairment of equity securities.
For debt securities, the new guidance requires an entity to
assess whether (a) it has the intent to sell the debt
security, or (b) it is more likely than not that it will be
required to sell the debt security before its anticipated
recovery. If either of these conditions is met, an
other-than-temporary
impairment on the security must be recognized.
In instances in which a determination is made that a credit loss
(defined as the difference between the present value of the cash
flows expected to be collected and the amortized cost basis)
exists but the entity does not intend to sell the debt security
and it is not more likely than not that the entity will be
required to sell the debt security before the anticipated
recovery of its remaining amortized cost basis (i.e., the
amortized cost basis less any current-period credit loss), the
new guidance changes the presentation and amount of the
other-than-temporary
impairment recognized in the income statement.
When adopting the additional guidance related to ASC 320, an
entity is required to record a cumulative-effect adjustment as
of the beginning of the period of adoption to reclassify the
noncredit component of a previously recognized
other-than-temporary
impairment from retained earnings to “Accumulated other
comprehensive income” if the entity does not intend to sell
the security and it is not more likely than not that the entity
will be required to sell the security before the anticipated
recovery of its amortized cost basis. We have adopted the
additional guidance related to ASC 320 for the period ending
June 30, 2009, and it did not have a material impact on the
Company’s Consolidated Financial Statements.
Fair Value Measurements and Disclosures: In
April 2009, the FASB issued additional guidance related to ASC
Topic No. 820, “Fair Value Measurements and
Disclosures” (ASC 820). ASC 820 provisions define fair
value, establish a framework for measuring fair value and expand
disclosure requirements. The new guidance emphasizes that even
if there has been a significant decrease in the volume and level
of activity, the objective of a fair value measurement remains
the same. Fair value is the price that would be received to sell
an asset or paid to transfer a liability in an orderly
transaction (that is, not a forced liquidation or distressed
sale) between market participants. The guidance provides a
number of factors to consider when evaluating whether there has
been a significant decrease in the volume and level of activity
for an asset or liability in relation to normal market activity.
In addition, when transactions or quoted prices are not
considered orderly, adjustments to those prices based on the
weight of available information may be needed to determine the
appropriate fair value. The guidance also requires increased
disclosures. We adopted the new guidance for the period ending
June 30, 2009, and it did not have a material impact on the
Company’s Consolidated Financial Statements. The required
disclosures are included in Note 3, “Fair Value
Measurements”.
Subsequent Events: In May 2009, the FASB
issued additional guidance related to ASC Topic No. 855,
“Subsequent Events” (ASC 855). ASC 855 establishes
that management must evaluate, as of each reporting period,
events or transactions that occur for potential recognition or
disclosure in the financial statements and the circumstances
under which an entity should recognize events or transactions
occurring after the balance sheet date through the date that the
financial statements are issued or available to be issued. It
also requires the disclosure of the date through which an entity
has evaluated subsequent events. We adopted ASC 855 for the
period ending June 30, 2009. The required disclosures are
included in Note 13, “Subsequent Events”.
Consolidation of Variable Interest
Entities: In June 2009, FASB issued additional
guidance related to ASC Topic No. 810,
“Consolidation” (ASC 810). ASC 810 requires an
analysis to determine whether a variable interest gives the
entity a controlling financial interest in a variable interest
entity. This guidance requires an ongoing reassessment and
eliminates the quantitative approach previously required for
determining whether an entity is the primary beneficiary. This
statement is effective for fiscal years beginning after
Nov. 15, 2009. Accordingly, we will adopt this guidance at
the beginning of 2010. The Company is currently evaluating
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DIGITAL
RIVER, INC.
Notes to
Consolidated Financial
Statements — (Continued)
and has not yet determined the impact, if any, its adoption will
have on the Company’s Consolidated Financial Statements.
Basic income per common share is computed by dividing net income
by the weighted average number of shares of common stock
outstanding during the period. Diluted earnings per common share
is calculated by dividing net income, adjusted to exclude
interest expense and financing cost amortization related to
potentially dilutive securities, by the weighted average number
of common shares related to potentially dilutive securities
outstanding during the period, plus any additional common shares
that would have been outstanding if potentially dilutive common
shares had been issued during the period.
The following table summarizes the computation of basic and
diluted earnings per share (in thousands, except per share data):
Options to purchase 1,298,087, 778,034 and 491,636 shares
for 2009, 2008 and 2007, were not included in the computation of
diluted EPS, because their effect on diluted EPS would have been
anti-dilutive.
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. The impact of the convertible note
repurchase was anti-dilutive for the year ending
December 31, 2009, and has been excluded from the
computation of diluted earnings per share as a result.
Financial assets and liabilities that are re-measured and
reported at fair value at each reporting period are classified
and disclosed in one of the following three categories:
Level 1 — Observable inputs such as quoted prices
in active markets;
Level 2 — Other observable inputs available at
the measurement date, other than quoted prices included in
Level 1, either directly or indirectly, including:
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DIGITAL
RIVER, INC.
Notes to
Consolidated Financial
Statements — (Continued)
Level 3 — Unobservable inputs that cannot be
corroborated by observable market data and reflect the use of
significant management judgment. These values are generally
determined using pricing models for which the assumptions
utilize management’s estimate of market participant
assumptions.
Assets
and Liabilities that are Measured at Fair Value on a Recurring
Basis
The fair value hierarchy requires the use of observable market
data when available. In instances in which the inputs used to
measure fair value fall into different levels of the fair value
hierarchy, the fair value measurement has been determined based
on the lowest level input that is significant to the fair value
measurement in its entirety. Our assessment of the significance
of a particular item to the fair value measurement in its
entirety requires judgment, including the consideration of
inputs specific to the assets or liability.
The following table sets forth by level within the fair value
hierarchy, our financial assets that were accounted for at fair
value on a recurring basis at December 31, 2009, according
to the valuation techniques we used to determine their fair
values:
The following is a reconciliation of assets measured at fair
value on a recurring basis using significant unobservable inputs
(Level 3 inputs) (in thousands):
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DIGITAL
RIVER, INC.
Notes to
Consolidated Financial
Statements — (Continued)
The
following methods and assumptions were used to estimate the fair
value of each class of financial instrument:
Cash and Cash equivalents. Consist of cash on
hand in bank deposits, highly liquid investments, primarily high
grade commercial paper and money market accounts. The fair value
was measured using quoted market prices and is classified as
Level 1. The carrying amount approximates fair value.
U.S. government sponsored entities. Consist of
Federal Farm Credit Bank and Federal Home Loan Bank investment
grade bonds that trade with sufficient frequency and volume to
enable us to obtain pricing information on an ongoing basis. The
fair value of these bonds was measured using quoted market
prices and is classified as Level 1. The contractual
maturity of these investments is within one year.
Corporate Bonds. Consist of investment grade
corporate bonds that trade with sufficient frequency and volume
to enable us to obtain pricing information on an ongoing basis.
The fair value of these bonds was measured using quoted market
prices and is classified as Level 1. The contractual
maturity of these investments is within two years.
Auction Rate Securities (Student loan bonds in
table). As of December 31, 2009, we held
$99.1 million of investments at par value,
$92.8 million fair value, in auction-rate securities (ARS),
all are AAA/Aaa rated and 105%-115% over collateralized by
student loans guaranteed by the U.S. government with the
exception of one security which is rated AAA/A3 and one security
which is rated AAA/Aa1. All the securities are 100% guaranteed
by the Department of Education or the Federal Family Education
Loan Program (FFELP) with the exception of two securities which
are 82.5% and 99% guaranteed by FFELP. Almost all of these
securities continue to fail at auction due to illiquid market
conditions.
The Company determined a market value discount, due to current
illiquid market conditions, was required and recorded a
temporary fair value reduction of $16.3 million (14.9% of
par value) recorded to “Accumulated other comprehensive
income” on the December 31, 2008 balance sheet. In
2009, $10.4 million of our ARS were successfully liquidated
at par. As of December 31, 2009, the Company adjusted the
market value discount to $6.3 million (6.4% of par value)
through “Accumulated other comprehensive income”.
The determination of fair value required management to make
estimates and assumptions about the securities. The discounted
cash flow model we used to value the securities included the
following assumptions:
In aggregate the ARS portfolio is yielding 1.8% and we continue
to receive 100% of the contractually required interest payments.
We continue to believe that we will be able to liquidate at par
over time. We do not intend to sell the investments prior to
recovery of their amortized cost basis nor do we believe it is
more likely than not we may be required to sell the investments
prior to recovery of their amortized cost basis. Accordingly, we
treated the fair value decline as temporary. We anticipate we
will have sufficient cash flow from operations to execute our
business strategy and fund our operational needs. We believe
that capital markets are also available if we need to finance
other investing alternatives.
Based on the current illiquid market conditions, the Company
classifies its auction rate securities as Level 3 long-term
investments until the Company has received a call or partial
call on the securities. Upon receipt of a call or partial call,
the Company classifies the securities subject to the call or
partial call, as Level 1 short term investments. As of
December 31, 2009 the fair value of the Company’s
$99.1 million in auction rate securities was classified as
$92.8 million Level 3 long-term investments. Also as
of December 31,
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DIGITAL
RIVER, INC.
Notes to
Consolidated Financial
Statements — (Continued)
2009, the difference between fair value and par value of these
auction rate securities was $6.3 million, or 1.2% of total
assets measured at fair value or 0.6% of total assets reported
in our financial statements.
Assets
and Liabilities that are Measured at Fair Value on a
Nonrecurring Basis
In 2009, we had no significant measurements of assets or
liabilities at fair value on a nonrecurring basis subsequent to
their initial recognition.
The carrying amount of accounts receivable and accounts payable
approximates fair value because of the short maturity of these
instruments.
The aggregate carrying value and fair value of the
Company’s cost method equity investments at
December 31, 2009, was $26.8 million. The Company
acquired the majority of these investments in late 2009 and
believes the entity valuations completed at acquisition continue
to represent the fair value of the acquisitions.
As of December 31, 2009 and 2008, the fair value of our
$8.8 million 1.25% fixed rate convertible senior notes was
valued at $7.5 million and $7.5 million, respectively,
based on the quoted fair market value of the debt.
As of December 31, 2009 and 2008, our
available-for-sale
securities consisted of the following (in thousands):
Realized gains or losses on investments are recorded in our
statement of income within “Other expense, net”. In
2009, the Company’s proceeds on sales of investment equaled
par value. In 2009, the Company reclassified from
“Accumulated other comprehensive income” to earnings
$0.9 million related to securities settled within the year.
Realized losses on sales of investments were immaterial in 2009,
2008 and 2007.
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DIGITAL
RIVER, INC.
Notes to
Consolidated Financial
Statements — (Continued)
The following table summarizes the purchase acquisitions
completed during the three years in the period ended
December 31, 2009 (in thousands):
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