e10vq
SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2009
OR
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o |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
FOR THE TRANSITION PERIOD FROM TO
Commission file number 000-24643
DIGITAL RIVER, INC.
(Exact name of registrant as specified in its charter)
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DELAWARE
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41-1901640 |
(State or other jurisdiction of
incorporation or organization)
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(I.R.S. Employer
Identification Number) |
9625 WEST 76TH STREET
EDEN PRAIRIE, MINNESOTA 55344
(Address of principal executive offices)
(952) 253-1234
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files).
Yes o No 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 (as defined in Exchange Act Rule 12b-2). See
definition of large accelerated filer, accelerated filer and smaller reporting company in
Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ |
Accelerated filer o |
Non-accelerated filer o (Do not check if a smaller reporting company) |
Smaller reporting company o
|
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes o No þ
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of
the latest practicable date.
The number of shares of common stock outstanding at July 1, 2009 was 38,573,928 shares.
DIGITAL RIVER, INC.
Form 10-Q
Index
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
DIGITAL RIVER, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
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(Unaudited) |
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June 30, |
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December 31, |
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2009 |
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2008 |
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ASSETS |
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CURRENT ASSETS: |
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Cash and cash equivalents |
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$ |
350,389 |
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$ |
490,335 |
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Short-term investments |
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10,000 |
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Accounts receivable, net of allowance of $2,582 and $2,457 |
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48,343 |
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53,216 |
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Deferred income taxes |
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7,613 |
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7,613 |
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Prepaid expenses and other |
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33,019 |
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42,522 |
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Total current assets |
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439,364 |
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603,686 |
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Property and equipment, net |
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52,620 |
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41,733 |
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Goodwill |
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271,719 |
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273,788 |
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Intangible assets, net of accumulated amortization of $70,269 and $66,346 |
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28,324 |
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32,222 |
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Long-term investments |
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94,637 |
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93,213 |
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Deferred income taxes |
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23,643 |
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24,824 |
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Other assets |
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2,461 |
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786 |
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TOTAL ASSETS |
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$ |
912,768 |
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$ |
1,070,252 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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CURRENT LIABILITIES: |
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Convertible senior notes |
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$ |
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$ |
186,195 |
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Accounts payable |
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185,518 |
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184,361 |
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Accrued payroll |
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12,325 |
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14,841 |
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Deferred revenue |
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15,962 |
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13,651 |
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Accrued acquisition costs |
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73 |
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3,278 |
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Other accrued liabilities |
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27,477 |
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41,336 |
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Total current liabilities |
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241,355 |
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443,662 |
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NON-CURRENT LIABILITIES: |
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Convertible senior notes |
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8,805 |
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8,805 |
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Other liabilities |
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15,871 |
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15,712 |
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Total non-current liabilities |
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24,676 |
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24,517 |
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TOTAL LIABILITIES |
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266,031 |
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468,179 |
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COMMITMENTS AND CONTINGENCIES |
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STOCKHOLDERS EQUITY: |
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Preferred Stock, $.01 par value; 5,000,000 shares authorized; no
shares issued or outstanding |
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Common Stock, $.01 par value; 120,000,000 shares authorized;
44,805,145 and 43,225,401 shares issued |
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448 |
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432 |
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Treasury stock at cost; 6,231,217 and 6,211,477 shares |
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(216,674 |
) |
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(216,163 |
) |
Additional paid-in capital |
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635,132 |
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623,778 |
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Retained earnings |
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217,456 |
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189,096 |
|
Accumulated other comprehensive income |
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10,375 |
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4,930 |
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Total stockholders equity |
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646,737 |
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602,073 |
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TOTAL LIABILITIES AND STOCKHOLDERS EQUITY |
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$ |
912,768 |
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$ |
1,070,252 |
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See accompanying notes to condensed consolidated financial statements.
3
DIGITAL RIVER, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data; unaudited)
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Three Months Ended |
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Six Months Ended |
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June 30, |
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June 30, |
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2009 |
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2008 |
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2009 |
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2008 |
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Revenue |
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$ |
96,564 |
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$ |
98,374 |
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$ |
199,495 |
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$ |
202,008 |
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Costs and expenses |
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Direct cost of services |
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3,951 |
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4,469 |
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7,893 |
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8,644 |
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Network and infrastructure |
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10,963 |
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10,396 |
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21,276 |
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20,584 |
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Sales and marketing |
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39,189 |
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39,247 |
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77,636 |
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78,977 |
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Product research and development |
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13,136 |
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13,074 |
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25,471 |
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25,744 |
|
General and administrative |
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9,832 |
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10,834 |
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18,961 |
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|
21,078 |
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Depreciation and amortization |
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|
4,629 |
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|
3,957 |
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|
8,473 |
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|
7,791 |
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Amortization of acquisition-related intangibles |
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1,916 |
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|
2,170 |
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3,919 |
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4,346 |
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Total costs and expenses |
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83,616 |
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|
84,147 |
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163,629 |
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167,164 |
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Income from operations |
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12,948 |
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|
14,227 |
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35,866 |
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|
34,844 |
|
Interest Income |
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|
762 |
|
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|
4,298 |
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|
1,951 |
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|
10,544 |
|
Other income (expense), net |
|
|
1,075 |
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|
|
(1,653 |
) |
|
|
(273 |
) |
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|
(2,402 |
) |
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Income before income tax expense |
|
|
14,785 |
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|
16,872 |
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|
|
37,544 |
|
|
|
42,986 |
|
Income tax expense |
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|
3,016 |
|
|
|
3,653 |
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|
|
9,184 |
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|
|
11,484 |
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Net income |
|
$ |
11,769 |
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|
$ |
13,219 |
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$ |
28,360 |
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$ |
31,502 |
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Net income per share basic |
|
$ |
0.32 |
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$ |
0.36 |
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$ |
0.77 |
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$ |
0.84 |
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Net income per share diluted |
|
$ |
0.31 |
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$ |
0.33 |
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$ |
0.76 |
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$ |
0.76 |
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Shares used in per-share calculation basic |
|
|
36,856 |
|
|
|
36,594 |
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|
|
36,794 |
|
|
|
37,562 |
|
|
|
|
|
|
|
|
|
|
|
|
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|
Shares used in per-share calculation diluted |
|
|
37,781 |
|
|
|
41,647 |
|
|
|
37,361 |
|
|
|
42,556 |
|
|
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See accompanying notes to condensed consolidated financial statements.
4
DIGITAL RIVER, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands; unaudited)
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Six Months Ended |
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June 30, |
|
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|
2009 |
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|
2008 |
|
OPERATING ACTIVITIES |
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Net income |
|
$ |
28,360 |
|
|
$ |
31,502 |
|
Adjustments to reconcile net income to net cash provided by
operating activities |
|
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|
|
|
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|
Amortization of acquisition-related intangibles |
|
|
3,919 |
|
|
|
4,346 |
|
Change in accounts receivable allowance, net of acquisitions |
|
|
96 |
|
|
|
603 |
|
Depreciation and amortization |
|
|
8,473 |
|
|
|
7,791 |
|
Stock-based compensation expense related to stock-based
compensation plans |
|
|
8,598 |
|
|
|
6,538 |
|
Excess tax benefits from stock-based compensation |
|
|
(144 |
) |
|
|
(1,001 |
) |
Deferred and other income taxes |
|
|
2,184 |
|
|
|
5,934 |
|
Change in operating assets and liabilities (net of acquisitions) |
|
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|
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|
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Accounts receivable |
|
|
4,497 |
|
|
|
12,495 |
|
Prepaid and other assets |
|
|
2,906 |
|
|
|
(6,876 |
) |
Accounts payable |
|
|
1,301 |
|
|
|
(12,582 |
) |
Deferred revenue |
|
|
2,299 |
|
|
|
1,867 |
|
Income tax payable |
|
|
(1,567 |
) |
|
|
(10,548 |
) |
Other accrued liabilities |
|
|
(14,406 |
) |
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|
(50 |
) |
|
|
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|
Net cash provided by operating activities |
|
|
46,516 |
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|
|
40,019 |
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INVESTING ACTIVITIES |
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Purchases of investments |
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|
(3,153 |
) |
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|
(227,625 |
) |
Sales of investments |
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|
17,100 |
|
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|
232,650 |
|
Cash paid for acquisitions, net of cash received |
|
|
(3,187 |
) |
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|
(17,352 |
) |
Purchases of equipment and capitalized software |
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|
(19,396 |
) |
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|
(9,532 |
) |
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|
Net cash used in investing activities |
|
|
(8,636 |
) |
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|
(21,859 |
) |
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FINANCING ACTIVITIES |
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Cash paid for convertible senior notes |
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|
(186,660 |
) |
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|
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|
Exercise of stock options |
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|
7,432 |
|
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|
4,439 |
|
Sales of common stock under employee stock purchase plan |
|
|
1,336 |
|
|
|
1,446 |
|
Repurchase of common stock |
|
|
|
|
|
|
(137,858 |
) |
Repurchase of restricted stock to satisfy tax withholding obligation |
|
|
(511 |
) |
|
|
(379 |
) |
Excess tax benefits from stock-based compensation |
|
|
144 |
|
|
|
1,001 |
|
|
|
|
|
|
|
|
Net cash used in financing activities |
|
|
(178,259 |
) |
|
|
(131,351 |
) |
|
|
|
|
|
|
|
EFFECT OF EXCHANGE RATE CHANGES ON CASH |
|
|
433 |
|
|
|
8,330 |
|
|
|
|
|
|
|
|
NET DECREASE IN CASH AND CASH EQUIVALENTS |
|
|
(139,946 |
) |
|
|
(104,861 |
) |
CASH AND CASH EQUIVALENTS, beginning of period |
|
|
490,335 |
|
|
|
381,788 |
|
|
|
|
|
|
|
|
CASH AND CASH EQUIVALENTS, end of period |
|
$ |
350,389 |
|
|
$ |
276,927 |
|
|
|
|
|
|
|
|
SUPPLEMENTAL DISCLOSURES: |
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|
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|
|
|
|
Cash paid for interest on convertible senior notes |
|
$ |
55 |
|
|
$ |
1,219 |
|
|
|
|
|
|
|
|
Cash paid for income taxes |
|
$ |
8,482 |
|
|
$ |
15,259 |
|
|
|
|
|
|
|
|
See accompanying notes to condensed consolidated financial statements.
5
DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The unaudited condensed consolidated financial statements included herein reflect all adjustments,
including normal recurring adjustments, which in our opinion are necessary to fairly state our
consolidated financial position, results of operations and cash flows for the periods presented.
These condensed consolidated financial statements should be read in conjunction with our audited
consolidated financial statements included in our Forms 10-K and 10-K/A for the year ended December
31, 2008, as filed with the Securities and Exchange Commission. The results of operations for the
three and six months ended June 30, 2009, are not necessarily indicative of the results to be
expected for any subsequent quarter or for the entire fiscal year ending December 31, 2009. The
December 31, 2008, balance sheet was derived from audited financial statements, but does not
include all disclosures required by generally accepted accounting principles in the United States.
Summary of Significant Accounting Policies
A detailed description of our significant accounting policies can be found in our most recent
Annual Report filed on Forms 10-K for the fiscal year ended December 31, 2008.
Software Development
Costs to develop software for internal use are required to be capitalized and amortized over the
estimated useful life of the software in accordance with American Institute of Certified Public
Accountants (AICPA) Statement of Position No. 98-1, Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use. For the three months ended June 30, 2009 and 2008, we
capitalized $5.9 million and $0.2 million related to software development, respectively. For the
six months ended June 30, 2009 and 2008, we capitalized $11.5 million and $0.2 million related to
software development, respectively.
This capitalization primarily related to the development of our new enterprise resource planning (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.
Comprehensive Income
Comprehensive income includes revenues, expenses, gains and losses that are excluded from net
earnings under Generally Accepted Accounting Principles (GAAP). Items of comprehensive income are
unrealized gains and losses on short-term investments and foreign currency translation adjustments
which are added to net income to compute comprehensive income. Comprehensive income is net of
income tax benefit or expense.
The components of comprehensive income are (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2009 |
|
|
2008 |
|
|
2009 |
|
|
2008 |
|
Net Income |
|
$ |
11,769 |
|
|
$ |
13,219 |
|
|
$ |
28,360 |
|
|
$ |
31,502 |
|
Other comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized foreign exchange
(loss)/gain on the
revaluation of investments in
foreign subsidiaries |
|
|
15,410 |
|
|
|
(761 |
) |
|
|
74 |
|
|
|
14,472 |
|
Reduction in temporary
impairment of auction rate
securities |
|
|
2,769 |
|
|
|
|
|
|
|
8,523 |
|
|
|
|
|
Unrealized loss on investments |
|
|
|
|
|
|
(1,518 |
) |
|
|
(7 |
) |
|
|
(206 |
) |
Tax expense |
|
|
(1,030 |
) |
|
|
|
|
|
|
(3,145 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income |
|
|
17,149 |
|
|
|
(2,279 |
) |
|
|
5,445 |
|
|
|
14,266 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income |
|
$ |
28,918 |
|
|
$ |
10,940 |
|
|
$ |
33,805 |
|
|
$ |
45,768 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign Currency
We adopted Statement of Financial Accounting Standards (SFAS) No. 161, Disclosures about
Derivative Instruments and Hedging Activities, an amendment of FAS 133 (SFAS 161) during the first
quarter of 2009. SFAS 161 applies to all derivative instruments and non-derivative instruments that
are designated and qualify as hedging instruments and related hedged items accounted for under SFAS
No. 133 Accounting for Derivative Instruments
6
DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
and Hedging Activities (SFAS 133). The Statement does not affect amounts reported in the financial
statements; it only expands the disclosure requirements of SFAS 133.
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. Substantially all of our foreign subsidiaries
use the local currency of their respective countries as their functional currency. At June 30,
2009, these exposures were mitigated by the use of foreign exchange forward contracts with
maturities of approximately one week. All of our derivatives are not designated as hedges under
the provisions of SFAS 133 and are adjusted to fair value through income each period. The principal
currency exposure being mitigated was the euro. Our foreign currency contracts contain credit risk
to the extent that our bank counterparties may be unable to meet the terms of the agreements.
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 equity. Gains and
losses resulting from foreign currency transactions are recognized as other expense, net. For
the three and six months ended June 30, 2009, derivative exposure was immaterial.
Recent Accounting Pronouncements
In April 2009, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP)
107-1 and Accounting Principles Board (APB) Opinion No. 28-1 (FSP 107-1 and APB 28-1), Interim
Disclosures about Fair Value of Financial Instruments (FSP 107-1). This FSP amends SFAS 107,
Disclosures about Fair Value of Financial Instruments, and APB No. 28, Interim Financial
Reporting. This FSP requires publicly-traded entities to disclose the fair value of all financial
instruments for which it is practicable to estimate that value, whether recognized or not
recognized in the statement of financial position, as required by SFAS 107. This FSP is effective
for interim and annual reporting periods ending after June 15, 2009. We adopted FSP 107-1 and APB
28-1 for the period ending June 30, 2009, and it did not have a material impact on the results of
operations or financial position.
In April 2009, the FASB issued FSP SFAS 115-2 Recognition and Presentation of Other-than-temporary
impairments (FSP SFAS 115-2). This FSP is intended 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. FSP SFAS 115-2 amends
the other-than-temporary impairment guidance for debt securities. 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. FSP SFAS 115-2 does not amend existing recognition and measurement guidance related to
other-than-temporary impairment of equity securities.
For debt securities, FSP SFAS 115-2 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 by FSP SFAS 115-2 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), FSP SFAS 115-2 changes the presentation and amount of the
other-than-temporary impairment recognized in the income statement.
FSP SFAS 115-2 is effective and is to be applied prospectively for financial statements issued for
interim and annual reporting periods ending after June 15, 2009. When adopting FSP SFAS 115-2, 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 adopted FSP SFAS
115-2 for the period ending June 30, 2009, and it did not have a material impact on the results of
operations or financial position.
7
DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
In April 2009, the FASB issued FSP SFAS 157-4, Determining Fair Value When the Volume and Level of
Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That
Are Not Orderly (FSP SFAS 157-4). This FSP 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 FSP 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 FSP also requires increased disclosures. This FSP is effective for interim and annual
reporting periods ending after June 15, 2009. We adopted FSP SFAS 157-4 for the period ending June
30, 2009, and it did not have a material impact on the results of operations or financial position.
In May 2009, the FASB issued SFAS No. 165 Subsequent Events (SFAS 165) which establishes general
standards of accounting for and disclosures of events that occur after the balance sheet date but
before the financial statements are issued or are available to be issued. It requires the
disclosure of the date through which an entity has evaluated subsequent events. SFAS 165 is
effective for interim and annual reporting periods ending after June 15, 2009. We adopted SFAS 165
for the period ending June 30, 2009, and it did not have a material impact on the results of
operations or financial position.
In June 2009 the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and the
Hierarchy of Generally Accepted Accounting (SFAS 168). SFAS 168 represents the last numbered
standard to be issued by FASB under the old (pre-Codification) numbering system, and amends the
GAAP hierarchy established under SFAS 162. On July 1, 2009 the FASB launched FASBs new
Codification entitled The FASB Accounting Standards Codification. The Codification will supersede
all existing non-SEC accounting and reporting standards. SFAS 168 is effective in the first interim
and annual periods ending after September 15, 2009. This pronouncement is not expected to have a
significant impact on the determination or reporting of our financial results, other than current
references to GAAP which will be replaced with references to the applicable codification
paragraphs.
2. NET INCOME PER SHARE
Basic income per common share is computed by dividing net income by the weighted average number of
shares of common stock outstanding during the period. Diluted earnings per common share is
calculated by dividing net income, adjusted to exclude interest expense and financing cost
amortization related to potentially dilutive securities, by the weighted average number of common
shares 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 net income per share (in
thousands, except per share amounts):
8
DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2009 |
|
|
2008 |
|
|
2009 |
|
|
2008 |
|
Earnings per share basic |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income basic |
|
$ |
11,769 |
|
|
$ |
13,219 |
|
|
$ |
28,360 |
|
|
$ |
31,502 |
|
Weighted average shares outstanding basic |
|
|
36,856 |
|
|
|
36,594 |
|
|
|
36,794 |
|
|
|
37,562 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per share basic |
|
$ |
0.32 |
|
|
$ |
0.36 |
|
|
$ |
0.77 |
|
|
$ |
0.84 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per share diluted |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income basic |
|
$ |
11,769 |
|
|
$ |
13,219 |
|
|
$ |
28,360 |
|
|
$ |
31,502 |
|
Exclude: Interest expense and amortized financing cost of
convertible senior notes, net of tax benefit |
|
|
21 |
|
|
|
435 |
|
|
|
42 |
|
|
|
869 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income diluted |
|
$ |
11,790 |
|
|
$ |
13,654 |
|
|
$ |
28,402 |
|
|
$ |
32,371 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding basic |
|
|
36,856 |
|
|
|
36,594 |
|
|
|
36,794 |
|
|
|
37,562 |
|
Dilutive impact of non-vested stock and options outstanding |
|
|
725 |
|
|
|
628 |
|
|
|
367 |
|
|
|
569 |
|
Dilutive impact of convertible senior notes |
|
|
200 |
|
|
|
4,425 |
|
|
|
200 |
|
|
|
4,425 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding diluted |
|
|
37,781 |
|
|
|
41,647 |
|
|
|
37,361 |
|
|
|
42,556 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share diluted |
|
$ |
0.31 |
|
|
$ |
0.33 |
|
|
$ |
0.76 |
|
|
$ |
0.76 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options to purchase 567,685 and 593,412 shares for the three months ended June 30, 2009 and 2008,
respectively, and 1,362,043 and 786,612 shares for the six months ended June 30, 2009 and 2008,
respectively, were not included in the computation of diluted EPS, because their effect on diluted
EPS would have been anti-dilutive.
In accordance with the Emerging Issues Task Force (EITF), Issue No. 04-8, the unissued shares
underlying contingent convertible notes are treated as if such shares were issued and outstanding
for the purposes of calculating GAAP diluted earnings per share beginning with the issuance of our
1.25% convertible senior notes on June 1, 2004.
3. INVESTMENTS
As of June 30, 2009, and December 31, 2008, our available-for-sale securities consisted of the
following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized Gain/(Loss) |
|
|
|
|
|
|
Maturities/Reset Dates |
|
|
|
|
|
|
|
Less than 12 |
|
|
Greater than 12 |
|
|
|
|
|
|
Less than 12 |
|
|
Greater than 12 |
|
Balance, June 30, 2009 |
|
Cost |
|
|
Months |
|
|
Months |
|
|
Fair Value |
|
|
Months |
|
|
Months |
|
Student loan bonds (1) |
|
$ |
102,400 |
|
|
$ |
(7,763 |
) |
|
$ |
|
|
|
$ |
94,637 |
|
|
$ |
|
|
|
$ |
94,637 |
|
|
|
|
Total available-for-sale securities |
|
$ |
102,400 |
|
|
$ |
(7,763 |
) |
|
$ |
|
|
|
$ |
94,637 |
|
|
$ |
|
|
|
$ |
94,637 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, December 31, 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. government sponsored entities |
|
$ |
9,900 |
|
|
$ |
100 |
|
|
$ |
|
|
|
$ |
10,000 |
|
|
$ |
10,000 |
|
|
$ |
|
|
Student loan
bonds (1) |
|
|
109,500 |
|
|
|
(16,287 |
) |
|
|
|
|
|
|
93,213 |
|
|
|
|
|
|
|
93,213 |
|
|
|
|
Total available-for-sale securities |
|
$ |
119,400 |
|
|
$ |
(16,187 |
) |
|
$ |
|
|
|
$ |
103,213 |
|
|
$ |
10,000 |
|
|
$ |
93,213 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Impairment identified in
December 2008 balance sheet. See
Note 8. Fair Value Measurements
for further information. |
Realized
gains or losses on investments are recorded in our statement of
income within Other income
(expense), net. All sales of investments for the six months ending June 30, 2009, were retired at
par.
4. BUSINESS COMBINATIONS, GOODWILL AND INTANGIBLE ASSETS
Business Combinations
In December 2007, the FASB issued SFAS No. 141 (Revised 2007), Business Combinations. This
revised Statement, which we refer to as SFAS 141(R), is intended to simplify existing guidance and
converge rulemaking under U.S. GAAP with international accounting rules. SFAS 141(R) will
significantly change the accounting for business combinations in a number of areas, including the
treatment of contingent consideration, contingencies, acquisition costs and restructuring costs.
Also under this Statement, changes in deferred tax asset valuation allowances and acquired income
tax uncertainties in a business combination after the measurement period will impact income tax
expense.
9
DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
SFAS 141(R) is effective for fiscal years beginning after December 15, 2008. We adopted SFAS 141(R)
as of January 1, 2009 and the impact was immaterial to our financial statements.
Acquisitions completed in 2008
On September 1, 2008, we acquired all of the capital stock of Think Subscription, a privately-held
company based in Provo, Utah, for approximately $5.1 million in cash. Think Subscription provides
subscription management and fulfillment software to content publishers, online service providers,
media vendors and other subscription-based businesses. The agreement provides Think Subscription
shareholders with an earn-out opportunity based on Think Subscription achieving certain revenue and
earnings targets during the first three years subsequent to the acquisition. Any future earn-out
will result in additional goodwill.
On January 1, 2008, we acquired all of the capital stock of DigitalSwift Corporation
(DigitalSwift), a privately-held company based in Madison, Georgia, for approximately $9.2 million
in cash. DigitalSwift is a manufacturer and fulfiller of on-demand, dynamic and build-to-order CDs
and DVDs to consumers. The agreement provides DigitalSwift shareholders with an earn-out
opportunity based on DigitalSwift achieving certain revenue and earnings targets during the first
year subsequent to the acquisition. In 2008, we paid earn-outs of $1.0 million and accrued $3.0
million for future earn-out payments. Earn-outs totaling $3.0 million were paid during the first
quarter of 2009. These earn-outs have been recorded as goodwill in 2008 as they were considered
incremental to the purchase price.
On January 1, 2008, we acquired the assets of IA Users Club d.b.a. CustomCD, Inc. (CustomCD), a
privately-held company based in Portland, Oregon and Krefeld, Germany, for approximately $7.0
million in cash. This acquisition involved an asset purchase of the US-based business and a stock
purchase of the business located in Germany. CustomCD creates, sells and delivers to consumers
custom CDs and DVDs containing software, games, and other licensed content. The agreement provides
CustomCD shareholders with an earn-out opportunity based on CustomCD achieving certain revenue and
earnings targets during the first two years subsequent to the acquisition. In 2008, we paid
earn-outs of $1.3 million. Earn-outs were recorded as goodwill in 2008 as they were considered
incremental to the purchase price. Any future earn-out will result in additional goodwill.
Future Earn-outs
As of June 30, 2009, there were no future earn-outs in accrued acquisition liabilities.
5. STOCK-BASED COMPENSATION
Expense Information under SFAS 123(R)
The following table summarizes stock-based compensation expense related to employee stock options
and awards and employee stock purchases recognized under SFAS 123(R) (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2009 |
|
|
2008 |
|
|
2009 |
|
|
2008 |
|
Costs and expenses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct cost of services |
|
$ |
172 |
|
|
$ |
247 |
|
|
$ |
341 |
|
|
$ |
439 |
|
Network and infrastructure |
|
|
207 |
|
|
|
31 |
|
|
|
320 |
|
|
|
63 |
|
Sales and marketing |
|
|
1,643 |
|
|
|
1,283 |
|
|
|
3,160 |
|
|
|
2,385 |
|
Product research and development |
|
|
622 |
|
|
|
336 |
|
|
|
1,078 |
|
|
|
598 |
|
General and administrative |
|
|
2,243 |
|
|
|
1,610 |
|
|
|
3,699 |
|
|
|
3,053 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation included
in costs and expenses |
|
$ |
4,887 |
|
|
$ |
3,507 |
|
|
$ |
8,598 |
|
|
$ |
6,538 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6. INCOME TAXES
For the three months ended June 30, 2009 and 2008, our tax expense was $3.0 million and $3.7
million, respectively. For the three months ended June 30, 2009, our tax expense consisted of
approximately $3.4 million of U.S. tax expense and $0.4 million of foreign tax benefit. For the
three months ended June 30, 2009 and 2008, the tax rate
10
DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
was 20.4% and 21.7%, respectively. Differences in our effective tax rate from the U.S. statutory
rate are primarily due to our mix of earnings from international operations and the differences in
statutory rates in these countries from the U.S. rate.
Tax expense was comparatively lower than in prior periods due to $0.9 million of discrete tax
benefits that occurred during the quarter. Approximately $0.2 million was due to effectively
settling certain tax positions with taxing authorities and $0.7 million was due to releasing part
of a valuation allowance related to acquired foreign net operating losses.
For the six months ended June 30, 2009 and 2008, our tax expense was $9.2 million and $11.5
million, respectively. For the six months ended June 30, 2009, our tax expense consisted of
approximately $8.3 million of U.S tax expense and $0.9 million of foreign tax expense. For the six
months ended June 30, 2009 and 2008, the tax rate was 24.4% and 26.7%, respectively.
During the quarter, valuation allowances were released for deferred tax assets consisting of
acquired U.S. net operating losses as we evaluated these deferred tax assets and concluded it is
more likely than not that approximately $1.7 million of these assets will be realized. This
release was based on an IRC Section 382 analysis completed during the quarter associated with a
2008 acquisition. In accordance with SFAS No. 141(R), the release of this valuation allowance
during the measurement period reduced goodwill. Also during the quarter, a valuation allowance of
approximately $0.9 million was released due to utilization of acquired foreign net operating
losses. In accordance with SFAS No. 141(R), the release of this valuation allowance reduced tax
expense.
As of June 30, 2009, we had $7.4 million of unrecognized tax benefits. All of these unrecognized
tax benefits would affect our effective tax rate if recognized. Gross unrecognized tax benefits
decreased by $0.8 million during the quarter as the Company effectively settled certain tax
positions with tax authorities. Gross unrecognized tax benefits increased by $0.5 million for
other items identified during the quarter. As of June 30, 2009, we had approximately $0.8 million
of accrued interest related to uncertain tax positions.
There is uncertainty of future realization of the remaining deferred tax assets resulting from
acquired tax loss carryforwards. Therefore a valuation allowance was recorded against the tax
effect of such tax loss carryforwards. At June 30, 2009, the Company has a valuation allowance on
approximately $1.2 million of deferred tax assets as we believe it is more likely than not that
these deferred tax assets will not be realized.
Due to the potential resolution of examinations currently being performed by taxing authorities,
and the expiration of various statutes of limitation, it is reasonably possible that the balance of
our gross unrecognized tax benefits may change within the next twelve months by a range of zero to
$1.5 million.
7. DEBT
In 2004 we sold and issued $195.0 million in aggregate principal amount of 1.25% convertible senior
notes due January 1, 2024 (Notes), in a private, unregistered offering. The Notes were sold at 100%
of their principal amount.
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. The Notes bear interest at a rate of 1.25% and, if specified conditions are
met, are convertible into our common stock at a conversion price of $44.063 per share. The Notes
may be surrendered for conversion under certain circumstances, including the satisfaction of a
market price condition, such that the price of our common stock reaches a specified threshold; the
satisfaction of a trading price condition, such that the trading price of the Notes falls below a
specified level; the redemption of the Notes by us, the occurrence of specified corporate
transactions, as defined in the related indenture; and the occurrence of a fundamental change, as
defined in the related indenture. The initial conversion price is equivalent to a conversion rate
of approximately 22.6948 shares per $1,000 of principal amount of the Notes. We will adjust the
conversion price if certain events occur, as specified in the related indenture, such as the
issuance of our common stock as a dividend or distribution or the occurrence of a stock subdivision
or combination.
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
11
DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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.
In the second quarter of 2009 and 2008, we incurred interest expense of $0.0 million and $0.6
million, respectively, on the Notes and made no interest payments in the second quarters of 2009
and 2008.
8. FAIR VALUE MEASUREMENTS
Effective January 1, 2008, we adopted the provisions of SFAS No. 157, Fair Value Measurements
(FAS 157) and subsequently adopted FSP SFAS 157-4, Determining Fair Value When the Volume and
Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying
Transactions That Are Not Orderly. See Note 1 Basis of Presentation. FAS 157 defines fair value,
establishes a framework for measuring fair value in accordance with GAAP, and requires enhanced
disclosures about fair value measurements. FAS 157 does not require any new fair value
measurements; rather it specifies valuation methods and disclosures to be applied when fair value
measurements are required under existing or future accounting pronouncements.
FAS 157 clarifies that fair value is an exit price, representing the amount that would be received
to sell an asset or paid to transfer a liability in an orderly transaction between market
participants. As such, fair value is a market-based measurement that should be determined based on
assumptions that market participants would use in pricing an asset or liability. As a basis for
considering such assumptions, FAS 157 establishes a three-tier fair value hierarchy, which
prioritizes the inputs used in measuring fair value as follows:
|
|
|
Level 1 |
|
Observable inputs such as quoted prices in active markets; |
|
|
|
Level 2 |
|
Inputs, other than the quoted prices in active markets, that are observable either
directly or indirectly; and |
|
|
|
Level 3 |
|
Unobservable inputs in which there is little or no market data, which require the
reporting entity to develop its own assumption. |
As of June 30, 2009, we held certain assets that are required to be measured at fair value on a
recurring basis. These included cash equivalents and long-term investments.
As of
June 30, 2009, we held $102.4 million of investments at par value, $94.6 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 A3/AAA 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 the
second quarter, $7.1 million of our ARS were successfully liquidated at par. As of June 30, 2009,
the Company has recorded a market value discount of $7.8 million (7.6% of par value) to Accumulated
other comprehensive income.
The determination of fair value required management to make estimates and assumptions about the
ARS. The discounted cash flow model we used to value these securities included the following
assumptions:
|
|
|
determination of the penalty coupon rate, frequency of reset period associated with each
ARS |
|
|
|
|
an average redemption period of seven years |
|
|
|
|
a contribution of the ARS paying its contractually stated interest rate |
|
|
|
|
determination of the risk adjusted discount rate based on LIBOR rates for these
maturities plus market information on student loan credit spreads |
In aggregate the ARS portfolio is yielding 1.2% 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
12
DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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.
The table below presents our assets measured at fair value on a recurring basis as of June 30, 2009
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements |
|
|
|
As of June 30, 2009 |
|
|
|
Total |
|
|
Level 1 |
|
|
Level 2 |
|
|
Level 3 |
|
Cash equivalents |
|
$ |
350,389 |
|
|
$ |
350,389 |
|
|
$ |
|
|
|
$ |
|
|
Short-term investments |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term investments |
|
|
94,637 |
|
|
|
|
|
|
|
|
|
|
|
94,637 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets measured at
fair value |
|
$ |
445,026 |
|
|
$ |
350,389 |
|
|
$ |
|
|
|
$ |
94,637 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Based on market conditions, we have classified the auction rate securities as Level 3 within FAS
157s hierarchy since our initial adoption of FAS 157 at January 1, 2008. As of June 30, 2009, the
difference between fair value and par value of these securities was $7.8 million, or 1.7% of total
assets measured at fair value or 0.9% of total assets reported in our financial statements.
The following is a reconciliation of assets measured at fair value on a recurring basis using
significant unobservable inputs (Level 3 inputs) (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements Using |
|
|
|
Significant Unobservable Inputs |
|
|
|
(Level 3) |
|
|
|
Short-term |
|
|
Long-term |
|
|
|
|
|
|
Investments |
|
|
Investments |
|
|
Total |
|
Balance as of December 31, 2007 |
|
$ |
119,750 |
|
|
$ |
|
|
|
$ |
119,750 |
|
Total gains or losses
(realized/unrealized) |
|
|
|
|
|
|
|
|
|
|
|
|
Included in other comprehensive
income |
|
|
|
|
|
|
(16,287 |
) |
|
|
(16,287 |
) |
Purchases, issuances, and settlements |
|
|
(10,250 |
) |
|
|
|
|
|
|
(10,250 |
) |
Transfers in and/or out of Level 3 |
|
|
(109,500 |
) |
|
|
109,500 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of December 31, 2008 |
|
|
|
|
|
|
93,213 |
|
|
|
93,213 |
|
Total gains or losses
(realized/unrealized) |
|
|
|
|
|
|
|
|
|
|
|
|
Included in other comprehensive
income |
|
|
|
|
|
|
7,468 |
|
|
|
7,468 |
|
Purchases, issuances, and settlements |
|
|
|
|
|
|
1,056 |
|
|
|
1,056 |
|
Transfers in and/or out of Level 3 |
|
|
|
|
|
|
(7,100 |
) |
|
|
(7,100 |
) |
|
|
|
|
|
|
|
|
|
|
Balance as of June 30, 2009 |
|
$ |
|
|
|
$ |
94,637 |
|
|
$ |
94,637 |
|
|
|
|
|
|
|
|
|
|
|
Fair Value of Financial Instruments
The carrying amount of cash and cash equivalents, accounts receivable, notes payable and accounts
payable approximate fair value because of the short maturity of these instruments.
As of June 30, 2009 and 2008, the fair value of our $8.8 million 1.25% fixed rate convertible
senior notes was valued at $8.0 million and $9.2 million, respectively, based on the quoted fair
market value of the debt.
9. LITIGATION
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
13
DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
resolutions of these lawsuits, proceedings and claims could exceed the amount we have currently
reserved for these matters. For more information on legal proceedings, please see Item 1 of Part II
of this Quarterly Report on Form 10-Q.
10. SUBSEQUENT EVENTS
The Company has completed an evaluation of all subsequent events through August 4, 2009, which is
the issuance date of these consolidated financial statements, and concluded no subsequent events
occurred that required recognition or disclosure.
14
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
The discussion in this Quarterly 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 in Item 1A
of Part II of this Quarterly Report. When used in this document, the words believes, expects,
anticipates, intends, plans, and similar expressions, are intended to identify certain of
these forward-looking statements. However, these words are not the exclusive means of identifying
such statements. In addition, any statements that refer to expectations, projections or other
characterizations of future events or circumstances are forward-looking statements. The cautionary
statements made in this document should be read as being applicable to all related forward-looking
statements wherever they appear in this document.
Overview
We provide 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 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 buyers 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.
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.
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.
Results of Operations
15
The following table sets forth certain items from our condensed consolidated statements of income
as a percentage of total revenue for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
|
|
2009 |
|
2008 |
|
2009 |
|
2008 |
Revenue |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of Revenue (exclusive of depreciation
and amortization expense shown separately
below): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct cost of services |
|
|
4.1 |
|
|
|
4.5 |
|
|
|
3.9 |
|
|
|
4.3 |
|
Network and infrastructure |
|
|
11.3 |
|
|
|
10.6 |
|
|
|
10.7 |
|
|
|
10.2 |
|
Sales and marketing |
|
|
40.6 |
|
|
|
39.9 |
|
|
|
38.9 |
|
|
|
39.1 |
|
Product research and development |
|
|
13.6 |
|
|
|
13.3 |
|
|
|
12.8 |
|
|
|
12.7 |
|
General and administrative |
|
|
10.2 |
|
|
|
11.0 |
|
|
|
9.5 |
|
|
|
10.4 |
|
Depreciation and amortization |
|
|
4.8 |
|
|
|
4.0 |
|
|
|
4.2 |
|
|
|
3.9 |
|
Amortization of acquisition-related costs |
|
|
2.0 |
|
|
|
2.2 |
|
|
|
2.0 |
|
|
|
2.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses |
|
|
86.6 |
|
|
|
85.5 |
|
|
|
82.0 |
|
|
|
82.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations |
|
|
13.4 |
|
|
|
14.5 |
|
|
|
18.0 |
|
|
|
17.2 |
|
Interest Income |
|
|
0.8 |
|
|
|
4.3 |
|
|
|
0.9 |
|
|
|
5.3 |
|
Other income (expense), net |
|
|
1.1 |
|
|
|
(1.7 |
) |
|
|
(0.1 |
) |
|
|
(1.2 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income tax expense |
|
|
15.3 |
|
|
|
17.1 |
|
|
|
18.8 |
|
|
|
21.3 |
|
Income tax expense |
|
|
3.1 |
|
|
|
3.7 |
|
|
|
4.6 |
|
|
|
5.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
|
12.2 |
% |
|
|
13.4 |
% |
|
|
14.2 |
% |
|
|
15.6 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We acquired Think Subscription on September 1, 2008. The results of this acquisition must be
factored into any comparison of our 2009 results to the results for 2008.
REVENUE. Our revenue was $96.6 million for the three months ended June 30, 2009 compared to $98.4
million for the same period in the prior year, a decrease of $1.8 million or 1.8%. For the six
months ended June 30, 2009, revenue totaled $199.5 million, a decrease of $2.5 million, or 1.2%,
from revenue of $202.0 million in the same period of the prior year. The revenue decreases were
attributed to foreign currency impact year over year partially offset by an increase due to
increased traffic, growth in the number of online game and consumer electronic clients we served
and expanded strategic marketing activities with a larger number of clients. Sales of security
software products for PCs represent the largest contributor to our revenues.
International e-commerce sales were approximately 39.4% and 37.6% of total sales in the three and
six months ended June 30, 2009, compared to 44.1% and 43.6% in the same periods of the prior year.
The decreases in international revenue were primarily driven by foreign currency exchange rate
fluctuations and increased sales by key U.S. clients.
DIRECT COST OF SERVICES. Direct cost of services primarily includes costs related to personnel,
product fulfillment, backup CD production and delivery solutions and certain client-specific costs.
Direct cost of service expense decreased to $4.0 million for the three months ended June 30, 2009,
compared to $4.5 million for the same period in the prior year. For the six months ended June 30,
2009, direct cost of service expense was $7.9 million, compared to $8.6 million for the same period
of the prior year. The decrease was primarily attributable to lower CD production and delivery
costs realized from the integration of our CD production companies acquired in January 2008.
As a percentage of revenue, direct cost of services were 4.1% and 3.9% for the three and six months
ended June 30, 2009, compared to 4.5% and 4.3% in the same periods of the prior year.
We currently believe 2009 direct cost of services will remain relatively flat compared to 2008 in
absolute dollars as costs associated with moderately higher CD sales volume are offset by lower
costs and efficiencies related to the full integration of our CD companies. If economic conditions
improve or further deteriorate or we complete any future acquisitions we expect a correlating
increase or decrease in direct cost of services in line with revenue.
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
16
and data center operations. Network and infrastructure expenses were $11.0 million
and $10.4 million for the three months ended June 30, 2009 and 2008, respectively. For the six
months ended June 30, 2009, network and infrastructure expenses were $21.3 million, up from $20.6
million for the same period of the prior year. The increases were mainly due to increased data
communication expenses and higher client website traffic as a result of various marketing campaigns
and client product launches.
As a percentage of revenue, network and infrastructure increased to 11.3% and 10.7% for the three
and six months ended June 30, 2009, compared to 10.6% and 10.2% in the same period of the prior
year.
We currently believe network and infrastructure expenses will increase in absolute dollars in 2009
compared to
2008 as we continue to expand our global data center and customer service capacity. Also, in the
second half of 2009 we will incur approximately $1 million of one-time severance and transition
costs related to outsourcing our customer service operations to Tennessee-based Sitel. We believe
the partnership with Sitel, which has offices in 27 countries and 60,000 associates, will allow us
to more efficiently scale to meet the growing requirements of our growing global client base. We
will be able to offer more flexible staffing, expanded support in emerging markets, added
multi-lingual capabilities, and in the near future, new global services such as in-bound and
out-bound telesales.
SALES AND MARKETING. Our sales and marketing expenses mainly include credit card transaction and
other payment processing fees, personnel and related costs, advertising, promotional and product
marketing expenses, credit card chargebacks and bad debt expense. Sales and marketing expenses
were flat at $39.2 million for the three months ended June 30, 2009, and 2008. Higher payment
processing related fees and new or expanded client paid search marketing programs in 2009 were
offset by lower personnel related costs and foreign currency translation favorability on our
European transactions. Sales and marketing expense decreased to $77.6 million for the six months
ended June 30, 2008 from $79.0 million for the same period in the prior year. The decrease in sales
and marketing for the six months ended June 30, 2009 compared to the same period of the prior year
resulted mainly from foreign currency favorability which was partially offset by increased payment
processing related fees and new or expanded client paid search marketing programs associated with
higher revenue.
As a percentage of revenue, sales and marketing expenses were 40.6% and 38.9% in the three and six
months ended June 30, 2009, compared to 39.9% and 39.1% in the same periods in the prior year.
We currently believe sales and marketing expenses will increase in absolute dollars in 2009
compared to 2008. We plan to increase our global sales force to strengthen our leadership position
in our core software business and support the expansion of our client relationships through
investments in subscriptions, international payment processing, strategic marketing services and
business-to-business or B2B software markets. We also expect to continue our investments in key
vertical markets, in particular consumer electronics and games. If economic conditions improve or
further deteriorate or we complete any future acquisitions we expect a correlating increase or
decrease in sales and marketing expenses.
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 flat at $13.1 million for the three
months ended June 30, 2009 and 2008. For the six month period ended June 30, 2009 product research
and development expenses were $25.5 million compared to $25.7 million for the same periods in the
prior year. Higher research and development workforce related costs were incurred during the six
month period ended June, 30 2009 as compared to the same periods of the prior year to support
increased investment in technologies to strengthen our leadership position in software and unlock
opportunities in markets such 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. We
capitalized internal software development employee and consultant labor costs of $5.7 million and
$10.8 million for the three and six months ended June 30, 2009, respectively, compared to $0.2
million in the same periods of the prior year. This capitalization primarily related to the
development of our new enterprise resource planning (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.
As a percentage of revenue, product research and development expenses were 13.6% and 12.8% in the
three and six months ended June 30, 2009, compared to 13.3% and 12.7% for the same periods in the
prior year.
17
We currently believe that product research and development expenses will increase moderately in
absolute dollars in 2009 compared to 2008, as a result of continued investments in product
development required to remain competitive and drive increased revenue. However, if global economic
conditions continue to deteriorate, cost containment actions may result in lower product research
and development spending in 2009 as compared to 2008. If we complete any future acquisitions we
expect research and development expenses to increase in line with higher revenue.
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 $9.8 million and
$19.0 million, respectively, for the three and six months ended June 30, 2009, compared to $10.8
million and $21.1 million for the same periods in the prior year. The decrease in general and
administrative costs for the three and six months ended June 30 2009, compared to the same periods
in 2008 were mainly due to lower personnel related costs as a result of targeted cost control
measures.
As a percentage of revenue, general and administrative expenses was 10.2% and 9.5% for the three
and six months ended June 30, 2009, compared to11.0% and 10.4% for the same periods of the prior
year.
We currently believe that general and administrative expenses will decrease in absolute dollars in
2009 compared to 2008. We plan to continue to invest in our infrastructure to support continued
organic growth. However, we expect these incremental expenses will be offset by efficiencies gained
through the implementation of our new
ERP system, client reporting enhancements and cost containment measures. If we complete any future
acquisitions we expect a correlating increase in our general and administrative expenses in line
with increased revenue.
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 life of
the asset or the remaining length of the lease. Depreciation and amortization expense was $4.6 and
$8.5 million for the three and six months ended June 30, 2009, respectively, compared to $4.0
million and $7.8 million for the same periods in the prior year.
We currently believe depreciation and amortization expenses will increase in absolute dollars in
2009 compared to 2008. In 2009, we expect to complete significant data management and client
reporting projects to support our business initiatives and begin the amortization of our new ERP
system and the depreciation of the associated equipment.
AMORTIZATION OF ACQUISITION-RELATED INTANGIBLES. For the period ended June 30, 2009 our
amortization of acquisition-related intangibles line item consisted of amortization of intangible
assets recorded from eight acquisitions in the past four years. Amortization of
acquisition-related intangible assets was $1.9 million and $3.9 million, respectively, for the
three and six months ended June 30, 2009, compared to $2.2 million and $4.3
million for the same periods in the prior year. The decreases in 2009 were primarily due to the
benefit of foreign currency translation on our NetGiro acquisition.
We have purchased, and expect to continue purchasing assets or businesses which may include the
purchase of intangible assets. We intend to pursue partnerships and acquisitions that can help
strengthen and broaden our e-commerce platform, expand our geographical footprint and grow our
client base.
INTEREST INCOME. Our interest income represents the total of interest income on our cash, cash
equivalents, short-term investments and long-term investments. Interest income was $0.8 million
and $2.0 million for the three and six months ended June 30, 2009, compared to $4.3 million and
$10.5 million for the same period in the prior year. The significant decrease in interest income
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, yields on fixed income investments have
declined substantially from 2008. We currently anticipate interest income will continue to decline
in 2009 due to lower cash balances and lower market yields when compared to 2008.
OTHER INCOME (EXPENSE), NET. Our other income (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
18
expense was $0.0 million and $0.1 million, respectively, for the three
and six months ended June 30, 2009, compared to $0.6 million and $1.2 million for the same periods
in the prior year. The decrease in other interest expense was due to the significant decrease in
our outstanding Convertible Senior Notes in January 2009. Foreign currency re-measurement was a
gain of $1.1 million and a $0.2 million loss for the three and six months ended June 30, 2009,
respectively, compared to a loss of $0.0 million and $0.1 million for the same periods in the prior
year. Gains and losses on asset disposals were immaterial for the three and six months ended June
30, 2009 compared to a loss of $1.0 million for the same periods in the prior year. The loss on
asset disposals 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.
INCOME TAXES. For the three months ended June 30, 2009 and 2008, our tax expense was $3.0 million
and $3.7 million, respectively. For the three months ended June 30, 2009, our tax expense
consisted of approximately $3.4 million of U.S. tax expense and $0.4 million of foreign tax
benefit. For the three months ended June 30, 2009 and 2008, the tax rate was 20.4% and 21.7%,
respectively. Differences in our effective tax rate from the U.S. statutory rate are primarily due
to our mix of earnings from international operations and the differences in statutory rates in
these countries from the U.S. rate.
For the six months ended June 30, 2009 and 2008, our tax expense was $9.2 million and $11.5
million, respectively. For the six months ended June 30, 2009, our tax expense consisted of
approximately $8.3 million of U.S tax expense and $0.9 million of foreign tax expense.
For the six months ended June 30, 2009 and 2008, the tax rate was 24.4% and 26.7%, respectively.
Off Balance Sheet Arrangements
None
19
Liquidity and Capital Resources
As of June 30, 2009, we had $350.4 million of cash and cash equivalents. Our primary source of
internal liquidity is our operating activities. Net cash provided by operations for the six months
ended June 30, 2009, of $46.5 million was primarily the result of net income adjusted for non-cash
expenses and balance sheet changes such as a decrease in other accrued liabilities. Net cash
provided by operations for the six months ended June 30, 2008, of $40.0 million was primarily the
result of net income adjusted for non-cash expenses and balance sheet changes such as a decrease in
accounts payable and income tax payable.
Net cash used for investing activities for the six months ended June 30, 2009, was $8.6 million and
was the result of net sales of investments of $13.9 million, cash paid for acquisitions net of cash
received of $3.2 million, and purchases of capital equipment of $19.4 million. Net cash used for
investing activities for the six months ended June 30, 2008 was $21.9 million and was the result of
net sales of investments of $5.0 million, cash paid for acquisitions net of cash received of $17.4
million, and purchases of capital equipment of $9.5 million.
Net cash used for financing activities for the six months ended June 30, 2009, was $178.3 million.
Cash paid for convertible senior notes was $186.7 million, proceeds of $7.4 million were provided
by the sale of stock through the exercise of stock options, proceeds of $1.3 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 $0.1
million were provided by the excess tax benefit from stock-based compensation. Net cash used for
financing activities for the six months ended June 30, 2008, was $131.4 million. Proceeds of $4.4
million were provided by the sale of stock through the exercise of stock options, proceeds of $1.4
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 $0.4 million, and proceeds
of $1.0 million were provided by the excess tax benefit from stock-based compensation and we
repurchased $137.9 million of common stock.
As of
June 30, 2009, we held $102.4 million of investments at par value, $94.6 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 A3/AAA 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 the
second quarter, $7.1 million of our ARS were successfully liquidated at par. As of June 30, 2009,
the Company has recorded a market value discount of $7.8 million (7.6% of par value) to Accumulated
other comprehensive income.
The determination of fair value required management to make estimates and assumptions about the
ARS. The discounted cash flow model we used to value these securities included the following
assumptions:
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determination of the penalty coupon rate, frequency of reset period associated with each
ARS |
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an average redemption period of seven years |
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a contribution of the ARS paying its contractually stated interest rate |
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determination of the risk adjusted discount rate based on LIBOR rates for these
maturities plus market information on student loan credit spreads |
In aggregate the ARS portfolio is yielding 1.2% 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 8 Fair Value Measurements for further
information.
Application of Critical Accounting Policies
Critical Accounting Estimates and Policies
20
A detailed description of our critical accounting policies can be found in our most recent Annual
Report on Form 10-K for the year ended December 31, 2008.
Recent Accounting Pronouncements
In April 2009, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP)
107-1 and Accounting Principles Board (APB) Opinion No. 28-1 (FSP 107-1 and APB 28-1), Interim
Disclosures about Fair Value of Financial Instruments. This FSP amends SFAS 107, Disclosures
about Fair Value of Financial Instruments, and APB No. 28, Interim Financial Reporting. This FSP
requires publicly-traded entities to disclose the fair value of all financial instruments for which
it is practicable to estimate that value, whether recognized or not recognized in the statement of
financial position, as required by SFAS 107. This FSP is effective for interim and annual reporting
periods ending after June 15, 2009. We adopted FSP 107-1 and APB 28-1 for the period ending June
30, 2009, and it did not have a material impact on the results of operations or financial position.
In April 2009, the FASB issued FSP SFAS 115-2 Recognition and Presentation of Other-than-temporary
impairments. FSP SFAS 115-2 is intended 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. FSP SFAS 115-2 amends the
other-than-temporary impairment guidance in GAAP for debt securities. 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. FSP SFAS 115-2 does not amend existing recognition and measurement guidance related to
other-than-temporary impairment of equity securities.
For debt securities, FSP SFAS 115-2 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 by FSP SFAS 115-2 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), FSP SFAS 115-2 changes the presentation and amount of the
other-than-temporary impairment recognized in the income statement.
FSP SFAS 115-2 is effective and is to be applied prospectively for financial statements issued for
interim and annual reporting periods ending after June 15, 2009. When adopting FSP SFAS 115-2 , 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 adopted FSP SFAS
115-2 for the period ending June 30, 2009, and it did not have a material impact on the results of
operations or financial position.
In April 2009, the FASB issued FSP SFAS 157-4, Determining Fair Value When the Volume and Level of
Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That
Are Not Orderly (FSP SFAS 157-4). This FSP 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 FSP 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 FSP also requires increased disclosures. This
FSP is effective for interim and annual reporting periods ending after June 15, 2009. We adopted
FSP SFAS 157-4 for the period ending June 30, 2009, and it did not have a material impact on the
results of operations or financial position.
In May 2009, the FASB issued SFAS No. 165 Subsequent Events, which establishes general standards
of accounting for and disclosures of events that occur after the balance sheet date but before the
financial statements are issued or are available to be issued. It requires the disclosure of the
date through which an entity has evaluated subsequent events. SFAS No. 165 is effective for
interim and annual reporting periods ending after June 15,
21
2009. We adopted SFAS No. 165 for the period ending June 30, 2009, and it did not have a material impact
on the results of operations or financial position.
In June 2009 the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and the
Hierarchy of Generally Accepted Accounting, or SFAS 168. SFAS 168 represents the last numbered
standard to be issued by FASB under the old (pre-Codification) numbering system, and amends the
GAAP hierarchy established under SFAS 162. On July 1, 2009 the FASB launched FASBs new
Codification entitled The FASB Accounting Standards Codification. The Codification will supersede
all existing non-SEC accounting and reporting standards. SFAS 168 is effective in the first interim
and annual periods ending after September 15, 2009. This pronouncement is not expected to have a
significant impact on the determination or reporting of our financial results, other than current
references to GAAP which will be replaced with references to the applicable codification
paragraphs.
Item 3. Qualitative and Quantitative Disclosure about Market Risk
Interest Rate Risk
Our portfolio of cash equivalents, short-term investments and long-term 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.
At June 30, 2009, we had long-term debt of $8.8 million associated with our Notes. The market value
of our long-term debt will fluctuate with movements of interest rates, increasing in periods of
declining rates of interest and declining in periods of increasing rates of interest.
Foreign Currency Risk
Any growth in our international operations will 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. Further, in September 2007 we acquired NetGiro Systems, a payment
processor based in Stockholm, Sweden that processes international transactions, and the anticipated
growth of this company will increase our exposure to foreign currency fluctuations. Accordingly,
our future results could be materially adversely impacted by changes in these or other factors.
Foreign exchange rate fluctuations may adversely impact our consolidated results of operations as
exchange rate fluctuations on transactions denominated in currencies other than our functional
currencies result in gains and losses that are reflected in our Consolidated Statement of Income.
To the extent the U.S. dollar weakens against foreign currencies, the translation of these foreign
currency-denominated transactions will result in increased net revenues and operating expenses.
Conversely, our net revenues and operating expenses will decrease when the U.S. dollar strengthens
against foreign currencies.
Transaction Exposure
The Company enters into short term foreign currency forward contracts to offset the foreign
exchange gains and losses generated by the re-measurement of certain assets and liabilities
recorded in non-functional currencies. Changes in the fair value of these derivatives, as well as
re-measurement gains and losses, are recognized in current earnings in Other income (expense),
net.
Translation Exposure
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, net of tax benefit or expense.
Other Market Risks
Investments in auction-rate securities
22
At June 30, 2009, we held approximately $102.4 million of auction rate securities at par. Given
current conditions in the auction rate securities market as described in Item 2, Managements
Discussion and Analysis of Financial Condition and Results of Operations, in this Quarterly Report
on Form 10-Q, we may incur temporary unrealized losses, or other-than-temporary realized losses, in
the future if market conditions persist and we are unable to recover the investment principal in
our auction rate securities.
23
Item 4. Controls and Procedures
Disclosure Controls and Procedures
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 SECs 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, under the
supervision and with the participation of our Chief Executive Officer and Chief Financial Officer,
carried out an evaluation of the effectiveness of the design and operation of our disclosure
controls and procedures as of June 30, 2009. Based upon this evaluation, our Chief Executive
Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as
defined in Rules 13a-15(e) or 15d-15(e) promulgated under the Securities Exchange Act of 1934) were
effective in providing reasonable assurance that material information required to be disclosed by
us in this Form 10-Q was recorded, processed, summarized and reported in a timely manner.
Changes in Internal Control over Financial Reporting
During the quarter ended June 30, 2009, there was no change in our internal control over financial
reporting that materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
Limitations on the Effectiveness of Controls
Our management, including the Chief Executive Officer and Chief Financial Officer, is responsible
for establishing and maintaining an adequate system of internal control over financial reporting.
This system of internal accounting controls is designed to provide reasonable assurance that assets
are safeguarded, transactions are properly recorded and executed in accordance with managements
authorization and financial statements are prepared in accordance with generally accepted
accounting principles. A control system, no matter how well conceived and operated, can provide
only reasonable, not absolute, assurance that the objectives of the control system are met.
Further, the design of a control system must reflect the fact that there are resource constraints,
and the benefits of controls must be considered relative to their costs. Because of the inherent
limitations in all control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within our company have been detected. These
inherent limitations include the realities that judgments in decision-making can be faulty, and
that breakdowns can occur because of simple error or mistake. Additionally, controls can be
circumvented by the individual acts of some persons, by collusion of two or more people, or by
management override of the control. The design of any system of controls also is based in part upon
certain assumptions about the likelihood of future events, and there can be no assurance that any
design will succeed in achieving its stated goals under all potential future conditions; over time,
controls 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.
24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
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 hosts
website. The case was filed in the U.S. District Court for the Eastern District of Texas on January
31, 2006. The complaint seeks injunctive relief, declaratory relief, damages and attorneys fees.
We have denied infringement of any valid claim of the patents-in-suit, and have asserted
counter-claims which seek a judicial declaration that the patents are invalid and not infringed. In
September 2006, DDR Holdings filed an application for reexamination of its patents based upon the
prior art produced by us and the other defendants in the case. As part of that application, DDR
Holdings asserted that this prior art raised a substantial question as to the patentability of the
inventions claimed in the patents. In December 2006, 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.
25
Item 1A. Risk Factors
There have been no material changes with regard to the risk factors set forth in Part I, Item 1A of
our Annual Report on Form 10-K for the year ended December 31, 2008, and in Part II, Item 1A of our
Quarterly Report on Form 10-Q for the quarter ended March 31, 2009 filed with the SEC.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None
Item 4. Submission of Matters to a Vote of Security Holders.
The Annual Meeting of Shareholders was held on May 28, 2009.
The following proposals were adopted by the margins indicated:
1. Election of one Class II director to hold office until the 2012 annual meeting of stockholders.
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Number of Shares |
|
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For |
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Withheld |
Douglas M. Steenland |
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31,946,745 |
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313,913 |
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2. Approval of the amendment to the 2007 Equity Incentive Plan.
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For |
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18,058,628 |
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Against |
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11,383,156 |
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Abstain |
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106,477 |
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3. Ratification of the selection by the Audit Committee of the Board of Directors of Ernst & Young
LLP as Digital Rivers independent auditors for its fiscal year ending December 31, 2009.
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For |
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32,021,787 |
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Against |
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227,339 |
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Abstain |
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11,536 |
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26
Item 6. Exhibits
(a) Exhibits
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EXHIBIT |
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NUMBER |
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DESCRIPTION OF DOCUMENTS |
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3.1
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(1 |
) |
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Amended and Restated Certificate of Incorporation, as amended, as currently in effect. |
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3.2
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(2 |
) |
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Amended and Restated Bylaws, as currently in effect. |
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4.1
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(3 |
) |
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Specimen of Common Stock Certificate. |
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4.2
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(4 |
) |
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Form of Senior Debt Indenture. |
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4.3
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(4 |
) |
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Form of Subordinated Debt Indenture. |
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4.4
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References are made to Exhibits 3.1 and 3.2. |
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4.5
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(5 |
) |
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Indenture dated as of June 1, 2004 between Digital River, Inc. and Wells Fargo Bank,
N.A. as trustee, including therein the form of the Note. |
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31.1
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Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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31.2
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Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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32.1
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Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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32.2
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Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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(1) |
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Filed as an exhibit to the Companys Current Report on Form 8-K, filed
on June 1, 2006, and incorporated herein by reference. |
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(2) |
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Filed as an exhibit to our Annual Report on Form 10-K for the year
ended December 31, 2000, filed on March 27, 2001, and incorporated
herein by reference. |
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(3) |
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Filed as an exhibit to our Registration Statement on Form S-1, File
No. 333-56787, declared effective on August 11, 1998, and incorporated
herein by reference. |
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(4) |
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Filed as exhibits 4.2 and 4.3 to our Registration Statement on Form
S-3, File No. 333-56787, declared effective on February 12, 2002, and
incorporated herein by reference. |
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(5) |
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Filed as exhibit 99.1 to our Current Report on Form 8-K, filed on July
13, 2004 and incorporated herein by reference. |
27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
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Date: August 4, 2009 |
DIGITAL RIVER, INC.
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By: |
/s/ Thomas M. Donnelly
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Thomas M. Donnelly |
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Chief Financial Officer
(Principal Financial and Accounting Officer) |
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28
EXHIBIT INDEX
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EXHIBIT |
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NUMBER |
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DESCRIPTION OF DOCUMENTS |
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3.1
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(1 |
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Amended and Restated Certificate of Incorporation, as amended, as currently in effect. |
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3.2
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(2 |
) |
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Amended and Restated Bylaws, as currently in effect. |
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4.1
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(3 |
) |
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Specimen of Common Stock Certificate. |
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4.2
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(4 |
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Form of Senior Debt Indenture. |
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4.3
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(4 |
) |
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Form of Subordinated Debt Indenture. |
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4.4
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References are made to Exhibits 3.1 and 3.2. |
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4.5
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(5 |
) |
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Indenture dated as of June 1, 2004 between Digital River, Inc. and Wells Fargo Bank,
N.A. as trustee, including therein the form of the Note. |
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31.1
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Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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31.2
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Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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32.1
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Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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32.2
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Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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(1) |
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Filed as an exhibit to the Companys Current Report on Form 8-K, filed
on June 1, 2006, and incorporated herein by reference. |
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(2) |
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Filed as an exhibit to our Annual Report on Form 10-K for the year
ended December 31, 2000, filed on March 27, 2001, and incorporated
herein by reference. |
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(3) |
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Filed as an exhibit to our Registration Statement on Form S-1, File
No. 333-56787, declared effective on August 11, 1998, and incorporated
herein by reference. |
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(4) |
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Filed as exhibits 4.2 and 4.3 to our Registration Statement on Form
S-3, File No. 333-56787, declared effective on February 12, 2002, and
incorporated herein by reference. |
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(5) |
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Filed as exhibit 99.1 to our Current Report on Form 8-K, filed on July
13, 2004 and incorporated herein by reference. |
29