Digital River 2002 Annual Report Download

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Keeping Our Eye on the Horizon
Digital River
2002 Annual Report

Table of contents

  • Page 1
    Digital River Keeping Our Eye on the Horizon 2002 Annual Report

  • Page 2
    ... include site development and hosting, order management, fraud prevention, site merchandising, reporting and analytics, product fulfillment, e-marketing and multi-lingual customer service. Digital River is headquartered in Eden Prairie, Minnesota, with an international office in the United Kingdom.

  • Page 3
    ...the strength of our business model.We posted strong gains in the second half of 2002 and record-breaking revenues for the year.We achieved record-level EBITDA profitability and the highest level of productivity in our corporate history as measured by revenue per employee. However, our most important...

  • Page 4
    ... strong returns to our business and our clients. Employee satisfaction. We are focused on creating a culture that values innovation, embraces open dialog, and encourages new business leaders to emerge and grow from our associate base. Developing entrepreneurs at Digital River is a very high priority...

  • Page 5
    ...New clients. In 2002, we grew our client base to nearly 34,000 companies, which includes software publishers, manufacturers, distributors and retailers.We expect to see continued growth in our client base as we move forward. Acquisitions. In 2002, we acquired certain assets of Beyond.com Corporation...

  • Page 6
    ... of clients provides a rich sales and distribution channel and serves as an important competitive differentiator. In 2003, we expect to see more clients generating revenues through our network by developing joint promotions and selling each other's products. Technology leadership. In 2002, we...

  • Page 7
    ... File Number: 000-24643 DIGITAL RIVER, INC. (Exact name of registrant as specified in its charter) DELAWARE (State or other jurisdiction of Incorporation or organization) 41-1901640 (I.R.S. Employer Identification No.) 9625 WEST 76TH STREET, SUITE 150 EDEN PRAIRIE, MINNESOTA 55344 (Address...

  • Page 8
    ... commerce system over the Internet. We have developed a technology platform that allows us to provide a suite of electronic commerce services, including Web commerce development and hosting, transaction processing, fraud screening, digital delivery, integration to physical fulfillment and customer...

  • Page 9
    ... We provide a complete, client-branded, electronic commerce outsourcing solution that includes Web commerce development and hosting, transaction processing, fraud screening, digital delivery, integration to physical fulfillment, site merchandising and marketing, and customer service that enables our...

  • Page 10
    ... 1, 2003, we were providing electronic commerce services such as Web commerce development and hosting, transaction processing, fraud screening, digital delivery, integration to physical fulfillment, merchandising services, analytical marketing and customer service to over 100 enterprise E-Business...

  • Page 11
    ... services to our clients, including Web commerce development and hosting, digital delivery, integration to physical fulfillment, transaction processing and fraud screening, customer service, merchandising services and analytical-based e-marketing services. Web Commerce Hosting. We provide hosted Web...

  • Page 12
    ... credit card transaction fees; (v) the collection, payment and returns filing of applicable sales taxes; and (vi) the distribution of a report to the online retailer detailing related sales activity that we have processed. While most software publishers use our entire suite of electronic commerce...

  • Page 13
    ... support, and staff located in an office in the United Kingdom. Our sales organization sells to top executives and vice-presidents within software and digital content publishers and online retailers, manufacturers, distributors and traditional retailers looking to create or expand their electronic...

  • Page 14
    ... recovery site. Both locations are currently processing transactions and downloads. All transaction data is replicated from DC1 to DC2 in less than 10 seconds. Our network software constantly monitors clients' electronic commerce sites and internal system functions and notifies systems engineers...

  • Page 15
    ... of Internet and server solutions, such as Corio, Inc., Electronic Data Systems Corporation and IBM Global Services; companies that provide tools and services enabling one or more of the transaction processing functions of electronic commerce, such as transaction control, data security, customer...

  • Page 16
    ..., more experience developing Internet-based software services and electronic commerce solutions, larger technical staffs, larger customer bases, more established distribution channels and customer relationships, greater brand recognition and greater financial, marketing and other resources than us...

  • Page 17
    ...the President President, Software and Digital Commerce Services Division and member of the Office of the President Chief Financial Officer Chief Technology Officer Mr. Ronning founded the Company in February 1994 and has been Chief Executive Officer and a director of the Company since that time. In...

  • Page 18
    ... of our business model depends upon our success in generating sufficient transaction and service fees from the use of our electronic commerce solutions by existing and future clients. Accordingly, we must maintain existing, and develop new relationships with software publishers, online retailers and...

  • Page 19
    ... same time, develop new client relationships. Our sales cycle is lengthy, which may cause us to incur substantial expenses and expend management time without generating corresponding revenue, which would impair our cash flow. We market our services directly to software publishers, online retailers...

  • Page 20
    ... of software products that are available for purchase through ESD as compared to those available through physical delivery; and the level of end-user comfort with the process of downloading software via the Internet, including the ease of use, lack of concern about transaction security and technical...

  • Page 21
    ... of Internet and server solutions, such as Corio, Inc., Electronic Data Systems Corporation, and IBM Global Services; companies that provide tools and services enabling one or more of the transaction processing functions of electronic commerce, such as transaction control, data security, customer...

  • Page 22
    ... to add software and hardware or to develop and upgrade existing technology, transaction-processing systems or network infrastructure to manage increased traffic on this platform may cause unanticipated systems disruptions, slower response times and degradation in client services, including impaired...

  • Page 23
    ... the attractiveness of our service offerings. We provide commerce, marketing and delivery services to our clients and end-users through our proprietary technology transaction processing and client management systems. These systems also maintain an electronic inventory of products and gather consumer...

  • Page 24
    ... merit, could be time-consuming, result in costly litigation and diversion of technical and management personnel, cause product enhancement delays or require that we develop non-infringing technology or enter into royalty or licensing agreements. Royalty or licensing agreements, if required, may...

  • Page 25
    ...providers have from time to time blocked such network addresses from sending emails to their users. If our network addresses mistakenly end up on these SPAM lists, our ability to provide services for our clients and consummate the sales of digital and physical goods over the Internet could be harmed...

  • Page 26
    ...the cost to us of doing business. For example, numerous state legislatures have proposed that tax rules for Internet retailing and catalog sales correspond to enacted tax rules for sales from physical stores. Any requirement that we collect sales tax for each online purchase and remit the tax to the...

  • Page 27
    ... laws governing the conduct of business with other countries, such as export control laws, which prohibit or restrict the export of goods, services and technology to designated countries, denied persons or denied entities from the United States. Any significant changes in these laws, particularly an...

  • Page 28
    ...the cost to us of doing business. Currently, we collect sales, use or other similar taxes with respect to electronic software download in states where we believe that we have Nexus. The application of sales related taxes to interstate and international sales over the Internet is unclear and evolving...

  • Page 29
    ... and certain of our officers and directors were named as defendants in several class action shareholder complaints filed in the United States District Court for the Southern District of New York, now consolidated as In re Digital River, Inc. Initial Public Offering Securities Litigation, Case No. 01...

  • Page 30
    ... other defendants, regarding United States Patent No. 6,014,651 owned by Christopher M. Crawford ("Crawford") of Washington, D.C. The case was filed on August 21, 2001. Crawford alleges that we directly infringe the patent by the provision of online software purchase and delivery services, that we...

  • Page 31
    ... of record of our Common Stock. On February 28, 2003, the last sale price reported on the Nasdaq National Market System for our Common Stock was $8.98 per share. We have never declared or paid any cash dividends on our capital stock. We intend to retain any future earnings to support operations...

  • Page 32
    ..., except per share data) 2002 1998 Statement of Operations Data: Revenue ...Costs and expenses (exclusive of depreciation and amortization expense shown separately below): Direct cost of services ...Network and infrastructure...Sales and marketing...Product research and development...General and...

  • Page 33
    ...,000 software publisher clients and online retailer clients served by the Software and Digital Commerce Services Division. In late 1998, the Company began to offer its comprehensive electronic commerce outsourcing services in the form of a transaction fee-based e-commerce service to clients outside...

  • Page 34
    ...the products sale price and fees from services rendered associated with the e-commerce services provided to its clients. These services include Web commerce development and hosting, transaction processing, fraud screening, digital delivery, integration to physical fulfillment, merchandising services...

  • Page 35
    ...the Software and Digital Commerce Services Division was 84.6%, up from 80.6% in 2001and 71.8% in 2000. The gross profit margin for the E-Business Services Division was 72.2% in 2002, up from 67.4% in 2001 and 62.4% in 2000. The Company continues to believe that Internet commerce and related services...

  • Page 36
    ... credit card transaction fees of $3.3 million. As a percentage of revenue, sales and marketing expense decreased to 41.7% in 2002 from 47.5% in 2001 and 82.4% in 2000, primarily reflecting the Company' s increased revenue. In 2002, the sales and marketing expense related to the Software and Digital...

  • Page 37
    ... of stock options and warrants. However, in 2002 the Company repaid the $2.5 million in notes payable related to its August 2001 acquisition of RegSoft which caused a decrease in cash provided by financing activities. Additionally, in April 2001, the Company initiated a share repurchase program of...

  • Page 38
    ... about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has implemented the annual reporting requirements for SFAS No. 148 at December 31, 2002. The Company has determined at this time to continue to account for all...

  • Page 39
    ...Gross profit is calculated as revenue less direct cost of services and network and infrastructure expenses and excludes depreciation and amortization expense. Income (loss) from operations includes amortization of goodwill and other intangibles and acquisition related costs of $1,549, $1,651, $1,356...

  • Page 40
    ... 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required in Item 13 of Part III of this report is incorporated by reference to our Proxy Statement in connection with our 2003 Annual Meeting to be filed in accordance with Regulation 14A under the Securities Exchange Act of 1934...

  • Page 41
    ... 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...

  • Page 42
    ... Debt Indenture. References are hereby made to Exhibits 3.1, 3.2 and 3.3. Form of Indemnity Agreement between Registrant and each of its directors and executive officers. 1998 Stock Option Plan. Employment and Non-Competition Agreement effective May 25, 1998 by and between Joel A. Ronning and the...

  • Page 43
    ...the 1999 Non-Officer Stock Option Plan. 2000 Employee Stock Purchase Plan. Voting Agreement, dated March 20, 2001, by and between the Registrant, Calico Commerce, Inc. and ConnectInc.com, Co. Subsidiaries of Digital River, Inc. Consent of Independent Auditors, dated March 24, 2003. Power of Attorney...

  • Page 44
    ... 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has caused this report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Eden Prairie, State of Minnesota, on the 28th of March 2003. DIGITAL RIVER, INC. By: /s/ Joel A. Ronning...

  • Page 45
    ... controls; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant' s internal controls; and 6. The registrant' s other certifying officers and I have indicated in this annual report whether there were significant changes...

  • Page 46
    ... controls; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant' s internal controls; and 6. The registrant' s other certifying officers and I have indicated in this annual report whether there were significant changes...

  • Page 47
    ... of Digital River, Inc. and subsidiaries as of December 31, 2002 and the related consolidated statements of operations, stockholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company' s management. Our responsibility is to express an...

  • Page 48
    ... such fiscal year. Report of independent public accountants To Digital River, Inc.: We have audited the accompanying consolidated balance sheets of Digital River, Inc. (a Delaware corporation) and Subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of operations...

  • Page 49
    DIGITAL RIVER, INC. Consolidated Balance Sheets as of December 31 (in thousands, except share data) 2002 ASSETS CURRENT ASSETS: Cash and cash equivalents...Short-term investments...Accounts receivable, net of allowance of $1,746 and $839...Prepaid expenses and other ...Total current assets......

  • Page 50
    ... below): Direct cost of services...Network and infrastructure ...Sales and marketing...Product research and development ...General and administrative ...Litigation and other charges ...Depreciation and amortization ...Amortization of goodwill and other intangibles and acquisition related costs (Note...

  • Page 51
    DIGITAL RIVER... earn-out ar r angem ents...E xerci se of stock opt ions and war rants ...Com mon S tock ... earn-out ar r angem ents...E xerci se of stock opt ions and war rants ...Com mon S tock ... ons and earn-out ar r angem ents...E xerci se of stock opt ions and war rants ...Com mon S tock issued under...

  • Page 52
    ... acquisitions, net of cash received ...Purchases of equipment...Patent acquisition costs...Net cash provided by (used in) investing activities ...FINANCING ACTIVITIES: Net proceeds from sales of common stock ...Exercise of stock options and warrants ...Repurchase of common stock...Repayment of notes...

  • Page 53
    ...: Digital River, Inc., a Delaware corporation, and its wholly owned subsidiaries (collectively, the Company) provide a suite of electronic commerce services to its clients, including web store development and hosting, transaction processing, electronic software delivery, fraud screening, customer...

  • Page 54
    ... assured. The Company derives its revenue primarily from transaction and service fees associated with the e-commerce services provided to its clients. These services include Web commerce hosting, transaction processing, digital and physical fulfillment services, fraud screening, customer service and...

  • Page 55
    ... computation of loss per share as their effect was antidilutive. Use of Estimates The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets...

  • Page 56
    ... and the effect of the method used on reported results. The Company has implemented the annual reporting requirements for SFAS No. 148 at December 31, 2002 (see above). The Company has determined at this time to continue to account for all stock-based employee compensation plans under ABP Opinion No...

  • Page 57
    ...(the "Agreement") between the Company and Beyond.com Corporation ("Beyond.com"), in exchange for 179,096 shares of the Company' s Common Stock, the Company purchased those assets and assumed those liabilities of Beyond.com related to its eStores business, which manages online stores for clients. The...

  • Page 58
    ... 2001, the former owners of Network Commerce received earn-out payments totaling $420,000 during the twelve months ended December 31, 2002. The Company recorded such amounts as additional goodwill. In connection with the Company' s acquisition of all the outstanding stock of RegSoft.com ("Regsoft...

  • Page 59
    .... In August 2001, the Company and certain of its officers and directors were named as defendants in several class action shareholder complaints filed in the United States District Court for the Southern District of New York. These actions include (1) Whalen v. Digital River, Inc., et al., Case...

  • Page 60
    ... Warrants to purchase 101,667 shares of Common Stock issued principally in conjunction with sales of Common Stock at an exercise price of $3.00 per share were outstanding as of December 31, 2002. The warrants expire at various dates between February and August 2003. Share Repurchase Program In April...

  • Page 61
    ...purchase of shares under the plan. Total shares purchased by employees under the plan were 49,000, 182,000, 113,000 in the years ended December 31, 2002, 2001 and 2000, respectively. 8. Segment Information: The Company has two operating segments, Software and Digital Commerce Services and E-Business...

  • Page 62
    ...the 1999 Non-Officer Stock Option Plan. 2000 Employee Stock Purchase Plan. Voting Agreement, dated March 20, 2001, by and between the Registrant, Calico Commerce, Inc. and ConnectInc.com, Co. Subsidiaries of Digital River, Inc. Consent of Independent Auditors, dated March 24, 2003. Power of Attorney...

  • Page 63
    EXHIBIT 21.1 Subsidiaries of Digital River, Inc. Digital River, Inc., a Minnesota corporation Digital River E-Business Services, Inc., a Delaware corporation RegSoft.com, Inc., a Georgia corporation Digital River UK, Limited, a United Kingdom Corporation 57

  • Page 64
    ...-81626 and 333-85996) of our reports dated January 28, 2003, with respect to the consolidated financial statements and schedule of Digital River, Inc. and subsidiaries included in this Form 10-K for the year ended December 31, 2002. /s/ Ernst & Young LLP Minneapolis, Minnesota, March 24, 2003 58

  • Page 65
    ... 28th day of March, 2003. /s/ Joel A. Ronning Joel A. Ronning Chief Executive Officer A signed original of this written statement required by Section 906 has been provided to Digital River, Inc. and will be retained by Digital River, Inc. and furnished to the Securities and Exchange Commission or...

  • Page 66
    ...the 28th day of March, 2003. /s/ Carter D. Hicks Carter D. Hicks Chief Financial Officer A signed original of this written statement required by section 906 has been provided to Digital River, Inc. and will be retained by Digital River, Inc. and furnished to the Securities and Exchange Commission or...

  • Page 67
    ... of Digital River, Inc. and subsidiaries as of December 31, 2002, and for the year then ended, and have issued our report thereon dated January 28, 2003 (included elsewhere in this Form 10-K). Our audit also included the financial statement schedule for the year ended December 31, 2002 listed in...

  • Page 68
    Digital River, Inc. Schedule II For Year Ended December 31, 2002 Balance at Beginning of Year Charges to Costs and Expenses Balance at End of Year 2002 Deductions Allowance for doubtful accounts and credit card chargebacks Litigation settlement reserve $ 839,000 $ - Balance at Beginning of Year...

  • Page 69
    ... Annual Meeting of stockholders will be held at 3:30 p.m. local time on Monday, May 19, 2003, at the Radisson Plaza Hotel, 35 South 7th Street, Minneapolis, MN. Corporate Headquarters 9625 West 76th Street, Suite 150 Eden Prairie, MN 55344 Joel A. Ronning (3) Chief Executive Officer Digital River...

  • Page 70
    Digital River, Inc. Corporate Headquarters 9625 West 76th Street, Suite 150 Eden Prairie, MN 55344 952.253.1234 www.digitalriver.com