Digital River 2006 Annual Report Download - page 50

OTHER INCOME, NET. Our other income, net line item is the total of interest income on our cash,
cash equivalents and short-term investments, interest expense on our debt and foreign currency transaction
gains and losses. Interest income was $6.4 million and $15.6 million, respectively, for the three and nine
months ended September 30, 2006 compared to $2.7 million and $6.8 million for the same periods in the prior
year. Interest expense was $0.6 million and $1.9 million, respectively, for the three and nine months ended
September 30, 2006 compared to $0.6 million and $1.8 million for the same periods in the prior year. Gains
from foreign currency remeasurement were $0.0 million and $1.4 million, respectively, for the three and nine
months ended September 30, 2006 compared to losses of $0.6 million and $1.4 million for the same periods in
the prior year. Gains and losses from the sale of investments were immaterial for the three and nine months
ended September 30, 2006 and 2005.
INCOME TAXES. For the three months ended September 30, 2006 and 2005, our tax expense was
$5.6 million and $4.7 million, respectively. For the three months ended September 30, 2006, our tax expense
consisted of approximately $5.1 million of U.S. tax expense and $0.5 million of foreign tax expense. For the
nine months ended September 30, 2006 and 2005, our tax expense was $20.3 million and $12.8 million,
respectively. For the nine months ended September 30, 2006, our tax expense consisted of approximately
$18.5 million of U.S. tax expense and $1.8 million of foreign tax expense.
During the three months ended September 30, 2006, we recorded tax expense at a rate that reflected the
estimated impact of current year changes in foreign operations. We established new locations in Shannon,
Ireland and Luxembourg. We transferred existing non-U.S. operations to these locations and expanded these
operations in order to more effectively manage current international activity and facilitate further international
growth. We commenced business operations in these locations on April 1, 2006. These operating changes
generally reduce our effective tax rate compared to prior years.
During the quarter, we recorded, as a discrete item, the tax benefit of research and development tax
credits as a result of a study completed during the quarter. The net effect of this benefit reduced our tax
expense in the third quarter by approximately $1.2 million. The research and development credit related to
federal and state tax credits generated prior to 2006. Current year federal tax credits are dependent upon
federal legislation to extend this benefit.
As of September 30, 2006, we had net U.S. tax loss carryforwards of approximately $66 million and
foreign tax loss carryforwards of $3 million. The U.S. amount consisted of approximately $24 million of
deductions resulting from exercise of stock options and $42 million of acquired net operating losses. The tax
loss carryforwards from exercise of stock options expire in the years 2020 through 2024. The acquired net
operating losses expire in the years 2020 through 2025 and are subject to other deductibility restrictions
discussed below.
In prior years, there was uncertainty of future realization of the deferred tax assets resulting from
temporary differences and from tax loss carryforwards from operations and stock option deductions, therefore
a valuation allowance equal to the deferred tax assets was recorded. At December 31, 2005, we evaluated our
deferred tax assets related to tax loss carryforwards from stock option deductions and other items and
concluded that it was more likely than not that the deferred tax assets would be realized, and accordingly the
valuation allowance was reversed.
We also have evaluated our deferred tax assets related to acquired operating losses and we believe a full
valuation allowance for these assets is required under GAAP. This valuation allowance is due to anticipated
limitations, including limitations under Section 382 of the Internal Revenue Code, on acquired losses. Any
future release of this valuation allowance will reduce goodwill.
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