Digital River 2006 Annual Report Download - page 57

During the three month period ending March 31, 2006, we recorded tax expense at a rate that reflected
the estimated impact of recent changes in foreign operations. These operating changes generally reduce our
effective tax rate compared to prior quarters. However, the estimated tax rate in the first quarter of 2005
reflected the favorable impact of utilizing U.S. tax loss carryforwards arising from operations including a
$2.0 million tax benefit related to stock-based compensation expense (see “Explanatory Note” immediately
preceding Part I Item 1 and in Note 2, “Restatement of Consolidated Financial Statements” in Notes to
Consolidated Financial Statements of this Form 10-K). The utilization of these U.S. tax loss carryforwards had
a favorable impact on our tax rate due to the fact that we released the valuation allowance associated with
these tax loss carryforwards at the time of utilization.
As of March 31, 2006, we had net U.S. tax loss carryforwards of approximately $97.0 million, and
foreign tax loss carryforwards of $6.0 million. The U.S. amount consists of $55.0 million of deductions
resulting from exercise of stock options and $42.0 million of acquired net operating losses. These tax loss
carryforwards 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 have evaluated
our deferred tax assets related to tax loss carryforwards from stock option deductions and other items and
concluded that the valuation allowance should be reversed. We met the requirements under GAAP as we
believe it is more likely than not that we will realize the benefit of these deferred tax assets. This conclusion
was based primarily on our earnings history over the last three years as well as our expected future taxable
income. The impact on U.S. taxable income of future stock option deductions should not reduce taxable
income to a level that would jeopardize this conclusion or unreasonably extend the period in which we may
recognize the tax benefit associated with these deferred tax assets. 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.
Liquidity and Capital Resources
As of December 31, 2006, we had $390.2 million of cash and cash equivalents, $235.7 million of short-
term investments, and working capital of $497.9 million. The major components of our working capital are
cash and cash equivalents, short-term investments and short-term receivables net of client and merchant
payables. Our primary source of internal liquidity is our operating activities. Net cash provided by operating
activities in 2006, 2005 and 2004 was $117.5 million, $119.8 million and $85.1 million, respectively. Net cash
provided by operating activities in 2006 and 2005 was primarily the result of net income adjusted for non-cash
expenses, and increases in accrued liabilities, accounts payable and income tax payable partially offset by an
increase in accounts receivable. Net cash provided by operating activities in 2004 was primarily the result of
net income adjusted for non-cash expenses, and increases in accrued liabilities and accounts payable partially
offset by an increase in accounts receivable. Due to our adoption of SFAS 123(R), as of January 1, 2006, the
impact of the excess tax benefits of stock-based compensation, defined as the benefits of a tax deduction for
share-based payment expenses that exceeds the recognized compensation expenses, is now reported under
financing activities with a corresponding deduction from operating activities in our Consolidated Statements of
Cash Flows.
Net cash used in investing activities was $68.0 million in 2006 and was the result of net purchases of
investments of $14.3 million, cash paid for acquisitions, net of cash received, of $37.8 million, and purchases
of capital equipment of $15.9 million. Net cash used in investing activities was $125.4 million in 2005 and
was the result of net purchases of investments of $62.9 million, cash paid for acquisitions, net of cash
received, of $54.2 million, and purchases of capital equipment of $8.3 million. Net cash used in investing
activities in 2004 was $241.4 million and was the result of net purchases of investments of $105.6 million
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