Digital River 2006 Annual Report Download - page 80

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to foreign currency transactions were $1.5 million in 2006 and a loss of $2.2 million in 2005, and gains or
losses were immaterial in 2004.
Use of Estimates
The preparation of financial statements in accordance with the United States generally accepted
accounting principles requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
Research and Development and Software Development
Research and development expenses consist primarily of development personnel and non-employee
contractor costs related to the development of new products and services, enhancement of existing products
and services, quality assurance, and testing. We follow AICPA Statement of Position No. 98-1, “Accounting
for the Costs of Computer Software Developed or Obtained for Internal Use,” in accounting for internally
developed software. During 2006, 2005 and 2004, we capitalized $0.1 million, $0.4 million and $2.7 million,
respectively, of software development costs.
Stock-Based Compensation Expense
On January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (Revised 2004),
“Share-Based Payment,” (“SFAS 123(R)”) which requires the measurement and recognition of compensation
expense for all share-based payments made to employees and directors including stock options, restricted stock
grants and employee stock purchases made through our Employee Stock Purchase Plan based on estimated fair
values. SFAS 123(R) supersedes our previous accounting under Accounting Principles Board Opinion No. 25
(“APB 25”), “Accounting for Stock Issued to Employees,” for periods beginning in 2006.
Prior to the adoption of SFAS 123(R), we had elected to apply the disclosure-only provision of
SFAS No. 123, “Accounting for Stock-Based Compensation” as amended by SFAS No. 148. Accordingly, we
accounted for stock-based compensation using the intrinsic value method prescribed in APB 25 and related
interpretations. Compensation expense for stock options was measured as the excess, if any, of the fair value
of our common stock at the date of grant over the stock option exercise price.
We have adopted SFAS 123(R) using the modified prospective transition method under which prior
periods are not revised. Stock-based compensation expense recognized during the period is based on the value
of the portion of share-based awards that are ultimately expected to vest during the period. Stock-based
compensation expense recognized in our Consolidated Statement of Operations for 2006 includes compensa-
tion expense for share-based awards granted prior to, but not yet vested, as of December 31, 2005 as well as
compensation expense for the share-based payment awards granted subsequent to December 31, 2005. The fair
value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing
model. The fair value of restricted stock is determined based on the number of shares granted and the closing
price of our common stock on the date of grant. Compensation expense for all share-based payment awards
are recognized using the straight-line amortization method over the vesting period. Stock-based compensation
expense of $13.9 million was charged to operating expenses during 2006. The related tax benefit of
$4.9 million resulted in a net after-tax stock-based compensation expense of $9.0 million for 2006.
As stock-based compensation expense recognized in our Consolidated Statement of Operations for 2006
is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R)
requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if
actual forfeitures differ from those estimates. Our pro forma information required under SFAS 123, for periods
76
DIGITAL RIVER, INC.
Notes to Consolidated Financial Statements — (Continued)