<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 30, 1998
REGISTRATION NO. 333-67913
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------
AMENDMENT NO. 1
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
--------------------------
DIGITAL RIVER, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C> <C>
DELAWARE 7375 41-1901640
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of Classification Code Number) Identification
incorporation or organization) Number)
</TABLE>
9625 W. 76TH STREET, SUITE 150
EDEN PRAIRIE, MN 55344
(612) 253-1234
(Address, including zip code, and telephone number, including
area code, of registrant's principal executive offices)
JOEL A. RONNING
CHIEF EXECUTIVE OFFICER
DIGITAL RIVER, INC.
9625 W. 76TH STREET, SUITE 150
EDEN PRAIRIE, MN 55344
(612) 253-1234
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
--------------------------
COPIES TO:
JEFFREY S. ZIMMAN, ESQ. HOWARD S. ZEPRUN, ESQ.
MICHAEL J. SULLIVAN, ESQ. ROBERT G. DAY, ESQ.
JAMES R. VIDANO, ESQ. ANIL P. PATEL, ESQ.
VIRGINIA C. EDWARDS, ESQ. WILSON SONSINI GOODRICH & ROSATI
COOLEY GODWARD LLP PROFESSIONAL CORPORATION
ONE MARITIME PLAZA, 20TH FLOOR 650 PAGE MILL ROAD
SAN FRANCISCO, CA 94111 PALO ALTO, CA 94304
(415) 693-2000 (650) 493-9300
--------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
AS SOON AS PRACTICABLE AFTER THE REGISTRATION STATEMENT BECOMES EFFECTIVE.
--------------------------
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act,
check the following box. / /
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. / /
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
number for the same offering. / /
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement for the same
offering. / /
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. / /
--------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT THAT SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(a), MAY DETERMINE.
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<PAGE>
SUBJECT TO COMPLETION
NOVEMBER 30, 1998
THE INFORMATION IN THIS PRELIMINARY PROSPECTUS IS NOT COMPLETE AND MAY BE
CHANGED. THESE SECURITIES MAY NOT BE SOLD UNTIL THE REGISTRATION STATEMENT FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION BECOMES EFFECTIVE. THIS PRELIMINARY
PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES NOR DOES IT SEEK OFFERS TO
BUY THESE SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT
PERMITTED.
<PAGE>
3,000,000 SHARES
[LOGO]
COMMON STOCK
Digital River, Inc. is offering 1,750,000 shares to be sold in the offering. The
selling stockholders identified in this prospectus are offering an additional
1,250,000 shares. Digital River will not receive any of the proceeds for the
sale of shares by the selling stockholders.
Digital River's Common Stock is traded on the Nasdaq National Market under the
symbol "DRIV." On November 27, 1998, the last reported sale price for the Common
Stock on the Nasdaq National Market was $30.125 per share.
INVESTING IN THE COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" BEGINNING ON
PAGE 6.
<TABLE>
<CAPTION>
PER SHARE TOTAL
----------- ---------
<S> <C> <C>
Public offering price..................................................... $ $
Underwriting discount..................................................... $ $
Proceeds, before expenses, to Digital River............................... $ $
Proceeds, before expenses, to the selling stockholders.................... $ $
</TABLE>
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY BODY HAS
APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
Digital River has granted the underwriters the right to purchase up to 450,000
additional shares at the public offering price to cover any over-allotments.
--------------
The underwriters are severally underwriting the shares being offered. The
underwriters expect to deliver the shares against payment in Baltimore, Maryland
on , 1998.
BT ALEX. BROWN
BANCBOSTON ROBERTSON STEPHENS
BEAR, STEARNS & CO. INC.
, 1998
<PAGE>
[GRAPHIC]
PICTORIAL FLOWCHART DEPICTING A PURCHASE OF
SOFTWARE THROUGH THE COMPANY'S CENTRAL NETWORK
SERVER ("CNS"), SHOWING THE TRANSACTION PROCESSING
AND OTHER VALUE-ADDED SERVICES PROVIDED BY THE
COMPANY.
DIGITAL RIVER IS A REGISTERED TRADEMARK OF THE COMPANY. ALL OTHER TRADEMARKS
OR SERVICE MARKS APPEARING IN THIS PROSPECTUS ARE THE PROPERTY OF THEIR
RESPECTIVE OWNERS.
2
<PAGE>
PROSPECTUS SUMMARY
YOU SHOULD READ THE FOLLOWING SUMMARY TOGETHER WITH THE MORE DETAILED
INFORMATION AND FINANCIAL STATEMENTS AND NOTES THERETO APPEARING ELSEWHERE IN
THIS PROSPECTUS.
THIS PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS. THE OUTCOME OF THE
EVENTS DESCRIBED IN THESE FORWARD-LOOKING STATEMENTS IS SUBJECT TO RISKS AND
ACTUAL RESULTS COULD DIFFER MATERIALLY. THE SECTIONS ENTITLED "RISK FACTORS,"
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS" AND "BUSINESS" AS WELL AS THOSE DISCUSSED ELSEWHERE IN THIS
PROSPECTUS CONTAIN A DISCUSSION OF SOME OF THE FACTORS THAT COULD CONTRIBUTE TO
THOSE DIFFERENCES.
DIGITAL RIVER
We are a leading provider of comprehensive electronic commerce outsourcing
solutions to software publishers and online retailers. We have developed a
technology platform that allows us to provide a suite of electronic commerce
services to our software publisher and online retailer clients, including
electronic software delivery ("ESD"). We also provide data mining and
merchandising services to assist clients in increasing Internet traffic and
sales through their Web stores. We have no branded Web store that would compete
with our clients. Instead, we provide an outsourcing solution that allows
clients to promote their own brands while leveraging our investment in
infrastructure and technology. As of September 30, 1998, we had contracts with
1,309 software publisher clients and 762 online retailer clients, including:
- Corel Corporation;
- Cyberian Outpost, Inc.;
- Lotus Development Corporation;
- Micro Warehouse, Inc.;
- Network Associates, Inc.; and
- Symantec Corporation.
As of the same date, we maintained a database of more than 131,000 software
products from our various software publisher clients, including more than 24,000
software titles and more than 107,000 digital images, such as photography, clip
art and type fonts. Through September 30, 1998, we had completed more than
288,000 transactions for more than 213,000 unique end-users.
Our proprietary commerce network server ("CNS") technology provides the
platform for our solutions. The CNS incorporates custom software applications
that enable ESD, Web store authoring, fraud prevention, export control,
merchandising programs and online registration. The CNS also features our
database of more than 131,000 software products. Using our CNS platform, we
create Web stores for our clients that replicate the look and feel of each
client's Web site. End-users enter the client Web site and are then seamlessly
transferred to our system. End-users can then browse for products and make
purchases online. Once purchases are made, we deliver the purchased software
products directly to the end-user, primarily through ESD. We also provide
transaction processing services, and collect and maintain critical information
about end-users. Our clients can use this information to facilitate add-on or
upgrade sales and for other direct marketing purposes. We actively manage direct
marketing campaigns for our clients, and deliver purchase information and Web
store traffic statistics to our clients on a regular basis.
We believe that the market for online software sales will continue to grow
rapidly. International Data Corporation estimates that the worldwide market for
ESD will increase from approximately $200 million in 1997 to approximately $5.9
billion by 2001, a 133% compound annual growth rate. The Internet is well-suited
for most software distribution because software products can be purchased and
delivered quickly, conveniently and cost-effectively to an end-user's home or
office computer through ESD. However, software applications exceeding 10
megabytes can be impractical to download at slower modem speeds. We
3
<PAGE>
believe that as Internet bandwidth increases, ESD will become increasingly
attractive even for large software titles. Accordingly, we believe that ESD will
represent an increasing share of online software sales and will become
increasingly critical to online retailers' success. Unlike established physical
distribution
channels for shrink-wrapped software, until recently there has been no
established, comprehensive electronic distribution source for online retailers.
We believe that the distribution of software products through ESD is complex and
requires up-front and ongoing investments in secure, reliable and scaleable
systems. Accordingly, we believe that a substantial market opportunity exists
for a comprehensive, cost-effective, outsourced electronic commerce solution
that provides software publishers and online retailers with access to a critical
mass of software products and a robust distribution and transaction network.
We provide a number of advantages to software publishers, online retailers
and end-users. We allow software publishers to:
- avoid the cost and complexity of operating an electronic commerce
infrastructure;
- offer a full library of their software products;
- avoid shipping and packaging costs;
- offer software products through their own Web store or our network of
online retailer clients; and
- benefit from valuable end-user information and data mining capabilities to
facilitate targeted marketing, upgrade notification and sophisticated
merchandising.
We allow online retailers to:
- access most of our 131,000 software products;
- avoid having to negotiate agreements with individual software publishers;
and
- avoid inventory costs and risks.
End-users who purchase software products through our network can benefit from
our:
- value-added services, including credit card security and upgrade
notifications; and
- archiving service, which guarantees replacement of software products if
they are lost or damaged.
Digital River was incorporated in Minnesota in February 1994 and
reincorporated into Delaware in December 1997. References in the prospectus to
"Digital River," "we," "our," "us" and the "Company" refer to Digital River,
Inc., a Delaware corporation and its subsidiaries. Our executive offices are
located at 9625 West 76th Street, Suite 150, Eden Prairie, Minnesota 55344. Our
telephone number is (612) 253-1234. Information contained on our Web site does
not constitute part of this Prospectus.
4
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Shares offered by Digital River.............. 1,750,000 shares
Shares offered by the Selling Stockholders... 1,250,000 shares
Shares to be outstanding after the 18,708,093 shares (1)
offering.....................................
Use of proceeds.............................. For general corporate purposes, including
product development, expansion of sales and
marketing activities, and working capital.
Nasdaq National Market symbol................ DRIV
</TABLE>
SUMMARY CONSOLIDATED FINANCIAL INFORMATION
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------- --------------------
1995 1996 1997 1997 1998
--------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Sales....................................................... $ -- $ 111 $ 2,472 $ 1,144 $ 11,504
Gross profit................................................ -- 16 420 204 1,894
Loss from operations........................................ (165) (697) (3,538) (2,143) (9,711)
Net loss.................................................... (143) (689) (3,485) (2,098) (9,292)
Basic and diluted net loss per share (2).................... $ (0.03) $ (0.13) $ (0.46) $ (0.30) $ (0.74)
Shares used in per share computation (2).................... 5,333 5,333 7,514 7,098 12,484
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
--------------------------
ACTUAL AS ADJUSTED(3)
---------- --------------
(IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents........................................................... $ 19,411 $ 68,698
Short-term investments.............................................................. 8,840 8,840
Working capital..................................................................... 26,107 75,394
Total assets........................................................................ 32,961 82,248
Accumulated deficit................................................................. (13,617) (13,617)
Total stockholders' equity.......................................................... 29,345 78,632
</TABLE>
- --------------------------
(1) Based on shares outstanding as of September 30, 1998. Excludes (i) 2,179,378
shares of Common Stock issuable upon exercise of options outstanding as of
September 30, 1998 at a weighted average exercise price of $4.40 per share
and includes options for 132,380 shares of Common Stock to be exercised in
connection with this offering, (ii) 711,342 shares of Common Stock issuable
upon exercise of warrants outstanding as of September 30, 1998 at a weighted
average exercise price of $2.52 per share and includes warrants for 91,666
shares of Common Stock to be exercised in connection with this offering, and
(iii) 613,791 shares reserved for future grants under the Company's stock
option plan. See "Management--Employee Benefit Plans" and Notes 3 and 4 of
Notes to Consolidated Financial Statements.
(2) See Note 1 of Notes to Consolidated Financial Statements for an explanation
of the determination of the number of shares used in computing per share
data.
(3) As adjusted reflects the estimated net proceeds from the sale of the
1,750,000 shares of Common Stock offered by Digital River in this offering,
after deducting the estimated underwriting discount and estimated offering
expenses. See "Use of Proceeds."
EXCEPT AS OTHERWISE SPECIFIED, ALL INFORMATION IN THIS PROSPECTUS ASSUMES NO
EXERCISE OF THE UNDERWRITERS' OVERALLOTMENT OPTION. SEE "UNDERWRITING."
5
<PAGE>
RISK FACTORS
THIS OFFERING INVOLVES A HIGH DEGREE OF RISK. YOU SHOULD CAREFULLY CONSIDER
THE RISKS AND UNCERTAINTIES DESCRIBED BELOW AND THE OTHER INFORMATION IN THIS
PROSPECTUS BEFORE DECIDING WHETHER TO INVEST IN SHARES OF OUR COMMON STOCK. IF
ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, OUR BUSINESS, FINANCIAL CONDITION OR
OPERATING RESULTS COULD BE MATERIALLY ADVERSELY AFFECTED. THIS COULD CAUSE THE
TRADING PRICE OF OUR COMMON STOCK TO DECLINE, AND YOU MAY LOSE PART OR ALL OF
YOUR INVESTMENT.
THIS PROSPECTUS ALSO CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS THAT
INVOLVE RISKS AND UNCERTAINTIES. THESE STATEMENTS RELATE TO OUR FUTURE PLANS,
OBJECTIVES, EXPECTATIONS AND INTENTIONS. THESE STATEMENTS MAY BE IDENTIFIED BY
THE USE OF WORDS SUCH AS "EXPECTS," "ANTICIPATES," "INTENDS," "PLANS" AND
SIMILAR EXPRESSIONS. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE
DISCUSSED IN THESE STATEMENTS. FACTORS THAT COULD CONTRIBUTE TO THESE
DIFFERENCES INCLUDE THOSE DISCUSSED BELOW AND ELSEWHERE IN THIS PROSPECTUS.
LIMITED OPERATING HISTORY
We have a very limited operating history. We were incorporated in February
1994 and were considered a development stage company through August 1996. We
conducted our first online sale through a client's Web store in August 1996, and
we are still in the early stages of development. Our business and prospects must
be considered in light of the risks encountered by companies in their early
stages of development, particularly companies in new and rapidly evolving
markets such as electronic commerce. Some of these risks relate to our ability
to:
- maintain or develop relationships with software publishers and online
retailers;
- execute our business and marketing strategy;
- continue to develop and upgrade our technology and transaction-processing
systems;
- provide superior customer service and order fulfillment;
- respond to competitive developments; and
- retain and motivate qualified personnel.
We may not be successful in addressing these risks, and if we are not
successful, our business, financial condition and operating results could be
adversely affected. Our current and future expense levels are based largely on
our planned operations and our estimates of future sales. It is difficult,
however, for us to accurately forecast future sales, because our business is
still new and our market is still developing. We may be unable to adjust
spending in a timely manner to compensate for any unexpected revenue shortfall.
As a result, any significant shortfall in sales would immediately and adversely
affect our business, financial condition and operating results. As a result of
our rapidly evolving business and our limited operating history, we believe that
period-to-period comparisons of our operating results are not necessarily
meaningful and investors should not rely upon our historical results as an
indication of future performance.
HISTORY OF LOSSES AND EXPECTATION OF FUTURE LOSSES
We have incurred significant losses since we were formed. As of September
30, 1998, we had an accumulated deficit of approximately $13.6 million. We
intend to continue to expend significant financial and management resources on
the development of additional services, sales and marketing, improved technology
and expanded operations. As a result, we expect operating losses and negative
cash flows to continue for the foreseeable future. In addition, we anticipate
our operating losses to increase significantly from current levels. Our sales
may not increase or even continue at their current level, and we may not be
profitable or generate cash from operations in future periods. See "Management's
Discussion and Analysis of Financial Conditions and Results of Operations."
6
<PAGE>
POTENTIAL FLUCTUATIONS IN OPERATING RESULTS
Our quarterly and annual operating results are likely to fluctuate
significantly in the future due to a variety of factors, many of which are
outside our control. Some of these factors include:
- our ability to retain existing software publishers and online retailers as
clients;
- our ability to attract new software publishers and online retailers as
clients;
- the introduction of new Web sites, Web stores, services or products by us
or by others;
- price competition and margin erosion;
- the rate at which the online market for the purchase of software products
continues to emerge;
- our ability to continue to upgrade and develop our systems and
infrastructure to meet emerging market needs and remain competitive in our
service offerings;
- termination of any account that represents a significant portion of our
sales;
- technical difficulties or system downtime;
- our ability to attract new personnel as needed as our business grows;
- our ability to increase the proportion of sales from online retailers,
which sales generally carry higher gross margins;
- the failure of Internet bandwidth to increase over time or any increase in
the cost of Internet bandwidth; and
- U.S. and foreign regulations relating to our business.
We also may offer favorable economic terms to certain software publishers
and online retailers in order to attract or retain their business, which would
reduce our gross margins. In addition, we may experience a decline in sales in
the month of December due to a potential reduction in the number of hours
business end-users spend online over the holidays. Due to these factors, our
annual or quarterly operating results may not meet the expectations of
securities analysts and investors. If this happens, the trading price of the
Common Stock would likely significantly decline. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
CLIENT CONCENTRATION; LENGTHY SALES CYCLE
Sales initiated through the Web stores of three software publisher clients
collectively accounted for approximately 29% of our sales in 1997 and 30% of our
sales for the nine months ended September 30, 1998. We expect that a small
percentage of our clients will continue to account for a substantial portion of
our sales for the foreseeable future. Contracts with these clients are generally
short term in nature. If any one of these contracts is not renewed or otherwise
ends, our business, financial condition and operating results could be
materially adversely affected.
We market our services directly to software publishers and online retailers.
These relationships are typically complex and take time to finalize. Due to
operating procedures in many large organizations, a significant amount of time
may pass between selection of our products by key decision makers and the
signing of a contract. As a result, the period between the initial sales call
and this signing of a contract with a software publisher or online retailer with
significant sales potential typically ranges from six to twelve months, and can
be longer. Therefore, the timing of sales from these software publisher and
online retailer clients is difficult to predict. Delays in signing contracts
with significant software publisher or online retailer clients could materially
adversely affect our business, financial condition and operating results.
RISKS ASSOCIATED WITH ESD; MARKET ACCEPTANCE OF ESD
Our success will depend in large part on growth in end-user acceptance of
ESD as a method of distributing software products. ESD is a relatively new
method of distributing software products and the
7
<PAGE>
growth and market acceptance of ESD is highly uncertain and subject to a number
of risks. Factors that will influence market acceptance of ESD include:
- the availability of sufficient bandwidth to enable purchasers to rapidly
download software products;
- the cost of time-based Internet access;
- the number 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 and lack of concern about
transaction security.
If ESD does not achieve widespread market acceptance, our business,
financial condition and operating results would be materially adversely
affected. Even if ESD achieves widespread acceptance, we cannot be certain that
we will overcome the substantial existing and future technical challenges
associated with electronically delivering software reliably and consistently on
a long-term basis. Our failure to do so would materially adversely affect our
business, financial condition and operating results.
DEPENDENCE ON CONTINUED GROWTH IN ELECTRONIC COMMERCE AND INTERNET
INFRASTRUCTURE DEVELOPMENT
Sales of software products using the Internet do not currently represent a
significant portion of overall software sales. We depend on the growing use and
acceptance of the Internet as an effective medium of commerce by end-users.
Rapid growth in the use of and interest in the Internet and other online
services is a recent development. No one can be certain that acceptance and use
of the Internet and other online services will continue to develop or that a
sufficiently broad base of consumers will adopt, and continue to use, the
Internet and other online services as a medium of commerce. We rely on
purchasers of software who have historically used traditional means of commerce
to purchase software products. If we are to be successful, these software
purchasers must accept and use the Internet as a means of purchasing software
and exchanging information and we cannot predict the rate at which purchasers
will do so.
The Internet may fail as a commercial marketplace for a number of reasons,
including potentially inadequate development of the necessary network
infrastructure or delayed development of enabling technologies and performance
improvements. If the number of Internet users or their use of Internet resources
continues to grow, it may overwhelm the existing Internet infrastructure. Delays
in the development or adoption of new standards and protocols required to handle
increased levels of Internet activity or increased governmental regulation could
also have a similar effect. In addition, growth in Internet usage which is not
matched by comparable growth in the infrastructure supporting Internet usage
could result in slower response times or adversely affect usage of the Internet.
DEPENDENCE ON SOFTWARE PUBLISHERS
We are entirely dependent upon the software publishers that supply us with
software, and the availability of such software is unpredictable. Our contracts
with our software publisher clients are generally one year in duration, with an
automatic renewal provision for additional one-year periods, unless we are
provided with a written notice at least 90 days before the end of the contract.
As is common in our industry, we have no long-term or exclusive contracts or
arrangements with any software publishers that guarantee the availability of
software products. We cannot be certain that the software publishers that
currently supply software to us will continue to do so or that we will be able
to establish new relationships with software publishers. If we cannot develop
and maintain satisfactory relationships with software publishers on acceptable
commercial terms, if we are unable to obtain sufficient quantities of software,
if the quality of service provided by such software publishers falls below a
satisfactory standard or if software returned to us exceeds our clients'
expectations, our business, financial condition and results or operations could
be materially adversely affected.
8
<PAGE>
DEPENDENCE ON ONLINE RETAILERS
Our strategy is dependent upon increasing our sales of software products
through online retailers. We have historically generated substantially all of
our sales from the sale of software to end-users that were initiated through the
Web stores of our software publisher clients. In 1997 and the nine months ended
September 30, 1998, less than 7% of our sales were generated through the Web
stores of our online retailer clients. We do not know if we will be successful
in establishing relationships with additional online retailers or if our current
relationships will continue. If we are unable to expand our relationships with
online retailers, we will likely be unable to continue to grow our business and
establish meaningful market share.
RISK OF LACK OF CAPACITY; RISK OF SYSTEM FAILURE; SYSTEM DEVELOPMENT RISKS
We provide commerce, marketing and delivery services to software publishers,
online retailers and end-users through our CNS transaction-processing and client
management systems. The systems also maintain an electronic inventory of
products and gather consumer marketing information. The satisfactory
performance, reliability and availability of the CNS and the underlying network
infrastructure are critical to our operations, our level of customer service,
and our reputation and ability to attract and retain clients. Our systems and
operations are vulnerable to damage or interruption from:
- fire, flood and other natural disasters; and
- power loss, telecommunications failure, break-ins and similar events.
We presently have no offsite back-up facilities and do not carry sufficient
business interruption insurance to fully compensate us for losses that may
occur. Despite the use of network security devices, our servers are vulnerable
to computer viruses, physical or electronic break-ins and similar disruptions,
which could lead to interruptions, delays, loss of data or the inability to
accept and fulfill end-user orders. Any systems interruption that impairs our
ability to accept and fill customer orders reduces the attractiveness of our
product and service offerings to software publishers, online retailers and
end-users, which could materially adversely affect our business, financial
condition and operating results.
We have experienced periodic interruptions, affecting all or a portion of
our systems, which we believe will continue to occur from time to time. We
periodically enhance and expand our technology and transaction-processing
systems, and network infrastructure and other technologies to accommodate
increases in the volume of traffic on the CNS. We may not be successful in our
efforts to improve and increase the capacity of our network infrastructure. We
may not be able to anticipate increases, if any, in the use of the CNS or to
expand and upgrade its systems and infrastructure to accommodate such increases.
Our inability to add software and hardware or to develop and upgrade existing
technology, transaction-processing systems or network infrastructure to handle
increased traffic on the CNS may cause unanticipated system disruptions, slower
response times and poor customer service, including problems filling customer
orders, any of which could materially adversely affect our business, financial
condition and operating results. In addition, additional network capacity may
not be available from third-party suppliers when we need it. Our network and our
suppliers' networks may be unable to maintain an acceptable data transmission
capability, especially if demands on the CNS increase. Our failure to maintain
an acceptable data transmission capability could significantly reduce demand for
our services, which would significantly impair our business, financial condition
and operating results.
ELECTRONIC COMMERCE SECURITY RISKS
A significant barrier to electronic commerce and communications is the
secure transmission of confidential information over public networks. We rely on
encryption and authentication technology licensed from third parties to provide
the security and authentication necessary for secure transmission of
confidential information, such as customer credit card numbers. A party who is
able to circumvent our security measures could misappropriate proprietary
information or interrupt our operations. Any such compromise or elimination of
our security could materially adversely affect our business, financial condition
and operating results.
9
<PAGE>
We may be required to expend significant capital and other resources to
protect against such security breaches or to address problems caused by such
breaches. Concerns over the security of the Internet and other online
transactions and the privacy of users may also inhibit the growth of the
Internet and other online services generally, and the Web in particular,
especially as a means of conducting commercial transactions. To the extent that
activities of the Company or third-party contractors involve the storage and
transmission of proprietary information, such as credit card numbers, security
breaches could damage our reputation and expose us to a risk of loss or
litigation and possible liability. Our security measures may not prevent
security breaches and failure to prevent such security breaches may materially
adversely affect our business, financial condition and operating results.
COMPETITION
The electronic commerce market is new, rapidly evolving and intensely
competitive. We expect competition to intensify in the future, particularly in
the area of electronic sale and distribution of software products. We currently
compete directly with other providers of electronic commerce solutions,
including CyberSource Corporation, Preview Systems, Inc., Release Software
Corporation and TechWave, Inc. We compete indirectly with software companies
that offer tools and services for electronic commerce, including companies that
provide a broad range of Internet and server solutions such as Microsoft
Corporation and Netscape Communications Corporation. We also compete indirectly
with a large number of 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 interaction and database marketing.
In addition, we compete with companies that use their own systems to sell
and distribute software products via the Internet, including Amazon.com, Inc.,
beyond.com Corporation, Ingram Micro Inc. and Tech Data Corporation. We also
compete with companies such as AltaVista (a subsidiary of Compaq Computer
Corporation), America Online, Inc., Excite, Inc., Infoseek Corporation, Lycos,
Inc. and Yahoo! Inc., which specialize in electronic commerce or derive a
substantial portion of their revenues from electronic commerce and may
themselves offer, or provide means for others to offer, software products.
We believe that the principal competitive factors in our market include:
- breadth of service and software product offerings;
- software publisher and online retailer relationships;
- brand recognition;
- system reliability and capacity;
- price;
- customer service;
- speed, accessibility and ease of use;
- convenience; and
- speed of fulfillment.
The online retailers and the other companies listed above may compete
directly with us by adopting a similar business model. Moreover, while some of
these companies are also clients or potential clients of ours, they may compete
with our electronic commerce outsourcing solution if they develop electronic
commerce systems or acquire such systems from other software vendors or service
providers.
Many of our current and potential competitors have longer operating
histories, larger customer bases, greater brand recognition and significantly
greater financial, marketing and other resources than do we. In addition,
larger, well-established and well-financed entities may acquire, invest in or
form joint ventures with online competitors as the use of the Internet and other
online services increases. In addition, new technologies and the expansion of
existing technologies, such as price comparison programs that select
10
<PAGE>
specific titles from a variety of Internet Web sites, may direct end-users to
online retailers that compete with us, which would increase competitive
pressures on us. Increased competition may result in reduced operating margins,
as well as a loss of market share. Further, in response to changes in the
competitive environment, we may from time to time make pricing, service or
marketing decisions or acquisitions that could materially adversely affect our
business, financial condition and operating results. We may not be able to
compete successfully against current and future competitors, and any inability
to do so could materially adversely affect our business, financial condition and
operating results.
RAPID TECHNOLOGICAL CHANGE
To remain competitive, we must continue to enhance and improve the
responsiveness, functionality and features of the CNS and the underlying network
infrastructure. The Internet and the electronic commerce industry are
characterized by rapid technological change, changes in user requirements and
preferences, frequent new product and service introductions embodying new
technologies and the emergence of new industry standards and practices that
could render our technology and systems obsolete. Our success will depend, in
part, on our ability to both license and internally develop leading technologies
to enhance our existing services, develop new services and technology that
address the increasingly sophisticated and varied needs of our clients, and
respond to technological advances and emerging industry standards and practices
on a cost-effective and timely basis. The development of the CNS technology and
other proprietary technology involves significant technical and business risks.
We may fail to use new technologies effectively or adapt our proprietary
technology and systems to customer requirements or emerging industry standards.
If we are unable to adapt to changing market conditions, client requirements or
emerging industry standards, our business, financial condition and operating
results could be materially adversely affected.
MANAGEMENT OF POTENTIAL GROWTH; NEW MANAGEMENT TEAM; LIMITED EXECUTIVE OFFICER
RESOURCES
We have rapidly and significantly expanded our operations and anticipate
that further significant expansion will be required to address potential growth
in our client base and market opportunities. From January 1, 1997 to September
30, 1998, we increased our number of employees from 11 to 97. This expansion is
placing a significant strain on our managerial, operational and financial
resources. Most of our existing senior management personnel joined us within the
last 18 months, including our President, who joined us in July 1998, our Vice
President of Marketing, who joined us in August 1998 and our Chief Financial
Officer, who joined us in April 1998. Joel A. Ronning, our Chief Executive
Officer, also serves as the Chairman of the Board of Tech Squared, Inc., a
principal stockholder of ours, and as a director of JASC, Inc., a significant
client. Our new employees include a number of key managerial, technical and
operations personnel who we have not yet fully integrated. We expect to add
additional key personnel in the near future, including direct sales and
marketing personnel. To manage the expected growth of our operations and
personnel, we will be required to:
- improve existing and implement new operational, financial and management
controls, reporting systems and procedures;
- install new management information systems; and
- train, motivate and manage our employees.
We may not be able to install management information and control systems in
an efficient and timely manner, and our current or planned personnel, systems,
procedures and controls may not be adequate to support our future operations. In
addition, we may not be able to hire, train, retain, motivate and manage
required personnel or to successfully identify, manage and exploit existing and
potential market opportunities. If we are unable to manage growth effectively,
our business, financial condition and operating results will be materially
adversely affected.
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<PAGE>
DEPENDENCE ON KEY PERSONNEL; NEED FOR ADDITIONAL PERSONNEL
Our future success significantly depends on the continued services and
performance of our senior management, particularly Joel A. Ronning, our Chief
Executive Officer, and Kelly J. Wical, our Chief Technology Officer. Our
performance also depends on our ability to retain and motivate our other
executive officers and key employees. The loss of the services of any of our
executive officers or other key employees could materially adversely affect our
business, financial condition and operating results. We have long-term
employment agreements only with Mr. Ronning and Perry W. Steiner, our President.
See "Management--Employee Agreements." We only maintain a "key person" life
insurance policy on Mr. Ronning. Our future success also depends on our ability
to identify, attract, hire, train, retain and motivate other highly skilled
technical, managerial, operations, merchandising, sales and marketing and
customer service personnel. Competition for such personnel is intense, and we
may not successfully attract, assimilate or retain sufficiently qualified
personnel. The failure to retain and attract the necessary personnel could
materially adversely affect our business, financial condition and operating
results.
INTELLECTUAL PROPERTY
Trademarks, patents, copyrights, trade secrets and other intellectual
property are critical to our success, and we rely on trademark, trade secret
protection and confidentiality and/or license agreements with our employees,
clients, partners and others to protect our proprietary rights. We seek to
protect our proprietary position by, among other methods, filing United States
and foreign patent applications related to our proprietary technology,
inventions and improvements that are important to the development of our
business. Proprietary rights relating to our technologies will be protected from
unauthorized use by third parties only to the extent that they are covered by
valid and enforceable patents or copyrights or are effectively maintained as
trade secrets. While we currently have twelve patent applications pending in the
United States, none has been issued. Pending patent applications may not result
in patents being issued. We have filed certain petitions to correct certain fee
deficiencies for our pending patent applications but these petitions may not be
granted. In addition, the laws of some foreign countries do not protect our
intellectual property rights to the same extent as do the laws of the United
States. The patent position of high technology companies involves complex legal
and factual questions and, therefore, we cannot predict their validity and
enforceability with certainty. Even if issued, our patent applications may be
challenged, invalidated, held unenforceable or circumvented. Further, rights
granted under future patents may not provide proprietary protection or
competitive advantages to us against competitors with similar technology. Others
may independently develop similar technologies or duplicate technologies
developed by us. We have one registered trademark for "Digital River." Effective
trademark and trade secret protection may not be available in every country in
which our products and services are made available online. The steps we have
taken to protect our proprietary rights may not be adequate, and third parties
may infringe or misappropriate our trade secrets, trademarks, trade dress and
similar proprietary rights. In addition, others may independently develop
substantially equivalent intellectual property. Any significant failure to
protect our intellectual property in a meaningful manner could materially
adversely affect our business, financial condition and operating results. In
addition, litigation may be necessary in the future to enforce our intellectual
property rights, to protect our trade secrets or to determine the validity and
scope of the proprietary rights of others. Such litigation could result in
substantial costs and diversion of management and technical resources, which
could materially adversely affect our business, financial condition and
operating results.
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<PAGE>
From time to time we may receive notice of claims of infringement of other
parties' proprietary rights. Any future assertions or prosecutions of such
claims may materially adversely affect our business, financial condition and
operating results. Defending any such claim, whether such claims are valid or
not, could be time-consuming, result in costly litigation and diversion of
technical and management personnel, cause product shipment delays or require us
to develop non-infringing technology or enter into royalty or licensing
agreements. Such royalty or licensing agreements, if required, may not be
available on terms acceptable to us, or at all. If a third party succeeds in any
infringement action against us and we fail or are unable to develop
non-infringing technology or license the infringed or similar technology on a
timely basis, our business, financial condition and operating results could be
materially adversely affected.
LIABILITY FOR SOFTWARE PRODUCTS CONTENT
Claims may be made against us for negligence, copyright or trademark
infringement or other theories based on the nature and content of software
products that are delivered electronically and subsequently distributed to
others. Although we carry general liability insurance, our insurance may not
cover potential claims of this type or may not be adequate to cover all costs
incurred in defense of potential claims or to indemnify us for all liability
that may be imposed. Any costs or imposition of liability that is not covered by
insurance or in excess of insurance coverage could materially adversely affect
our business, financial condition and operating results.
FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING
We require substantial working capital to fund our business. We have had
significant operating losses and negative cash flow from operations since
inception and expect to continue to do so for the foreseeable future. We expect
to use the net proceeds of this offering primarily to continue investments in
product development, to fund continued operations, and to expand sales and
marketing activities. We believe that such proceeds, together with our existing
capital resources, will be sufficient to meet our capital requirements for at
least the next twenty-four months. However, our capital requirements depend on
several factors, including the rate of market acceptance of our products, the
ability to expand our client base, the growth of sales and marketing and other
factors. If capital requirements vary materially from those currently planned,
we may require additional financing sooner than anticipated. If additional funds
are raised through the issuance of equity securities, the percentage ownership
of the stockholders of the Company will be reduced, stockholders may experience
additional dilution, or such equity securities may have rights, preferences or
privileges senior to those of the holders of the Company's Common Stock.
Additional financing may not be available when needed on terms favorable to us
or at all. If adequate funds are not available or are not available on
acceptable terms, we maybe unable to develop or enhance our services, take
advantage of future opportunities or respond to competitive pressures, which
could materially adversely affect the Company's business, financial condition
and operating results.
GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES
We are not currently subject to direct regulation by any domestic or foreign
governmental agency, other than regulations applicable to businesses generally,
export control laws and laws or regulations directly applicable to electronic
commerce. However, due to the increasing popularity and use of the Internet, it
is possible that a number of laws and regulations may be adopted with respect to
the Internet covering issues such as:
- user privacy;
- pricing;
- content;
- copyrights;
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<PAGE>
- distribution; and
- characteristics and quality of products and services.
Furthermore, the growth and development of the market for electronic
commerce may prompt calls for more stringent consumer protection laws that may
impose additional burdens on those companies conducting business online. The
adoption of additional laws or regulations may decrease the growth of the
Internet or other online services, which could, in turn, decrease the demand for
our products and services and increase our cost of doing business, or otherwise
adversely affect our business, financial condition and operating results.
The applicability of existing laws governing issues such as property
ownership, copyrights, encryption and other intellectual property issues,
taxation, libel, export or import matters, obscenity and personal privacy to the
Internet is uncertain. The vast majority of such laws were adopted prior to the
advent of the Internet and related technologies. As a result, they do not
contemplate or address the unique issues of the Internet and related
technologies. Changes to such laws intended to address these issues, including
some recently proposed changes, could create uncertainty in the Internet
marketplace. Such uncertainty could reduce demand for our services or increase
the cost of doing business due to increased costs of litigation or increased
service delivery costs.
In addition, as our services are available over the Internet in multiple
states and foreign countries, such jurisdictions may claim that we are required
to qualify to do business as a foreign corporation in each such state of foreign
country. We are qualified to do business only in Minnesota, Iowa and Washington.
Failure to qualify as a foreign corporation in a jurisdiction where we are
required to do so could subject us to taxes and penalties and could result in
our inability to enforce contracts in such jurisdictions. New legislation or
regulation, the application of laws and regulations from jurisdictions whose
laws do not currently apply to our business, or the application of existing laws
and regulations to the Internet and other electronic services could materially
adversely affect our business, financial condition and operating results.
RISK OF INTERNATIONAL SALES
Although we sell software products to end-users outside the United States,
we might not succeed in expanding our international presence. Conducting
business outside of the United States is subject to certain risks, including:
- changes in regulatory requirements and tariffs;
- reduced protection of intellectual property rights;
- difficulties in distribution;
- the burden of complying with a variety of foreign laws; and
- political or economic constraints on international trade or instability.
In addition, some software exports from the United States are subject to
export restrictions as a result of the encryption technology in such software
and we may become liable to the extent we violate such restrictions. We might
not successfully market, sell and distribute our products in local markets and
we cannot be certain that one or more of such factors will not materially
adversely affect our future international operations, and consequently, our
business, financial condition and operating results.
SALES AND OTHER TAXES
We do not currently collect sales, use or other similar taxes with respect
to ESD or shipments of software products into states other than Minnesota.
However, one or more local, state or foreign jurisdictions may seek to impose
sales or use tax collection obligations on out of state companies, such as
Digital River, which engage in electronic commerce. In addition, any new
operation in states outside
14
<PAGE>
Minnesota could subject shipments into such states to state sales or use taxes
under current or future laws. A successful assertion by one or more states or
any foreign country that we should collect sales, use or other taxes on the sale
of merchandise could materially adversely affect our business, financial
condition and operating results.
CONTROL BY EXISTING STOCKHOLDERS
Upon completion of this offering, our executive officers, directors and
principal stockholders and their affiliates will own approximately 7,730,859 or
40.31% of the outstanding shares of Common Stock (39.38% if the Underwriters'
over-allotment option is exercised in full). As a result, they may have the
ability to effectively control us and direct our affairs and business, including
the election of directors and approval of significant corporate transactions.
Such concentration of ownership may also have the effect of delaying, deferring
or preventing a change in control of Digital River, and make some transactions
more difficult or impossible without the support of such stockholders, including
proxy contests, mergers involving Digital River, tender offers, open-market
purchase programs or other purchases of Common Stock that could give our
stockholders the opportunity to realize a premium over the then-prevailing
market price for shares of Common Stock.
VOLATILITY OF STOCK PRICE
The trading price of our Common Stock has been and is likely to continue to
be highly volatile and could be subject to wide fluctuations in response to
factors such as:
- actual or anticipated variations in quarterly operating results;
- announcements of technological innovations;
- new products or services offered by Digital River or our competitors;
- changes in financial estimates by securities analysts;
- conditions or trends in the Internet and online commerce industries;
- changes in the economic performance and/or market valuations of other
Internet, online service industries;
- changes in the economic performance and/or market valuations of other
Internet, online service or retail companies;
- announcements by the Company of significant acquisitions, strategic
partnerships, joint ventures or capital commitments;
- additions or departures of key personnel;
- sales of Common Stock; and
- other events or factors, many of which are beyond our control.
In addition, the stock market in general, and the Nasdaq National Market and
the market for Internet-related and technology companies in particular, has
experienced extreme price and volume fluctuations that have often been unrelated
or disproportionate to the operating performance of such companies. The trading
prices of many technology companies' stocks are at or near historical highs and
these trading prices and multiples are substantially above historical levels.
These trading prices and multiples may not be sustained. These broad market and
industry factors may materially, adversely affect the market price of the Common
Stock, regardless of our actual operating performance. In the past, following
periods of volatility in the market price of a company's securities, securities
class-action litigation has often been instituted against such companies. Such
litigation, if instituted, could result in substantial
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<PAGE>
costs and a diversion of management's attention and resources, which would
materially adversely affect the Company's business, financial condition and
operating results.
SHARES ELIGIBLE FOR FUTURE SALE; REGISTRATION RIGHTS
Sales of significant amounts of Common Stock in the public market after this
offering or the perception that such sales will occur could materially adversely
affect the market price of the Common Stock or our future ability to raise
capital through an offering of our equity securities. Upon the completion of
this offering, we will have outstanding 18,713,300 shares of Common Stock, based
on the number of shares of Common Stock outstanding as of November 20, 1998,
assuming (i) our issuance of 1,750,000 shares of Common Stock in this offering,
(ii) the exercise of 224,046 options, warrants or other obligations in
connection with this offering and (iii) no exercise of the Underwriters'
over-allotment option to purchase 450,000 shares of Common Stock, except as
otherwise noted. The 3,000,000 shares sold in this offering will be freely
tradable without restriction under the Securities Act. Of the shares outstanding
upon completion of the offering, 12,260,106 shares of Common Stock held by
existing stockholders are restricted securities in that they may be sold in the
public market only if registered or if they qualify for an exemption from
registration under the Securities Act or Rules 144, 144(k) or 701 or Regulation
S as promulgated under the Securities Act. Holders, including all officers and
directors, of 3,961,306 shares of the Company's Common Stock and an additional
462,510 shares issuable upon exercise of warrants and vested options have agreed
with the representatives of the Underwriters, subject to certain exceptions, not
to sell the Common Stock without the prior written consent of BT Alex. Brown
Incorporated for a period of 180 days after the date of the Company's initial
public offering on August 11, 1998, and holders of 7,772,072 shares of the
Company's Common Stock and an additional 699,785 shares issuable upon exercise
of warrants and vested options have agreed to the same sale restrictions for a
period of 90 days after the date of this Prospectus (the "Lock-Up Agreements").
As a result of such contractual restrictions and the provisions of Rule 144 and
701 or Regulation S, additional shares will be available for sale in the public
market, subject to presentation of evidence satisfactory to the Company,
including an opinion of counsel acceptable to the Company, that such sales may
be made without registration pursuant to the Securities Act as follows:
- 425,543 shares of Common Stock currently outstanding will be available for
sale into the public market following the effectiveness of this
Registration Statement;
- 2,293,438 shares of Common Stock currently outstanding and 46,469 shares
of Common Stock issuable upon exercise of currently outstanding options
will be eligible for sale on February 9, 1999;
- 7,855,883 shares of Common Stock currently outstanding and 519,917 shares
of Common Stock issuable upon exercise of currently outstanding options
will be eligible for sale 91 days after the date of this Prospectus; and
- the remainder of the restricted securities will be eligible for sale from
time to time thereafter upon expiration of their respective one-year
holding periods.
After this offering, the holders of approximately 7,065,256 shares of Common
Stock and warrants to purchase 376,084 shares of Common Stock will be entitled
to certain rights with respect to registration of such shares under the
Securities Act. If such holders, by exercising their registration rights, cause
a large number of securities to be registered and sold in the public market,
such sales could have an adverse effect on the market price for our Common
Stock. If we were to include in a company-initiated registration shares held by
such holders pursuant to the exercise of their registration rights, such sales
may have an adverse effect on our ability to raise needed capital.
ANTI-TAKEOVER EFFECT OF CERTAIN CHARTER PROVISIONS
Certain provisions of our Amended and Restated Certificate of Incorporation,
Bylaws, other agreements and Delaware law could make it more difficult for a
third party to acquire us, even if a change in
16
<PAGE>
control would be beneficial to our stockholders. See "Certain Transactions" and
"Description of Capital Stock."
NO SPECIFIC PLAN FOR SIGNIFICANT PORTION OF PROCEEDS
We currently have no specific plans for a significant portion of the net
proceeds of the offering. As a consequence, our management will have the
discretion to allocate this portion of the net proceeds of this offering to uses
that the stockholders may not deem desirable. We may not be able to, invest
these proceeds to yield a significant return. Substantially all of the proceeds
of the offering will be invested in short-term, interest-bearing, investment
grade securities for an indefinite period of time.
DILUTION; ABSENCE OF DIVIDENDS
The price of the Common Stock offered herein is substantially higher than
the book value per share of Common Stock. Investors purchasing shares of Common
Stock in this offering will incur immediate, substantial dilution of $25.925 per
share in the pro forma net tangible book value of Common Stock. Additional
dilution will occur upon the exercise of outstanding options and warrants. We
have never declared or paid any cash dividends and do not anticipate paying cash
dividends in the foreseeable future. Our loan and security agreement and capital
equipment leases prohibit the payment of dividends without the consent of the
respective lenders.
YEAR 2000 COMPLIANCE
Like many other companies, Year 2000 computer issues create certain risks
for Digital River. If our internal management information systems and external
electronic commerce information systems do not correctly recognize the process
date information beyond the year 1999, it could have a significant adverse
impact on the Company's ability to process client and end-user transactions,
which could create significant potential liability for the Company. To address
potential Year 2000 issues with its internal and external systems, we have
evaluated these systems. Remediation is proceeding, and we currently plan to
have changes to these systems completed and tested by March 31, 1999. These
activities are intended to encompass all of our major systems, including
electronic commerce, sales processing, sales and financial systems. The initial
assessment indicated that certain internal systems should be upgraded or
replaced as part of a solution to the Year 2000 problem. The costs incurred to
date related to these programs have not been material. The estimated cost to be
incurred by us in the future is not expected to exceed $10,000. These estimates
do not include potential costs related to any customer or other claims or the
cost of internal software and hardware replaced in the normal course of
business. These estimates are based on our current assessment of the projects
and may change as the project progresses.
We are also working with key suppliers of products and services to monitor
their progress toward Year 2000 compliance. The failure of a major supplier to
become Year 2000 Compliant on a timely basis, or any system conversion by a
supplier that is incompatible with our systems could materially adversely affect
our business, financial condition and operating results. In addition our
business, financial condition and operating results may be materially adversely
affected if our end-users are unable to use their credit cards due to the Year
2000 issues that are not rectified by their credit card vendors.
We have begun internal discussions concerning contingency planning to
address potential problem areas with internal systems and with suppliers and
other third parties. We expect assessment, remediation and contingency planning
activities to continue throughout calendar year 1998 and 1999 with the goal of
resolving all material internal and external systems and third party issues.
We deem "Year 2000 Compliant" to mean software that can individually, and in
combination with all other systems, products or processes with which the
software is designed to interface, continue to operate successfully (both in
functionality and performance in all material respects) over the transition into
the twenty first century when used in accordance with the documentation relating
to such software. Year 2000
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<PAGE>
Compliance includes being able to, before, on and after January 1, 2000
substantially conform to the following:
- use logic pertaining to dates which allow users to identify and/or use the
century portion of any date fields without special processing;
- respond to all date elements and date input to resolve any ambiguity as to
century in a disclosed, defined and pre-determined manner; and
- provide date information in ways which are unambiguous as to century.
This may be achieved by permitting or requiring the century to be specified
or where the data element is represented without a century, the correct century
is unambiguous for all manipulations involving that element.
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<PAGE>
USE OF PROCEEDS
The Company is offering a total of 1,750,000 shares hereby and Selling
Stockholders are offering a total of 1,250,000 shares. The net proceeds to the
Company from the sale of the 1,750,000 shares of Common Stock, at an assumed
public offering price of $30.125 per share, are estimated to be approximately
$49.3 million ($62.0 million if the Underwriters' over-allotment option is
exercised in full), after deducting underwriting discounts and commissions and
estimated offering expenses payable by the Company. The Company intends to use
the net proceeds for general corporate purposes, including product development,
expansion of sales and marketing activities, and working capital. The amounts
and timing of the Company's actual expenditures will depend upon numerous
factors, including the status of the Company's product development efforts,
marketing and sales activities, the amount of cash generated by the Company's
operations and competition. Pending application of the net proceeds as described
above, the Company intends to invest the net proceeds of the offering in
short-term, investment-grade, interest-bearing securities. The Company will not
receive any proceeds from the sale of Common Stock by the Selling Stockholders.
See "Risk Factors--No Specific Plans for Significant Portion of Proceeds" and
"Principal and Selling Stockholders."
PRICE RANGE OF COMMON STOCK
The Company's Common Stock is traded on the Nasdaq National Market under the
symbol "DRIV." Public trading of the Common Stock commenced on August 11, 1998.
Prior to that, there was no public market for the Common Stock. The following
table sets forth, for the periods indicated, the high and low sale price per
share of the Common Stock on the Nasdaq National Market.
<TABLE>
<CAPTION>
1998 HIGH LOW
<S> <C> <C>
Third Quarter (from August 11, 1998).................................. $ 13.250 $ 5.000
Fourth Quarter (through November 27, 1998)............................ $ 31.000 $ 5.625
</TABLE>
As of November 20, 1998, there were approximately 152 holders of record of
the Company's Common Stock. On November 27, 1998, the last sale price reported
on the Nasdaq National Market for the Company's Common Stock was $30.125 per
share.
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on its capital
stock. The Company intends to retain any future earnings to support operations
and to finance the growth and development of the Company's business and does not
anticipate paying cash dividends for the foreseeable future.
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CAPITALIZATION
The following table sets forth the capitalization of the Company as of
September 30, 1998 on an actual basis and as adjusted to reflect the sale of
1,750,000 shares of Common Stock offered by the Company hereby at an assumed
public offering price of $30.125 per share and after deducting the estimated
underwriting discount and estimated offering expenses payable by the Company.
See "Use of Proceeds."
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
-----------------------
ACTUAL AS ADJUSTED
---------- -----------
(IN THOUSANDS)
<S> <C> <C>
Stockholders' equity:
Preferred Stock; $0.01 par value; 5,000,000 shares authorized, no shares issued and
outstanding, actual and as adjusted.................................................. $ -- $ --
Common Stock; $0.01 par value; 45,000,000 shares authorized, 16,734,047 shares issued
and outstanding, actual; 45,000,000 shares authorized, 18,708,093 shares issued and
outstanding, as adjusted (1)......................................................... 167 185
Additional paid-in capital............................................................. 44,415 93,684
Deferred compensation.................................................................. (1,620) (1,620)
Accumulated deficit.................................................................... (13,617) (13,617)
---------- -----------
Total stockholders' equity........................................................... 29,345 78,632
---------- -----------
Total capitalization............................................................... $ 29,345 $ 78,632
---------- -----------
---------- -----------
</TABLE>
- ------------------------
(1) Excludes (i) 2,179,378 shares of Common Stock issuable upon exercise of
outstanding options as of September 30, 1998 at a weighted average exercise
price of $4.40 per share and includes options for 132,380 shares of Common
Stock to be exercised in connection with this offering, (ii) 711,342 shares
of Common Stock issuable upon exercise of warrants outstanding as of
September 30, 1998 at a weighted average exercise price of $2.52 per share
and includes warrants for 91,666 shares of Common Stock to be exercised in
connection with this offering, and (iii) 613,791 shares reserved for future
grants under the Company's stock option plan. See "Management--Employee
Benefit Plans" and Notes 3 and 4 of Notes to Consolidated Financial
Statements.
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DILUTION
The net tangible book value of the Company at September 30, 1998 was $29.2
million or $1.75 per share of Common Stock. Net tangible book value per share
represents the amount of the Company's stockholders' equity less intangible
assets divided by the total number of shares of Common Stock outstanding for the
period immediately prior to this offering.
Net tangible book value dilution per share represents the difference between
the amount per share paid by purchasers of shares of Common Stock in the
offering made hereby and the net tangible book value per share of Common Stock
immediately after completion of the offering. After giving effect to the sale by
the Company of the 1,750,000 shares of Common Stock offered hereby at an assumed
public offering price of $30.125 per share, after deducting the estimated
underwriting discount and estimated offering expenses, the net tangible book
value of the Company as of September 30, 1998 would have been $78.5 million, or
$4.20 per share. This represents an immediate increase in net tangible book
value of $2.45 per share to existing stockholders and an immediate dilution in
net tangible book value of $25.925 per share to new investors purchasing shares
at the public offering price. The following table illustrates this per share
dilution:
<TABLE>
<S> <C> <C>
Assumed public offering price per share.................................... $ 30.125
---------
Net tangible book value per share at September 30, 1998.................. $ 1.75
Increase per share attributable to new investors......................... 2.45
---------
Net tangible book value per share after the offering....................... 4.20
---------
Net tangible book value dilution per share to new investors................ $ 25.925
---------
---------
</TABLE>
The following table sets forth as of September 30, 1998 the difference
between the number of shares of Common Stock purchased from the Company, the
total consideration paid and the average price per share paid by the existing
stockholders and by the new investors at a public offering price of $30.125 per
share for shares purchased in this offering, before deducting the estimated
underwriting discount and estimated offering expenses:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
------------------------ ------------------------ AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
------------- --------- ------------- --------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders......................... 16,958,093 91% $ 46,584,613 47% $ 2.75
New investors................................. 1,750,000 9% 52,718,750 53% 30.125
------------- --------- ------------- ---------
Total....................................... 18,708,093 100% $ 99,303,363 100%
------------- --------- ------------- ---------
------------- --------- ------------- ---------
</TABLE>
The foregoing tables assume no exercise of outstanding stock options or
warrants and as of September 30, 1998, excludes (i) 2,179,378 shares of Common
Stock issuable upon exercise of outstanding options at a weighted average
exercise price of $4.40 per share and includes options for 132,380 shares of
Common Stock to be exercised in connection with this offering, (ii) 711,342
shares of Common Stock issuable upon exercise of outstanding warrants at a
weighted average exericse price of $2.52 and includes warrants for 91,666 shares
of Common Stock to be exercised in connection with this offering and (iii)
613,791 shares reserved for future grants under the Company's stock option plan.
To the extent that outstanding options or warrants are exercised, there will be
further dilution to new investors. See "Management--Employee Benefit Plans" and
Notes 3 and 4 of Notes to Consolidated Financial Statements.
21
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the Company's Consolidated Financial Statements and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included herein. The statement of operations data for the years
ended December 31, 1995, 1996 and 1997 and the balance sheet data as of December
31, 1996 and 1997 have been derived from the audited Consolidated Financial
Statements of the Company included elsewhere in this Prospectus. The statement
of operations data for the period from inception to December 31, 1994 and the
balance sheet data as of December 31, 1994 and 1995 are derived from audited
Financial Statements not included in this Prospectus. The statement of
operations data for the nine months ended September 30, 1997 and 1998 and the
balance sheet data as of September 30, 1998 are derived from the Company's
unaudited Consolidated Financial Statements also included elsewhere in this
Prospectus. Such unaudited statements have been prepared on the same basis as
the audited Consolidated Financial Statements and in the opinion of management
include all adjustments (consisting only of normal recurring adjustments)
necessary for a fair presentation of the financial position and results of
operations of the Company for the unaudited interim periods. The statement of
operations data for the interim periods are not necessarily indicative of
results that may be expected for any other interim period or for the year as a
whole.
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION NINE MONTHS ENDED
(FEBRUARY 9,
1994) TO YEAR ENDED DECEMBER 31, SEPTEMBER 30,
DECEMBER 31, ------------------------------- --------------------
1994 1995 1996 1997 1997 1998
------------- --------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Sales................................................ $ -- $ -- $ 111 $ 2,472 $ 1,144 $ 11,504
Cost of sales........................................ -- -- 95 2,052 940 9,610
------ --------- --------- --------- --------- ---------
Gross profit....................................... -- -- 16 420 204 1,894
Operating expenses:
Sales and marketing................................ -- 3 68 1,501 875 6,538
Product development and operations................. -- 130 230 1,528 945 2,903
General and administrative......................... 13 32 415 929 527 2,164
------ --------- --------- --------- --------- ---------
Total operating expenses......................... 13 165 713 3,958 2,347 11,605
------ --------- --------- --------- --------- ---------
Loss from operations................................. (13) (165) (697) (3,538) (2,143) (9,711)
Interest income, net............................... 5 22 8 53 45 419
------ --------- --------- --------- --------- ---------
Net loss............................................. $ (8) $ (143) $ (689) $ (3,485) $ (2,098) $ (9,292)
------ --------- --------- --------- --------- ---------
------ --------- --------- --------- --------- ---------
Basic and diluted net loss per share (1)............. $ (0.00) $ (0.03) $ (0.13) $ (0.46) $ (0.30) $ (0.74)
------ --------- --------- --------- --------- ---------
------ --------- --------- --------- --------- ---------
Shares used in per share computation (1)............. 5,333 5,333 5,333 7,514 7,098 12,484
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------ SEPTEMBER 30,
1994 1995 1996 1997 1998
--------- --------- --------- --------- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents......................................... $ 679 $ 487 $ 800 $ 2,126 $ 19,411
Short-term investments............................................ -- -- -- -- 8,840
Working capital (deficit)......................................... 667 478 (451) 1,244 26,107
Total assets...................................................... 783 635 1,202 3,405 32,961
Accumulated deficit............................................... (8) (152) (840) (4,325) (13,617)
Total stockholders' equity (deficit).............................. 770 627 (58) 2,329 29,345
</TABLE>
- --------------------------
(1) See Note 1 of Notes to Consolidated Financial Statements for an explanation
of the method employed to determine the number of shares used to compute per
share amounts.
22
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THIS PROSPECTUS CONTAINS CERTAIN STATEMENTS OF A FORWARD-LOOKING NATURE
RELATING TO FUTURE EVENTS OR THE FUTURE FINANCIAL PERFORMANCE OF DIGITAL RIVER.
PROSPECTIVE INVESTORS ARE CAUTIONED THAT SUCH STATEMENTS ARE ONLY PREDICTIONS,
INVOLVE RISKS AND UNCERTAINTIES, AND THAT ACTUAL EVENTS OR RESULTS MAY DIFFER
MATERIALLY. IN EVALUATING SUCH STATEMENTS, PROSPECTIVE INVESTORS SHOULD
SPECIFICALLY CONSIDER THE VARIOUS FACTORS IDENTIFIED IN THIS PROSPECTUS,
INCLUDING THE MATTERS SET FORTH UNDER THE CAPTION "RISK FACTORS," WHICH COULD
CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE INDICATED BY SUCH
FORWARD-LOOKING STATEMENTS.
OVERVIEW
Digital River is a leading provider of comprehensive electronic commerce
outsourcing solutions to software publishers and online retailers. The Company
was incorporated in February 1994 and commenced offering products for sale
through its clients' Web stores in August 1996. From inception through August
1996, the Company had no sales, and its activities related primarily to the
development of its CNS technology related to electronic commerce. In 1996, the
Company began to focus its business development efforts on building its
inventory of software products through contracts with software publishers and
had contracts with a total of 953 and 1,309 software publishers as of December
31, 1997 and September 30, 1998, respectively. In 1997, the Company began to
develop distribution relationships with online retailers and had contracts with
a total of 105 and 762 online retailers as of December 31, 1997 and September
30, 1998, respectively. During the nine months ended September 30, 1998, the
Company completed transactions for 990 software publishers and 215 online
retailers.
The Company derives its revenue primarily from sales of third-party
software. The Company has contractual relationships with its software publisher
and online retailer clients which obligate the Company to pay to the client a
specified percentage of each sale. Revenues from the sale of software products,
net of estimated returns, are recognized upon either delivery through ESD or
shipment of the physical product to the end-user. The amount payable to the
software publisher or online retailer is reported as cost of sales. The Company
bears full credit risk with respect to substantially all sales. The Company
determines reserves for charge-backs using a percentage of sales based on
historical experience. As of September 30, 1998, the Company's reserve balance
for charge-backs totalled $45,000. Sales of software products that are delivered
through ESD accounted for 68% of sales for the nine months ended September 30,
1998. The Company maintains a supply of packaged software to meet the physical
delivery requirements of its clients, which supply is primarily held on
consignment.
The Company has a limited operating history upon which investors may
evaluate its business and prospects. Since inception, the Company has incurred
significant losses, and as of September 30, 1998 had an accumulated deficit of
approximately $13.6 million. The Company intends to continue to expend
significant financial and management resources on the development of additional
services, sales and marketing, improved technology and expanded operations. As a
result, the Company expects to incur additional losses and continued negative
cash flow from operations for the foreseeable future, and such losses are
anticipated to increase significantly from current levels. There can be no
assurance that the Company's sales will increase or even continue at their
current level or that the Company will achieve or maintain profitability or
generate cash from operations in future periods. The Company's prospects must be
considered in light of the risks, expenses and difficulties frequently
encountered by companies in their early stages of development, particularly
companies in new and rapidly evolving markets such as electronic commerce. To
address these risks, the Company must, among other things, maintain existing and
develop new relationships with software publishers and online retailers,
implement and successfully execute its business and marketing strategy, continue
to develop and upgrade its technology and transaction-processing systems,
provide superior customer service and order fulfillment, respond to competitive
developments, and attract, retain and motivate qualified personnel. There can be
no assurance that the Company will be successful in addressing such risks, and
the failure to do so would have a material adverse effect on the Company's
business, financial condition and results of operations. The Company's current
23
<PAGE>
and future expense levels are based largely on its planned operations and
estimates of future sales. Sales and operating results generally depend on the
volume and timing of orders received, which are difficult to forecast. The
Company may be unable to adjust spending in a timely manner to compensate for
any unexpected revenue shortfall. Accordingly, any significant shortfall in
sales would immediately and adversely affect the Company's business, financial
condition and results of operations. In view of the rapidly evolving nature of
the Company's business and its limited operating history, the Company is unable
to accurately forecast its sales and believes that period-to-period comparisons
of its operating results are not necessarily meaningful and should not be relied
upon as an indication of future performance. See "Risk Factors--Limited
Operating History" and "--History of Losses and Expectation of Future Losses."
RESULTS OF OPERATIONS
The following table sets forth consolidated statement of operations data for
the periods indicated as a percentage of revenues:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER NINE MONTHS ENDED
31, SEPTEMBER 30,
-------------------- --------------------
1996 1997 1997 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Sales............................................................ 100.0% 100.0% 100.0% 100.0%
Cost of sales.................................................... 85.6 83.0 82.2 83.5
-------- -------- -------- --------
Gross profit................................................... 14.4 17.0 17.8 16.5
Operating expenses:
Sales and marketing............................................ 61.2 60.7 76.5 56.9
Product development and operations............................. 207.2 61.8 82.6 25.2
General and administrative..................................... 373.9 37.6 46.1 18.8
-------- -------- -------- --------
Total operating expenses..................................... 642.3 160.1 205.2 100.9
-------- -------- -------- --------
Loss from operations............................................. (627.9) (143.1) (187.4) (84.4)
Interest income, net........................................... 7.2 2.1 3.9 3.6
-------- -------- -------- --------
Net loss......................................................... (620.7)% (141.0)% (183.5)% (80.8)%
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1998
SALES. The Company derives its revenue primarily from sales of third-party
software. The Company recognizes revenue from the sale of software products upon
delivery through ESD or shipment of the physical product to the end-user. Sales
are comprised of the gross selling price of software sold by the Company, net of
estimated returns, plus any outbound shipping and handling charges, as well as
gross revenue generated by certain merchandising activities. The Company bears
credit risk with respect to substantially all sales. Sales increased from $1.1
million for the nine months ended September 30, 1997 to $11.5 million for the
nine months ended September 30, 1998 primarily as a result of significant growth
in the number of the Company's software publisher and online retailer clients as
well as increasing market acceptance of ESD. International sales represented
approximately 31% and 29% of sales for the nine months ended September 30, 1997
and 1998, respectively.
GROSS PROFIT. Cost of sales consists primarily of the amount payable to the
software publishers and online retailers for product sold to the end-user and
outbound and inbound shipping and distribution costs for physical product. Cost
of sales increased from $940,000 in the nine months ended September 30, 1997 to
$9.6 million in the nine months ended September 30, 1998, reflecting the
Company's growth in sales. The Company's gross profit margin decreased from
17.8% in the nine months ended September 30, 1997 to 16.5% in the nine months
ended September 30, 1998, as a result of the addition of certain lower margin
software publisher clients during the second half of 1997 and the higher cost
impact of a greater proportion of sales in 1998 involving physical shipments.
The Company has historically generated higher gross margins on sales through
online retailer client Web stores compared to sales through software publisher
client Web stores. There can be no assurance, however, that the Company will
continue to generate higher gross
24
<PAGE>
margins on sales through online retailer client Web stores. In each of the nine
months ended September 30, 1997 and 1998, less than 7% of the Company's sales
were generated through online retailer client Web stores. The Company expects
that an increasing percentage of its sales will be generated through online
retailers. The Company believes that Internet commerce and related services will
become more competitive in the near future. Accordingly, the Company may reduce
or alter its pricing structure and policies in the future and any such change
would reduce gross margins.
SALES AND MARKETING. Sales and marketing expense consists primarily of
personnel and related expenses, advertising and promotional expenses, bad debt
expense and credit card transaction fees. Sales and marketing expense increased
from $875,000 in the nine months ended September 30, 1997 to $6.5 million in the
nine months ended September 30, 1998. The increase resulted from expanding the
sales and marketing infrastructure required to increase the number of and
provide support to software publisher and online retailer clients. The primary
components of this increase for the comparable nine months ended September 30
were an increase in advertising and marketing expenditures of $2.6 million and
an increase in wages and benefits of $971,000. As a percentage of sales, sales
and marketing expense decreased from 76.5% in the nine months ended September
30, 1997 to 56.9% in the nine months ended September 30, 1998, primarily
reflecting the Company's growth in sales. The Company expects that sales and
marketing expense will continue to increase in absolute dollars as the Company
continues to build its sales and marketing infrastructure and to develop
marketing programs.
PRODUCT DEVELOPMENT AND OPERATIONS. Product development and operations
expense consists primarily of personnel and related expenses and consulting
associated with developing, enhancing and maintaining the Company's CNS and
related facilities, internal systems and telecommunications infrastructure as
well as customer service. Product development and operations expense increased
from $945,000 in the nine months ended September 30, 1997 to $2.9 million in the
nine months ended September 30, 1998. The increase was primarily related to
increased personnel and consulting costs related to developing, enhancing and
maintaining the Company's CNS and related facilities. The primary components of
this increase for the comparable nine months ended September 30 were an increase
in wages and benefits of $872,000 and an increase in consulting costs of
$409,000. As a percentage of sales, product development and operations expense
decreased from 82.6% in the nine months ended September 30, 1997 to 25.2% in the
nine months ended September 30, 1998, primarily reflecting the Company's growth
in sales. The Company believes that continued investment in product development
and operations is critical to attaining its strategic objectives and, and as a
result, expects product development and operations expenses will continue to
increase in absolute dollars.
GENERAL AND ADMINISTRATIVE. General and administrative expense consists
principally of executive, accounting and administrative personnel and related
expenses, including deferred compensation expense, professional fees, and
recruiting expense. General and administrative expense increased from $527,000
in the nine months ended September 30, 1997 to $2.2 million in the nine months
ended September 30, 1998. The increase was primarily due to increased personnel
and related expenses and increased professional fees. The primary components of
this increase for the comparable nine months ended September 30 were an increase
in deferred compensation expense of $959,000 and an increase in wages and
benefits of $452,000. As a percentage of sales, general and administrative
expense decreased from 46.1% in the nine months ended September 30, 1997 to
18.8% in the nine months ended September 30, 1998, primarily reflecting the
Company's growth in sales. The Company expects general and administrative
expense, excluding the impact of deferred compensation expense, to increase in
absolute dollars in the future, particularly as the Company continues to build
infrastructure to support growth and incurs additional costs associated with
being a public company. As a percentage of sales, these expenses are expected to
decrease as sales increase.
INTEREST INCOME, NET. Interest income consists of earnings on the Company's
cash, cash equivalents and short-term investments, net of interest expense.
Interest income increased from $45,000 in the nine months ended September 30,
1997 to $419,000 in the nine months ended September 30, 1998. The increase
25
<PAGE>
was attributable to interest received on higher average cash and cash equivalent
balances resulting from the initial public offering in August 1998 and private
sales of Common and Preferred Stock in 1998. The Company expects interest income
to increase in the fourth quarter of 1998 and then begin to decrease in the
future as cash is used to fund operations and is used for investments in
infrastructure.
INCOME TAXES. The Company paid no income taxes in any reported period. The
Company has incurred a net loss for each period since inception. As of September
30, 1998, the Company had approximately $12.0 million of net operating loss
carryforwards for federal income tax purposes, which expire beginning in 2009.
Due to the uncertainty of future profitability, a valuation allowance equal to
the deferred tax asset has been recorded. Certain changes in ownership resulting
from the sales of Common Stock will limit the future annual realization of the
tax net operating loss carryforwards to a specified percentage of the Company
under Section 382 of the Internal Revenue Code.
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
SALES. The Company had no sales in 1995, as it was still developing its
technology related to electronic commerce. The Company's sales increased from
$111,000 for the year ended December 31, 1996 to $2.5 million for the year ended
December 31, 1997 as a result of significant growth in the number of the
Company's software publisher and online retailer clients as well as the
increasing market acceptance of ESD. International sales accounted for 32% and
31% of total sales in the years ended December 31, 1996 and 1997, respectively.
GROSS PROFIT. Cost of sales increased substantially during 1997, reflecting
the Company's growth in sales. The Company's gross margin increased from 14.4%
for the year ended December 31, 1996 to 17.0% for the year ended December 31,
1997.
SALES AND MARKETING. Sales and marketing expense increased from $3,000 to
$68,000 to $1.5 million for the years ended December 31, 1995, 1996 and 1997,
respectively, resulting from additional sales and marketing personnel and
related expenses, increased advertising and promotional expense, increased bad
debt expense and increased credit card transaction fees due to the increased
sales. The primary components of the increase from 1996 to 1997 were an increase
in wages and benefits of $799,000 and an increase in advertising and marketing
expenditures of $315,000. As a percentage of sales, sales and marketing expense
decreased from 61.2% in the year ended December 31, 1996 to 60.7% for the year
ended December 31, 1997, primarily reflecting the Company's growth in sales.
PRODUCT DEVELOPMENT AND OPERATIONS. Product development and operations
expense increased from $130,000 to $230,000 to $1.5 million for the years ended
December 31, 1995, 1996 and 1997, respectively. The increase was primarily
related to increased personnel and consulting costs related to developing,
enhancing and maintaining the Company's CNS and related facilities. The primary
components of the increase from 1996 to 1997 were an increase in wages and
benefits of $653,000 and an increase in consulting costs of $233,000. As a
percentage of sales, product development and operations expense decreased from
207.2% in the year ended December 31, 1996 to 61.8% for the year ended December
31, 1997, primarily reflecting the Company's growth in sales.
GENERAL AND ADMINISTRATIVE. General and administrative expense increased
from $32,000 to $415,000 to $929,000, for the years ended December 31, 1995,
1996 and 1997, respectively, primarily due to increased personnel related
expense and professional fees. As a percentage of sales, general and
administrative expense decreased from 373.9% in the year ended December 31, 1996
to 37.6% for the year ended December 31, 1997, primarily reflecting the
Company's growth in sales.
INTEREST INCOME, NET. Interest income decreased from $22,000 to $8,000 and
increased to $53,000 for the years ended December 31, 1995, 1996 and 1997,
respectively, resulting from changes in average cash and cash equivalent
balances.
INCOME TAXES. The Company paid no income taxes in the years ended December
31, 1995, 1996 and 1997.
26
<PAGE>
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth certain unaudited consolidated quarterly
statement of operations data for the eight quarters ended September 30, 1998. In
the opinion of management, this information has been prepared substantially on
the same basis as the audited Consolidated Financial Statements appearing
elsewhere in this Prospectus, and all necessary adjustments, consisting only of
normal recurring adjustments, have been included in the amounts stated below to
present fairly the unaudited consolidated quarterly results of operations. The
consolidated quarterly data should be read in conjunction with the audited
Consolidated Financial Statements of the Company and the Notes thereto appearing
elsewhere in this Prospectus. The results of operations for any quarter are not
necessarily indicative of the results of operations for any future period.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------------------------------------------------------------------------
DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30,
1996 1997 1997 1997 1997 1998 1998
------------ --------- -------- ------------- ------------ --------- ---------
(IN THOUSANDS, UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
Sales............................ $ 86 $ 179 $ 282 $ 683 $ 1,328 $ 2,270 $ 3,476
Cost of sales.................... 74 147 232 561 1,112 1,896 2,895
----- --------- -------- ------------- ------------ --------- ---------
Gross profit................... 12 32 50 122 216 374 581
Operating expenses:
Sales and marketing............ 38 270 359 246 626 1,060 2,373
Product development and
operations................... 118 169 246 530 583 703 908
General and administrative..... 241 81 152 294 402 208 1,205
----- --------- -------- ------------- ------------ --------- ---------
Total operating expenses..... 397 520 757 1,070 1,611 1,971 4,486
----- --------- -------- ------------- ------------ --------- ---------
Loss from operations............. (385) (488) (707) (948) (1,395) (1,597) (3,905)
Interest income, net........... 1 8 11 26 8 42 108
----- --------- -------- ------------- ------------ --------- ---------
Net loss......................... $(384) $(480) $(696) $ (922) $(1,387) $(1,555) $(3,797)
----- --------- -------- ------------- ------------ --------- ---------
----- --------- -------- ------------- ------------ --------- ---------
<CAPTION>
SEPTEMBER
30,
1998
---------
<S> <C>
Sales............................ $ 5,758
Cost of sales.................... 4,819
---------
Gross profit................... 939
Operating expenses:
Sales and marketing............ 3,105
Product development and
operations................... 1,292
General and administrative..... 751
---------
Total operating expenses..... 5,148
---------
Loss from operations............. (4,209)
Interest income, net........... 269
---------
Net loss......................... $(3,940)
---------
---------
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
------------------------------------------------------------------------------------------
DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30,
1996 1997 1997 1997 1997 1998 1998
------------ --------- -------- ------------- ------------ --------- ---------
(IN THOUSANDS, UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
Sales............................ 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales.................... 86.0 82.1 82.3 82.1 83.7 83.5 83.3
------------ --------- -------- ------------- ------------ --------- ---------
Gross profit................... 14.0 17.9 17.7 17.9 16.3 16.5 16.7
Operating expenses:
Sales and marketing............ 44.2 150.8 127.3 36.0 47.1 46.7 68.2
Product development and
operations................... 137.2 94.4 87.2 77.7 43.9 31.0 26.1
General and administrative..... 280.2 45.3 53.9 43.0 30.3 9.2 34.7
------------ --------- -------- ------------- ------------ --------- ---------
Total operating expenses..... 461.6 290.5 268.4 156.7 121.3 86.9 129.0
------------ --------- -------- ------------- ------------ --------- ---------
Loss from operations............. (447.6) (272.6) (250.7) (138.8) (105.0) (70.4) (112.3)
Interest income, net........... 1.1 4.4 3.9 3.8 0.6 1.9 3.1
------------ --------- -------- ------------- ------------ --------- ---------
Net loss......................... (446.5)% (268.2)% (246.8)% (135.0)% (104.4)% (68.5)% (109.2)%
------------ --------- -------- ------------- ------------ --------- ---------
------------ --------- -------- ------------- ------------ --------- ---------
<CAPTION>
SEPTEMBER
30,
1998
---------
<S> <C>
Sales............................ 100.0%
Cost of sales.................... 83.7
---------
Gross profit................... 16.3
Operating expenses:
Sales and marketing............ 53.9
Product development and
operations................... 22.5
General and administrative..... 13.0
---------
Total operating expenses..... 89.4
---------
Loss from operations............. (73.1)
Interest income, net........... 4.7
---------
Net loss......................... (68.4)%
---------
---------
</TABLE>
The Company's sales increased in each of the quarters presented as a result
of an increase in the number of the Company's software publisher and online
retailer clients as well as an increase in the market acceptance of ESD. Most
operating expense categories generally increased in absolute dollars over the
quarters presented, reflecting the increased spending on personnel and related
expenses, advertising and marketing, and developing, enhancing and maintaining
the Company's CNS and related facilities. Gross margins declined beginning the
quarter ended December 31, 1997 primarily as a result of the addition of certain
lower margin software publisher clients during the second half of 1997 and the
higher cost impact of a greater proportion of sales in 1998 involving physical
shipments. Sales and marketing expenses for the three months ended September 30,
1997 were lower than the generally increasing quarter to quarter trend,
primarily as a result of reduced advertising and promotional expenses. General
and administrative
27
<PAGE>
expenses have varied widely in the periods indicated due to the timing and
amounts of professional fees, transactions costs and deferred compensation
expense.
The Company's quarterly and annual operating results are likely to fluctuate
significantly in the future due to a variety of factors, many of which are
outside the Company's control. Factors that will influence the Company's
operating results include: (i) the Company's ability to retain existing software
publishers and online retailers as clients, to attract new software publishers
and online retailers as clients at a steady rate and to maintain software
publisher, online retailer and end-user satisfaction; (ii) the announcement or
introduction of new Web sites, Web stores, services and products by the Company
and its competitors; (iii) price competition and margin erosion; (iv) the rate
at which the online market for the purchase of software products continues to
emerge; (v) the Company's ability to upgrade and develop its systems and
infrastructure, in particular its CNS; (vi) the termination of any account that
represents a significant portion of its sales; (vii) technical difficulties or
system downtime; (viii) the Company's ability to attract new personnel in a
timely and effective manner; (ix) the Company's ability to increase the
proportion of sales from online retailers, which sales generally carry higher
gross margins; (x) the failure of Internet bandwidth to increase over time
and/or an increase in the cost to end-users of obtaining or utilizing Internet
bandwidth; and (xi) certain U.S. and foreign government regulations. The Company
also may, as inducement to obtain certain strategic contracts, offer favorable
pricing terms to software publishers and online retailers which would reduce its
gross margins. As a result, the Company believes that it will continue to incur
operating losses in the future. Due to the foregoing factors, the Company's
annual or quarterly operating results may fall below the expectations of
securities analysts and investors. In such event, the trading price of the
Common Stock would likely be materially adversely affected.
LIQUIDITY AND CAPITAL RESOURCES
In August 1998, the Company completed its initial public offering in which
the Company sold 3,000,000 shares of Common Stock. Net proceeds to the Company
were $22.7 million after expenses. Prior to the Company's initial public
offering, the Company financed its operations primarily through the private
placement of equity securities, which yielded an aggregate of $19.3 million of
net proceeds.
Net cash used in operating activities in the years ended December 31, 1995,
1996 and 1997 and in the nine months ended September 30, 1998 was $142,000,
$409,000, $2.6 million and $6.6 million, respectively. Net cash used for
operating activities in each of these periods was primarily the result of net
losses, offset in part by increases in accounts payable, accrued expenses and
non-cash expenses.
Net cash used in investing activities in the years ended December 31, 1995,
1996 and 1997 and the nine months ended September 30, 1998 was $50,000,
$133,000, $984,000 and $11.4 million, respectively. Net cash used in investing
activities in each of these periods was related to the purchases of property and
equipment and patent acquisition costs and the purchase of short-term
investments in 1998. The property and equipment purchased consisted primarily of
computer hardware and software.
Net cash provided by financing activities in the years ended December 31,
1995, 1996 and 1997 and in the nine months ended September 30, 1998 was $0,
$855,000, $4.9 million and $35.3 million, respectively. The cash provided by
financing activities was the result of proceeds from the sale of convertible
debentures (subsequently converted into shares of Common Stock), sales of the
Company's Common Stock in 1996, 1997 and the first nine months of 1998 and the
sale of the Company's Series A Preferred Stock in April 1998.
As of September 30, 1998 the Company had approximately $19.4 million of cash
and cash equivalents and $8.8 million of short-term investments. The Company's
principal commitments consisted of obligations outstanding under operating
leases. Although the Company has no material commitments for capital
expenditures, it anticipates an increase in the rate of capital expenditures
consistent with its anticipated growth in operations, infrastructure and
personnel. The Company anticipates that it will expend approximately $3.0
million over the next 24 months on capital expenditures based on the Company's
current anticipated growth rate. The Company anticipates that it will continue
to add computer hardware
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resources, deploy additional commerce servers worldwide, and expand its primary
office facility during the next twelve months. The Company further anticipates
that it will expend approximately $11.0 million over the next 24 months on
product development based on the Company's current anticipated growth rate in
operations. There can be no assurance, however that the Company's growth rate
will continue at current levels or that it will meet the Company's current
expectations. The Company may also use cash to acquire or license technology,
products or businesses related to the Company's current business. The Company
also anticipates that it will continue to experience significant growth in its
operating expenses for the foreseeable future and that its operating expenses
will be a material use of the Company's cash resources.
The Company believes that the net proceeds from this offering, together with
existing cash, cash equivalents and short-term investments, will be sufficient
to meet its anticipated cash needs for working capital and capital expenditures
for at least the next 24 months, although the Company may seek to raise
additional capital during that period. The sale of additional equity or
convertible debt securities could result in additional dilution to the Company's
stockholders. There can be no assurance that financing will be available in
amounts or on terms acceptable to the Company, if at all. See "Risk
Factors--Future Capital Needs; Uncertainty of Additional Funding."
YEAR 2000 COMPLIANCE
Like many other companies, Year 2000 computer issues create certain risks
for Digital River. If the Company's internal management information systems and
external electronic commerce information systems do not correctly recognize the
process date information beyond the year 1999, it could have a significant
adverse impact on the Company's ability to process client and end-user
transactions, which could create significant potential liability for the
Company. To address potential Year 2000 issues with its internal and external
systems, the Company has evaluated such systems. Remediation is proceeding, and
the Company currently plans to have changes to these systems completed and
tested by March 31, 1999. These activities are intended to encompass all major
categories of systems used by the Company, including electronic commerce, sales
processing, sales and financial systems. The initial assessment indicated that
certain internal systems should be upgraded or replaced as part of a solution to
the Year 2000 problem. The costs incurred to date related to these programs have
not been material. The estimated cost to be incurred by the Company in the
future is not expected to exceed $10,000. These estimates do not include
potential costs related to any customer or other claims or the cost of internal
software and hardware replaced in the normal course of business. These estimates
are based on the current assessment of the projects and is subject to change as
the project progresses.
The Company is also working with key suppliers of products and services to
determine that their operations and products are Year 2000 compliant or to
monitor their progress toward Year 2000 compliance, as appropriate. The failure
of a major supplier to become Year 2000 Compliant on a timely basis, or any
system conversion by a supplier that is incompatible with the Company's systems
could have a material adverse effect on the Company's business, financial
condition and operating results. In addition the Company's business, financial
condition and operating results may be materially adversely affected to the
extent its end-users are unable to use their credit cards due to the Year 2000
issues that are not rectified by their credit card vendors.
In addition, the Company has begun internal discussions concerning
contingency planning to address potential problem areas with internal systems
and with suppliers and other third parties. It is expected that assessment,
remediation and contingency planning activities will be on-going throughout
calendar year 1998 and 1999 with the goal of appropriately resolving all
material internal and external systems and third party issues.
As used by the Company, "Year 2000 Compliant" shall mean software that can
individually, and in combination and in conjunction with all other systems,
products or processes with which they are required or designed to interface,
continue to be used normally and to operate successfully (both in functionality
and performance in all material respects) over the transition into the
twenty-first century when used in
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accordance with the documentation relating to such software, including being
able to, before, on and after January 1, 2000 substantially conform to the
following: (i) use logic pertaining to dates which allow users to identify
and/or use the century portion of any date fields without special processing;
(ii) respond to all date elements and date input so as to resolve any ambiguity
as to century in a disclosed, defined and pre-determined manner; and (iii)
provide date information in ways which are unambiguous as to century. This may
be achieved by permitting or requiring the century to be specified or where the
data element is represented without a century, the correct century is
unambiguous for all manipulations involving that element.
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<PAGE>
BUSINESS
Digital River is a leading provider of comprehensive electronic commerce
outsourcing solutions to software publishers and online retailers. The Company
has developed a technology platform that allows it to provide a suite of
electronic commerce services to its software publisher and online retailer
clients, including ESD. The Company also provides data mining and merchandising
services to assist clients in increasing Internet page view traffic to, and
sales through, their Web stores. Rather than maintaining its own branded Web
store that would compete with its clients, Digital River provides an outsourcing
solution that allows its clients to promote their own brands while leveraging
Digital River's investment in infrastructure and technology. As of September 30,
1998, the Company had contracts with 1,309 software publisher clients and 762
online retailer clients, including Corel Corporation, Cyberian Outpost, Inc.,
Lotus Development Corporation, Micro Warehouse, Inc., Network Associates, Inc.
and Symantec Corporation, and maintained a database of more than 131,000
software products from its various software publisher clients, including more
than 24,000 software titles and more than 107,000 digital images and fonts.
Through September 30, 1998, the Company had completed more than 288,000
transactions for more than 213,000 unique end-users.
Digital River's proprietary CNS technology serves as the platform for the
Company's solutions. The CNS incorporates custom software applications that
enable ESD, Web store authoring, fraud prevention, export control, merchandising
programs and online registration, and features a database of more than 131,000
software products. Using its CNS platform, the Company creates Web stores for
its clients that replicate the look and feel of each client's Web site.
End-users enter the client site and are then seamlessly transferred to the
Company's system. End-users can then browse for products and make purchases
online, and, once purchases are made, the Company delivers the products directly
to the end-user, primarily through ESD. The Company also provides transaction
processing services and collects and maintains critical information about
end-users. This information can later be used by the Company's clients to
facilitate add-on or upgrade sales and for other direct marketing purposes. The
Company actively manages direct marketing campaigns for its clients, and also
delivers purchase information and Web store traffic statistics to its clients on
a regular basis.
INDUSTRY BACKGROUND
GROWTH OF THE INTERNET AND ELECTRONIC COMMERCE.
The Internet has emerged as a significant global communications medium,
enabling millions of people to share information and conduct business
electronically. A number of factors have contributed to the growth of the
Internet and its commercial use, including: (i) the large and growing installed
base of personal computers in homes and businesses; (ii) improvements in network
infrastructure and bandwidth; (iii) easier and cheaper access to the Internet;
(iv) increased awareness of the Internet among consumer and business users; and
(v) the rapidly expanding availability of online content and commerce which
increases the value to users of being connected to the Internet. According to
International Data Corporation ("IDC"), the number of Internet users worldwide
will grow from an estimated 69 million at the end of 1997 to an estimated 320
million by 2002.
The increasing functionality, accessibility and overall usage of the
Internet have made it an attractive commercial medium. Online retailers can
interact directly with end-users and can frequently adjust their featured
selections, shopping interfaces and pricing. The ability to reach and serve a
large and global group of end-users electronically from a central location and
the potential for personalized low-cost customer interaction provide additional
economic benefits for online retailers. Unlike traditional retail channels,
online retailers do not have the burdensome costs of managing and maintaining a
significant physical retail store infrastructure or the continuous printing and
mailing costs of catalog marketing. Because of these advantages, online
retailers have the potential to build large, global customer bases quickly and
to achieve superior economic returns over the long term. An increasingly broad
base of products is being sold successfully online, including computers, travel
services, brokerage services, automobiles and music, as well as software
products. IDC estimates that the total value of goods and services purchased
over the Web worldwide will increase from an estimated $12.4 billion in 1997 to
an estimated $133.0 billion in 2000.
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THE RETAIL SOFTWARE MARKET.
The Company believes that the market for retail software is large and will
continue to grow. According to the Software Publishers Association, sales of PC
applications software in the United States and Canada reached $10.6 billion in
1996. The traditional channels for the retail sale of software products are
highly fragmented and include regional and national superstore retail chains,
catalog companies and small single location stores. The superstores and catalog
companies carry hundreds to thousands of software products, while the single
location stores generally carry only a limited number.
Traditional sales channels have inherent limitations and disadvantages for
software publishers, retailers and end-users. A significant limitation of
physical retail stores is the limited amount of available shelf space. As a
result, competition for shelf space is intense, and often only the major
software publishers are able to effectively distribute their software products.
Even these publishers usually cannot offer their total available product
offerings in retail stores. In addition, software publishers typically must
grant generous rights of return because of the high cost of inventory and the
risk of inventory obsolescence. As a result, software publishers effectively
bear the risk of any difference between projected and actual sales, creating
uncertainty as to future sales and revenue recognition risks. Physical retailers
must also make significant investments in real estate, personnel and
inventories. Similarly, direct mail distribution is constrained by practical
catalog size limitations, which restrict both the number of products and the
information about those products that can be included in a catalog. Direct mail
distribution also involves printing expenses, mailing costs, inherent delays in
reacting to price and product changes and low response rates. With both physical
retail and direct mail distribution, there is a significant lead time between
the development or upgrading of software and its introduction into the market.
Finally, traditional sales channels are typically characterized by low end-user
registration rates, and provide software publishers little information on end-
user behavior, demographics and product demand.
ADVANTAGES OF ESD.
The Internet provides a compelling solution that addresses many of the
limitations of traditional distribution methods. The Internet is particularly
well-suited for the distribution of most software because software products can
be purchased and delivered quickly, conveniently and cost-effectively to an end-
user's home or office computer through ESD. The Company believes that ESD is an
effective means of delivery today for most software applications. Although
current Internet bandwidth restrictions currently render ESD less effective as a
means of delivery for large software applications (delivery of software
applications of greater than 10 megabytes can be impractical at slower modem
speeds), the Company believes that as Internet bandwidth increases, ESD will
become increasingly attractive even for such software titles. Accordingly, the
Company believes that ESD will represent an increasing share of online software
sales and will be critical to online retailers' success. In addition, unlike
physical retail stores or catalogs, shelf space on the Internet is virtually
unlimited, enabling software publishers to offer the full range of their
software products. ESD significantly reduces or eliminates many of the costs in
the distribution chain, including manufacturing, packaging, shipping and
warehousing costs, such as costs related to returns and inventory management.
OPPORTUNITY FOR ELECTRONIC COMMERCE OUTSOURCING.
The Company believes that the market for software sales online continues to
grow rapidly. IDC estimates that the worldwide market for ESD will increase from
approximately $200 million in 1997 to approximately $5.9 billion by 2001, a 133%
compound annual growth rate. However, unlike established physical distribution
channels for shrink-wrapped software, there is currently no established,
comprehensive electronic distribution source for online retailers. The Company
believes that the distribution of software products via ESD is complex and
requires up-front and ongoing investments in secure, reliable and scaleable
systems. Accordingly, the Company believes that a substantial market opportunity
exists for a comprehensive, cost-effective, outsourced electronic commerce
solution that provides software publishers and online retailers with access to a
critical mass of software products and a robust distribution and transaction
network.
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THE DIGITAL RIVER SOLUTION
The Company has developed a technology platform that enables it to provide a
comprehensive suite of electronic commerce services to its software publisher
and online retailer clients, including ESD. The Company also leverages its
merchandising expertise to increase traffic and sales for its clients. Rather
than maintaining its own branded Web store that would compete with its clients,
Digital River provides an outsourcing solution for ESD and merchandising
services that enables its clients to promote their own brands while leveraging
Digital River's investment in infrastructure. In addition, this approach enables
Digital River to leverage its clients' brand investments and the traffic at its
clients' sites to maximize the number of transactions completed through Digital
River.
The following illustrates the process through which an end-user purchases
software products from a client using the Company's CNS technology platform:
[GRAPHIC]
PICTORIAL FLOWCHART DEPICTING A PURCHASE OF
SOFTWARE THROUGH THE COMPANY'S CENTRAL NETWORK
SERVER ("CNS"), SHOWING THE TRANSACTION PROCESSING
AND OTHER VALUE-ADDED SERVICES PROVIDED BY THE
COMPANY.
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BENEFITS TO SOFTWARE PUBLISHERS. The Company's electronic commerce solution
enables software publishers to offer the complete library of their software
products directly to end-users from their Web stores and through the Company's
network of online retailers. This benefit is particularly significant for
smaller software publishers who have limited market access through traditional
distribution methods. The Company's solution also provides major software
publishers a channel for their underdistributed products permitting them to
offer online their complete product catalog. In addition, through its 100%
end-user registration and data warehousing, Digital River provides software
publishers with valuable end-user information that can facilitate targeted
marketing, upgrade notification and sophisticated merchandising strategies.
Finally, by exploiting the distribution relationships Digital River has
developed with a large network of online retailers, software publishers can
reduce or eliminate the need for multiple retailer relationships, thereby
lowering administrative costs and reducing the number of master copies of their
software in existence for distribution.
BENEFITS TO ONLINE RETAILERS. Online retailers can use Digital River's
robust CNS technology to sell software products online, without having to build
and maintain their own electronic commerce infrastructure. In addition, Digital
River enables online retailers to offer their end-users access to virtually all
of Digital River's inventory of more than 131,000 software products, without the
burden of developing and maintaining relationships with hundreds of software
publishers. Like software publishers, online retailers enjoy the cost savings
from online fulfillment and the database marketing benefits offered by Digital
River. Online retailers can effectively outsource electronic commerce
functionality while building their own brands online. Online retailers also
eliminate the cost and risk associated with carrying inventory and the risk of
inventory obsolescence. The Company also allows niche market and high traffic
Web sites to become online retailers at minimal cost.
BENEFITS TO END-USERS. Digital River's solution emphasizes convenience by
allowing end-users to purchase and receive software products online distributed
through ESD twenty-four hours a day, seven days a week ("24x7"), from their home
or office. End-users are not required to make a trip to the store, can act
immediately on a purchase impulse, and can locate software products that are
difficult to find. Because Digital River has a global reach, it can deliver an
extremely broad selection to end-users in rural, international or other
locations that cannot support retail stores. Software products purchased online
can either be quickly and conveniently downloaded and installed through ESD or
delivered physically. Using the Company's sophisticated search engine
technology, end-users visiting retailers' online Web stores can access virtually
all of Digital River's inventory of more than 131,000 software products.
End-users also benefit from the protection of Digital River's archiving service,
through which the Company guarantees replacement of software in the event of
accidental destruction through computer error or malfunction. End-users also
benefit from Digital River's 24x7 ESD support and readily available upgrades.
STRATEGY
The Company's objective is to become the leading provider of comprehensive
electronic commerce outsourcing solutions to software publishers and online
retailers. The Company intends to achieve its objective through the following
key strategies:
DEVELOP AND EXPAND RELATIONSHIPS WITH SOFTWARE PUBLISHERS. The Company
plans to continue to build its inventory of software products through additional
contractual relationships with software publishers. As of September 30, 1998,
the Company had signed contracts with 1,309 software publishers, representing
more than 131,000 software products and 1,029 Web stores. The Company believes
that its ability to develop Web hosting relationships with its software
publisher clients increases its reach to end-users and provides the basis for a
long term relationship with its software publisher clients. The Company further
believes that the large number of software products offered by the Company from
its software publisher clients will be critical to the Company's ability to
deliver a compelling inventory of products to online retailer clients.
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AGGRESSIVELY EXPAND NETWORK OF ONLINE RETAILERS. The Company believes that
by increasing the number of points of entry to its CNS, Digital River will
increase the number of transactions over its network. Accordingly, in addition
to expanding and developing relationships with software publishers, the Company
seeks to expand aggressively its network of online retailer clients. Online
retailer clients include traditional store-based and mail order retailers with a
Web presence, online retailers dedicated to online commerce, as well as high
traffic or niche Web site operators desiring to add electronic commerce
functionality. The Company had contracts with 762 online retailers as of
September 30, 1998. The Company's model enables it to leverage its clients'
marketing resources to direct traffic to its software distribution network. The
Company expects online retailers to represent an increasing percentage of its
sales.
PROVIDE COMPLEMENTARY SOLUTIONS. Digital River intends to continue to be a
neutral provider of cost-effective outsourcing solutions that complement the
business models of its software publisher and online retailer clients. The
Company does not maintain its own branded Web store. Instead, the Company
provides an outsourcing solution that enables its clients to promote their own
brands while leveraging Digital River's investment in infrastructure and
technology. Digital River therefore leverages its clients' investments in their
brands to generate sales. The Company may co-invest with its clients from time
to time to help drive traffic to its clients' Web stores and to Digital
River-assisted transactions.
PROVIDE CLIENTS VALUE-ADDED SERVICES. The Company believes its growing data
warehouse of end-user purchasing information provides it with a powerful tool to
assist clients with value-added services, such as targeted advertising,
promotions and direct response merchandising. The Company offers merchandising
and marketing programs, customer support and communications programs,
advertising placement services, and Web store design services. The Company
intends to continue to expand its programs and believes that these programs help
build stronger partnerships with its software publisher and online retailers,
while enabling its clients to increase sales of software on their sites.
MAINTAIN TECHNOLOGY LEADERSHIP. The Company believes that its CNS
technology has given it a competitive advantage in the market for ESD
outsourcing solutions. The Company will continue to invest in and enhance its
CNS technology in order to increase redundancy, reliability and bandwidth, to
expand services and to reduce costs. By leveraging its fixed-cost
infrastructure, Digital River will improve its ability to provide low cost, high
value services to its clients while utilizing the latest technology.
EXPAND INTERNATIONALLY. Digital River will continue to expand
internationally to gain access to additional software publishers, online
retailers and end-users. The Company intends to replicate its domestic strategy
by building its inventory of international and foreign language software
products and expanding its distribution through software publishers and online
retailers. The Company believes that significant opportunities exist
internationally to increase sales and to further leverage its scaleable
infrastructure.
SERVICES
The Company provides a broad range of services to its software publisher and
online retailer clients, including Web store hosting, ESD, physical fulfillment
and merchandising services.
WEB STORE HOSTING. The Company hosts the Web stores for all of its online
retailer clients and for those software publisher clients that choose this
option. The Company's outsourcing solution is mission-critical for many of its
software publisher and online retailer clients. Therefore, the Company has a
data center that is designed to provide its clients with the performance they
require for continuous Web store operations. The data center features redundant,
high speed connections to the Internet, 24x7 security and monitoring, back-up
generators and dedicated power.
Digital River can quickly and efficiently create Web stores for its clients,
which can be accessed easily by clicking on a "buy button" on a client's
existing Web site. The end-user is then transferred to a Web
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store hosted on Digital River's CNS, which replicates the look and feel of the
client Web site. The end-user can then shop for products and make purchases
online. By replicating the look and feel of its clients' Web sites, Digital
River supports clients in conducting electronic commerce under their own brands.
Digital River's solution allows clients to choose either ESD or physical
delivery, and clients also benefit from Digital River's 24x7 ESD customer
support and archiving services. The transaction information is captured and
added to Digital River's data warehouse. The Company's ability to retrieve and
manipulate this information creates a powerful data mining tool, which can be
used for targeted merchandising to end-users through e-mails, banner
presentations and special offers.
ESD. The Company offers clients access to its ESD capabilities to permit
delivery of software products to an end-user's computer via the Internet. ESD
eliminates many of the costs that exist in the physical distribution chain, such
as manufacturing, packaging, shipping, warehousing and inventory carrying and
handling costs. Delivery is fulfilled when a copy is made from the master on the
Company's CNS and is then securely downloaded to the end-user via the Internet.
Digital River's ESD distribution model not only reduces costs, thereby
increasing margins available to software publishers and online retailers, but
also solves the shelf space problem constraining product availability and sales.
While most software publishers use the Company's Web hosting services, certain
software publishers use only the Company's ESD services, which provide them with
online distribution through the Company's extensive network of online retailers.
PHYSICAL FULFILLMENT. In addition to distribution through ESD, the Company
offers clients physical distribution services. The Company maintains an
inventory of physical products, generally on consignment from its clients that
select this option, for shipment to end-users. The Company believes physical
fulfillment services are important to its ability to provide a comprehensive
electronic commerce outsourcing solution.
MERCHANDISING SERVICES. The Company offers a range of merchandising
services to its clients to help them drive additional traffic to their Web
stores. Software publisher and online retailer clients are provided with
detailed electronic and hard copy reports of transactions on their Web stores,
as well as end-user marketing information about visits to their Web stores. The
CNS captures Web page visits, banner and pricing information and other data that
can be used by the software publishers and online retailers to analyze their Web
stores' success.
The Company also offers advanced merchandising services to assist software
publishers and online retailers in increasing response rates for their marketing
efforts. These services include e-mail campaigns for special promotions, upgrade
notification programs, and the presentation of complementary products, bundled
products or other programs designed to increase average order size based on a
targeted end-user profile. The Company participates in co-op dollar and market
development fund programs with its clients and buys selected banner placements
in bulk to support clients' promotional campaigns. In addition, Digital River
tests and analyzes merchandising techniques, such as promotional pricing and
banner advertising, based on information gathered in the CNS data warehouse.
CLIENTS
The Company distributes software products through a network of software
publishers and online retailers. Online retailer clients include traditional
store-based and direct mail retailers with a Web presence, online retailers
dedicated to online commerce, as well as high traffic or niche Web site
operators desiring to add electronic commerce functionality. In a typical online
retailer contract, the Company is responsible for (i) a payment to the online
retailer based on a percentage of net sales of software products that the
Company distributes through the online retailer's Web site, (ii) the processing
of payments made by end-users, (iii) the delivery of the software products to
end-users, (iv) the payment of applicable credit card transaction fees, (v) the
payment and filing of applicable sales taxes and (vi) the distribution of a
report to the online retailer detailing sales activity processed by the Company.
The Company expects to
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<PAGE>
support traditional physical retailers in developing their online stores for the
sale of software products online. While most software publishers use the
Company's Web hosting services, certain software publishers use only the
Company's "channel services," whereby the software publishers are provided with
ESD and physical fulfillment capability through the Company's extensive network
of online retailers. In a typical software publisher contract, the Company is
responsible for (i) the maintenance of master copies of software products in a
secure format for distribution to end-users, (ii) a payment to the software
publisher for the cost of software products that the Company distributes through
either a retailers' Web site or through the publisher's host Web site, (iii) the
processing of payments made by end-users, (iv) the delivery of software products
to end-users, (v) the payment of applicable credit card transaction fees, (vi)
the payment and filing of applicable sales taxes and (vii) the distribution of a
report to the software publisher detailing sales activity processed by the
Company.
As of September 30, 1998, the Company had 1,309 contracts with software
publishers and 762 contracts with online retailers. Typically, there is some
delay between signing contracts and gathering the necessary materials to bring a
new client online. As of September 30, 1998, the Company had 1,075 software
publishers and 548 online retailers activated within its CNS. During the
nine-month period ended September 30, 1998, the Company completed transactions
for 990 software publishers and 215 online retailers. The Company's clients
include:
<TABLE>
<CAPTION>
SOFTWARE PUBLISHERS ONLINE RETAILERS
- -------------------------------------------- ------------------------------
<S> <C>
WEB HOSTING AND CHANNEL SERVICES BuyDirect.com, Inc.
Corel Corporation BuySafe, Inc.
Dragon Systems, Inc. Channel MarketMakers
JASC, Inc. Cyberian Outpost, Inc.
Powerquest Corporation Damark International, Inc.
Ulead Systems, Inc. Micro Warehouse, Inc.
Multiple Zones International,
Inc.
CHANNEL SERVICES ONLY Shopping.com
Cendant Corporation Software Warehouse plc
Lotus Development Corporation US WEST Internet
Network Associates, Inc.
QUALCOMM Incorporated
Symantec Corporation
</TABLE>
Revenues attributable to sales of software products of Corel Corporation
accounted for 18% and 12% of the Company's sales for the year ended December 31,
1997 and the nine months ended September 30, 1998, respectively. The Company's
contract with Corel Corporation expires in April 1999. Revenues attributable to
sales of software products of JASC, Inc. accounted for 11% of the Company's
sales for the nine months ended September 30, 1998.
SALES AND MARKETING
The Company markets its services directly to software publishers and online
retailers. The Company does not operate its own Web store because of its
strategy to serve as a neutral provider of electronic commerce outsourcing
solutions. This strategy allows the Company to avoid competing with its clients.
Generally, the Company's direct marketing to end-users focuses on supporting the
marketing and promotional efforts of its clients in driving traffic to their Web
stores. This direct marketing effort leverages the Company's extensive data
warehouse, which enables the Company to create and quickly implement marketing
programs targeted at specific end-user segments. By providing consistent quality
service, branding client order pages with its name and logo, billing credit card
transactions under the Digital River name and engaging in brand positioning,
advertising and promotion, the Company intends to
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<PAGE>
establish the Digital River brand as a trusted name for ESD and electronic
commerce outsourcing solutions among software publishers, online retailers and
end-users.
The Company's sales and marketing organization is divided into three groups:
the Strategic Sales Group, the Product Management Group and the Account
Development Group. The Strategic Sales Group focuses on large software
publishers and online retailers, including traditional physical retailers, with
significant online revenue potential. These sales are typically complex in
nature and involve a lengthy sales cycle. Contracts with these larger clients
often involve certain incentives, principally pricing concessions. The Company
makes decisions with respect to such contract incentives on a case by case
basis. The Product Management Group focuses on all other software publishers and
online retailers. Generally, these sales involve a much shorter sales cycle, are
managed primarily through a telesales effort and result in the new client
selecting one of the Company's standard programs. The Account Development Group
serves existing clients and provides them with merchandising and database
marketing assistance designed to increase revenues. The Company leverages its
extensive inventory of software products and large number of end-users to create
opportunities for targeted marketing and bundled sales. As of September 30,
1998, the Company had 42 employees engaged in sales and marketing. See "Risk
Factors--Client Concentration; Lengthy Sales Cycle."
The Company currently markets its services to clients via direct marketing,
print advertising, trade show participation and other media events. The Company
plans to increase its expenditures on direct marketing and print advertising, as
well as introducing online advertising efforts directed at potential clients. In
addition, the Company recently opened a sales office in the United Kingdom.
TECHNOLOGY
Digital River delivers its electronic commerce outsourcing solution using
its proprietary CNS technology, which enables the sale and distribution of
software products via the Internet.
ARCHITECTURE. The Company's scaleable CNS is designed to handle tens of
thousands of different Web stores and millions of software products. The CNS
consists of a pool of network servers and a proprietary software application
that serves dynamic Web pages using an Oracle database. The Company's CNS was
designed to scale to support growth by adding CPUs, memory, disk drives and
bandwidth without substantial changes to the application. The CNS software code
is written in modular layers, enabling the Company to quickly adapt in response
to industry changes, including bandwidth opportunities, payment processing
changes, international requirements for taxes and export screening, new
technologies such as Java, XML, DHTML, VRML, SET, banking procedures and
encryption technologies. The CNS product search system allows end-users to
search for items across millions of potential products and thousands of
categories specific to various product specifications, while maintaining a fast
page response that is acceptable to the end-user. The Company uses sophisticated
database indexing coupled with a dynamic cache system to provide flexibility and
speed. These caches help increase the overall speed of each page and facilitate
complex searches across the entire inventory of software products. The CNS has
also been designed to index, retrieve and manipulate all transactions that flow
through the system, including detailed commerce transaction and end-user
interaction data. This enables the Company to create proprietary market profiles
of each end-user and groups of end-users that can be used to create
merchandising campaigns. The Company's CNS is also used for internal purposes,
including reporting and maintenance for fraud detection and prevention, physical
shipping, return authorizations, back order processing and full transaction
auditing and reporting capabilities for all commerce functions.
WEB STORE MAINTENANCE. Clients' Web stores are built and maintained using
the CNS centralized management system. Global changes that affect all Web stores
or groups of Web stores can be made as easily as changes to an individual Web
store. Client Web stores include a main store and may optionally include several
"focus stores" and "channel sites" to which highly targeted traffic may be
routed. Clients
38
<PAGE>
may also link specific locations on their Web stores to detailed product or
category areas of the stores, in
order to better target their end-users' interests.
SECURITY. Digital River's security systems apply both to access to internal
systems and to illegal access to commerce data via the Internet. Internally,
logins and passwords are maintained for all systems, with additional logins,
passwords and IP access control granted on an individual basis to only the
required commerce areas the person is responsible for. Firewalls prevent
unauthorized access from outside. The Company relies on certain encryption and
authentication technology licensed from third parties to provide secure
transmission of confidential information, such as end-user credit card numbers.
Unix, Oracle and Web server security additionally restrict access from the
outside to the appropriate transaction data. The CNS security system is designed
not to interfere with the end-user experience. Product wrappers, clearing-house
processing, and additional password mechanisms that negatively impact ESD
performance are not needed. The CNS security system never allows direct access
to the clients' products and ensures that an end-user requests ESD through a
valid page and has purchased the product. See "Risk Factors-- Electronic
Commerce Security Risks."
DATA CENTER OPERATIONS. Continuous data center operations are crucial to
the Company's success. All transaction data is backed up periodically and all
inventory data is archived and kept in fireproof storage facilities. The
Company's network software constantly monitors clients' Web stores and internal
system functions and notifies systems engineers if any unexpected conditions
arise. The Company currently leases six T1 lines from multiple vendors and
maintains a policy of adding additional lines if more than 50% of its bandwidth
capacity is utilized. Accordingly, if one line fails the other lines are able to
assume the capacity of the failed line. The Company's data center is located in
a single location at the Company's main facilities in Eden Prairie, Minnesota.
In the case of electrical power failure, the Company has a back-up power supply
system. The Company has also installed a FM-200 automatic fire suppression
system in the data center. The data center currently incorporates redundant
systems consisting of additional servers and arrays. The Company currently has
no automatic switchover in the case of equipment or software failure, although
it has plans to implement further redundancy in the future. See "Risk
Factors--Risk of Capacity Constraints; Risk of System Failure; System
Development Risks."
PRODUCT DEVELOPMENT
Digital River's product development strategy is to enhance the technology
and features of its CNS. To this end, the Company has numerous development
projects in process including, but not limited to, Internet optimization tools,
end-user profiling and collaboration technologies and online interactive
customer service. Product development and operations expenses (which include
customer service, data center operations and telecommunications infrastructure)
were $130,000, $230,000, $1.5 million and $2.9 million in 1995, 1996, 1997 and
the first nine months of 1998, respectively. As of September 30, 1998, the
Company employed 26 persons in product development.
To remain competitive, the Company must continue to enhance and improve the
responsiveness, functionality and features of the CNS and the underlying network
infrastructure. The Internet and the online commerce industry are characterized
by rapid technological change, changes in user and client requirements and
preferences, frequent new product and service introductions embodying new
technologies and the emergence of new industry standards and practices that
could render the Company's existing CNS proprietary technology and systems
obsolete. The Company's success will depend, in part, on its ability to both
license and internally develop leading technologies useful in its business,
enhance its existing services, develop new services and technology that address
the increasingly sophisticated and varied needs of its clients, and respond to
technological advances and emerging industry standards and practices on a
cost-effective and timely basis. The development of the CNS technology and other
proprietary technology entails significant technical and business risks. There
can be no assurance that the Company will successfully use new technologies
effectively or adapt its proprietary technology and transaction-processing
systems to customer requirements or emerging industry standards. If the Company
is unable, for technical,
39
<PAGE>
legal, financial or other reasons, to adapt in a timely manner to changing
market conditions, client requirements or emerging industry standards, its
business, financial condition and results of operations could be materially
adversely affected. See "Risk Factors--Rapid Technological Change."
COMPETITION
The electronic commerce market is new, rapidly evolving and intensely
competitive, and the Company expects competition to intensify in the future,
particularly in the area of electronic sale and distribution of software
products. The Company currently competes directly with other providers of
electronic commerce solutions, including CyberSource Corporation, Preview
Systems, Inc., Release Software Corporation and TechWave, Inc. The Company also
competes indirectly with software companies that offer tools and services for
electronic commerce, including companies that provide a broad range of Internet
and server solutions such as Microsoft Corporation and Netscape Communications
Corporation, as well as a large number of 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
interaction and database marketing. In addition to direct competition with other
transaction processing providers and enablers and indirect competition with
other providers of electronic commerce software and systems, the Company
competes with companies that sell and distribute software products via the
Internet, including Amazon.com, Inc., beyond.com Corporation, Ingram Micro Inc.
and Tech Data Corporation. The Company also competes with companies such as
AltaVista (a subsidiary of Compaq Computer Corporation), America Online, Inc.,
Excite, Inc., Infoseek Corporation, Lycos, Inc. and Yahoo! Inc., which
specialize in electronic commerce or derive a substantial portion of their
revenues from electronic commerce and may themselves offer, or provide means for
others to offer, software products.
The Company believes that the principal competitive factors in its market
are breadth of services and software product offerings, software publisher and
online retailer relationships, brand recognition, system reliability and
capacity, price, customer service, speed and accessibility and ease of use,
convenience and speed of fulfillment. There can be no assurance that the online
retailers and the other companies listed above will not compete directly with
the Company by adopting a similar business model. Moreover, while certain of
these companies are also clients or potential clients of the Company, they may
compete with the Company's electronic commerce outsourcing solution to the
extent that they develop electronic commerce systems or acquire such systems
from other software vendors or service providers.
Many of the Company's current and potential competitors have longer
operating histories, larger customer bases, greater brand recognition and
significantly greater financial, marketing and other resources than the Company.
In addition, larger, well-established and well-financed entities may acquire,
invest in or form joint ventures with online competitors as the use of the
Internet and other online services increases. In addition, new technologies and
the expansion of existing technologies, such as price comparison programs that
select specific titles from a variety of Internet Web sites may direct end-users
to online retailers that compete with the Company, which would increase
competitive pressures on the Company. Increased competition may result in
reduced operating margins, as well as a loss of market share. Further, as a
strategic response to changes in the competitive environment, the Company may
from time to time make certain pricing, service or marketing decisions or
acquisitions that could have a material adverse effect on its business,
financial condition and results of operations. There can be no assurance that
the Company will be able to compete successfully against current and future
competitors, and any inability to do so could have a material adverse effect on
the Company's business, financial condition and results of operations.
INTELLECTUAL PROPERTY
The Company regards trademarks, copyrights, trade secrets and other
intellectual property as critical to its success, and relies on trademark, trade
secret protection and confidentiality and/or license agreements with its
employees, clients, partners and others to protect its proprietary rights. The
Company's
40
<PAGE>
policy is to seek to protect its proprietary position by, among other methods,
filing United States and foreign patent applications related to its proprietary
technology, inventions and improvements that are important to the development of
its business. Proprietary rights relating to the Company's technologies will be
protected from unauthorized use by third parties only to the extent that they
are covered by valid and enforceable patents or are effectively maintained as
trade secrets. While the Company currently has twelve patent applications
pending in the United States, none have yet been issued and there can be no
assurance that any pending patent applications now or hereafter filed by, or
licensed to, the Company will result in patents being issued. The Company has
filed certain petitions to correct certain fee deficiencies for its pending
patent applications and there can be no assurance that such petitions can be
granted or that the Company will elect to pursue these applications. In
addition, the laws of certain foreign countries do not protect the Company's
intellectual property rights to the same extent as do the laws of the United
States. The patent position of high technology companies involves complex legal
and factual questions and, therefore, their validity and enforceability cannot
be predicted with certainty. There can be no assurance that any of the Company's
patent applications, if issued, will not be challenged, invalidated, held
unenforceable or circumvented, or that the rights granted thereunder will
provide proprietary protection or competitive advantages to the Company against
competitors with similar technology. Furthermore, there can be no assurance that
others will not independently develop similar technologies or duplicate any
technology developed by the Company. The Company has one registered trademark
for "Digital River." Effective trademark and trade secret protection may not be
available in every country in which the Company's products and services are made
available online. There can be no assurance that the steps taken by the Company
to protect its proprietary rights will be adequate or that third parties will
not infringe or misappropriate the Company's trade secrets, trademarks, trade
dress and similar proprietary rights. In addition, there can be no assurance
that others will not independently develop substantially equivalent intellectual
property. A failure by the Company to protect its intellectual property in a
meaningful manner could have a material adverse effect on the Company's
business, financial condition and results of operations. In addition, litigation
may be necessary in the future to enforce the Company's intellectual property
rights, to protect the Company's trade secrets or to determine the validity and
scope of the proprietary rights of others. Such litigation could result in
substantial costs and diversion of management and technical resources, which
could have a material adverse effect on the Company's business, financial
condition and results of operations.
In addition, there can be no assurance that other parties will not assert
infringement claims against the Company. From time to time, the Company may
receive notice of claims of infringement of other parties' proprietary rights.
There can be no assurance that such claims will not be asserted or prosecuted
against the Company in the future or that any past or future assertions or
prosecutions will not materially adversely affect the Company's business,
financial condition and results of operations. The defense of any such claims,
whether such claims are with or without merit, could be time-consuming, result
in costly litigation and diversion of technical and management personnel, cause
product shipment delays or require the Company to develop non-infringing
technology or enter into royalty or licensing agreements. Such royalty or
licensing agreements, if required, may not be available on terms acceptable to
the Company, or at all. In the event of a successful claim of infringement
against the Company and the failure or inability of the Company to develop
non-infringing technology or license the infringed or similar technology on a
timely basis, the Company's business, financial condition and results of
operations could be materially adversely affected.
EMPLOYEES
As of September 30, 1998, the Company employed 97 people, including 11 in
administration, 44 in product development and operations and 42 in sales and
marketing. The Company also employs independent contractors and other temporary
employees. None of the Company's employees is represented by a labor union, and
the Company considers its employee relations to be good. Competition for
qualified personnel in the Company's industry is intense, particularly among
software development and other
41
<PAGE>
technical staff. The Company believes that its future success will depend in
part on its continued ability to attract, hire and retain qualified personnel.
FACILITIES
The Company currently subleases approximately 32,900 square feet of office
and warehouse space in Eden Prairie, Minnesota. The sublease agreement expires
on July 31, 2003. The Company also leases approximately 6,400 and 7,000 square
feet of office and warehouse space, respectively from Tech Squared, Inc. in
Edina, Minnesota. Obligations under the lease from Tech Squared will continue
through December 31, 1998 or until a party is found to sublease the office
space, whichever is earlier. The Company will continue to pay for warehouse
space from Tech Squared as long as it continues to utilize any of the space.
Rent for the warehouse space will be calculated pursuant to a formula based on
square footage utilized. In addition, the Company leases on a month to month
basis approximately 900 square feet of office space in suburban London that
houses its European sales office. The Company believes that its facilities will
be adequate to accommodate the Company's needs for the foreseeable future.
LEGAL PROCEEDINGS
From time to time, the Company may be involved in litigation relating to
claims arising out of its ordinary course of business. The Company presently is
not subject to any material legal proceedings.
42
<PAGE>
MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES
The following table sets forth information regarding the Company's executive
officers, key employees and directors as of November 24, 1998.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ----------------------------------- --- ------------------------------------------------------------
<S> <C> <C>
Joel A. Ronning.................... 42 Chief Executive Officer and Director
Perry W. Steiner................... 32 President and Director
Robert E. Strawman................. 39 Chief Financial Officer and Treasurer
Kelly J. Wical..................... 42 Chief Technology Officer
Draper M. Jaffray.................. 36 Vice President of Business Development
Terence M. Strom................... 54 Vice President of Marketing
Gregory R.L. Smith................. 31 Secretary and Controller
Randy J. Womack.................... 34 Chief Information Officer
Timothy C. Choate.................. 33 Director
William Lansing.................... 40 Director
Thomas F. Madison (1)(2)........... 62 Director
Charles E. Reese, Jr............... 44 Director
Christopher J. Sharples............ 51 Director
J. Paul Thorin (1)(2).............. 54 Director
</TABLE>
- ------------------------
(1) Member of Audit Committee.
(2) Member of Compensation Committee.
Mr. Ronning founded the Company in February 1994 and has been President and
Chief Executive Officer and a director of the Company since that time. From
February 1994 to July 1998, Mr. Ronning was also President of the Company. Since
May 1995, Mr. Ronning has served as Chairman of the Board of Directors of Tech
Squared, a direct catalog marketer of software and hardware products. From May
1995 to July 1998, Mr. Ronning served as Chief Executive Officer, Chief
Financial Officer and Secretary of Tech Squared, Inc. From May 1995 to August
1996, Mr. Ronning also served as the President of Tech Squared. Mr. Ronning is
the founder of MacUSA, Inc., a wholly-owned subsidiary of Tech Squared, and has
served as a director and Chief Executive Officer of MacUSA, Inc. since April
1990. Mr. Ronning also serves as a director of the Software Publishers
Association and JASC, Inc.
Mr. Steiner joined the Company in July 1998 as President and has served as a
director of the Company since April 1998. From January 1997 to July 1998 Mr.
Steiner served as Vice President of Wasserstein Perella & Co., Inc., an
investment banking firm, and as Vice President of Wasserstein Perella Ventures,
Inc., the general partner of Wasserstein Adelson Ventures, L.P., a venture
capital fund. From June 1993 to December 1996, Mr. Steiner was a principal of
TCW Capital, a group of leveraged buyout funds managed by Trust Company of the
West.
Mr. Strawman joined the Company in April 1998 as Chief Financial Officer and
Treasurer. From September 1995 to April 1998, Mr. Strawman served as Director of
Finance and Vice President of Finance for Caribou Coffee Company, Inc., a
gourmet coffee retailer. From 1989 to 1995, Mr. Strawman held various financial
positions at Software Etc. Stores, Inc., a specialty retailer of software, most
recently as Chief Financial Officer.
Mr. Wical joined the Company in April 1997 as Chief Technology Officer. From
1992 to April 1997, Mr. Wical was Director of Development and Chief
Scientist/Architect of the ConText Server Division of Oracle Corporation. From
1987 to 1992, Mr. Wical was co-founder and Vice President of Research and
Development for Artificial Linguistics, Inc., a developer of text management
software.
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<PAGE>
Mr. Jaffray joined the Company in December 1996 as Vice President of
Business Development. From January 1996 to December 1996, Mr. Jaffray was a
partner in The Firm, a computer products manufacturers representative. From 1991
to 1995, Mr. Jaffray served as Director of Sales for Tech Squared.
Mr. Strom joined the Company as Vice President of Marketing in August 1998.
From June 1993 to February 1997, Mr. Strom held various positions at Egghead,
Inc., a computer software retailer, most recently as Chief Executive Officer.
From January 1990 to June 1993, Mr. Strom held various positions at Best Buy
Co., Inc., a consumer electronics retailer, most recently as Senior Vice
President of Marketing.
Mr. Smith joined the Company as Controller in June 1997 and has served as
Secretary and Controller since December 1997. From November 1995 to June 1997,
Mr. Smith was Manager, External Reporting and Investor Relations at Secure
Computing Corporation, a developer of network and Internet security products.
From June 1988 to November 1995, Mr. Smith held various positions with Ernst &
Young LLP.
Mr. Womack joined the Company in October 1997 as Chief Information Officer.
From May 1997 to September 1997, Mr. Womack was Director of Engineering at Xerox
Corporation. From 1992 to 1997, Mr. Womack held various positions, including
Development Manager at Oracle Corporation. From 1989 to 1992, Mr. Womack was
Director of Technical Services at Artificial Linguistics, Inc.
Mr. Choate has served as a director of the Company since May 1998. Mr.
Choate has been Chairman of FreeShop International, Inc. since its inception in
June 1997 and has been President and Chief Executive Officer since March 1998.
Mr. Choate co-founded Online Interactive, Inc., the original parent company of
FreeShop International, Inc., in June 1994, and served as President, Chief
Executive Officer and Chairman until February, 1997 and Chairman until July
1997. Mr. Choate served as a Vice President of Micro Warehouse, Inc. from July
1997, when it acquired Online Interactive, Inc., until February 1998. From
February 1991 to May 1994, Mr. Choate held various positions at Softdisk
Publishing, LLC, most recently as President. From February 1989 until February
1991, Mr. Choate was a Senior Marketing Manager at Prodigy Services Company.
Mr. Lansing has served as a director of the Company since November 1998. In
May 1998, Mr. Lansing joined Fingerhut Companies, Inc. as President and Chief
Operating Officer. From October 1996 to May 1998, Mr. Lansing served as Vice
President for Business Development for General Electric Corporation. From
January 1996 to October 1996, he was Chief Operating Officer at Prodigy, an
online joint venture of IBM Corporation and Sears Roebuck and Co. From September
1986 to December 1995, Mr. Lansing was at McKinsey & Co. where he was a partner
leading the consulting firm's Internet practice. Mr. Lansing began his career in
1984 at Davis Polk & Wardwell as a securities lawyer.
Mr. Madison has served as a director of the Company since August 1996. Since
January 1993 he has been the President and Chief Executive Officer of MLM
Partners, a consulting and small business investment company. From February 1994
to September 1994, Mr. Madison served as Vice Chairman and Chief Executive
Officer at Minnesota Mutual Life Insurance Company. From June 1987 to December
1992, Mr. Madison was President of US WEST Communications Markets, a division of
US WEST, Inc. Mr. Madison also serves on the Boards of Directors of Valmont
Industries Inc., Eltrax Systems, Inc., Minnegasco Division of Houston
Industries, ACI Telecentrics, Span Link Communications and Delaware Group of
Funds.
Mr. Reese has served as a director of the Company since July 1996. In August
1996, Mr. Reese joined Tech Squared, Inc. as President and Chief Operating
Officer and has served as a director of Tech Squared since April 1996. From
April 1995 to August 1996, Mr. Reese served as Vice President of Sales and
Marketing for the Weidt Group, Inc., a privately-held custom software
development firm specializing in Internet Web site design and development. From
July 1987 to April 1995, Mr. Reese served as Vice President of Sales at
Lasermaster Corp., a manufacturer and seller of high-resolution plain paper
typesetters, chemical-free image setters and large format color printers.
Mr. Sharples has served as a director of the Company and Digital River Ltd.,
a wholly-owned subsidiary of the Company, since April 1998. Since 1973, Mr.
Sharples has served as a director of GNI Ltd., a firm specializing in the
derivatives market, which he co-founded in 1972. Since 1995, Mr. Sharples has
44
<PAGE>
been Chairman of Lombard Street Research, an economic research firm. Since
November 1996, Mr. Sharples has been the Chairman of Datastream International
Ltd., a supplier of on-line historical financial and economic information to
investment professionals. Since 1981, Mr. Sharples has been the Chairman of ICV
Ltd, a financial information company. Both Datastream International Ltd. and ICV
Ltd. are subsidiaries of Primark Corporation, a information services company.
From 1987 to 1995, Mr. Sharples was Chairman of the Association of Futures
Brokers & Dealers and the Securities and Futures Authority, front line
regulatory organizations designated under the laws of Great Britain.
Mr. Thorin has served as a director of the Company since June 1996. Since
April 1996, Mr. Thorin has served as General Counsel of Fujitsu America Inc., a
subsidiary of Fujitsu Limited and since June 1997 as its Vice President and
General Counsel. From April 1990 to March 1996, Mr. Thorin held the position of
Associate Corporate Counsel of Fujitsu America Inc.
BOARD COMPOSITION
The Company currently has authorized seven directors. In accordance with the
terms of the Company's Restated Certificate of Incorporation, effective upon the
closing of this offering, the terms of office of the Board of Directors will be
divided into three classes: the Class I term will expire at the annual meeting
of stockholders to be held in 1999; the Class II term will expire at the annual
meeting of stockholders to be held in 2000; and the Class III, term will expire
at the annual meeting of stockholders to be held in 2001. The Class I directors
will be Messrs. Madison and Reese, the Class II directors will be Messrs.
Choate, Sharples and Lansing, and the Class III directors will be Messrs.
Ronning, Steiner and Thorin. At each annual meeting of stockholders after the
initial classification, the successors to directors whose term will then expire
will be elected to serve from the time of election and qualification until the
third annual meeting following election. In addition, the Company's Restated
Certificate of Incorporation provides that the authorized number of directors
may be changed only by resolution of the Board of Directors. Any additional
directorships resulting from an increase in the number of directors will be
distributed among the three classes so that, as nearly as possible, each class
will consist of one-third of the directors. This classification of the Board of
Directors may have the effect of delaying or preventing changes in control or
management of the Company. Although directors of the Company may be removed for
cause by the affirmative vote of the holders of a majority of the Common Stock,
the Company's Restated Certificate of Incorporation provides that holders of
two-thirds of the Common Stock must vote to approve the removal of a director
without cause. There are no family relationships among any of the directors and
executive officers of the Company.
BOARD COMMITTEES
The Audit Committee consists of Messrs. Madison and Thorin. The Audit
Committee makes recommendations to the Board of Directors regarding the
selection of independent public accountants, reviews the results and scope of
the audit and other services provided by the Company's independent public
accountants and reviews and evaluates the Company's control functions.
The Compensation Committee consists of Messrs. Madison and Thorin. The
Compensation Committee administers the issuance of stock under the Company's
1998 Stock Option Plan, makes recommendations regarding the Company's various
incentive compensation and benefit plans and determines salaries for the
executive officers and incentive compensation for employees and consultants of
the Company.
DIRECTOR COMPENSATION
Directors do not receive any cash compensation for their services as members
of the Board of Directors, although they are reimbursed for certain expenses
incurred in connection with attendance at Board and Committee meetings. From
time to time, certain non-employee directors of the Company have received grants
of options to purchase shares of the Company's Common Stock. In June 1996, Mr.
Thorin was granted an option to purchase 13,333 shares of the Company's Common
Stock at an exercise price of $0.38 per share. In September 1996, Messrs.
Madison and Reese were granted options to purchase 53,333
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<PAGE>
and 13,333 shares of the Company's Common Stock, respectively, each at an
exercise price of $1.13 per share. In April 1998, Messrs. Madison, Reese and
Thorin were granted options to purchase 1,867, 467 and 467 shares of the
Company's Common Stock, respectively, each at an exercise price of $3.00 per
share. In May 1998, Mr. Choate was granted an option to purchase 5,000 shares of
the Company's Common Stock at an exercise price of $3.00 per share. In November
1998, Mr. Lansing was granted an option to purchase 10,000 shares of the
Company's Common Stock at an exercise price of $12.50 per share. The Company may
compensate non-employee directors in the future for their attendance at Board
and Committee meetings.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Prior to April 1998, the Company did not have a Compensation Committee of
the Board of Directors, and the entire Board participated in all compensation
decisions, except that Mr. Ronning did not participate in decisions relating to
his compensation. In April 1998, the Board formed the Company's Compensation
Committee to review and recommend to the Board the compensation and benefits for
the Company's executive officers and administer the Company's stock option plan.
Certain of the Company's directors, or affiliated entities, have purchased
securities of the Company. See "Certain Transactions" and "Principal
Stockholders."
EXECUTIVE COMPENSATION
The following table sets forth the compensation paid by the Company during
the fiscal year ended December 31, 1997 to the Company's Chief Executive Officer
and all other executive officers receiving compensation in excess of $100,000 in
fiscal 1997 (the "Named Executive Officers"):
SUMMARY COMPENSATION TABLE (1)
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION AWARDS
--------------------
SECURITIES
ANNUAL COMPENSATION UNDERLYING
NAME AND PRINCIPAL POSITION SALARY($) OPTIONS(#)
- ---------------------------------------------------------------------- -------------------- --------------------
<S> <C> <C>
Joel A. Ronning ...................................................... $ 140,000 --
Chief Executive Officer
Draper M. Jaffray .................................................... 120,000 80,267
Vice President of Business Development
</TABLE>
- ------------------------
(1) In accordance with the rules of the Securities and Exchange Commission, the
compensation described in this table does not include medical, group life
insurance or other benefits received by the Named Executive Officers which
are available generally to all salaried employees of the Company and certain
perquisites and other personal benefits received by the Named Executive
Officers, which do not exceed the lesser of $50,000 or 10% of any such
officer's salary and bonus disclosed in this table.
46
<PAGE>
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth information regarding stock options granted
by the Company during the fiscal year ended December 31, 1997 to each of the
Named Executive Officers:
<TABLE>
<CAPTION>
POTENTIAL
REALIZABLE VALUE
AT ASSUMED
INDIVIDUAL GRANTS ANNUAL RATES OF
-------------------------------------------------------------- STOCK PRICE
NUMBER OF PERCENTAGE OF APPRECIATION FOR
SECURITIES TOTAL OPTIONS OPTION
UNDERLYING GRANTED IN EXERCISE TERM($)(4)
OPTIONS FISCAL 1997 PRICE --------------------------
NAME GRANTED(#)(1) (%)(2) ($/SH)(3) EXPIRATION DATE 5%($) 10%($)
- --------------------- ------------- --------------- ------------- --------------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Joel A. Ronning...... -- -- -- -- -- --
Draper M. Jaffray.... 80,000 16.1% $ 1.13 2/4/07 $ 3,837,900 $ 6,151,500
267 .1 1.69 6/26/07 12,659 20,381
</TABLE>
- ------------------------
(1) The options become exercisable at a rate of 25% on the first anniversary of
the vesting commencement date and 25% annually thereafter and expire ten
years from the date of grant, or earlier upon termination of employment.
(2) Based on an aggregate of 496,817 shares subject to options granted to
employees, directors of and consultants to the Company in the fiscal year
ended December 31, 1997, including the Named Executive Officers.
(3) Options were granted at an exercise price equal to the fair market value of
the Company's Common Stock, as determined by the Board of Directors on the
date of grant.
(4) The 5% and 10% assumed annual rates of compounded stock price appreciation
are mandated by rules of the Securities and Exchange Commission. There can
be no assurance provided to any executive officer or any other holder of the
Company's securities that the actual stock price appreciation over the
option term will be at the assumed 5% and 10% levels or at any other defined
level. Unless the market price of the Common Stock appreciates over the
option term, no value will be realized from the option grants made to the
executive officers. The potential realizable value is calculated using the
assumed public offering price of $30.125 per share appreciates at the
indicated rate for the entire term of the option and that the option is
exercised at the exercise price and sold on the last day of its term at the
appreciated price. The potential realizable value computation is net of the
applicable exercise price, but does not take into account applicable federal
or state income tax consequences and other expenses of option exercises or
sales of appreciated stock.
RECENT OPTION GRANTS. Since December 31, 1997, the Company has granted
options to purchase 433,333, 80,000 and 26,667 shares of Common Stock, each at
an exercise price of $3.00 per share, to Messrs. Ronning, Strawman and Wical,
respectively. In August 1998, the Company granted to Mr. Strom an option to
purchase 150,000 shares of Common Stock at an exercise price of $8.50 per share.
With the exception of the grant to Mr. Ronning, which becomes exercisable at a
rate of 25% on the date of grant and 18.75% annually thereafter, all grants made
to the above executive officers become exercisable at a rate of 25% on the first
anniversary of the vesting commencement date and 25% annually thereafter. In
July 1998, the Company granted options to purchase 550,000 shares of Common
Stock to Mr. Steiner. See "--Employment Agreements."
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<PAGE>
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND 1997 YEAR-END OPTION VALUES
The following table sets forth for each of the Named Executive Officers the
number and value of securities underlying unexercised options held by the Named
Executive Officers at December 31, 1997:
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED OPTIONS IN-THE- MONEY OPTIONS AT
SHARES AT DECEMBER 31, 1997 DECEMBER 31, 1997(1)
ACQUIRED ON VALUE ------------------------------ --------------------------
NAME EXERCISE(#) REALIZED($) EXERCISABLE(#) UNEXERCISABLE($) EXERCISABLE($) UNEXERCISABLE($)
- --------------------- ------------- ----------- ------------- --------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Joel A. Ronning...... -- -- 160,000 53,333 $4,760,000 $ 1,606,657
Draper M. Jaffray.... -- -- 20,000 60,267 580,000 1,747,743
</TABLE>
- ------------------------
(1) Value of unexercised in-the-money options are based on a value of $30.125
per share, the assumed public offering price minus the per share exercise
price, multiplied by the number of shares underlying the option.
EMPLOYMENT AGREEMENTS
In May 1998, the Company entered into an employment and non-competition
agreement (the "Employment Agreement") with Joel A. Ronning, the Company's Chief
Executive Officer. The term of the Employment Agreement is for a period of two
years (the "Expiration Date") with automatic one-year renewals if not terminated
prior to the Expiration Date (as extended in connection with any renewed term).
Mr. Ronning's compensation pursuant to the Employment Agreement consists of a
base salary of $225,000. In addition, in 1998, Mr. Ronning received a bonus
consisting of 50% of his base salary upon the successful completion of the
Company's initial public offering and may receive up to 50% of his base salary
upon the Company achieving certain revenue milestones in 1998. Future annual
bonuses will be determined at the discretion of the Board. In the event of Mr.
Ronning's termination under certain circumstances, including termination upon a
change in control of the Company, he will be entitled to termination payments
equal to his base salary at the time of termination plus a weighted three year
average of his annual bonus amount. In the event of a change of control, any
unvested and unexercised stock options held by Mr. Ronning will immediately vest
and become exercisable. Mr. Ronning has also agreed not to compete with the
Company, for a period of twelve months following termination under certain
circumstances, in countries or territories where the Company conducts business.
In July 1998, the Company entered into an employment agreement with Perry
Steiner, the Company's President. Mr. Steiner's compensation pursuant to his
employment agreement consists of base salary of $200,000. In addition, Mr.
Steiner will be paid a bonus equal to 50% of his base salary on December 31,
1998 unless he has voluntarily terminated or been terminated for cause on that
date. Future annual bonuses will be determined at the discretion of the Board.
Mr. Steiner also was granted options to purchase 550,000 shares of the Company's
Common Stock at an exercise price equal to $8.50 per share. Options to purchase
137,500 shares of Common Stock vested on Mr. Steiner's first day of employment
with the Company and options to purchase an additional 137,500 shares of Common
Stock will vest on the third anniversary of Mr. Steiner's date of employment;
provided that vesting of such options will accelerate if certain events occur
related to Mr. Steiner's relocation. Of the remaining options, options to
purchase 91,666 shares of Common stock will vest on the first anniversary of Mr.
Steiner's hire date, options to purchase 91,667 shares of Common Stock will vest
on the second anniversary of his hire date and options to purchase 91,667 shares
of Common Stock will vest on the third anniversary of his hire date. In the
event of a change of control, as defined in the employment agreement, any
unvested stock options granted to Mr. Steiner in connection with his employment
agreement (except, in the case of a change of control that occurs after April 1,
1999, for any options that have failed to vest by April 1, 1999 as a result of a
failure to relocate as described above) will immediately vest and become
exercisable. If Mr. Steiner is terminated involuntarily other than for cause, he
will be entitled to receive upon execution of a one year noncompete agreement
(i) salary continuation payments, at his monthly base salary rate, for a period
of twelve months
48
<PAGE>
after his date of termination, (ii) acceleration of vesting for the next
increment of outstanding options that have not vested and (iii) a bonus for the
year in which termination occurred. If Mr. Steiner terminates his employment
voluntarily, the Company has the right to require Mr. Steiner to execute a
noncompete agreement effective for a period of one year from the date of
termination. If the Company exercises this option, Mr. Steiner will receive
salary continuation payments, at his monthly base salary rate, for a period of
six months after his date of termination, if termination occurs in his first
year of employment, or for a period of twelve months after his date of
termination, if termination occurs subsequent to the first anniversary of his
hire date.
EMPLOYEE BENEFIT PLANS
1998 STOCK OPTION PLAN. The Company's 1998 Stock Option Plan (the "Option
Plan") was adopted by the Board of Directors in June 1998 as an amendment and
restatement of the Amended and Restated 1994 Stock Option Plan which had been
adopted in December 1997. There is currently an aggregate of 2,333,333 shares of
Common Stock authorized for issuance under the Option Plan.
The Option Plan provides for the grant of incentive stock options, as
defined under the Internal Revenue Code of 1986, as amended (the "Code"), to
employees (including officers and employee-directors) of the Company and its
affiliates. The Option Plan also provides for the grant of nonstatutory stock
options to such employees as well as to directors and consultants of the Company
and its affiliates.
The Board (or a Committee appointed by the Board) administers the Option
Plan and determines both the recipients of options and the type of options to be
granted, including the exercise price, number of shares subject to the option
and the exercisability thereof. The terms of options granted under the Option
Plan generally may not exceed 10 years. While the Board determines the exercise
price of options, the exercise price for an incentive stock option may not be
less than 100% of the fair market value of the Common Stock on the date of the
option grant. Options vest at the rate specified in the option agreement.
No incentive stock option may be granted to any person who, at the time of
the grant, owns (or is deemed to own) stock possessing more than 10% of the
total combined voting power of the Company or any affiliate of the Company,
unless the option exercise price is at least 110% of the fair market value of
the stock subject to the option on the date of grant, and the term of the option
does not exceed five years from the date of grant. In addition, the aggregate
fair market value, determined at the time of grant, of the shares of Common
Stock with respect to which incentive stock options are exercisable for the
first time by an optionee during any calendar year (under the Option Plan and
all other option plans of the Company and its affiliates) may not exceed
$100,000.
When the Company becomes subject to Section 162(m) of the Code (which denies
a deduction to publicly held corporations for certain compensation paid to
specified employees in a taxable year to the extent that the compensation
exceeds $1,000,000), no employee may be granted options under the Option Plan
covering more than 333,333 shares of Common Stock in any calendar year.
If there is any sale of all or substantially all of the Company's assets,
any merger, any reverse merger or any consolidation in which the Company is not
the surviving corporation, any surviving entity may assume or substitute for all
outstanding options under the Option Plan. If the surviving entity does not do
so, the vesting and exercisability of options held by persons still serving the
Company or an affiliate will be accelerated. However, if the Company and the
other party to such transaction agree that such transaction is to be treated as
a "pooling of interests" for financial reporting purposes, and if such
transaction in fact is so treated, then the accelerated vesting of options will
not occur to the extent that the Company's independent public accountants and
such other party's independent public accountants separately determine in good
faith that such acceleration would preclude the use of "pooling of interests"
accounting. In any event, all options will terminate if not exercised prior to
such sale of assets, merger, reverse merger or consolidation.
49
<PAGE>
If there is an acquisition by certain persons, entities or groups of 50% or
more of the Company's stock, then the exercisability and vesting of options held
by persons still serving the Company or an affiliate also will be accelerated
but the options will not automatically terminate if not exercised prior to such
acquisition (unless such options otherwise expire by their terms).
Generally, an optionee may not transfer an option other than by will or the
laws of descent or distribution. An optionee whose service to the Company and
its affiliates ceases for any reason (other than by death or permanent and total
disability) may exercise an option, as to vested shares, in the three-month
period following such cessation (unless such option expires sooner or later by
its terms). An optionee may exercise an option, as to vested shares, for up to
one year after the optionee's service to the Company and its affiliates ceases
due to death or disability (unless such option expires sooner or later by its
terms).
Shares subject to options that have expired or otherwise terminated without
having been exercised in full again become available for the grant of options
under the Option Plan.
As of September 30, 1998, 13,666 shares of Common Stock had been issued upon
the exercise of options granted under the Option Plan, options to purchase
2,311,758 shares of Common Stock were outstanding and 613,791 shares remained
available for future grant. The Option Plan will terminate in June 2008 unless
sooner terminated by the Board.
In addition, the Company has granted options outside of the Option Plan to
purchase 605,882 shares of Common Stock and as of September 30, 1998, all of
these shares were outstanding.
401(K) PLAN. In 1997, the Company established a defined contribution
retirement plan (the "401(k) Plan") covering all employees of the Company
meeting minimum age and service requirements. Pursuant to the 401(k) Plan,
employees may elect to reduce their current compensation by up to the lesser of
15% of their annual compensation or the statutorily prescribed annual limit
allowable under Internal Revenue Service Regulations and to have that amount
contributed to the 401(k) Plan. The 401(k) Plan permits, but does not require,
additional matching contributions by the Company on behalf of all participants
in the 401(k) Plan. The Company currently provides a matching contribution of
50% of an employee's contribution on an annual basis. Company matching
contributions vest 100% upon completion of two years of service by the employee.
The 401(k) Plan is intended to qualify under Section 401(k) of the Code so that
contributions to the 401(k) Plan by employees or by the Company, and the
investment earnings thereon, are not taxable to employees until withdrawn from
the 401(k) Plan, and that contributions by the Company will be deductible by the
Company when made. The trustee of the 401(k) Plan invests the assets of the
401(k) Plan at the direction of each participant based on certain investment
options.
INDEMNIFICATION AND LIMITATION OF DIRECTOR AND OFFICER LIABILITY
The Company's Restated Certificate of Incorporation limits the liability of
directors to the maximum extent permitted by Delaware law. Delaware law provides
that directors of a corporation will not be personally liable for monetary
damages for breach of their fiduciary duties as directors, except liability for
(i) any breach of their duty of loyalty to the corporation or its stockholders,
(ii) acts or omissions not in good faith or which involve intentional misconduct
or a knowing violation of law, (iii) unlawful payments of dividends or unlawful
stock repurchases or redemptions, or (iv) any transaction from which the
director derived an improper personal benefit. Such limitation of liability does
not apply to liabilities arising under the federal securities laws and does not
affect the availability of equitable remedies such as injunctive relief or
rescission.
The Company's Bylaws provide that the Company shall indemnify its directors
and officers and may indemnify its employees and other agents to the fullest
extent permitted by law. The Company's Bylaws also permit it to secure insurance
on behalf of any officer, director, employee or other agent for any liability
arising out of his or her actions in such capacity, regardless of whether the
Bylaws would permit
50
<PAGE>
indemnification. The Company has obtained officer and director liability
insurance with respect to liabilities arising out of certain matters, including
matters arising under the Securities Act.
The Company has entered into agreements to indemnify its directors and
executive officers, in addition to indemnification provided for in the Company's
Bylaws. These agreements, among other things, indemnify the Company's directors
and executive officers for certain expenses (including attorneys' fees),
judgments, fines and settlement amounts incurred by any such person in any
action or proceeding, including any action by or in the right of the Company
arising out of such person's services as a director or executive officer of the
Company, any subsidiary of the Company or any other company or enterprise to
which the person provides services at the request of the Company. The Company
believes that these provisions and agreements are necessary to attract and
retain qualified persons as directors and executive officers.
51
<PAGE>
CERTAIN TRANSACTIONS
TRANSACTIONS WITH TECH SQUARED, INC.
Joel A. Ronning is currently the Chairman of the Board of Directors of Tech
Squared, Inc. ("Tech Squared") and owns approximately 49% of Tech Squared's
outstanding Common Stock as of September 30, 1998. In December 1995, Mr. Ronning
issued an option to MacUSA, Inc., a wholly owned subsidiary of Tech Squared, to
purchase 3,200,000 shares of the Company's Common Stock held by him for $1.00.
The option is not transferable and is exercisable at any time through December
31, 2000. During the term of the option, Mr. Ronning has agreed to vote the
3,200,000 shares as directed by the Board of Directors of MacUSA, Inc. In
addition, MacUSA, Inc. has agreed to reimburse Mr. Ronning for any tax liability
that he may incur in connection with the transfer of the option or the shares of
Digital River stock issuable upon exercise thereunder. If MacUSA, Inc. exercises
its option to purchase Mr. Ronning's interest in Digital River, it will own
approximately 16.23% of the outstanding capital stock of the Company after the
completion of this offering. In addition, some of Mr. Ronning's time is spent
fulfilling his duties as Chairman of the Board of Directors of Tech Squared.
Mr. Reese, a director of the Company, is also President and Chief Operating
Officer of Tech Squared.
In fiscal 1997 and the nine months ended September 30, 1998, Tech Squared
provided office and warehouse space and certain administrative, financial and
software product fulfillment services for the Company. Charges for these
services totalled approximately $168,000 and $306,000 for fiscal 1997 and the
nine months ended September 30, 1998, respectively.
TRANSACTIONS WITH FUJITSU LIMITED
Fujitsu Limited ("Fujitsu"), which owns 13.1% of the outstanding capital
stock of the Company as of September 30, 1998, purchased 2,133,333 shares of
Common Stock for $800,000 pursuant to a Stock Purchase Agreement between the
Company and Fujitsu, dated August 1994 (the "Stock Purchase Agreement"). Under
the terms of the Stock Purchase Agreement and related agreements, Fujitsu
obtained certain rights and guarantees including, but not limited to the
following: a security interest in the Company's Common Stock held by Mr.
Ronning; covenants requiring Fujitsu's approval for certain major business
transactions and decisions; registration rights; right of first refusal on
future equity offerings of the Company; right to designate two members of the
Company's Board of Directors; a right of first refusal or an option to purchase
the Company's technology in the event of a bonafide third party offer or change
in control, respectively; and a perpetual, exclusive and royalty-free license to
use, develop, market and distribute certain encryption technologies, unrelated
to the current encryption technologies utilized by the Company relating to ESD,
in the Asia-Pacific region. Prior to the Modification Agreement (as defined
below), the covenants requiring Fujitsu's approvals for certain major business
transactions and decisions were to terminate in August 2001 and substantially
all other rights, with the exception of the registration rights and technology
license, were to terminate following an initial public offering or change in
control.
In December 1997, Fujitsu and the Company entered into the Fujitsu
Modification Agreement (the "Modification Agreement") pursuant to which, in
exchange for receiving 60,000 shares of Common Stock, Fujitsu agreed to
relinquish its rights under the Stock Purchase Agreement (the "Prior Rights")
except for the right to (i) designate, provided that Fujitsu's ownership
percentage in the Company is not less than 10% and the Company has not initiated
a public offering, one member to the Company's Board of Directors, (ii) retain
its prior registration rights and (iii) retain a perpetual, exclusive and
royalty-free license to use, develop, market and distribute certain encryption
technologies, unrelated to the current encryption technologies utilized by the
Company relating to ESD, in the Asia-Pacific region. In addition, pursuant to
the terms of the Modification Agreement, the Company and Mr. Ronning agreed to
execute and deliver a non-competition agreement. See "Management--Employment
Agreements."
52
<PAGE>
Mr. Thorin, a director of the Company, is also Vice President and General
Counsel of Fujitsu America, Inc., a subsidiary of Fujitsu.
TRANSACTIONS WITH CHRISTOPHER J. SHARPLES
Christopher J. Sharples, a director and stockholder of the Company, has
purchased, in the aggregate, 1,234,666 shares of Common Stock for an aggregate
purchase price of $3,704,000 or $3.00 per share. In addition, in February 1998,
Mr. Sharples and another stockholder (the "Sharples Team") entered into a
preliminary agreement with the Company (the "International Agreement") whereby
the Sharples Team will help establish and oversee the international operations
of the Company, to be based in the United Kingdom, for a term of three years. As
consideration for their services, Mr. Sharples and the other stockholder each
received a warrant issuable for 100,000 shares of Common Stock, at a purchase
price of $3.00 per share. The International Agreement also requires the Company
to designate Mr. Sharples as a member of the Company's Board of Directors.
TRANSACTIONS WITH WASSERSTEIN ADELSON VENTURES, L.P.
In April 1998, Wasserstein Adelson Ventures, L.P. ("Wasserstein") purchased
1,500,000 shares of Series A Preferred Stock from the Company at a purchase
price of $2.00 per share (which converted into 1,000,000 shares of Common Stock
upon consummation of the Company's initial public offering). In connection with
the purchase of the Series A Preferred Stock, the Company issued to Wasserstein
a warrant to purchase 50,000 shares of Common Stock at $3.00 per share. The
Warrant can be exercised immediately and expires in April 2003.
In connection with certain advisory services provided by Wasserstein to the
Company, the Company issued to Wasserstein a conditional warrant (the
"Conditional Warrant") that became exercisable as of the date of the Company's
initial public offering and expires on the fifth anniversary of the initial
public offering. The Conditional Warrant represents the right to purchase
100,000 shares of Common Stock at $3.00 per share.
Each of the above warrants contain provisions for the adjustment of the
exercise price and the aggregate number of shares issuable upon the exercise of
the warrant under certain circumstances including stock dividends, stock splits,
reorganizations, reclassifications and consolidations. Wasserstein is also
entitled to certain rights with respect to the registration of such shares
underlying the warrants under the Securities Act.
From January 1997 to July 1998, Mr. Steiner, the President and a director of
the Company, served as Vice President of Wasserstein Perella & Co., Inc. and
Wasserstein Perella Ventures, Inc., the general partner of Wasserstein.
TRANSACTION WITH JASC, INC.
In August 1998 Joel A. Ronning joined the Board of Directors of JASC, Inc.,
a privately-held software development company that was responsible for
approximately 11% of the Company's sales for the nine months ended September 30,
1998.
53
<PAGE>
OTHER TRANSACTIONS
Listed below are the directors, executive officers and five percent
stockholders who have acquired or have the right to acquire shares of the
Company's Common Stock or Series A Preferred Stock:
<TABLE>
<CAPTION>
SHARES OF
SHARES OF SERIES A
COMMON PREFERRED AGGREGATE
STOCK STOCK CONSIDERATION($)
------------ ---------- ---------------
<S> <C> <C> <C>
Tech Squared, Inc. (1)........................... 3,200,000 1
Fujitsu Limited (2).............................. 2,193,333 800,000
Wasserstein Adelson Ventures, L.P. (3)........... 150,000 1,500,000 3,001,250
Joel A. Ronning (1) (4).......................... 3,270,175 200,000
Robert E. Strawman............................... 2,666 7,600
Kelly J. Wical................................... 3,508 10,000
Draper M. Jaffray................................ 1,666 4,750
Gregory R.L. Smith............................... 2,733 7,403
Randy J. Womack.................................. 18,771 53,498
Thomas F. Madison................................ 33,333 95,000
Christopher J. Sharples (5)...................... 1,334,666 3,704,000
</TABLE>
- ------------------------
(1) Includes 3,200,000 shares of Common Stock which MacUSA, Inc., a wholly-owned
subsidiary of Tech Squared, has the right to acquire, at a purchase price of
$1.00, from Mr. Ronning pursuant to the terms of a stock option agreement
entered into between Mr. Ronning and MacUSA, Inc. in December 1995.
(2) Includes 60,000 shares of Common Stock received as part of the Modification
Agreement as consideration to Fujitsu Limited for relinquishing the Prior
Rights.
(3) Includes 50,000 shares of Common Stock issuable, at a purchase price of
$3.00 per share, pursuant to a warrant purchased for $750 and 100,000 shares
of Common Stock issuable, at a purchase price of $3.00 per share, pursuant
to a conditional warrant purchased for $500. The shares of Series A
Preferred Stock converted into 1,000,000 shares of Common Stock upon
consummation of the Company's initial public offering. See "Principal
Stockholders."
(4) The Company issued 3,200,000 shares of Common Stock to Mr. Ronning in August
1994 as consideration for rights to certain technology contributed to the
Company by Mr. Ronning.
(5) Includes 541,666, 166,666 and 526,333 shares of Common Stock registered in
the name of Latour Trustees (Jersey) Limited, Latour Trustees (Jersey)
Limited and Mark Henry Murray as Trustees of the Murray 1987 Settlement and
Wilbro Nominees Limited, respectively. Of the 541,666 shares of Common Stock
registered in the name of Latour Trustees (Jersey) Limited, 41,666 of such
shares are held by Mr. Sharples' wife. Of the 526,333 shares of Common Stock
registered in the name of Wilbro Nominees Limited, 5,000 of such shares are
held by Mr. Sharples' children. Also, includes 100,000 shares of Common
Stock issuable, at a purchase price of $3.00 per share, pursuant to a
warrant issued to Mr. Sharples as consideration for entering into the
International Agreement.
Certain holders of Common Stock are entitled to certain registration rights
with respect to the Common Stock issued or issuable upon conversion thereof. See
"Description of Capital Stock--Registration Rights."
The Company entered into indemnification agreements with its directors and
executive officers for the indemnification of and advancement of expenses to
such persons to the fullest extent permitted by law. The Company also intends to
execute such agreements with its future directors and executive officers.
54
<PAGE>
The Company believes that the foregoing transactions were in its best
interest and were made on terms no less favorable to the Company than could have
been obtained from unaffiliated third parties. All future transactions between
the Company and any of its officers, directors or principal stockholders will be
approved by a majority of the independent and disinterested members of the Board
of Directors, will be on terms no less favorable to the Company than could be
obtained from unaffiliated third parties and will be in connection with bona
fide business purposes of the Company.
55
<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information with respect to the
beneficial ownership of the Company's Common Stock as of November 20, 1998, and
as adjusted to reflect the sale of the shares of Common Stock offered hereby by
(i) each of the Company's Named Executive Officers, (ii) each of the Company's
directors, (iii) each stockholder who is known by the Company to own
beneficially more than 5% of the Company's Common Stock (iv) each stockholder of
the Company who is selling shares of Common Stock in this offering ("Selling
Stockholder") and (v) all current directors and executive officers as a group.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED PRIOR TO THE NUMBER OWNED AFTER THE
OFFERING (1) OF SHARES OFFERING (1)
----------------------- BEING -----------------------
BENEFICIAL OWNER NUMBER PERCENT OFFERED NUMBER PERCENT
- ---------------------------------------------------------- ---------- ----------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Joel A. Ronning (2) (3) .................................. 3,591,841 21.05% 70,000 3,321,841 18.57%
c/o Digital River, Inc.
9625 West 76th Street
Eden Prairie, Minnesota 55344
Tech Squared, Inc. (3) ................................... 3,200,000 19.12 200,000 3,000,000 16.03
5198 West 76th Street, Suite 220
Edina, Minnesota 55439
Fujitsu Limited .......................................... 2,193,333 13.10 -- 2,193,333 11.72
1-1 Kamikodanaka 4-Chome
Nakahara-Ku
Kawasaki 211 Japan
Christopher J. Sharples (4) .............................. 1,334,666 7.93 125,000 1,209,666 6.43
GNI Ltd.
25 Dowgate Hill
London EC4R 2GN
United Kingdom
Wasserstein Adelson Ventures, L.P. (5) ................... 1,150,000 6.81 100,000 1,050,000 5.57
31 West 52nd Street
New York New York 10019
Draper M. Jaffray (6) .................................... 41,732 * 8,000 33,732 *
Timothy C. Choate (7) .................................... 6,090 * -- 6,090 *
William Lansing (7) ...................................... 10,000 * -- 10,000 *
Thomas F. Madison (8) .................................... 93,532 * -- 93,532 *
Charles E. Reese, Jr. (9) ................................ 13,800 * 1,380 12,420 *
Perry W. Steiner (10) .................................... 275,000 1.62 20,000 255,000 1.34
J. Paul Thorin (11) ...................................... 17,800 * -- 17,800 *
All directors and executive officers as a group (14
persons) (12) .......................................... 5,457,906 30.96 245,380 5,212,526 26.76
Other Selling Stockholders (13) .......................... 3,146,207 19.49 704,620 2,585,651 14.24
</TABLE>
56
<PAGE>
- ------------------------
* Represents beneficial ownership of less than 1% of the outstanding shares
of the Company's Common Stock.
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to securities. Beneficial ownership also
includes shares of stock subject to options and warrants currently
exercisable or exercisable within 60 days of November 20, 1998. Percentage
of beneficial ownership is based on 16,739,254 shares of Common Stock
outstanding as of November 20, 1998 and 18,713,300 shares of Common Stock
outstanding after the completion of this offering.
(2) Includes 321,666 shares Mr. Ronning has the right to acquire pursuant to
options exercisable within 60 days of November 20, 1998, 70,000 of which
will be exercised and sold in connection with the offering.
(3) Includes 3,200,000 shares MacUSA, Inc., a wholly-owned subsidiary of Tech
Squared, has the right to acquire from Mr. Ronning pursuant to a stock
option agreement entered into between Mr. Ronning and MacUSA, Inc. in
December 1995, 200,000 of which will be exercised and sold in connection
with the offering. During the term of the option, Mr. Ronning has agreed to
vote such 3,200,000 shares at the discretion of MacUSA, Inc.
(4) Includes 541,666, 166,666 and 526,333 shares registered in the name of
Latour Trustees (Jersey) Limited, Latour Trustees (Jersey) Limited and Mark
Henry Murray as Trustees of the Murray 1987 Settlement and Wilbro Nominees
Limited, respectively. Of the 541,666 shares of Common Stock registered in
the name of Latour Trustees (Jersey) Limited, 41,666 of such shares are
held by Mr. Sharples' wife. Of the 526,333 shares of Common Stock
registered in the name of Wilbro Nominees Limited, 5,000 of such shares are
held by Mr. Sharples' children. Also includes 100,000 shares Mr. Sharples
has the right to acquire pursuant to a warrant exercisable within 60 days
of November 20, 1998.
(5) Includes 50,000 shares Wasserstein Adelson Ventures, L.P. has the right to
acquire pursuant to a warrant exercisable within 60 days and 100,000 shares
issuable to Wasserstein Adelson Ventures, L.P. pursuant to a warrant which
became exercisable upon the completion of the Company's initial public
offering.
(6) Includes 40,066 shares issuable upon exercise of options exercisable within
60 days of November 20, 1998, 8,000 of which will be exercised and sold in
connection with the offering.
(7) Includes 5,000 shares issuable upon exercise of options exercisable within
60 days of November 20, 1998.
(8) Includes 55,200 shares issuable upon exercise of options exercisable within
60 days of November 20, 1998.
(9) Includes 13,800 shares issuable upon exercise of options exercisable within
60 days of November 20, 1998.
(10) Includes 137,500 shares issuable upon exercise of options exercisable
within 60 days of November 20, 1998, 20,000 of which will be exercised and
sold in connection with the offering, and 137,500 shares issuable to Mr.
Steiner pursuant to an option which is exercisable upon the earlier of (i)
the occurrence of certain events related to Mr. Steiner's relocation or
(ii) on the third anniversary of his first day of employment. Subsequent
to accepting employment with the Company in July 1998, Mr. Steiner
submitted his resignation to Wasserstein Perella & Co., Inc. and
Wasserstein Perella Ventures, Inc., the general partner of Wasserstein
Adelson Ventures, L.P. Mr. Steiner disclaims beneficial ownership of the
shares held by Wasserstein Adelson Ventures, L.P. except to the extent of
his pecuniary interest therein.
57
<PAGE>
(11) Includes 13,800 shares issuable upon exercise of options exercisable
within 60 days of November 20, 1998.
(12) Includes the following executive officers and the shares to be sold by
such executive officers in the offering: Gregory R. L. Smith (7,000) and
Kelly Wical (14,000). Also includes 787,198 shares issuable upon exercise
of options exercisable within 60 days of November 20, 1998, of which an
aggregate of 120,380 will be exercised and sold in connection with the
offering, and 100,000 shares subject to exercisable warrants.
(13) Includes the following stockholders and the shares to be sold by such
stockholders in the offering: Avid Investments Limited (9,000), Ryan
Leslie Cornelius (18,000), Kevin Dammen (3,000), William DeBroe nominee
(13,467), Richard Fossett (5,859), Todd Frostad (4,000), Gabelli
Securities, Inc. (8,333), Gallic Shipping Limited (15,000), Genesis
Capital Fund, L.P. (75,000), James R. Gibson-Fleming (3,333), Charles
Anthony Good (20,000), Paul Graf (11,666), Charles House (1,000), Mark
Hubbard (80,000), Perronelle Hudleston (2,333), Insight Holdings Ltd.
(9,000), William B. Knowles (15,000), Latour Trustees (Jersey) Ltd.
(6,666), Latour Trust Company Ltd. (60,000), Leboc Trust (35,000), MSS
Nominees Limited (32,999), Simon C. Murphy in trust for Anna Murphy
(1,276), Simon C. Murphy in trust for Christopher Murphy (1,281), Simon C.
Murphy in trust for David Murphy (1,276), Ronald Nazely (10,614), Novelty
Investments Limited (9,000), Ronald Henry Ronning (14,034), John Rundall
(4,733), Firdaus Ruttonsha (15,000), Sean Ryan (4,000), Sebastian
Sainsbury (13,000), Susannah Seely (1,000), Walter H. Sullivan, III
(50,000), Anita Taylor (41,250), VMR High Octane Fund (48,000), Allison &
Ian Wright (4,500), Zaphiriou Zarifi Overseas Equities, Inc. (35,000) and
Zeta Holding Limited (22,000). Of the shares beneficially owned prior to
the offering, 144,064 are issuable upon exercise of options and warrants
exercisable within 60 days of November 20, 1998, 103,666 of which will be
exercised and sold in connection with the offering.
58
<PAGE>
DESCRIPTION OF CAPITAL STOCK
Upon the closing of this offering, the authorized capital stock of the
Company will consist of 45,000,000 shares of Common Stock, par value $0.01 per
share, and 5,000,000 shares of Preferred Stock, par value $0.01 per share
("Preferred Stock").
COMMON STOCK
As of September 30, 1998, there were 16,734,047 shares of Common Stock
outstanding held of record by 132 stockholders.
The holders of Common Stock are entitled to one vote for each share held of
record on all matters submitted to a vote of the stockholders. Subject to
preferences that may be applicable to any outstanding shares of the Preferred
Stock, the holders of Common Stock are entitled to receive ratably such
dividends as may be declared by the Board of Directors out of funds legally
available therefor. See "Dividend Policy." In the event of a liquidation,
dissolution, or winding up of the Company, holders of the Common Stock are
entitled to share ratably in all assets remaining after payment of liabilities.
Holders of Common Stock have no preemptive rights and no right to convert their
Common Stock into any other securities. There are no redemption or sinking fund
provisions applicable to the Common Stock. All outstanding shares of Common
Stock are, and all shares of Common Stock to be outstanding upon the completion
of this offering will be, fully paid and non-assessable.
PREFERRED STOCK
Pursuant to the Restated Certificate, the Board of Directors has the
authority, without further action by the stockholders, to issue up to 5,000,000
shares of Preferred Stock, $0.01 par value, in one or more series and to fix the
designations, powers, preferences, privileges, and relative participating,
optional, or special rights and the qualifications, limitations, or restrictions
thereof, including dividend rights, conversion rights, voting rights, terms of
redemption and liquidation preferences, any or all of which may be greater than
the rights of the Common Stock. The Board of Directors, without stockholder
approval, can issue Preferred Stock with voting, conversion, or other rights
that could adversely affect the voting power and other rights of the holders of
Common Stock. Preferred Stock could thus be issued with terms calculated to
delay or prevent a change in control of the Company or make removal of
management more difficult. Additionally, the issuance of Preferred Stock may
have the effect of decreasing the market price of the Common Stock, and may
adversely affect the voting and other rights of the holders of Common Stock.
There are no shares of Preferred Stock outstanding and the Company has no
current plans to issue any of the Preferred Stock.
WARRANTS
As of September 30, 1998, the Company had outstanding warrants to purchase
an aggregate of 803,008 shares of the Company's Common Stock at exercise prices
ranging from $1.13 to $3.00 per share. The warrants expire at various times
ranging from December 2001 to May 2003. Generally, each warrant contains
provisions for the adjustment of the exercise price and the aggregate number of
shares issuable upon the exercise of the warrant under certain circumstances,
including stock dividends, stock splits, reorganizations, reclassifications,
consolidations and certain dilutive issuances of securities at prices below the
then existing warrant exercise price. All warrants are currently exercisable.
REGISTRATION RIGHTS
Pursuant to agreements between the Company and the holders (or their
permitted transferees) ("Holders") of approximately 7,065,256 shares of Common
Stock and warrants to purchase 376,084 shares of Common Stock, the Holders are
entitled to certain rights with respect to the registration of such shares under
the Securities Act. If the Company proposes to register its Common Stock under
the Securities Act,
59
<PAGE>
subject to certain exceptions, the Holders are entitled to notice of the
registration and are entitled at the Company's expense to include such shares
therein, provided that the managing underwriters have the right to limit the
number of such shares included in the registration. In addition, certain of the
Holders may require the Company, at its expense, on no more than one occasion,
to file a registration statement under the Securities Act with respect to their
shares of Common Stock. Such rights may not be exercised until February 9, 1999.
Further, Holders may require the Company, once every 12 months and at the
Company's expense, to register the shares on Form S-3 when such form becomes
available to the Company, subject to certain conditions and limitations.
DELAWARE LAW AND CERTAIN CHARTER PROVISIONS
The Company is subject to the provisions of Section 203 of the Delaware
General Corporation Law, an anti-takeover law. In general, the statute prohibits
a publicly-held Delaware corporation from engaging in a "business combination"
with an "interested stockholder" for a period of three years after the date of
the transaction in which the person became an interested stockholder, unless the
business combination is approved in a prescribed manner. For purposes of Section
203, a "business combination" includes a merger, asset sale or other transaction
resulting in a financial benefit to the interested stockholder, and an
"interested stockholder" is a person who, together with affiliates and
associates, owns (or within three years prior, did own) 15% or more of the
corporation's voting stock.
The Company's Restated Certificate of Incorporation and Bylaws also require
that, effective upon the closing of this offering, any action required or
permitted to be taken by stockholders of the Company must be effected at a duly
called annual or special meeting of the stockholders and may not be effected by
a consent in writing. In addition, special meetings of the stockholders of the
Company may be called only by the Board of Directors, the Chairman of the Board
or the Chief Executive Officer of the Company. The Company's Restated
Certificate of Incorporation also provides for the classification of the Board
of Directors into three classes, only one of which will be elected at each
annual meeting, and specifies that the authorized number of directors may be
changed only by resolution of the Board of Directors. These provisions, which
require the vote of stockholders holding at least two-thirds of the outstanding
shares to amend, may have the effect of deterring hostile takeovers or delaying
changes in control or management of the Company. See "Management--Board
Composition."
TRANSFER AGENT AND REGISTRAR
Norwest Bank Minnesota, N.A. is the transfer agent and registrar for the
Company's Common Stock.
60
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon the completion of this offering, the Company will have outstanding
18,713,300 shares of Common Stock, based on the number of shares of Common Stock
outstanding as of November 20, 1998, assuming (i) the issuance by the Company of
an aggregate of 1,750,000 shares of Common Stock, (ii) the exercise of 224,046
options, warrants or other obligations in connection with this offering and
(iii) no exercise of the Underwriters' over-allotment option to purchase 450,000
shares of Common Stock, except as otherwise noted. The 3,000,000 shares sold in
this offering will be freely tradable without restriction under the Securities
Act. Of the shares outstanding upon completion of the offering, 12,260,106
shares of Common Stock held by existing stockholders are restricted securities
in that they may be sold in the public market only if registered or if they
qualify for an exemption from registration under the Securities Act or Rules
144, 144(k) or 701 or Regulation S as promulgated under the Securities Act.
Holders, including all officers and directors, of 3,961,306 shares of the
Company's Common Stock and an additional 462,510 shares issuable upon exercise
of warrants and vested options have agreed with the representatives of the
Underwriters, subject to certain exceptions, not to offer, pledge, sell,
contract to sell, sell any option or contract to purchase, purchase any option
or contract to sell, grant any option, right or warrant to purchase, or
otherwise transfer or dispose of, directly or indirectly, any shares of Common
Stock or any securities convertible into or exercisable or exchangeable for
Common Stock (whether such shares or any such securities are then owned by such
person or are thereafter acquired directly from the Company), or to enter into
any swap or similar arrangement that transfers, in whole or in part, the
economic risks of ownership of the Common Stock, without the prior written
consent of BT Alex. Brown Incorporated for a period of 180 days after the date
of the Company's initial public offering on August 11, 1998, and holders of
7,772,072 shares of the Company's Common Stock and an additional 699,785 shares
issuable upon exercise of warrants and vested options have agreed to the same
sale restrictions for a period of 90 days after the date of this Prospectus (the
"Lock-Up Agreements"). As a result of such contractual restrictions and the
provisions of Rule 144 or Regulation S, additional shares will be available for
sale in the public market, subject to presentation of evidence satisfactory to
the Company, including an opinion of counsel acceptable to the Company, that
such sales may be made without registration pursuant to the Securities Act as
follows: (i) 425,543 shares of Common Stock currently outstanding will be
available for sale into the public market following the effectiveness of this
Registration Statement; (ii) 2,293,438 shares of Common Stock currently
outstanding and 46,469 shares of Common Stock issuable upon exercise of
currently outstanding options will be eligible for sale on February 9, 1999;
(iii) 7,855,883 shares of Common Stock currently outstanding and 519,917 shares
of Common Stock issuable upon exercise of currently outstanding options will be
eligible for sale 91 days after the date of this Prospectus; and (iv) the
remainder of the restricted securities will be eligible for sale from time to
time thereafter upon expiration of their respective one-year holding periods.
In general, under Rule 144 as currently in effect, beginning 90 days after
the date of this Prospectus, any holder, including an affiliate of the Company,
of restricted securities as to which at least one year has elapsed since the
later of the date of the holder's acquisition of such shares from the Company or
from an affiliate, would be entitled within any three-month period to sell a
number of shares that does not exceed the greater of 1% of the then outstanding
shares of Common Stock (approximately 187,133 shares immediately after the
closing of this offering assuming no exercise of the Underwriters'
over-allotment option) or the average weekly trading volume of the Common Stock
on the Nasdaq National Market during the four calendar weeks preceding the date
on which notice of the sale is filed with the Commission. Sales under Rule 144
are subject to certain requirements relating to manner of sale, notice and
availability of current public information about the Company. However, a person
(or persons whose shares are aggregated) who is not deemed to have been an
affiliate of the Company at any time during the 90 days immediately preceding
the sale and who beneficially owns restricted securities is entitled to sell
such shares under Rule 144(k) without regard to the limitations described above,
provided that at least two years have elapsed since the later of the date the
shares were acquired from the Company or from an affiliate of the
61
<PAGE>
Company. The foregoing is a summary of Rule 144 and is not intended to be a
complete description of that rule.
Subject to certain limitations on the aggregate offering price of a
transaction and other conditions, Rule 701 may be relied upon with respect to
the resale of securities originally purchased from the Company by its employees,
directors, officers, consultants or advisers prior to the closing of the
Company's initial public offering, pursuant to written compensatory benefit
plans or written contracts relating to the compensation of such persons. In
addition, the Commission has indicated that Rule 701 will apply to stock options
granted by the Company before the initial public offering, along with the shares
acquired upon exercise of such options. Securities issued in reliance on Rule
701 are deemed to be restricted securities and, beginning 90 days after the date
of the Company's initial public offering (unless subject to the contractual
restrictions described above), may be sold by persons other than affiliates,
subject only to the manner of sale provisions of Rule 144 and by affiliates
under Rule 144 without compliance with its one-year minimum holding period
requirements.
The Company has filed a registration statement on Form S-8 under the
Securities Act covering shares of Common Stock reserved for issuance under the
1998 Stock Option Plan and also shares of Common Stock issuable upon exercise of
options granted outside the 1998 Stock Option Plan. See "Management-- Employee
Benefit Plans." Accordingly, shares registered under such registration statement
are, subject to limitations applicable to affiliates of the Company, available
for sale in the open market, unless such shares are subject to vesting
restrictions with the Company or other contractual lock-up restrictions. As of
November 20, 1998, an aggregate of 5,668 shares of Common Stock had been issued
upon exercise of options under the Company's option plans subsequent to the
Company's initial public offering, and options to purchase additional shares of
Common Stock were issued and outstanding. See "Management-- Employee Benefit
Plans."
There can be no assurance that an active public market for the Common Stock
will continue after this offering or that the market price of the Common Stock
will not decline below the public offering price. Future sales of substantial
amounts of Common Stock in the public market could adversely affect market
prices prevailing from time to time. As described herein, only a limited number
of shares will be available for sale shortly after this offering because of
certain contractual and legal restrictions on resale. Sales of substantial
amounts of Common Stock of the Company in the public market after the
restrictions lapse could adversely affect the prevailing market price and the
ability of the Company to raise equity capital in the future.
62
<PAGE>
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement (the
"Underwriting Agreement"), the underwriters named below (the "Underwriters"),
through their representatives BT Alex. Brown Incorporated, BancBoston Robertson
Stephens Inc. and Bear, Stearns & Co. Inc. (the "Representatives"), have
severally agreed to purchase from the Company the following respective numbers
of shares of Common Stock at the public offering price less the underwriting
discounts set forth on the cover page of this Prospectus.
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
----------
<S> <C>
BT Alex. Brown Incorporated......................................................
BancBoston Robertson Stephens Inc................................................
Bear, Stearns & Co. Inc..........................................................
----------
Total.......................................................................... 3,000,000
----------
----------
</TABLE>
The Underwriting Agreement provides that the obligations of the Underwriters
are subject to certain conditions precedent and that the Underwriters will
purchase all of the shares of Common Stock offered hereby if any of such shares
are purchased.
Digital River and the Selling Stockholders have been advised by the
Representatives that the Underwriters propose to offer the shares of Common
Stock to the public at the public offering price set forth on the cover page of
this Prospectus and to certain dealers at such price less a concession not in
excess of $ per share. The Underwriters may allow, and such dealers may
re-allow, a concession not in excess of $ per share to certain other dealers.
After the public offering, the offering price and other selling terms may be
changed by the Representatives.
The Company has granted the Underwriters an option, exercisable not later
than 30 days after the date of this Prospectus, to purchase up to 450,000
additional shares of Common Stock at the public offering price less the
underwriting discounts and commissions set forth on the cover page of this
Prospectus. To the extent that the Underwriters exercise such option, each of
the Underwriters will have a firm commitment to purchase approximately the same
percentage thereof that the number of shares of Common Stock to be purchased by
it in the above table bears to 3,000,000, and the Company will be obligated,
pursuant to the option to sell such shares to the Underwriters. The Underwriters
may exercise such option only to cover over-allotments made in connection with
the sale of the Common Stock offered hereby. If purchased, the Underwriters will
offer such additional shares on the same terms as those on which the 3,000,000
shares are being offered.
The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act.
Each of the officers and directors and certain stockholders of the Company,
holding in the aggregate 7,772,072 shares of Common Stock, have agreed not to
offer, sell, contract to sell or otherwise dispose of (or enter into any
transaction which is designed to, or could be expected to, result in the
disposition of any portion of) any Common Stock for a period of 90 days after
the date of the Company's public offering, without the prior written consent of
BT Alex. Brown Incorporated. Such consent may be given at any time without
public notice. The Company has entered into a similar agreement, except that it
may issue, and grant options or warrants to purchase, shares of Common Stock or
any securities convertible into, exercisable for or exchangeable for shares of
Common Stock, pursuant to the exercise of outstanding options and warrants and
the Company's issuance of options and stock granted under the existing stock and
stock purchase plans.
The Representatives have advised the Company that the Underwriters do not
intend to confirm sales to any account over which they exercise discretionary
authority.
63
<PAGE>
The Representatives have advised the Company that, pursuant to Regulation M
under the Securities Exchange Act of 1934, as amended, certain persons
participating in the offering may engage in transactions, including stabilizing
bids, syndicate covering transactions and the imposition of penalty bids, which
may have the effect of stabilizing or maintaining the market price of the Common
Stock at a level above that which might otherwise prevail in the open market. A
"stabilizing bid" is a bid for or the purchase of the Common Stock on behalf of
the Underwriters for the purpose of fixing or maintaining the price of the
Common Stock. A "syndicate covering transaction" is the bid for or the purchase
of the Common Stock on behalf of the Underwriters to reduce a short position
incurred by the Underwriters in connection with the offering. A "penalty bid" is
an arrangement permitting the Representatives to reclaim the selling concession
otherwise accruing to an Underwriter or syndicate member in connection with the
offering if the Common Stock originally sold by such Underwriter or syndicate
member is purchased by the Representatives in a syndicate covering transaction
and has therefore not been effectively placed by such Underwriter or syndicate
member. The Representatives have advised the Company that such transactions may
be effected on the Nasdaq National Market or otherwise and, if commenced, may be
discontinued at any time.
In connection with this offering, certain Underwriters and selling group
members (if any) who are qualified market makers on the Nasdaq National Market
may engage in passive market making transactions in the Common Stock on the
Nasdaq National Market in accordance with Rule 103 of Regulation M under the
Securities Exchange Act of 1934, as amended, during the business day prior to
the pricing of the offering before the commencement of offers or sales of the
Common Stock. Passive market makers must comply with applicable volume and price
limitations and must be identified as such. In general, a passive market maker
must display its bid at a price not in excess of the highest independent bid of
such security; if all independent bids are lowered below the passive market
maker's bid, however, such bid must then be lowered when certain purchase limits
are exceeded.
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed upon for the
Company by Cooley Godward LLP, San Francisco and Palo Alto, California. Certain
legal matters related to the offering will be passed upon for the Underwriters
by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto,
California. As of the date of this prospectus, a member of Cooley Godward LLP
beneficially owns 1,500 shares of the Company's Common Stock.
EXPERTS
The financial statements of the Company as of December 31, 1996 and 1997,
and for each of the years in the three year period ended December 31, 1997
included in this Prospectus and elsewhere in the Registration Statement have
been audited by Arthur Andersen LLP, independent public accountants, as
indicated in their report with respect thereto, and are included herein in
reliance upon the authority of said firm as experts in giving said report.
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission"), Washington, D.C. 20549, a Registration Statement on Form S-1
under the Securities Act with respect to the shares of Common Stock offered
hereby. This Prospectus does not contain all the information set forth in the
Registration Statement and the exhibits and schedules thereto. For further
information with respect to the Company and such Common Stock, reference is made
to the Registration Statement and to the exhibits and schedules filed therewith.
Statements contained in this Prospectus as to the contents of any contract or
other document referred to are not necessarily complete, and in each instance
reference is made to the copy of such contract or other document filed as an
exhibit to the Registration Statement, each such statement being qualified in
all respects by such reference. A copy of the Registration Statement may be
64
<PAGE>
inspected by anyone without charge at the Commission's principal office in
Washington, D.C., and copies of all or any part of the Registration Statement
may be obtained from the Public Reference Section of the Commission, 450 Fifth
Street, N.W., Washington, D.C. 20549, upon payment of certain fees prescribed by
the Commission. The Commission also maintains a World Wide Web site that
contains reports, proxy and information statements and other information
regarding registrants, such as the Company, that file electronically with the
Commission. The address of the site is http://www.sec.gov.
65
<PAGE>
DIGITAL RIVER, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants.................................. F-2
Consolidated Balance Sheets as of December 31, 1996, 1997 and September
30, 1998 (unaudited).................................................... F-3
Consolidated Statements of Operations for the years ended December 31,
1995, 1996, 1997 and for the nine months ended September 30, 1997 and
1998 (unaudited)........................................................ F-4
Consolidated Statements of Stockholders' Equity (Deficit) for the years
ended December 31, 1995, 1996, 1997 and for the nine months ended
September 30, 1998 (unaudited).......................................... F-5
Consolidated Statements of Cash Flows for the years ended December 31,
1995, 1996, 1997 and for the nine months ended September 30, 1997 and
1998 (unaudited)........................................................ F-6
Notes to Consolidated Financial Statements................................ F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Digital River, Inc.:
We have audited the accompanying consolidated balance sheets of Digital
River, Inc. and Subsidiaries as of December 31, 1996 and 1997, and the related
consolidated statements of operations, stockholders' equity (deficit) and cash
flows for each of the three years in the period ended December 31, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Digital River, Inc. and
Subsidiaries as of December 31, 1996 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota,
March 6, 1998 (except with respect to
the reverse stock split described
in Note 3, as to which the date is July 14, 1998)
F-2
<PAGE>
DIGITAL RIVER, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
-------------- SEPTEMBER 30,
1996 1997 1998
------ ------ -------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 800 $2,126 $19,411
Short-term investments.................................... -- -- 8,840
Accounts receivable, net allowance of $0, $20 and $45..... 4 94 1,008
Prepaid expenses and other................................ 5 100 464
------ ------ -------------
Total current assets.................................... 809 2,320 29,723
------ ------ -------------
Property and equipment:
Property and equipment.................................... 115 1,035 3,543
Accumulated depreciation.................................. (8) (132) (409)
------ ------ -------------
Net property and equipment.............................. 107 903 3,134
Other assets................................................ 286 182 104
------ ------ -------------
Total assets............................................ $1,202 $3,405 $32,961
------ ------ -------------
------ ------ -------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Convertible debentures.................................... $ 998 $ -- $--
Accounts payable.......................................... 112 720 2,655
Accrued payroll........................................... 30 197 622
Due to related party...................................... 67 46 22
Other accrued liabilities................................. 53 113 317
------ ------ -------------
Total current liabilities............................... 1,260 1,076 3,616
------ ------ -------------
Commitments and contingencies (Note 6)
Stockholders' equity (deficit):
Preferred stock, $.01 par value; 5,000,000 shares
authorized; no shares issued and outstanding............ -- -- --
Common stock, $.01 par value; 45,000,000 shares
authorized; 5,333,333, 9,241,881 and 16,734,047 shares
issued and outstanding.................................. 53 92 167
Additional paid-in capital................................ 729 6,562 44,415
Deferred compensation..................................... -- -- (1,620)
Accumulated deficit....................................... (840) (4,325) (13,617)
------ ------ -------------
Total stockholders' equity (deficit).................... (58) 2,329 29,345
------ ------ -------------
Total liabilities and stockholders' equity
(deficit)........................................... $1,202 $3,405 $32,961
------ ------ -------------
------ ------ -------------
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
F-3
<PAGE>
DIGITAL RIVER, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
------------------------------- ------------------------
1995 1996 1997 1997 1998
--------- --------- --------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Sales......................................... $ -- $ 111 $ 2,472 $ 1,144 $ 11,504
Cost of sales................................. -- 95 2,052 940 9,610
--------- --------- --------- ----------- -----------
Gross profit................................ -- 16 420 204 1,894
--------- --------- --------- ----------- -----------
Operating expenses:
Sales and marketing......................... 3 68 1,501 875 6,538
Product development and operations.......... 130 230 1,528 945 2,903
General and administrative.................. 32 415 929 527 2,164
--------- --------- --------- ----------- -----------
Total operating expenses.................. 165 713 3,958 2,347 11,605
--------- --------- --------- ----------- -----------
Loss from operations.......................... (165) (697) (3,538) (2,143) (9,711)
Interest income, net...................... 22 8 53 45 419
--------- --------- --------- ----------- -----------
Net loss...................................... $ (143) $ (689) $ (3,485) $ (2,098) $ (9,292)
--------- --------- --------- ----------- -----------
--------- --------- --------- ----------- -----------
Basic and diluted net loss per share.......... $ (0.03) $ (0.13) $ (0.46) $ (0.30) $ (0.74)
--------- --------- --------- ----------- -----------
--------- --------- --------- ----------- -----------
Basic and diluted weighted average common
shares outstanding.......................... 5,333 5,333 7,514 7,098 12,484
--------- --------- --------- ----------- -----------
--------- --------- --------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
DIGITAL RIVER, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS)
<TABLE>
<CAPTION>
TOTAL
PREFERRED STOCK COMMON STOCK STOCKHOLDERS'
----------------- -------------------- PAID-IN DEFERRED ACCUMULATED EQUITY
SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION DEFICIT (DEFICIT)
--------- ------ ----------- ------ ------- ------------ ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1994......... -- $-- 5,333 $ 53 $ 725 $-- $ (8) $ 770
Net loss......................... -- -- -- -- -- -- (143) (143)
--------- ------ ----------- ------ ------- ------------ ----------- -------------
Balance, December 31, 1995......... -- -- 5,333 53 725 -- (151) 627
Issuance of warrant in exchange
for financing services......... -- -- -- -- 4 -- -- 4
Net loss......................... -- -- -- -- -- -- (689) (689)
--------- ------ ----------- ------ ------- ------------ ----------- -------------
Balance, December 31, 1996......... -- -- 5,333 53 729 -- (840) (58)
Convertible debentures exchanged
for common stock............... -- -- 1,018 10 987 -- -- 997
Sales of common stock............ -- -- 2,831 28 4,746 -- -- 4,774
Common stock issued in Fujitsu
agreement...................... -- -- 60 1 100 -- -- 101
Net loss......................... -- -- -- -- -- -- (3,485) (3,485)
--------- ------ ----------- ------ ------- ------------ ----------- -------------
Balance, December 31, 1997......... -- -- 9,242 92 6,562 -- (4,325) 2,329
Sales of common stock
(unaudited).................... -- -- 6,492 65 32,459 -- -- 32,524
Sales of preferred stock
(unaudited).................... 1,500 15 -- -- 2,810 -- -- 2,825
Conversion of preferred stock to
common stock (unaudited)....... (1,500 ) (15) 1,000 10 5 -- -- --
Deferred compensation related to
stock options and warrants
(unaudited).................... -- -- -- -- 2,579 (2,579) -- --
Deferred compensation expense
(unaudited).................... -- -- -- -- -- 959 -- 959
Net loss (unaudited)............. -- -- -- -- -- -- (9,292) (9,292)
--------- ------ ----------- ------ ------- ------------ ----------- -------------
Balance, September 30, 1998
(unaudited)...................... -- $-- 16,734 $167 $44,415 $(1,620) $(13,617) $29,345
--------- ------ ----------- ------ ------- ------------ ----------- -------------
--------- ------ ----------- ------ ------- ------------ ----------- -------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
DIGITAL RIVER, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
------------------------------- ------------------------
1995 1996 1997 1997 1998
--------- --------- --------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Operating activities:
Net loss............................................ $ (143) $ (689) $ (3,485) $ (2,098) $ (9,292)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization..................... 5 35 195 112 439
Deferred compensation expense..................... -- -- -- -- 959
Common stock granted to Fujitsu................... -- -- 101 -- --
Change in operating assets and liabilities;
Accounts receivable and prepaid expenses........ 1 (9) (184) (128) (1,278)
Accounts payable................................ (9) 108 607 380 1,935
Accrued payroll and other accrued liabilities... 4 79 227 103 629
Due to related party............................ -- 67 (21) (4) (24)
--------- --------- --------- ----------- -----------
Net cash used in operating activities......... (142) (409) (2,560) (1,635) (6,632)
--------- --------- --------- ----------- -----------
Investing activities:
Purchases of short-term investments................. -- -- -- -- (10,840)
Proceeds from sales of short-term investments....... -- -- -- -- 2,000
Purchases of equipment.............................. (9) (105) (920) (783) (2,548)
Patent acquisition costs............................ (41) (28) (64) (60) (44)
--------- --------- --------- ----------- -----------
Net cash used in investing activities......... (50) (133) (984) (843) (11,432)
--------- --------- --------- ----------- -----------
Financing activities:
Sales of preferred and common stock................. -- -- 4,774 3,300 35,393
Proceeds from convertible debentures................ -- 998 147 147 --
Payment of debt issuance costs and other............ -- (143) (51) -- (44)
--------- --------- --------- ----------- -----------
Net cash provided by financing activities..... -- 855 4,870 3,447 35,349
--------- --------- --------- ----------- -----------
Net increase (decrease) in cash and cash
equivalents......................................... (192) 313 1,326 969 17,285
Cash and cash equivalents,
beginning of period................................. 679 487 800 800 2,126
--------- --------- --------- ----------- -----------
Cash and cash equivalents, end of period.............. $ 487 $ 800 $ 2,126 $ 1,769 $ 19,411
--------- --------- --------- ----------- -----------
--------- --------- --------- ----------- -----------
Noncash investing and financing activities:
Convertible debentures exchanged for common stock,
net of direct costs............................... $ -- $ -- $ 998 $ 998 $ --
--------- --------- --------- ----------- -----------
--------- --------- --------- ----------- -----------
Preferred stock converted to common stock........... $ -- $ -- $ -- $ -- $ 2,825
--------- --------- --------- ----------- -----------
--------- --------- --------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE>
DIGITAL RIVER, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1997
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Digital River, Inc., a Delaware corporation, and its wholly owned
subsidiaries (collectively, the Company) have developed a technology platform
that allows it to provide a suite of electronic commerce services to its
software publisher and online retailer clients, including electronic software
delivery. Through contractual relationships with software publishers and online
retailers, the Company offers software products for sale via the Internet.
The Company was incorporated in February 1994, and was considered a
development stage company through August 1996. The Company conducted its first
online sale through a clients' Web store in August 1996 and is still in the
early stages of development. The Company has experienced significant losses
since inception and has experienced significant negative cash flows from
operations. The Company anticipates that operating expenses will continue to
increase, resulting in continuing net losses and negative cash flows from
operations for the foreseeable future.
The Company's prospects must be considered in light of the risks frequently
encountered by companies in their early stage of development, particularly
companies in new and rapidly evolving markets such as electronic commerce. To
address these risks, the Company must, among other things, maintain existing and
develop new relationships with independent software publishers and online
retailers, maintain and increase its client base, implement and successfully
execute its business and marketing strategy, continue to develop and upgrade its
technology and transaction-processing systems, provide superior customer service
and order fulfillment, respond to competitive developments, and attract, retain
and motivate qualified personnel. There can be no assurance that the Company
will be successful in addressing such risks, and the failure to do so could have
a material adverse effect on the Company's business, financial condition and
results of operations.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Digital River,
Inc. and its wholly owned subsidiaries. All intercompany balances and
transactions have been eliminated in consolidation.
INTERIM FINANCIAL STATEMENTS
The consolidated balance sheet as of September 30, 1998 and the related
consolidated statements of operations and cash flows for the nine months ended
September 30, 1997 and 1998, and the consolidated statement of stockholders'
equity (deficit) for the nine months ended September 30, 1998 are unaudited.
Such unaudited statements have been prepared on the same basis as the audited
consolidated financial statements and in the opinion of management include all
adjustments (consisting of only normal recurring adjustments) necessary for the
fair presentation of the results for the interim periods presented. The results
of operations for the unaudited nine months ended September 30, 1998 are not
necessarily indicative of the results that may be expected for the entire 1998
fiscal year.
CASH AND CASH EQUIVALENTS
The Company considers all short-term, highly liquid investments, primarily
high grade commercial paper and money market accounts, that are readily
convertible into known amounts of cash and that have original maturities of
three months or less to be cash equivalents.
F-7
<PAGE>
DIGITAL RIVER, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1997
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(CONTINUED)
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
(CONTINUED)
SHORT-TERM INVESTMENTS
At September 30, 1998, short-term investments represent U.S. government
treasury bills and high grade commercial paper maturing in less than one year
and classified as available-for-sale. At September 30, 1998, amortized cost
approximated fair value and unrealized gains and losses were insignificant.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost and is being depreciated under the
straight-line method using lives of three to seven years. Impairment losses are
recorded on long-lived assets used in operations when indicators of impairment
are present and the undiscounted cash flows estimated to be generated by those
assets are less than the assets' carrying amount. Impairment losses are measured
by comparing the fair value of the assets, as determined by discounting the
future cash flows at a market rate of interest, to their carrying amount.
PATENTS AND ORGANIZATION COSTS
The costs of developing patents are amortized over a three-year period
utilizing the straight-line method of amortization once the patent application
is filed. Organization costs are being amortized using the straight-line method
over five years. Patents and organizational costs are included in other assets
on the accompanying consolidated balance sheets, net of accumulated amortization
of $33,000, $104,000 and $162,000 as of December 31, 1996, 1997 and September
30, 1998.
DEBT ISSUANCE COSTS
Debt issuance costs represent direct financing costs incurred in 1996 to
issue convertible debentures. These costs totalling $147,413 are included in
other assets as of December 31, 1996 and were offset against paid-in capital
upon the conversion of the convertible debentures to common stock in 1997.
REVENUE RECOGNITION
The Company derives its revenue primarily from sales of third-party
software. The Company has contractual relationships with its software publisher
and online retailer clients which obligate the Company to pay to the client a
specified percentage of each sale. Revenues from the sale of software products,
net of estimated returns, are recognized upon either the electronic delivery or
shipment of the physical product to the end-user. The amount payable to the
software publisher or online retailer is reported as cost of sales. The Company
bears full credit risk with respect to substantially all sales. For sales on
consignment, the Company takes title to merchandise, charges the customer's
credit card and arranges for a third party to complete delivery to the customer.
The Company is at risk of loss for collecting all sales proceeds, delivery of
the merchandise and returns from customers. The Company records the full sales
amount as revenue upon verification of credit card authorization and shipment of
the merchandise. Sales to foreign clients accounted for 32% and 31% of sales for
the years ended December 31, 1996 and 1997, respectively, and 31% and 29% for
the nine months ended September 30, 1997 and 1998, respectively. One client
accounted for 18% of sales for the year ended December 31, 1997. For the nine
months ended
F-8
<PAGE>
DIGITAL RIVER, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1997
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(CONTINUED)
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
(CONTINUED)
September 30, 1998 there were two significant clients which comprised 12% and
11% of sales for the period.
ADVERTISING COSTS
The costs of advertising are charged to sales and marketing expense as
incurred. For the years ended December 31, 1996 and 1997, the Company incurred
advertising expense of $7,000 and $292,000, respectively. No advertising expense
was incurred in 1995. Advertising expense totalled $168,000 and $2,161,000 for
the nine months ended September 30, 1997 and 1998, respectively.
PRODUCT DEVELOPMENT
Costs associated with the development of new products and services are
charged to operations as incurred. Those costs totalled $130,000, $230,000, and
$1,393,000 for the three years ended December 31, 1995, 1996 and 1997,
respectively. Product development costs totalled $875,000 and $1,892,000 for the
nine months ended September 30, 1997 and 1998, respectively.
NET LOSS PER SHARE
The Company adopted Statement of Financial Accounting Standards (SFAS) No.
128, "Earnings per Share," during 1997. All prior loss per share amounts are
presented in accordance with the new standard. Basic loss per common share is
computed by dividing net loss by the weighted average number of shares of common
stock outstanding during the year. The computation of diluted earnings per
common share, formerly referred to as fully diluted earnings per share, is
similar to the computation of basic loss per common share, except that the
denominator is increased for the assumed conversion of convertible securities
and the exercise of dilutive options using the treasury stock method. The
weighted average shares used in computing basic and diluted loss per share were
the same for the three years ended December 31, 1995, 1996 and 1997 and the nine
months ended September 30, 1997 and 1998. Options, warrants and the Series A
Preferred Stock totalling 0, 344,210, 1,056,642, 988,241 and 3,124,101 for the
three years ended December 31, 1995, 1996 and 1997 and the nine months ended
September 30, 1997 and 1998, respectively, were excluded from the computation of
earnings per share as their effect is antidilutive.
USE OF ESTIMATES
The preparation of financial statements in accordance with 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. Ultimate results could differ from those estimates.
RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board has released SFAS No. 130,
"Reporting Comprehensive Income," effective for the fiscal years beginning after
December 15, 1997. SFAS No. 130 establishes
F-9
<PAGE>
DIGITAL RIVER, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1997
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(CONTINUED)
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
(CONTINUED)
standards for reporting and display in the financial statements of total net
income and the components of all other nonowner changes in equity, referred to
as comprehensive income. The Company adopted SFAS No. 130 on January 1, 1998.
There was no impact to the Company as a result of the adoption of SFAS No. 130,
as there is no difference between the Company's net loss reported and the
comprehensive net loss for SFAS No. 130 for the periods presented.
The Financial Accounting Standards Board has released SFAS No. 131
"Disclosures about Segments of an Enterprise and Related Information," effective
for fiscal years beginning after December 15, 1997. SFAS No. 131 requires
disclosure of business and geographic segments in the consolidated financial
statements of the Company. The Company is currently analyzing the impact SFAS
No. 131 will have on the disclosures in its financial statements.
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants (AICPA) issued Statement of Position
(SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained
for Internal Use," which is effective for fiscal years beginning after December
15, 1998. SOP 98-1 provides guidance on accounting for the costs of computer
software developed or obtained for internal use. The Company believes that the
adoption of SOP 98-1 will have no material impact on its financial condition or
results of operations.
During April 1998, the Accounting Standards Executive Committee of the AICPA
issued SOP 98-5, "Reporting on the Costs of Start-Up Activities," which is
effective for fiscal years beginning after December 15, 1998. SOP 98-5 requires
companies to expense as incurred all start-up, preopening, and organizational
costs that are not otherwise capitalizable as long-lived assets. The Company
believes that the adoption of SOP 98-5 will have no impact on its financial
condition or results of operations.
2. INCOME TAXES:
Deferred tax assets and liabilities are determined based on the difference
between the financial statement and tax bases of assets and liabilities using
currently enacted tax rates. No income taxes were paid in any of the years
presented.
As of December 31, 1997, the Company had net operating loss carryforwards of
approximately $4,300,000. These income tax net operating loss carryforwards
expire beginning in the year 2009. Because of the uncertainty of future
profitability, a valuation allowance equal to the deferred tax asset has been
recorded.
F-10
<PAGE>
DIGITAL RIVER, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1997
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(CONTINUED)
2. INCOME TAXES: (CONTINUED)
The components of deferred income taxes are as follows:
<TABLE>
<CAPTION>
1996 1997
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Net operating loss carryforwards........................................... $ 294 $ 1,489
Nondeductible reserves and accruals........................................ 3 11
Depreciation and amortization.............................................. 5 5
Valuation allowance........................................................ (302) (1,505)
--------- ---------
$ -- $ --
--------- ---------
--------- ---------
</TABLE>
Ownership changes resulting from the conversion of debentures to common
stock and the issuance of additional equity will limit future annual realization
of the tax net operating loss carryforwards to a specified percentage of the
value of the Company under Section 382 of the Internal Revenue Code.
3. STOCKHOLDERS' EQUITY:
INITIAL PUBLIC OFFERING
On August 11, 1998, the Company completed its initial public offering in
which the Company sold 3,000,000 shares of Common Stock at an offering price of
$8.50 per share. Net proceeds to the Company after underwriting and other
offering expenses was $22.7 million. The proceeds from the offering will be used
for general corporate purposes, including continued investment in product
development, expansion of sales and marketing activities and working capital.
STOCK SPLITS
The Company effected an 8-for-1 split of its common stock in September 1997
in the form of a stock dividend and on July 14, 1998 the Company declared a
2-for-3 reverse stock split of its common stock, which was effected on August
11, 1998. All common share, per share and weighted average share information has
been restated to reflect the splits.
PREFERRED STOCK
During April 1998, the Company sold 1,500,000 shares of its $.01 par value
Series A Preferred Stock in a private placement transaction. Net proceeds to the
Company totalled $2,825,000. The preferred stock was converted to common stock
on a 2-for-3 basis in conjunction with the closing of the Company's initial
public offering of common stock in August 1998.
CONVERTIBLE DEBENTURES
During 1996 the Company issued convertible debentures totalling $998,000.
These debentures were converted to common stock in February 1997 at a conversion
rate of $1.13 per share.
F-11
<PAGE>
DIGITAL RIVER, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1997
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(CONTINUED)
3. STOCKHOLDERS' EQUITY: (CONTINUED)
WARRANTS
Warrants to purchase 263,832 shares of common stock issued principally in
conjunction with sales of common stock at exercise prices ranging from $1.13 to
$3.00 per share were outstanding as of December 31, 1997. All warrants are
exercisable for a period of five years from their respective purchase dates.
Warrants to purchase 803,008 shares of common stock at exercise prices ranging
from $1.13 to $3.00 per share were outstanding as of September 30, 1998.
In connection with certain advisory services provided by the preferred
stockholder of the Company, the Company issued a conditional warrant (the
"Conditional Warrant"). Upon consummation of the Company's initial public
offering in August 1998, the Conditional Warrant represented the right to
purchase 100,000 shares of Common Stock at $3.00 per share. The Conditional
Warrant is exercisable for a period of 5 years from the date of the Company's
initial public offering.
4. STOCK OPTIONS:
The Company's 1998 Stock Option Plan (the "Option Plan") was adopted by the
Board of Directors in June 1998 as an amendment and restatement of the Amended
and Restated 1994 Stock Option Plan which had been adopted in 1997. The Option
Plan provides for the granting of stock options to purchase up to 2,333,333
shares of common stock. Options granted to employees under the plan expire no
later than ten years after the date of grant. The exercise price must be at
least 100% of the fair market value of the shares at the date of grant for
incentive options. The Option Plan covers both incentive and nonstatutory stock
options. Incentive stock options granted to employees who immediately before
such grant owned stock directly or indirectly representing more than 10% of the
voting power of all the stock of the Company, expire no later than five years
from the grant date unless the option exercise price is at least 110% of the
fair market value of the stock.
In addition to shares granted under the Option Plan, during 1998 the Company
has granted options to purchase 605,882 shares of common stock at an exercise
price of $8.50 per share to certain members of management outside of the Option
Plan.
F-12
<PAGE>
DIGITAL RIVER, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1997
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(CONTINUED)
4. STOCK OPTIONS: (CONTINUED)
A summary of change in outstanding options under the Option Plan is as
follows:
<TABLE>
<CAPTION>
WEIGHTED
OPTIONS AVERAGE
OUTSTANDING $/SHARE
----------- -----------
<S> <C> <C>
Balance, December 31, 1995............................................ -- $ --
Grants.............................................................. 338,665 0.60
----------- -----
Balance, December 31, 1996............................................ 338,665 0.60
Grants.............................................................. 496,817 1.66
Cancelled........................................................... (42,672) 1.69
----------- -----
Balance, December 31, 1997............................................ 792,810 1.20
Grants (unaudited).................................................. 996,070 4.40
Exercised (unaudited)............................................... (13,666) 0.41
Cancelled (unaudited)............................................... (69,338) 1.64
----------- -----
Balance, September 30, 1998 (unaudited)............................... 1,705,876 $ 2.94
----------- -----
----------- -----
</TABLE>
A summary of information about stock options outstanding at December 31,
1997 is as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------- ------------------------
EXERCISE NUMBER WEIGHTED AVG. NUMBER WEIGHTED
PRICE OUTSTANDING LIFE REMAINING EXERCISABLE AVG. PRICE
- ------------ ----------- -------------- ----------- ----------
<S> <C> <C> <C> <C>
$ 0.38 239,999 4 years 186,666 $0.38
1.13 183,999 9 years 94,667 1.13
1.69 342,142 9.5 years -- --
3.00 26,670 10 years -- --
- ------------ ----------- -------------- ----------- -----
$ 0.38-3.00 792,810 8 years 281,333 $0.63
- ------------ ----------- -------------- ----------- -----
- ------------ ----------- -------------- ----------- -----
</TABLE>
The Company recorded deferred compensation for the difference between the
grant price and the deemed fair value of the Company's common stock on options
to purchase 467,803 shares at exercise prices of $3.00 to $9.00 during May and
June 1998.
The Company has elected to apply the disclosure-only provisions of SFAS No.
123, "Accounting for Stock-Based Compensation." Accordingly, the Company
accounts for stock-based compensation using the intrinsic value method
prescribed in Accounting Principles Board Opinion (APB) No. 25, "Accounting for
Stock Issued to Employees," and related interpretations. Compensation cost for
stock options is measured as the excess, if any, of the fair value of the
Company's common stock at the date of grant over the stock
F-13
<PAGE>
DIGITAL RIVER, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1997
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(CONTINUED)
4. STOCK OPTIONS: (CONTINUED)
option exercise price. Had compensation costs for these plans been determined
consistent with SFAS No. 123, the Company's net loss would have been adjusted to
the following pro forma amounts:
<TABLE>
<CAPTION>
1996 1997
--------- ---------
(IN THOUSANDS,
EXCEPT PER SHARE
DATA)
<S> <C> <C>
Net loss:
As reported........................................................... $ (689) $ (3,485)
Pro forma............................................................. (704) (3,565)
Basic and diluted net loss per share:
As reported........................................................... (0.13) (0.46)
Pro forma............................................................. (0.13) (0.47)
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions used: risk-free interest rates of 6%; no expected dividends;
expected lives of five years; and a volatility factor of 1.1 and .7 in 1996 and
1997, respectively. The weighted average fair value of the options granted in
1996 and 1997 was $.48 and $1.04, respectively.
5. RELATED-PARTY TRANSACTIONS:
As of September 30, 1998, the Company's CEO owned 49% of Tech Squared, Inc.
(Tech Squared) where he spends a portion of his time working as Tech Squared's
Chairman. Tech Squared, through a wholly-owned subsidiary, holds an option to
purchase 3,200,000 shares of the Company's common stock for $1.00 from the
Company's CEO. The Company currently conducts its operations in leased
facilities of Tech Squared. Rent and other direct expenses, including direct
labor costs, paid to Tech Squared totalled $52,000 and $160,000 in 1996 and
1997, respectively. No amounts were due under this arrangement in 1995. Rent and
other direct expenses totalled $106,000 and $183,000 for the nine months ended
September 30, 1997 and 1998.
During 1997, Tech Squared began performing fulfillment services for Digital
River on physical shipments of products, for which Digital River pays Tech
Squared a fulfillment fee. In 1997, Tech Squared billed Digital River $8,000 for
these services. For the nine months ended September 30, 1997 and 1998, the
Company was billed $0 and $123,000 for such services.
The Company's CEO is also a director of a significant client which comprised
11% of sales for the nine months ended September 30, 1998.
In February 1998, two stockholders, one of which is a director of the
Company, entered into an agreement with the Company whereby the stockholders
will help establish and oversee the international operations for the Company for
a term of three years. As consideration for entering into the agreement, the
stockholders each received warrants to purchase 100,000 shares of common stock,
at $3.00 per share. Deferred compensation has been reflected for the estimated
fair value of the services and will be recognized over the term of the
agreement.
F-14
<PAGE>
DIGITAL RIVER, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1997
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(CONTINUED)
6. COMMITMENTS AND CONTINGENCIES:
In connection with an investment in the Company in 1994, Fujitsu Limited
(Fujitsu) obtained certain rights with respect to the Company's common stock and
the operations of the Company's business. In December, 1997, in exchange for the
issuance of 60,000 shares of the Company's common stock, Fujitsu agreed to
relinquish its rights with certain exceptions. Fujitsu retained the right to
designate one member to the Company's board of directors as long as its
ownership percentage is not less than 10% of the Company's common stock,
retained its prior share registration rights and retained certain technology
rights. In 1997, The Company recorded a charge to expense for the fair value of
the common shares issued totalling $101,250, based upon the most recent private
placement price per share of $1.69. As of September 30, 1998, Fujitsu held 13%
of the common stock of the Company.
The United States Department of State and Department of Commerce restrict
the export of encrypting technology outside the United States. Although Digital
River does not currently believe its method of conducting business is impacted
to any significant degree by these restrictions, any significant change in these
rules or interpretations or any failure by Digital River to comply with existing
or future restrictions could have a material adverse impact on the business of
Digital River.
F-15
<PAGE>
- -------------------------------------------
-------------------------------------------
- -------------------------------------------
-------------------------------------------
YOU MAY RELY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE HAVE NOT
AUTHORIZED ANYONE TO PROVIDE INFORMATION DIFFERENT FROM THAT CONTAINED IN THIS
PROSPECTUS. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR SALE OF COMMON STOCK
MEANS THAT INFORMATION CONTAINED IN THIS PROSPECTUS IS CORRECT AFTER THE DATE OF
THIS PROSPECTUS. THIS PROSPECTUS IS NOT AN OFFER TO SELL OR SOLICITATION OF AN
OFFER TO BUY THESE SHARES OF THE COMMON STOCK IN ANY CIRCUMSTANCES UNDER WHICH
THE OFFER OR SOLICITATION IS UNLAWFUL.
--------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Prospectus Summary............................. 3
Risk Factors................................... 6
Use of Proceeds................................ 19
Price Range of Common Stock.................... 19
Dividend Policy................................ 19
Capitalization................................. 20
Dilution....................................... 21
Selected Consolidated Financial Data........... 22
Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................... 23
Business....................................... 31
Management..................................... 43
Certain Transactions........................... 52
Principal and Selling Stockholders............. 56
Description of Capital Stock................... 59
Shares Eligible for Future Sale................ 61
Underwriting................................... 63
Legal Matters.................................. 64
Experts........................................ 64
Additional Information......................... 64
Index to Consolidated Financial Statements..... F-1
</TABLE>
3,000,000 SHARES
[LOGO]
COMMON STOCK
----------------
P R O S P E C T U S
----------------
BT ALEX. BROWN
BANCBOSTON ROBERTSON STEPHENS
BEAR, STEARNS & CO. INC.
, 1998
- -------------------------------------------
-------------------------------------------
- -------------------------------------------
-------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth all expenses, other than the underwriting
discounts and commissions, payable by the Registrant in connection with the sale
of the shares of Common Stock being registered. All the amounts shown are
estimates except for the registration fee, the NASD filing fee and the Nasdaq
National Market application fee.
<TABLE>
<S> <C>
Registration fee.................................................. $ 18,583
NASD filing fee................................................... 7,185
Nasdaq National Market listing fee................................ 17,500
Blue sky qualification fee and expenses........................... 5,000
Printing and engraving expenses................................... 100,000
Legal fees and expenses........................................... 175,000
Accounting fees and expenses...................................... 50,000
Transfer agent and registrar fees................................. 5,000
Miscellaneous..................................................... 21,732
---------
Total......................................................... $ 400,000
---------
---------
</TABLE>
ITEM 14. INDEMNIFICATION OF OFFICERS AND DIRECTORS.
As permitted by Section 145 of the Delaware General Corporation Law, the
Bylaws of the Company provide that (i) the Company is required to indemnify its
directors and executive officers to the fullest extent permitted by the Delaware
General Corporation Law, (ii) the Company may, in its discretion, indemnify
other officers, employees and agents as set forth in the Delaware General
Corporation Law, (iii) to the fullest extent permitted by the Delaware General
Corporation Law, the Company is required to advance all expenses incurred by its
directors and executive officers in connection with a legal proceeding (subject
to certain exceptions), (iv) the rights conferred in the Bylaws are not
exclusive, (v) the Company is authorized to enter into indemnification
agreements with its directors, officers, employees and agents and (vi) the
Company may not retroactively amend the Bylaws provisions relating to indemnity.
The Company has entered into agreements with its directors and executive
officers that require the Company to indemnify such persons against expenses,
judgments, fines, settlements and other amounts that such person becomes legally
obligated to pay (including expenses of a derivative action) in connection with
any proceeding, whether actual or threatened, to which any such person may be
made a party by reason of the fact that such person is or was a director or
officer of the Company or any of its affiliated enterprises, provided such
person acted in good faith and in a manner such person reasonably believed to be
in or not opposed to the best interests of the Company. The indemnification
agreements also set forth certain procedures that will apply in the event of a
claim for indemnification thereunder.
The Underwriting Agreement filed as Exhibit 1.1 to this Registration
Statement provides for indemnification by the Underwriters of the Registrant and
its officers and directors for certain liabilities arising under the Securities
Act of 1933, as amended (the "Act"), or otherwise.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
(a) Since February 9, 1994, the Registrant has sold and issued the following
unregistered securities:
(1) From February 9, 1994 to November 20, 1998, the Company sold an
aggregate of 12,734,047 shares of Common Stock to certain investors for an
aggregate purchase price of $17,526,213.
II-1
<PAGE>
(2) From February 9, 1994 to November 10, 1998, the Company granted
stock options to employees, directors and consultants covering an aggregate
of 2,321,424 shares of the Company's Common Stock (net of cancellations), at
exercise prices varying from $0.38 to $11.75. Through November 10, 1998 (the
date of filing of the Company's Form S-8), a total of 16,666 shares were
exercised in accordance with Rule 701.
(3) From February 9, 1994 to November 20, 1998, the Company has issued
warrants to purchase 803,008 shares of Common Stock with a weighted average
exercise price of $2.52.
(4) In April 1998, the Company sold 1,500,000 shares of the Company's
Series A Preferred Stock (which converted into 1,000,000 shares of Common
Stock upon consummation of the Company's initial public offering) to
Wasserstein Adelson Ventures, L.P. for an aggregate purchase price of
$3,000,000.
The sales and issuances of securities in the transactions described above
were deemed to be exempt from registration under the Act in reliance upon
Section 4(2) of the Act, Regulation D promulgated thereunder, Regulation S
promulgated thereunder, or Rule 701 promulgated under Section 3(b) of the Act,
as transactions by an issuer not involving any public offering or transactions
pursuant to compensatory benefit plans and contracts relating to compensation as
provided under Rule 701. The recipients of securities in each such transaction
represented their intentions to acquire the securities for investment only and
not with a view to or for sale in connection with any distribution thereof and
appropriate legends were affixed to the securities issued in such transactions.
All recipients had adequate access, through their relationship with the Company,
to information about the Registrant.
(b) There were no underwritten offerings employed in connection with any of
the transactions set forth in Item 15(a).
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------ --------------------------------------------------------------------------
<C> <S>
1.1 Form of Underwriting Agreement.
**3.1 Amended and Restated Certificate of Incorporation of the Registrant, as
currently in effect.
**3.2 Bylaws of the Registrant, as currently in effect.
**4.1 Specimen Stock Certificate.
5.1 Opinion of Cooley Godward LLP.
**10.1 Form of Indemnity Agreement between Registrant and each of its directors
and executive officers.
**10.2 1998 Stock Option Plan.
**10.3 Distributor Agreement dated April 23, 1997 by and between Corel
Corporation and the Registrant.
**10.4 Employment and Non-Competition Agreement effective May 25, 1998 by and
between Joel A. Ronning and the Registrant.
**10.5 Fujitsu Modification Agreement dated December 11, 1997 by and between Joel
A. Ronning, the Registrant, Fujitsu Limited and MacUSA, Inc.
**10.6 Heads of Agreement for International Agreement dated February 25, 1998 by
and between Christopher J. Sharples, David A. Taylor and the Registrant.
</TABLE>
II-2
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------ --------------------------------------------------------------------------
<C> <S>
**10.7 Stock Subscription Warrant for Shares of Common Stock dated February 26,
1998 by and between Christopher Sharples and Registrant.
**10.8 Termination of Lease Letter dated April 30, 1998 by and between Tech
Squared, Inc. and Registrant.
**10.9 Services Agreement dated July 30, 1998 by and between Tech Squared, Inc.
and Registrant.
**10.10 Stock Option Agreement dated December 28, 1995 by and between Joel A.
Ronning and MacUSA, Inc.
**10.11 Form of Registration Rights Agreement by and between Wasserstein Adelson
Ventures, L.P., certain other investors and Registrant.
**10.12 Form of Conditional Warrant to Purchase Common Stock dated April 22, 1998
by and between Wasserstein Adelson Ventures, L.P. and Registrant.
**10.13 Form of Warrant to Purchase Common Stock by and between certain investors
and Registrant.
**10.14 Form of Registration Rights Agreement by and between certain investors and
Registrant.
**10.15 Consent to Assignment and Assumption of Lease dated April 22, 1998 by and
between CSM Investors, Inc., IntraNet Integration Group, Inc. and
Registrant.
**10.16 Employment Agreement effective July 30, 1998 by and between Perry W.
Steiner and the Registrant.
**21.1 Subsidiaries of Digital River, Inc.
23.1 Consent of Independent Public Accountants.
23.2 Consent of Cooley Godward LLP (reference is made to Exhibit 5.1).
24.1 Power of Attorney. Reference is made to the signature page.
27.1 Financial Data Schedule.
</TABLE>
- ------------------------
** Previously filed as an Exhibit to the Form S-1 filed in connection with the
Company's initial public offering.
(b) FINANCIAL STATEMENT SCHEDULES.
Schedules not listed above are omitted because they are not required, they
are not applicable or the information is already included in the Consolidated
Financial Statements or Notes thereto.
ITEM 17. UNDERTAKINGS.
The undersigned Registrant hereby undertakes to provide the Underwriters at
the closing specified in the Underwriting Agreement certificates in such
denominations and registered in such names as required by the Underwriters to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Act may be
permitted to directors, officers, and controlling persons of the Registrant
pursuant to the provisions described in Item 14 or otherwise, the Registrant has
been advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the Registrant of expenses incurred
or paid by a director, officer, or controlling person of the Registrant in the
successful defense of any action, suit, or proceeding) is asserted by such
director, officer, or controlling person in
II-3
<PAGE>
connection with the securities being registered, the Registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act and will
be governed by the final adjudication of such issue.
The undersigned Registrant hereby undertakes that: (1) for purposes of
determining any liability under the Act, the information omitted from the form
of prospectus as filed as part of the registration statement in reliance upon
Rule 430A and contained in the form of prospectus filed by the Registrant
pursuant to Rule 424(b)(1) or (4) or 497(h) under the Act shall be deemed to be
part of the registration statement as of the time it was declared effective, (2)
for the purpose of determining any liability under the Act, each post-effective
amendment that contains a form of prospectus shall be deemed to be a new
registration statement relating to the securities offered therein, and this
offering of such securities at that time shall be deemed to be the initial BONA
FIDE offering thereof, and (3) to remove from registration by means of a
post-effective amendment any of the securities being registered which remain
unsold at the termination of the offering.
II-4
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has caused this Amendment No. 1 to the Registration Statement to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of Eden Prairie, State of Minnesota, on the 30th day of November 1998.
DIGITAL RIVER, INC.
By: /s/ JOEL A. RONNING
-----------------------------------------
Joel A. Ronning
CHIEF EXECUTIVE OFFICER AND DIRECTOR
Pursuant to the requirements of the Securities Act of 1933, as amended, this
Amendment No. 1 to the Registration Statement has been signed below by the
following persons in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
/s/ JOEL A. RONNING Chief Executive Officer
- ------------------------------ and Director (Principal November 30, 1998
Joel A. Ronning Executive Officer)
Chief Financial Officer
/s/ ROBERT E. STRAWMAN and Treasurer (Principal
- ------------------------------ Financial and Accounting November 30, 1998
Robert E. Strawman Officer)
*PERRY W. STEINER
- ------------------------------ President and Director November 30, 1998
Perry W. Steiner
*WILLIAM LANSING
- ------------------------------ Director November 30, 1998
William Lansing
*THOMAS F. MADISON
- ------------------------------ Director November 30, 1998
Thomas F. Madison
*CHARLES E. REESE, JR.
- ------------------------------ Director November 30, 1998
Charles E. Reese, Jr.
*CHRISTOPHER J. SHARPLES
- ------------------------------ Director November 30, 1998
Christopher J. Sharples
*J. PAUL THORIN
- ------------------------------ Director November 30, 1998
J. Paul Thorin
*TIMOTHY C. CHOATE
- ------------------------------ Director November 30, 1998
Timothy C. Choate
*By: /s/ ROBERT E. STRAWMAN
------------------------------
Robert E. Strawman
(ATTORNEY-IN-FACT)
II-5
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ---------- ------------------------------------------------------------------------------------------------------
<C> <S>
1.1 Form of Underwriting Agreement.
**3.1 Amended and Restated Certificate of Incorporation of the Registrant, as currently in effect.
**3.2 Bylaws of the Registrant, as currently in effect.
**4.1 Specimen Stock Certificate.
5.1 Opinion of Cooley Godward LLP.
**10.1 Form of Indemnity Agreement between Registrant and each of its directors and executive officers.
**10.2 1998 Stock Option Plan.
**10.3 Distributor Agreement dated April 23, 1997 by and between Corel Corporation and the Registrant.
**10.4 Employment and Non-Competition Agreement effective May 25, 1998 by and between Joel A. Ronning and the
Registrant.
**10.5 Fujitsu Modification Agreement dated December 11, 1997 by and between Joel A. Ronning, the Registrant,
Fujitsu Limited and MacUSA, Inc.
**10.6 Heads of Agreement for International Agreement dated February 25, 1998 by and between Christopher J.
Sharples, David A. Taylor and the Registrant.
**10.7 Stock Subscription Warrant for Shares of Common Stock dated February 26, 1998 by and between
Christopher Sharples and Registrant.
**10.8 Termination of Lease Letter dated April 30, 1998 by and between Tech Squared, Inc. and Registrant.
**10.9 Services Agreement dated July 30, 1998 by and between Tech Squared, Inc. and Registrant.
**10.10 Stock Option Agreement dated December 28, 1995 by and between Joel A. Ronning and MacUSA, Inc.
**10.11 Form of Registration Rights Agreement by and between Wasserstein Adelson Ventures, L.P., certain other
investors and Registrant.
**10.12 Form of Conditional Warrant to Purchase Common Stock dated April 22, 1998 by and between Wasserstein
Adelson Ventures, L.P. and Registrant.
**10.13 Form of Warrant to Purchase Common Stock by and between certain investors and Registrant.
**10.14 Form of Registration Rights Agreement by and between certain investors and Registrant.
**10.15 Consent to Assignment and Assumption of Lease dated April 22, 1998 by and between CSM Investors, Inc.,
IntraNet Integration Group, Inc. and Registrant.
**10.16 Employment Agreement effective July 30, 1998 by and between Perry W. Steiner and the Registrant.
**21.1 Subsidiaries of Digital River, Inc.
23.1 Consent of Independent Public Accountants.
23.2 Consent of Cooley Godward LLP (reference is made to Exhibit 5.1).
24.1 Power of Attorney. Reference is made to the signature page.
27.1 Financial Data Schedule.
</TABLE>
- ------------------------
** Previously filed as an Exhibit to the Form S-1 filed in connection with the
Company's initial public offering.
<PAGE>
(b) FINANCIAL STATEMENT SCHEDULES.
Schedules not listed above are omitted because they are not required, they
are not applicable or the information is already included in the Consolidated
Financial Statements or Notes thereto.
<PAGE>
3,000,000 SHARES
DIGITAL RIVER, INC.
COMMON STOCK
($0.01 PAR VALUE)
UNDERWRITING AGREEMENT
__________, 1998
BT Alex. Brown Incorporated
BancBoston Robertson Stephens Inc.
Bear, Stearns & Co. Inc.
As Representatives of the Several Underwriters
c/o BT Alex. Brown Incorporated
1 South Street
Baltimore, Maryland 21202
Gentlemen:
Digital River, Inc., a Delaware corporation (the "Company"), and certain
stockholders of the Company as listed herein (the "Selling Stockholders")
propose to sell to the several underwriters (the "Underwriters") named in
Schedule I hereto for whom you are acting as representatives (the
"Representatives") an aggregate of 3,000,000 shares of the Company's Common
Stock, $0.01 par value (the "Firm Shares"), of which 1,750,000 shares will be
sold by the Company and 1,250,000 shares will be sold by the Selling
Stockholders. If you are the only Underwriters, all references herein to the
Representatives shall be deemed to be references to the Underwriters. The
respective amounts of the Firm Shares to be so purchased by the several
Underwriters are set forth opposite their names in Schedule I hereto, and the
respective amounts to be sold by the Selling Stockholders are set forth opposite
their names in Schedule II hereto. The Company and the Selling Stockholders are
sometimes referred to herein collectively as the "Sellers". The Company and
[certain of the Selling Stockholders] also propose[s] to sell at the
Underwriters' option an aggregate of up to 450,000 additional shares of the
Company's Common Stock (the "Option Shares") as set forth below.
As the Representatives, you have advised the Company and the Selling
<PAGE>
Stockholders (a) that you are authorized to enter into this Agreement on behalf
of the several Underwriters and (b) that the several Underwriters are willing,
acting severally and not jointly, to purchase the numbers of Firm Shares set
forth opposite their respective names in Schedule I, plus their pro rata portion
of the Option Shares if you elect to exercise the over-allotment option in whole
or in part for the accounts of the several Underwriters. The Firm Shares and
the Option Shares (to the extent the aforementioned option is exercised) are
herein collectively called the "Shares."
In consideration of the mutual agreements contained herein and of the
interests of the parties in the transactions contemplated hereby, the parties
hereto agree as follows:
1. REPRESENTATIONS AND WARRANTIES OF THE COMPANY.
(a) The Company represents and warrants to each of the Underwriters
as follows:
(i) A registration statement on Form S-1 (File No. 333-67913)
with respect to the Shares has been prepared by the Company in conformity with
the requirements of the Securities Act of 1933, as amended (the "Act"), and the
Rules and Regulations (the "Rules and Regulations") of the Securities and
Exchange Commission (the "Commission") thereunder and has been filed with the
Commission. Copies of such registration statement, including any amendments
thereto, the preliminary prospectuses (meeting the requirements of the Rules and
Regulations) contained therein and the exhibits, financial statements and
schedules, as finally amended and revised, have heretofore been delivered by the
Company to you. Such registration statement, together with any registration
statement filed by the Company pursuant to Rule 462 (b) of the Act, herein
referred to as the "Registration Statement," which shall be deemed to include
all information omitted therefrom in reliance upon Rule 430A and contained in
the Prospectus referred to below, has become effective under the Act and no
post-effective amendment to the Registration Statement has been filed as of the
date of this Agreement. "Prospectus" means (a) the form of prospectus first
filed with the Commission pursuant to Rule 424(b) or (b) the last preliminary
prospectus included in the Registration Statement filed prior to the time it
becomes effective or filed pursuant to Rule 424(a) under the Act that is
delivered by the Company to the Underwriters for delivery to purchasers of the
Shares, together with the term sheet or abbreviated term sheet filed with the
Commission pursuant to Rule 424(b)(7) under the Act. Each preliminary
prospectus included in the Registration Statement prior to the time it becomes
effective is herein referred to as a "Preliminary Prospectus." Any reference
herein to the Registration Statement, any Preliminary Prospectus or to the
Prospectus shall be deemed to refer to and include any supplements or amendments
to any Prospectus, filed with the Commission after the date of filing of the
Prospectus under Rules 424(b) or 430A, and prior to the termination of the
offering of the Shares by the Underwriters.
(ii) The Company has been duly organized and is validly
existing as a corporation in good standing under the laws of the State of
Delaware, with corporate
<PAGE>
power and authority to own or lease its properties and conduct its business
as described in the Registration Statement. Each of the subsidiaries of the
Company as listed in EXHIBIT A hereto (collectively, the "Subsidiaries") has
been duly organized and is validly existing as a corporation in good standing
under the laws of the jurisdiction of its incorporation, with corporate power
and authority to own or lease its properties and conduct its business as
described in the Registration Statement. The Subsidiaries are the only
subsidiaries, direct or indirect, of the Company. The Company and each of
the Subsidiaries are duly qualified to transact business in all jurisdictions
in which the conduct of their business requires such qualification, except
where the failure to be so qualified would not have a material adverse effect
on the business, properties, financial condition or results of operations of
the Company and its subsidiaries, taken as a whole. All of the outstanding
shares of capital stock of each of the Subsidiaries have been duly authorized
and validly issued, are fully paid and non-assessable and are owned by the
Company or another Subsidiary free and clear of all liens, encumbrances and
equities and claims; and no options, warrants or other rights to purchase,
agreements or other obligations to issue or other rights to convert any
obligations into shares of capital stock or ownership interest in the
Subsidiaries are outstanding. All prior securities of the Company (and its
predecessor in Minnesota) have been duly authorized and validly issued, are
fully paid and nonassessable, and were issued in compliance with the
applicable federal and state securities laws.
(iii) The outstanding shares of Common Stock of the Company
have been duly authorized and validly issued and are fully paid and
non-assessable; the Shares, including all shares to be sold by the Selling
Stockholders, have been duly authorized and when issued and paid for as
contemplated herein will be validly issued, fully paid and non-assessable;
and no preemptive rights of stockholders exist with respect to any of the
Shares or the issue and sale thereof. Neither the filing of the Registration
Statement nor the offering or sale of the Shares as contemplated by this
Agreement gives rise to any rights, other than those which have been waived
or satisfied, for or relating to the registration of any shares of Common
Stock.
(iv) The information set forth under the caption
"Capitalization" in the Prospectus is true and correct as of the date therein
indicated. All of the Shares conform to the description thereof contained in
the Registration Statement. The form of certificates for the Shares conforms
to the corporate law of the jurisdiction of the Company's incorporation.
(v) The Commission has not issued an order preventing or
suspending the use of any Prospectus relating to the proposed offering of the
Shares nor instituted proceedings for that purpose. The Registration Statement
contains, and the Prospectus and any amendments or supplements thereto will
contain, all statements which are required to be stated therein by, and will
conform in all material respects, to the requirements of the Act and the Rules
and Regulations. At the time it became effective, the Registration Statement
and any amendment thereto did not contain and will not contain as of the Closing
Date and Option Closing Date (both as defined in Section 2 hereof), any untrue
statement of a material fact and did not omit, and as of the Closing Date and
Option
<PAGE>
Closing Date will not omit to state any material fact required to be stated
therein or necessary to make the statements therein not misleading. The
Prospectus and any amendments and supplements thereto do not contain, and
will not as of the Closing Date or the Option Closing Date contain, any
untrue statement of material fact; and do not omit, and will not, as of the
Closing Date or the Option Closing Date, omit to state any material fact
required to be stated therein or necessary to make the statements therein, in
the light of the circumstances under which they were made, not misleading;
provided, however, that the Company makes no representations or warranties as
to information contained in or omitted from the Registration Statement or the
Prospectus, or any such amendment or supplement, in reliance upon, and in
conformity with, written information furnished to the Company by or on behalf
of any Underwriter through the Representatives, specifically for use in the
preparation thereof.
(vi) The consolidated financial statements of the Company
and the Subsidiaries, together with related notes and schedules as set forth
in the Registration Statement, present fairly on a consolidated basis the
financial position and the results of operations and cash flows of the
Company and the consolidated Subsidiaries, at the indicated dates and for the
indicated periods. Such financial statements and related schedules have been
prepared in accordance with generally accepted principles of accounting,
consistently applied throughout the periods involved, except as disclosed
herein, and all adjustments necessary for a fair presentation of results for
such periods have been made. The summary financial and statistical data
included in the Registration Statement presents fairly the information shown
therein and such data has been compiled on a basis consistent with the
financial statements presented therein and the books and records of the
Company. The pro forma financial information included in the Registration
Statement and the Prospectus present fairly the information shown therein,
have been prepared in accordance with the Commission's rules and guidelines
with respect to pro forma financial statements, have been properly compiled
on the pro forma bases described therein, and, in the opinion of the Company,
the assumptions used in the preparation thereof are reasonable and the
adjustments used therein are appropriate to give effect to the transactions
or circumstances referred to therein.
(vii) Arthur Andersen LLP, who have certified certain of the
financial statements filed with the Commission as part of the Registration
Statement, are independent public accountants as required by the Act and the
Rules and Regulations.
(viii) There is no action, suit, claim or proceeding pending or,
to the knowledge of the Company, threatened against the Company or any of the
Subsidiaries before any court or administrative agency or otherwise, which, if
determined adversely to the Company or any of its Subsidiaries might result in
any material adverse change in the earnings, business, management, properties,
assets, rights, operations, condition (financial or otherwise) or prospects of
the Company and of the Subsidiaries taken as a whole or to prevent the
consummation of the transactions contemplated hereby, except as set forth in the
Registration Statement.
<PAGE>
(ix) The Company and the Subsidiaries have good and marketable
title to all of the properties and assets reflected in the financial statements
(or as described in the Registration Statement) hereinabove described, subject
to no lien, mortgage, pledge, charge or encumbrance of any kind except those
reflected in such financial statements (or as described in the Registration
Statement) or which are not material in amount. The Company and the
Subsidiaries occupy their leased properties under valid and binding leases
conforming in all material respects to the description thereof set forth in the
Registration Statement.
(x) The Company and the Subsidiaries have filed all Federal,
State, local and foreign income tax returns which have been required to be filed
and have paid all taxes indicated by said returns and all assessments received
by them or any of them to the extent that such taxes have become due. All tax
liabilities have been adequately provided for in the financial statements of the
Company, and the Company does not know of any actual or proposed additional tax
assessments.
(xi) Since the respective dates as of which information is
given in the Registration Statement, as it may be amended or supplemented, there
has not been any material adverse change or any development involving a
prospective material adverse change in or affecting the earnings, business,
management, properties, assets, rights, operations, condition (financial or
otherwise), or prospects of the Company and its Subsidiaries taken as a whole,
whether or not occurring in the ordinary course of business, and there has not
been any material transaction entered into or any material transaction that is
probable of being entered into by the Company or the Subsidiaries, other than
transactions in the ordinary course of business and changes and transactions
described in the Registration Statement, as it may be amended or supplemented.
The Company and the Subsidiaries have no material contingent obligations which
are not disclosed in the Company's financial statements which are included in
the Registration Statement.
(xii) Neither the Company nor any of the Subsidiaries is or
with the giving of notice or lapse of time or both, will be, (i) in violation of
or in default under its Certificate of Incorporation or Bylaws or (ii) in
material breach of or default under any agreement, lease, contract, indenture or
other instrument or obligation to which it is a party or by which it, or any of
its properties, is bound and which default is of material significance in
respect of the condition, financial or otherwise of the Company and its
Subsidiaries taken as a whole or the business, management, properties, assets,
rights, operations, condition (financial or otherwise) or prospects of the
Company and its Subsidiaries taken as a whole. The execution and delivery of
this Agreement and the consummation of the transactions herein contemplated and
the fulfillment of the terms hereof will not conflict with or result in a breach
of any of the terms or provisions of, or constitute a default under, any
indenture, mortgage, deed of trust or other agreement or instrument to which the
Company or any Subsidiary is a party, or of the Certificate of Incorporation or
Bylaws of the Company or any order, rule or regulation applicable to the Company
or any Subsidiary of any court or of any regulatory body or administrative
agency or other governmental body.
<PAGE>
(xiii) Each approval, consent, order, authorization,
designation, declaration or filing by or with any regulatory, administrative or
other governmental body necessary in connection with the execution and delivery
by the Company of this Agreement and the consummation of the transactions herein
contemplated (except such additional steps as may be required by the Commission,
the National Association of Securities Dealers, Inc. (the "NASD") or such
additional steps as may be necessary to qualify the Shares for public offering
by the Underwriters under state securities or Blue Sky laws) has been obtained
or made and is in full force and effect.
(xiv) The Company and each of the Subsidiaries holds all
material licenses, certificates and permits from governmental authorities which
are necessary to the conduct of their businesses. Except as specifically
disclosed in the Prospectus, the Company and each of the Subsidiaries has
sufficient trademarks, trade names, patents, patent rights, mask works,
copyrights, licenses, approvals and governmental authorizations to conduct its
business as now conducted and as proposed to be conducted; and except as
specifically disclosed in the Prospectus, neither the Company nor any of the
Subsidiaries has infringed any trademark, trade name, patent, patent right, mask
work, copyright, license, trade secret or other similar right of others, and,
except as disclosed in the Prospectus, no claim has been made against the
Company or any of the Subsidiaries regarding trademark, trade name, patent, mask
work, copyright, license, trade secret or other infringement which could have a
material adverse effect on the condition (financial or otherwise), business,
results of operations or prospects of the Company and its Subsidiaries taken as
a whole. The Company knows of no material infringement by others of any
trademark, trade name, patent, patent right, mask work, copyright, license,
trade secret or other similar right owned by or licensed to the Company.
(xv) Neither the Company, nor to the Company's best knowledge,
any of its affiliates, has taken or may take, directly or indirectly, any action
designed to cause or result in, or which has constituted or which might
reasonably be expected to constitute, the stabilization or manipulation of the
price of the shares of Common Stock to facilitate the sale or resale of the
Shares. The Company acknowledges that the Underwriters may engage in passive
market making transactions in the Shares on the Nasdaq Stock Market in
accordance with Regulation M under the Securities Exchange Act of 1934, as
amended (the "Exchange Act").
(xvi) Neither the Company nor any Subsidiary is an "investment
company" within the meaning of such term under the Investment Company Act of
1940 and the rules and regulations of the Commission thereunder.
(xvii) The Company maintains a system of internal accounting
controls sufficient to provide reasonable assurances that (i) transactions are
executed in accordance with management's general or specific authorization; (ii)
transactions are recorded as necessary to permit preparation of financial
statements in conformity with generally accepted accounting principles and to
maintain accountability for assets; (iii) access to assets is permitted only in
accordance with management's general or specific
<PAGE>
authorization; and (iv) the recorded accountability for assets is compared
with existing assets at reasonable intervals and appropriate action is taken
with respect to any differences.
(xviii) The Company and each of its Subsidiaries carry, or
are covered by, insurance in such amounts and covering such risks as is adequate
for the conduct of their respective businesses and the value of their respective
properties.
(xix) The Company is in compliance in all material respects
with all presently applicable provisions of the Employee Retirement Income
Security Act of 1974, as amended, including the regulations and published
interpretations thereunder ("ERISA"); no "reportable event" (as defined in
ERISA) has occurred with respect to any "pension plan" (as defined in ERISA) for
which the Company would have any liability; the Company has not incurred and
does not expect to incur liability under (i) Title IV of ERISA with respect to
termination of, or withdrawal from, any "pension plan" or (ii) Sections 412 or
4971 of the Internal Revenue Code of 1986, as amended, including the regulations
and published interpretations thereunder (the "Code"); and each "pension plan"
for which the Company would have any liability that is intended to be qualified
under Section 401(a) of the Code is so qualified in all material respects and
nothing has occurred, whether by action or by failure to act, which would cause
the loss of such qualification.
(xx) To the Company's knowledge, there are not affiliations or
associations between any member of the NASD and any of the Company's officers,
directors or 5% or greater security holders, except as set forth in the
Registration Statement.
(xxi) Neither the Agreement and Plan of Exchange dated as of
December 5, 1997 between the Company and Digital River, Inc., a Minnesota
corporation nor the exchange of shares consummated in connection therewith
contravened, conflicted with or resulted in a material violation or breach of,
or resulted in a default under, any provisions of any agreement or contract of
the Company or its predecessor Minnesota corporation, except for (i) any
contravention, conflict, violation, breach or default which could not reasonably
be expected to result in a material adverse effect on the Company and its
Subsidiaries taken as a whole; (ii) gave any person the right to (a) declare a
default or exercise any remedy under any such agreement or contract, except
where any such default or exercise of a remedy could not reasonably be expected
to result in a material adverse effect on the Company and its Subsidiaries taken
as a whole, (b) accelerate the maturity or performance of any such agreement or
contract, expect where such acceleration could not reasonably be expected to
result in a material adverse effect on the Company and its Subsidiaries taken as
a whole, or (c) cancel, terminate or modify any such contract, except where any
such cancellation, termination or modification could not reasonably be expected
to result in a material adverse effect on the Company and its Subsidiaries taken
as a whole; or (iii) result in the imposition or creation of any encumbrance
upon or with respect to any of the shares of capital stock or the assets of the
Company and its Subsidiaries, except where such encumbrance would not result in
a
<PAGE>
material adverse effect on the Company and its Subsidiaries taken as a whole.
(xxii) The Company has duly filed on a timely basis with the
Commission all reports, registration statements and other documents required by
the Act, the Exchange Act, or the rules and regulations of the Commission
promulgated pursuant to the Act or the Exchange Act. All of such reports,
registration statements and other documents, when they were filed with the
Commission, conformed in all material respects to the requirements of the Act,
the Exchange Act or the rules and regulations of the Commission promulgated
pursuant to the Act or the Exchange Act, as appropriate. None of such reports,
registration statements or other documents contained an untrue statement of a
material fact or omitted to state a material fact required to be stated therein
or necessary to make the statements therein not misleading.
(xxiii) The Company's Common Stock is duly and validly
registered pursuant to the requirements of the Exchange Act and the rules and
regulations promulgated thereunder. The Company has received written notice
from the Nasdaq National Market stating that the Shares have been approved for
additional listing thereon.
(b) Each of the Selling Stockholders severally represents and
warrants as follows:
(i) Such Selling Stockholder now has and at the Closing Date
and the Option Closing Date, as the case may be (as such dates are hereinafter
defined), will have good and marketable title to the Firm Shares and the Option
Shares, if any, to be sold by such Selling Stockholder, free and clear of any
liens, encumbrances, equities and claims, and full right, power and authority to
effect the sale and delivery of such Firm Shares and Option Shares; and upon the
delivery of, against payment for, such Firm Shares and Option Shares pursuant to
this Agreement, the Underwriters will acquire good and marketable title thereto,
free and clear of any liens, encumbrances, equities and claims.
(ii) Such Selling Stockholder has full right, legal capacity,
power and authority to execute and deliver this Agreement, the Power of
Attorney, and the Custodian Agreement referred to below and to perform its
obligations under such Agreements. Such Selling Stockholder has executed and
delivered a Power of Attorney and caused to be executed and delivered on his or
its behalf the Custodian Agreement referred to below and in connection herewith
such Selling Stockholder further represents, warrants and agrees that such
Selling Stockholder has deposited in custody, under the Custodian Agreement,
with the agent named therein as Custodian, certificates in negotiable form for
the Firm Shares and any Option Shares to be sold hereunder by such Selling
Stockholder, for the purpose of further delivery pursuant to this Agreement. The
execution and delivery of this Agreement on behalf of each Selling Stockholder
and the consummation by such Selling Stockholder of the transactions herein
contemplated and the fulfillment by such Selling Stockholder of the terms hereof
will not require any consent, approval, authorization, or other order of any
court, regulatory body, administrative agency
<PAGE>
or other governmental body (except as may be required under the Act, state
securities laws or Blue Sky laws) and will not result in a breach of any of
the terms and provisions of, or constitute a default under, any
organizational documents of such Selling Stockholder, if not an individual,
or any indenture, mortgage, deed of trust or other agreement or instrument to
which such Selling Stockholder is a party, or of any order, rule or
regulation applicable to such Selling Stockholder of any court or of any
regulatory body or administrative agency or other governmental body having
jurisdiction. This Agreement and the Custodian Agreement have been duly
executed and delivered by or on behalf of such Selling Stockholder and a copy
of such duly executed Custodian Agreement has been delivered to you.
(iii) Such Selling Stockholder has not taken and will not take,
directly or indirectly, any action designed to, or which has constituted, or
which might reasonably be expected to cause or result in the stabilization or
manipulation of the price of the Common Stock of the Company and, other than as
permitted by the Act, the Selling Stockholder will not distribute any prospectus
or other offering material in connection with the offering of the Shares.
(iv) The information pertaining to such Selling Stockholder
under the caption "Selling Stockholders" in the Prospectus is complete and
accurate in all material respects.
(v) Without having undertaken to determine independently, for
the purposes of the offering of the Shares, the accuracy or completeness of the
representations and warranties of the Company contained herein, such Selling
Stockholder has no knowledge of any material fact, condition or information not
disclosed in the Registration Statement which has adversely affected or may
adversely affect the business of the Company and its Subsidiaries, taken as a
whole; and the sale of the Firm Shares and any Option Shares by such Selling
Stockholder pursuant hereto is not prompted by any material information
concerning the Company or any of the Subsidiaries which is not set forth in the
Registration Statement or the documents incorporated by reference therein.
(vi) Each Selling Stockholder who is (i) an executive officer
or director of the Company or (ii) an investment entity of which any person who
is (or within the past twelve months was) a director, executive officer, general
partner, principal or member of such entity is (or within the past twelve months
was) an executive officer or director of the Company (any of the foregoing being
referred to hereafter as a "Principal Stockholder") hereby severally, and not
jointly, represents, warrants and agrees that (A) such Principal Stockholder
does not have any reason to believe that the representations and warranties of
the Company contained in this Section 1 are not true and correct and (B) such
Principal Stockholder has reviewed the Registration Statement and Prospectus and
during the course of such review, no facts have come to such Principal
Stockholder's attention which leads such Principal Stockholder to believe that
the Registration Statement, at the time it became effective, contained any
untrue statement of a material fact or omitted to state any material fact
required to be stated therein or necessary in order to make the
<PAGE>
statements therein, in light of the circumstances under which they were made,
not misleading, or that the Prospectus, as of the date of the Prospectus,
contains any untrue statement of a material fact or omits to state a material
fact required be stated therein or necessary in order to make the statements
therein, in light of the circumstances under which they were made, not
misleading.
2. PURCHASE, SALE AND DELIVERY OF THE FIRM SHARES.
(a) On the basis of the representations, warranties and covenants
herein contained, and subject to the conditions herein set forth, the Sellers
agree to sell to the Underwriters and each Underwriter agrees, severally and not
jointly, to purchase, at a price of $______ per share, the number of Firm Shares
set forth opposite the name of such Underwriter in Schedule I hereof, subject to
adjustments in accordance with Section 9 hereof.
(b) Certificates in negotiable form for the total number of Shares to
be sold hereunder by the Selling Stockholders have been placed in custody with
Norwest Bank Minnesota, N.A. as custodian (the "Custodian") pursuant to the
Custodian Agreement executed by each Selling Stockholder for delivery of all
Firm Shares and any Option Shares to be sold hereunder by the Selling
Stockholders. Each of the Selling Stockholders specifically agrees that the
Firm Shares and any Option Shares represented by the certificates held in
custody for the Selling Stockholders under the Custodian Agreement are subject
to the interests of the Underwriters hereunder, that the arrangements made by
the Selling Stockholders for such custody are to that extent irrevocable, and
that the obligations of the Selling Stockholders hereunder shall not be
terminable by any act or deed of the Selling Stockholders (or by any other
person, firm, or corporation including the Company, the Custodian or the
Underwriters) or by operation of law (including the death of an individual
Selling Stockholder or the dissolution of a corporate Selling Stockholder) or by
the occurrence of any other event or events, except as set forth in the
Custodian Agreement. If any such event should occur prior to the delivery of
the Underwriters of the Firm Shares or the Option Shares hereunder, certificates
for the Firm Shares or the Option Shares, as the case may be, shall be delivered
by the Custodian in accordance with the terms and conditions of this Agreement
as if such event has not occurred. The Custodian is authorized to receive and
acknowledge receipt of the proceeds of sale of the Shares held by it against
delivery of such Shares.
(c) Payment for the Firm Shares to be sold hereunder is to be made in
same day funds by wire transfer to an account designated by the Company for the
shares to be sold by it and to the Custodian for the shares to be sold by the
Selling Stockholders, in each case against delivery of certificates therefor to
the Representatives for the several accounts of the Underwriters. Such payment
and delivery are to be made at the offices of BT Alex. Brown Incorporated, 1
South Street, Baltimore, Maryland, at 10:00 a.m., Baltimore time, on the third
business day after the date of this Agreement in accordance with rule 15c6(1)
under the Exchange Act or at such other time and date not later than five
business days thereafter as you and Company shall agree upon, such time and date
being herein referred to as the "Closing Date." (As used herein, "business day"
means a day on
<PAGE>
which the New York Stock Exchange is open for trading and on which banks in
New York are open for business and are not permitted by law or executive
order to be closed.) The certificates for the Firm Shares will be delivered
in such denominations and in such registrations as the Representatives
request in writing not later than the second full business day prior to the
Closing Date, and will be made available for inspection by the
Representatives at least one business day prior to the Closing Date.
(d) In addition, on the basis of the representations and warranties
herein contained and subject to the terms and conditions hereto set forth, the
Company [and certain of the Selling Stockholders listed on Schedule II hereto]
hereby grant[s] an option to the several Underwriters to purchase the Option
Shares at the price per share as set forth in the first paragraph of this
Section 2. [The maximum number of Option Shares to be sold by the Company and
such Selling Stockholders is set forth opposite their respective names on
Schedule II hereto.] The option granted hereby may be exercised in whole or in
part by giving written notice (i) at any time before the Closing Date and
(ii) only once thereafter within 30 days after the date of this Agreement, by
you, as Representatives of the several Underwriters, to the Company, the
Attorney-in-fact, and the Custodian setting forth the number of Option Shares as
to which the Option Shares are to be registered and the time and date at which
such certificates are to be delivered. If the option granted hereby is
exercised in part, the respective number of Option Shares to be sold by the
Company and each of the Selling Stockholders listed Schedule II hereto shall be
determined on a pro rata basis in accordance with the percentages set forth
opposite their names on Schedule II hereto, adjusted by you in such a manner as
to avoid fractional shares. The time and date at which certificates for Option
Shares are to be delivered shall be determined by the Representatives but shall
not be earlier than three nor later than 10 full business days after the
exercise of such option, nor in any event prior to the Closing Date (such time
and date being herein referred to as the "Option Closing Date"). If the date of
notice of exercise of the option is three or more days before the Closing Date,
the notice of exercise shall set the Closing Date as the Option Closing Date.
The number of Option Shares to be purchased by each Underwriter shall be in the
same proportion to the total number of Option Shares being purchased as the
number of Firm Shares being purchased by such Underwriter bears to the total
number of Firm Shares, adjusted by you in such manner as to avoid fractional
shares. The option with respect to the Option Shares granted hereunder may be
exercised only to cover over-allotments in the sale of the Firm Shares by the
Underwriters. You, as Representatives of the several Underwriters, may cancel
such option at any time prior to its expiration by giving written notice of such
cancellation to the Company and the Attorney-in-fact. To the extent, if any,
that the option is exercised, payment for the Option Shares will be made on the
Option Closing Date in same day funds by wire transfer to the order of the
Company for the Option Shares to be sold by it and to the order of the Custodian
for the Option Shares to be sold by the Selling Stockholders against delivery of
certificates therefor at the offices of BT Alex. Brown Incorporated, 1 South
Street, Baltimore, Maryland.
3. OFFERING BY THE UNDERWRITERS.
<PAGE>
It is understood that the several Underwriters are to make a public
offering of the Firm Shares as soon as the Representatives deem it advisable to
do so. The Firm Shares are to be initially offered to the public at the initial
public offering price set forth in the Prospectus.. The
Representatives may from time to time thereafter change the public offering
price and other selling terms. To the extent, if at all, that any Option Shares
are purchased pursuant to Section 2 hereof, the Underwriters will offer them to
the public on the foregoing terms.
It is further understood that you will act as the Representatives for
the Underwriters in the offering and sale of the Shares in accordance with a
Master Agreement Among Underwriters entered into by you and the several other
Underwriters.
4. COVENANTS OF THE COMPANY AND THE SELLING STOCKHOLDERS.
(a) The Company covenants and agrees with the several Underwriters
that:
(i) The Company will (A) use its best efforts to cause the
Registration Statement to become effective or, if the procedure in Rule 430A of
the Rules and Regulations is followed, to prepare and timely file with the
Commission under Rule 424(b) of the Rules and Regulations a Prospectus in a form
approved by the Representatives containing information previously omitted at the
time of effectiveness of the Registration Statement in reliance on Rule 430A of
the Rules and Regulations, (B) not file any amendment to the Registration
Statement or supplement to the Prospectus of which the Representatives shall not
previously have been advised and furnished with a copy or to which the
Representatives shall have reasonably objected in writing or which is not in
compliance with the Rules and Regulations and (C) file on a timely basis all
reports and any definitive proxy or information statements required to be filed
by the Company with the Commission subsequent to the date of the Prospectus and
prior to the termination of the offering of the Shares by the Underwriters.
(ii) The Company will advise the Representatives promptly (A)
when the Registration Statement or any post-effective amendment thereto shall
have become effective, (B) of receipt of any comments from the Commission, (C)
of any request of the Commission for amendment of the Registration Statement or
for supplement to the Prospectus or for any additional information, and (D) of
the issuance by the Commission of any stop order suspending the effectiveness of
the Registration Statement or the use of the Prospectus or of the institution of
any proceedings for that purpose. The Company will use its best efforts to
prevent the issuance of any such stop order preventing or suspending the use of
the Prospectus and to obtain as soon as possible the lifting thereof, if issued.
(iii) The Company will cooperate with the Representatives in
endeavoring to qualify the Shares for sale under the securities laws of such
jurisdictions as the Representatives may reasonably have designated in writing
and will make such
<PAGE>
applications, file such documents, and furnish such information as may be
reasonably required for that purpose, provided the Company shall not be
required to qualify as a foreign corporation or to file a general consent to
service of process in any jurisdiction where it is not now so qualified or
required to file such a consent. The Company will, from time to time,
prepare and file such statements, reports, and other documents, as are or may
be required to continue such qualifications in effect for so long a period as
the Representatives may reasonably request for distribution of the Shares.
(iv) The Company will deliver to, or upon the order of, the
Representatives, from time to time, as many copies of any Preliminary Prospectus
as the Representatives may reasonably request. The Company will deliver to, or
upon the order of, the Representatives during the period when delivery of a
Prospectus is required under the Act, as many copies of the Prospectus in final
form, or as thereafter amended or supplemented, as the Representatives may
reasonably request. The Company will deliver to the Representatives at or
before the Closing Date, four signed copies of the Registration Statement and
all amendments thereto including all exhibits filed therewith, and will deliver
to the Representatives such number of copies of the Registration Statement
(including such number of copies of the exhibits filed therewith that may
reasonably be requested), and of all amendments thereto, as the Representatives
may reasonably request.
(v) The Company will comply with the Act and the Rules and
Regulations, and the Securities Exchange Act of 1934 (the "Exchange Act"), and
the rules and regulations of the Commission thereunder, so as to permit the
completion of the distribution of the Shares as contemplated in this Agreement
and the Prospectus. If during the period in which a prospectus is required by
law to be delivered by an Underwriter or dealer, any event shall occur as a
result of which, in the judgment of the Company or in the reasonable opinion of
the Underwriters, it becomes necessary to amend or supplement the Prospectus in
order to make the statements therein, in the light of the circumstances existing
at the time the Prospectus is delivered to a purchaser, not misleading, or, if
it is necessary at any time to amend or supplement the Prospectus to comply with
any law, the Company promptly will prepare and file with the Commission an
appropriate amendment to the Registration Statement or supplement to the
Prospectus so that the Prospectus as so amended or supplemented will not, in the
light of the circumstances when it is so delivered, be misleading, or so that
the Prospectus will comply with the law.
(vi) The Company will make generally available to its security
holders, as soon as it is practicable to do so, but in any event not later than
15 months after the effective date of the Registration Statement, an earnings
statement (which need not be audited) in reasonable detail, covering a period of
at least 12 consecutive months beginning after the effective date of the
Registration Statement, which earnings statement shall satisfy the requirements
of Section 11(a) of the Act and Rule 158 of the Rules and Regulations and will
advise you in writing when such statement has been so made available.
(vii) The Company will, for a period of five years from the
Closing
<PAGE>
Date, deliver to the Representatives copies of annual reports and copies of
all other documents, reports and information furnished by the Company to its
stockholders or filed with any securities exchange pursuant to the
requirements of such exchange or with the Commission pursuant to the Act or
the Securities Exchange Act of 1934, as amended. The Company will deliver to
the Representatives similar reports with respect to significant subsidiaries,
as that term is defined in the Rules and Regulations, which are not
consolidated in the Company's financial statements.
(viii) No offering, sale, short sale or other disposition of any
shares of Common Stock of the Company or other securities convertible into or
exchangeable or exercisable for shares of Common Stock or derivative of Common
Stock (or agreement for such) will be made for a period of 90 days after the
date of this Agreement, directly or indirectly, by the Company otherwise than
hereunder or with the prior written consent of BT Alex. Brown Incorporated
except for sales of shares pursuant to the exercise of outstanding stock options
under the Company's employee benefit plans, as such employee benefit plans are
described in Prospectus.
(ix) The Company has caused each officer and director, and
certain security holders of the Company to furnish to you, on or prior to the
date of this agreement, a letter or letters, in form and substance satisfactory
to the Underwriters, pursuant to which each such person shall agree not to,
directly or indirectly, offer, sell, pledge, contract to sell, grant any option
to purchase, grant a security interest in, hypothecate or otherwise sell or
dispose of any shares of Common Stock of the Company (including, without
limitation, shares of Common Stock that may be deemed to be beneficially owned
by such person in accordance with the rules and regulations of the Commission
and shares of Common Stock that may be issued upon the exercise of a stock
option or warrant) or any securities convertible into, derivative of or
exchangeable or exercisable for Common Stock of the Company, owned directly by
such person or as to which such person has the power of disposition, in any such
case whether owned as of the date of such letter or acquired thereafter (other
than Common Stock purchased in the open market and not otherwise in breach of
such letter) during the period commencing on the date of such letter and ending
on the close of business on the ninetieth (90th) day after the date of the
Prospectus, except with the prior written consent of BT Alex. Brown Incorporated
("Lockup Agreements").
(x) The Company shall apply the net proceeds of its sale of
the Shares as set forth in the Prospectus and shall file such reports with
the Commission with respect to the sale of the Shares and the application of
the proceeds therefrom as may be required in accordance with Rule 463 under
the Act.
(xi) The Company shall not invest, or otherwise use the
proceeds received by the Company from its sale of the Shares in such a manner as
would require the Company or any of the Subsidiaries to register as an
investment company under the Investment Company Act of 1940, as amended (the
"1940 Act").
<PAGE>
(xii) The Company will maintain a transfer agent and, if
necessary under the jurisdiction of incorporation of the Company, a registrar
for the Common Stock.
(xiii) The Company will not take, directly or indirectly, any
action designed to cause or result in, or that has constituted or might
reasonably be expected to constitute, the stabilization or manipulation of the
price of any securities of the Company.
(b) Each of the Selling Stockholders covenants and agrees with the
several Underwriters that:
(i) Such Selling Stockholder will not, directly or
indirectly, offer, sell, pledge, contract to sell, grant any option to purchase,
grant a security interest in, hypothecate or otherwise sell or dispose of any
shares of Common Stock of the Company (including, without limitation, shares of
Common Stock that may be deemed to be beneficially owned by such Selling
Stockholder in accordance with the rules and regulations of the Commission and
shares of Common Stock that may be issued upon the exercise of a stock option or
warrant) or any securities convertible into, derivative of or exchangeable or
exercisable for Common Stock of the Company, owned directly by such Selling
Stockholder or as to which such Selling Stockholder has the power of
disposition, in any such case whether owned as of the date hereof or acquired
hereafter (other than Common Stock purchased in the open market and not
otherwise in breach of such letter) during the period commencing on the date of
this Agreement and ending on the close of business on the ninetieth (90th) day
after the date of the Prospectus, except with the prior written consent of BT
Alex. Brown Incorporated.
(ii) In order to document the Underwriters' compliance with
the reporting and withholding provisions of the Tax Equity and Fiscal
Responsibility Act of 1982 and the Interest and Dividend Tax Compliance Act of
1983 with respect to the transactions herein contemplated, each of the Selling
Stockholders agrees to deliver to you prior to or at the Closing Date a properly
completed and executed United States Treasury Department Form W-8 or Form W-9
(or other applicable form or statement specified by Treasury Department
regulations in lieu thereof).
(iii) Such Selling Stockholder will not take, directly or
indirectly, any action designed to cause or result in, or that has constituted
or might reasonably be expected to constitute, the stabilization or manipulation
of the price of any securities of the Company.
5. COSTS AND EXPENSES.
The Company will pay all costs, expenses and fees incident to the
performance of the obligations of the Sellers under this Agreement, including,
without limiting the generality of the foregoing, the following: accounting
fees of the Company; the fees and disbursements of counsel for the Company and
the Selling Stockholders; the cost of printing and delivering to, or as
requested by, the Underwriters copies of the Registration
<PAGE>
Statement, Preliminary Prospectuses, the Prospectus, this Agreement, the
Underwriters' Selling Memorandum, the Underwriters' Invitation Letter, the
Listing Application, the Blue Sky Survey and any supplements or amendments
thereto; the filing fees of the Commission; the filing fees incident to
securing any required review by the National Association of Securities
Dealers, Inc. (the "NASD") of the terms of the sale of the Shares; the
Listing Fee of the Nasdaq National Market; and the expenses, including the
fees and disbursements of counsel for the Underwriters, incurred in
connection with the qualification of the Shares under state securities or
Blue Sky laws; PROVIDED, that (i) to the extent, if at all, that any of the
Selling Stockholders engage special legal counsel to represent them in
connection with this offering, the fees and expenses of such counsel shall be
borne by such Selling Stockholder, and (ii) any transfer taxes imposed on the
sale of the Shares to the several Underwriters will be paid by the Sellers
pro rata. The Company agrees to pay all costs and expenses of the
Underwriters, including the fees and disbursements of counsel for the
Underwriters, incident to the offer and sale of directed shares of the Common
Stock by the Underwriters to employees and persons having business
relationships with the Company and its Subsidiaries. The Sellers shall not,
however, be required to pay for any of the Underwriters expenses (other than
those related to qualification under State securities or Blue Sky laws)
except that, if this Agreement shall not be consummated because the
conditions in Section 6 hereof are not satisfied, or because this Agreement
is terminated by the Representatives pursuant to Section 11 hereof, or by
reason of any failure, refusal or inability on the part of the Company or the
Selling Stockholders to perform any undertaking or satisfy any condition of
this Agreement or to comply with any of the terms hereof on their part to be
performed, unless such failure to satisfy said condition or to comply with
said terms be due to the default or omission of any Underwriter, then the
Company shall reimburse the several Underwriters for reasonable out-of-pocket
expenses, including fees and disbursements of counsel, reasonably incurred in
connection with investigating, marketing and proposing to market the Shares
or in contemplation of performing their obligations hereunder; but the
Company and the Selling Stockholders shall not in any event be liable to any
of the several Underwriters for damages on account of loss of anticipated
profits from the sale by them of the Shares.
6. CONDITIONS OF OBLIGATIONS OF THE UNDERWRITERS.
The several obligations of the Underwriters to purchase the Firm
Shares on the Closing Date and the Option Shares, if any, on the Option Closing
Date are subject to the accuracy, as of the Closing Date or the Option Closing
Date, as the case may be, of the representations and warranties of the Company
and the Selling Stockholders contained herein, and to the performance by the
Company and the Selling Stockholders of their covenants and obligations
hereunder and to the following additional conditions:
(a) The Registration Statement and all post-effective amendments
thereto shall have become effective and any and all filings required by Rule 424
and Rule 430A of the Rules and Regulations shall have been made, and any request
of the Commission for additional information (to be included in the Registration
Statement or otherwise) shall
<PAGE>
have been disclosed to the Representatives and complied with to their
reasonable satisfaction. No stop order suspending the effectiveness of the
Registration Statement, as amended from time to time, shall have been issued
and no proceedings for that purpose shall have been taken or, to the
knowledge of the Company or the Selling Stockholders, shall be contemplated
by the Commission and no injunction, restraining order, or order of any
nature by a Federal or state court of competent jurisdiction shall have been
issued as of the Closing Date which would prevent the issuance of the Shares.
(b) The Representatives shall have received on the Closing Date or
the Option Closing Date, as the case may be, the legal opinions from Cooley
Godward LLP and from Messerli and Kramer, each as counsel for the Company, dated
the Closing Date or the Option Closing Date, as the case may be, addressed to
the Underwriters (and stating that it may be relied upon by counsel to the
Underwriters) which collectively shall opine to the effect that:
(i) The Company has been duly incorporated and is validly
existing as a corporation in good standing under the laws of the State of
Delaware, with corporate power and authority to own or lease its properties and
conduct its business as described in the Registration Statement; each of its
Subsidiaries has been duly organized and is validly existing as a corporation in
good standing under the laws of the jurisdiction of its incorporation, with
corporate power and authority to own or lease its properties and conduct its
business as described in the Registration Statement; the Company and each of its
Subsidiaries are duly qualified to transact business in all jurisdictions in
which the conduct of their business requires such qualification, or in which the
failure to qualify would have a materially adverse effect upon the business of
the Company and its Subsidiaries taken as a whole; the outstanding shares of
capital stock of each of the Subsidiaries have been duly authorized and validly
issued and are fully paid and nonassessable and are owned by the Company or a
Subsidiary; and, to the best of such counsel's knowledge, the outstanding shares
of capital stock of each of its Subsidiaries are owned free and clear of all
liens, encumbrances and equities and claims, and no options, warrants or other
rights to purchase, agreements or other obligations to issue or other rights to
convert any obligations into any shares of capital stock or of ownership
interests in the Subsidiaries are outstanding.
(ii) The authorized and outstanding capital stock is as set
forth under the caption "Capitalization" in the Prospectus as of the date stated
therein; the authorized shares of the Company's Common Stock have been duly
authorized; the outstanding shares of the Company's Common Stock, including the
Shares to be sold by the Selling Stockholders, have been duly authorized and
validly issued and are fully paid and non-assessable; all of the Shares conform
to the description thereof contained in the Prospectus under the caption
"Description of Capital Stock"; the certificates for the Common Stock, in the
form filed with the Commission, are in due and proper form; the shares of
Common Stock, including the Option Shares, if any, to be sold by the Company
pursuant to this Agreement (i) have been duly authorized and (ii) will be
validly issued, fully paid and non-assessable when issued and paid for as
contemplated by this Agreement;
<PAGE>
and no preemptive rights of stockholders or other rights to subscribe for or
purchase securities under the Delaware General Corporation Law, the Minnesota
Business Corporation Act, the Company's Certificate of Incorporation or
Bylaws or any agreement or contract known to such counsel exist with respect
to any of the Shares or the issue or sale thereof.
(iii) Except as described in or contemplated by the Prospectus,
to the knowledge of such counsel (i) there are no outstanding securities of the
Company convertible or exchangeable into or evidencing the right to purchase or
subscribe for any shares of capital stock of the Company and (ii) there are no
outstanding or authorized options, warrants or rights of any character
obligating the Company to issue any shares of its capital stock or any
securities convertible or exchangeable into or evidencing the right to purchase
or subscribe for any shares of such stock; and (iii) no holder of any securities
of the Company or any other person has the right which has not been satisfied or
effectively waived, to cause the Company to sell or otherwise issue to them any
of the Shares or the right to have any Common Stock or other securities of the
Company included in the Registration Statement or the right, as a result of the
filing of the Registration Statement, to require registration under the Act of
any shares of Common Stock or other securities of the Company.
(iv) The Registration Statement has become effective under the
Act and, to the best of the knowledge of such counsel, no stop order proceedings
with respect thereto have been instituted or are pending or threatened under the
Act.
(v) At the time it became effective and at the Closing Date
or Option Closing Date (as the case may be) the Registration Statement and the
Prospectus comply or will have complied (as the case may be) as to form in all
material respects with the requirements of the Act and the applicable rules and
regulations thereunder (except that such counsel need express no opinion as to
the financial statements, including supporting schedules, or other financial
information and statistical information derived therefrom).
(vi) The statements under the captions "Management--Employment
Agreements," "Certain Transactions" and "Description of Capital Stock" in the
Prospectus, insofar as such statements constitute a summary of documents
referred to therein or matters of law have been reviewed and are correct in all
material respects and present the information called for with respect thereto
under the Act and the Rules and Regulations.
(vii) Such counsel does not know of any contracts or documents
required to be filed as exhibits to the Registration Statement or described in
the Registration Statement or the Prospectus which are not so filed or described
as required, and the contracts or documents described therein are summarized to
the extent required by the Act and the Rules and Regulations.
(viii) Such counsel knows of no material legal or governmental
<PAGE>
proceedings pending or threatened against the Company or any of the Subsidiaries
required under the Act and the Rules and Regulations to be described in the
Prospectus except as set forth in the Prospectus.
(ix) The execution and delivery of this Agreement and the
consummation of the transactions herein contemplated do not and will not
conflict with or result in a breach of any of the terms or provisions of, or
constitute a default under, the Certificate of Incorporation or Bylaws of the
Company, or any agreement or instrument known to such counsel to which the
Company or is a party or by which the Company or any of the Subsidiaries may be
bound, except where such conflict, breach or default would not have a material
adverse effect on the earnings, business, management, properties, assets,
rights, operations or financial condition of the Company and its Subsidiaries
taken as a whole.
(x) This Agreement has been duly authorized, executed and
delivered by the Company.
(xi) No approval, consent, order, authorization, designation,
declaration or filing by or with any regulatory, administrative or other
governmental body is necessary in connection with the execution and delivery of
this Agreement and the consummation of the transactions herein contemplated
(other than as may be required by the NASD or as required by State securities
and Blue Sky laws as to which such counsel need express no opinion) except such
as have been obtained or made under the Act and the Exchange Act.
(xii) The Company is not, and will not become, as a result of
the consummation of the transactions contemplated by this Agreement, and
application of the net proceeds therefrom as described in the Prospectus,
required to register as an investment company under the 1940 Act.
(xiii) The Company's Common Stock is duly and validly registered
pursuant to the requirements of the Exchange Act and the rules and regulations
promulgated thereunder. The Shares have been approved for additional listing on
the Nasdaq National Market.
(xiv) This Agreement has been duly authorized, executed and
delivered on behalf of the Selling Stockholders.
(xv) Each Selling Stockholder has full legal right, power and
attorney, and any approval required by law (other than as required by State
securities and Blue Sky laws as to which such counsel need express no opinion),
to sell, assign, transfer and deliver the portion of the Shares to be sold by
such Selling Stockholder.
(xvi) The Custodian Agreement, the Power of Attorney and this
Agreement have been duly executed and delivered by or duly on behalf of each
Selling
<PAGE>
Stockholder and each such instrument constitutes the valid and binding
agreement of such Selling Stockholder.
(xvii) Assuming the Underwriters purchase the Shares to be sold
by each Selling Stockholder for value, in good faith and without notice of any
adverse claim within the meaning of Article VIII of the Uniform Commercial Code,
upon delivery and payment for the Shares to be sold by each Selling Stockholder
pursuant to this Agreement, the Underwriters will receive good and valid title
to such Shares, free and clear of all security interests, liens, equities,
claims and other encumbrances.
In rendering such opinion, Cooley Godward LLP and
Messerli and Kramer may rely as to matters governed by the laws of states other
than California, Delaware, Minnesota or Federal laws on local counsel in such
jurisdictions, provided that in each case, Cooley Godward LLP or Messerli and
Kramer shall state that they believe that they and the Underwriters are
justified in relying on such other counsel. In addition to the matters set
forth above, such opinion shall also include a statement to the effect that
nothing has come to the attention of such counsel which leads them to believe
that (i) the Registration Statement, at the time it became effective under the
Act (but after giving effect to any modifications incorporated therein pursuant
to Rule 430A under the Act) and as of the Closing Date or the Option Closing
Date, as the case may be, contained an untrue statement of a material fact or
omitted to state a material fact required to be stated therein or necessary to
make the statements therein not misleading, and (ii) the Prospectus, or any
supplement thereto, on the date it was filed pursuant to the Rules and
Regulations and as of the Closing Date or the Option Closing Date, as the case
may be, contained an untrue statement of a material fact or omitted to state a
material fact necessary in order to make the statements, in the light of the
circumstances under which they are made, not misleading (except that such
counsel need express no view as to financial statements, including supporting
schedules, or other financial information and statistical information derived
therefrom). With respect to such statement, Cooley Godward LLP may state that
their belief is based upon the procedures set forth therein, but is without
independent check and verification.
(c) The Underwriters shall have received on the Closing Date or the
Option Closing Date, as the case may be, legal opinions from Merchant & Gould
and Larkin, Hoffman, Daly & Lindgren, Ltd. dated the Closing Date or the Option
Closing Date, as the case may be, with respect to certain intellectual property
matters, which collectively shall opine to the effect that:
(i) To the best of such counsel's knowledge, the
Company owns all patents, trademarks, trademark registrations,
service marks, service mark registrations and rights described in
the Prospectus as being owned by it or necessary for the conduct of
its business, and such counsel is not aware of any claim to the
contrary or any challenge by any other person or organization to
the rights of the Company with respect to the foregoing other than
those expressly identified in the Registration Statement.
<PAGE>
(ii) To the best of such counsel's knowledge, there are no
legal actions, claims or proceedings pending or threatened against
the Company alleging that the Company is infringing or otherwise
violating any patents or trade secrets owned by others other than
those identified in the Registration Statement.
(iii) To the best of such counsel's knowledge, to the extent
they constitute matters of law or legal conclusions, the
descriptions of patents and patent applications under the captions
"Risk Factors--Intellectual Property" and "Business--Intellectual
Property" in the Registration Statement are accurate and fairly and
completely present the patent situation of the Company.
(iv) To the best of such counsel's knowledge, the
descriptions of patents and patent applications under the captions
"Risk Factors--Intellectual Property" and "Business--Intellectual
Property" in the Registration Statement do not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made therein, in light of the
circumstances under which they were made, not misleading, including
without limitation, any undisclosed material issue with respect to
the subsequent validity or enforceability of such patent or patent
issuing from any such pending patent application.
(d) The Representatives shall have received from Wilson Sonsini
Goodrich & Rosati, P.C., counsel for the Underwriters, an opinion dated the
Closing Date or the Option Closing Date, as the case may be, substantially to
the effect specified in subparagraphs (iv) and (v) of Paragraph (b) of this
Section 6, and that the Company is a duly organized and validly existing
corporation under the laws of the State of Delaware. In rendering such opinion
Wilson Sonsini Goodrich & Rosati, P.C. may rely as to all matters governed other
than by the laws of the State of California, the State of Delaware or Federal
laws on the opinion of counsel referred to in Paragraph (b) of this Section 6.
In addition to the matters set forth above, such opinion shall also include a
statement to the effect that nothing has come to the attention of such counsel
which leads them to believe that (i) the Registration Statement, or any
amendment thereto, as of the time it became effective under the Act (but after
giving effect to any modifications incorporated therein pursuant to Rule 430A
under the Act) as of the Closing Date or the Option Closing Date, as the case
may be, contained an untrue statement of a material fact or omitted to state a
material fact required to be stated therein or necessary to make the statements
therein not misleading, and (ii) the Prospectus, or any supplement thereto, on
the date it was filed pursuant to the Rules and Regulations and as of the
Closing Date or the Option Closing Date, as the case may be, contained an untrue
statement of a material fact or omitted to state a material fact, necessary in
order to make the statements, in the light of the circumstances under which they
are made, not misleading (except that such counsel need express no view as to
financial statements, related notes, schedules and other financial information
therein). With respect to such statement, Wilson Sonsini Goodrich & Rosati,
P.C. may state that their belief is based upon the procedures set forth therein,
but is without independent check and verification.
<PAGE>
(e) The Representatives shall have received at or prior to the
Closing Date from Wilson Sonsini Goodrich & Rosati, P.C., a memorandum or
summary, in form and substance satisfactory to the Representatives, with respect
to the qualification for offering and sale by the Underwriters of the Shares
under the State securities or Blue Sky laws of such jurisdictions as the
Representatives may reasonably have designated to the Company.
(f) You shall have received, on each of the dates hereof, the Closing
Date and the Option Closing Date, as the case may be, a letter dated the date
hereof, the Closing Date or the Option Closing Date, as the case may be, in form
and substance satisfactory to you, of Arthur Andersen LLP confirming that they
are independent public accountants within the meaning of the Act and the
applicable published Rules and Regulations thereunder and stating that in their
opinion the financial statements and schedules examined by them and included in
the Registration Statement comply in form in all material respects with the
applicable accounting requirements of the Act and the related published Rules
and Regulations; and containing such other statements and information as is
ordinarily included in accountants' "comfort letters" to Underwriters with
respect to the financial statements and certain financial and statistical
information contained in the Registration Statement and Prospectus.
(g) The Representatives shall have received on the Closing Date or
the Option Closing Date, as the case may be, a certificate or certificates of
the Chief Executive Officer and the Chief Financial Officer of the Company to
the effect that, as of the Closing Date or the Option Closing Date, as the case
may be, each of them severally represents as follows:
(i) The Registration Statement has become effective under the
Act and no stop order suspending the effectiveness of the Registration Statement
has been issued, and no proceedings for such purpose have been taken or are, to
his knowledge, contemplated by the Commission;
(ii) The representations and warranties of the Company
contained in Section 1 hereof are true and correct as of the Closing Date or the
Option Closing Date, as the case may be;
(iii) All filings required to have been made pursuant to Rules
424 or 430A under the Act have been made;
(iv) He has carefully examined the Registration Statement and
the Prospectus and, in his opinion, as of the effective date of the Registration
Statement, the statements contained in the Registration Statement were true and
correct, and such Registration Statement and Prospectus did not omit to state a
material fact required to be stated therein or necessary in order to make the
statements therein not misleading, and since the effective date of the
Registration Statement, no event has occurred which should
<PAGE>
have been set forth in a supplement to or an amendment of the Prospectus
which has not been so set forth in such supplement or amendment; and
(v) Since the respective dates as of which information is
given in the Registration Statement and Prospectus, there has not been any
material adverse change or any development involving a prospective material
adverse change in or affecting the condition, financial or otherwise, of the
Company and its Subsidiaries taken as a whole or the earnings, business,
management, properties, assets, rights, operations, condition (financial or
otherwise) or prospects of the Company and its Subsidiaries taken as a whole,
whether or not arising in the ordinary course of business.
(h) The Representatives shall have received a certificate, dated as
of the Closing Date or Option Closing Date, as the case may be, signed by or on
behalf of each of the Selling Stockholders to the effect that the
representations and warranties of such Selling Stockholder in this Agreement are
true and correct, as if made at and as of such Closing Date, and such Selling
Stockholder has complied with all the agreements and satisfied all the
conditions on his or its part to be performed or satisfied prior to such Closing
Date.
(i) The Company shall have furnished to the Representatives such
further certificates and documents confirming the representations and
warranties, covenants and conditions contained herein and related matters as the
Representatives may reasonably have requested.
(j) The Firm Shares and Option Shares, if any, have been approved for
additional listing upon notice of issuance on the Nasdaq National Market.
(k) The Lockup Agreements described in Section 4(a)(ix) are in full
force and effect.
The opinions and certificates mentioned in this Agreement shall be
deemed to be in compliance with the provisions hereof only if they are in all
material respects satisfactory to the Representatives and to Wilson Sonsini
Goodrich & Rosati, P.C., counsel for the Underwriters.
If any of the conditions hereinabove provided for in this Section 6
shall not have been fulfilled when and as required by this Agreement to be
fulfilled, the obligations of the Underwriters hereunder may be terminated by
the Representatives by notifying the Company of such termination in writing or
by telegram at or prior to the Closing Date or the Option Closing Date, as the
case may be.
In such event, the Company and the Underwriters shall not be under any
obligation to each other (except to the extent provided in Sections 5 and 8
hereof).
7. CONDITIONS OF THE OBLIGATIONS OF THE SELLERS.
<PAGE>
The obligations of the Sellers to sell and deliver the portion of the
Shares required to be delivered as and when specified in this Agreement are
subject to the conditions that at the Closing Date or the Option Closing Date,
as the case may be, no stop order suspending the effectiveness of the
Registration Statement shall have been issued and in effect or proceedings
therefor initiated or threatened.
8. INDEMNIFICATION.
(a) (i) The Company and each of the Selling Stockholders jointly
and severally agree to indemnify and hold harmless each Underwriter and each
person, if any, who controls any Underwriter within the meaning of the Act,
against any losses, claims, damages or liabilities to which such Underwriter or
any such controlling person may become subject under the Act or otherwise,
insofar as such losses, claims, damages or liabilities (or actions or
proceedings in respect thereof) arise out of or are based upon (A) any untrue
statement or alleged untrue statement of any material fact contained in the
Registration Statement, any Preliminary Prospectus, the Prospectus or any
amendment or supplement thereto, or (B) the omission or alleged omission to
state therein a material fact required to be stated therein or necessary to make
the statements therein not misleading; and will reimburse each Underwriter and
each such controlling person upon demand for any legal or other expenses
reasonably incurred by such Underwriter or such controlling person in connection
with investigating or defending any such loss, claim, damage or liability,
action or proceeding or in responding to a subpoena or governmental inquiry
related to the offering of the Shares, whether or not such Underwriter or
controlling person is a party to any action or proceeding; provided, however,
that the Company and the Selling Stockholders will not be liable in any such
case to the extent that any such loss, claim, damage or liability arises out of
or is based upon an untrue statement or alleged untrue statement, or omission or
alleged omission made in the Registration Statement, any Preliminary Prospectus,
the Prospectus, or such amendment or supplement, in reliance upon and in
conformity with written information furnished to the Company by or through the
Representatives specifically for use in the preparation thereof and that the
indemnity agreement contained in this Section 8 (a) with respect to any
Preliminary Prospectus shall not inure to the benefit of any Underwriter from
whom the person asserting any such losses, claims, damages, liabilities or
expenses purchased the shares which is the subject thereof (or to the benefit of
any person, controlling such Underwriter) if at or prior to the written
confirmation of the sale of such shares a copy of the Prospectus (or the
Prospectus as amended or supplemented) was not sent or delivered to such person
and the untrue statement or omission of a material fact contained in such
Preliminary Prospectus was corrected in the Prospectus (or the Prospectus as
amended or supplemented). Notwithstanding anything herein to the contrary, the
Underwriters agree that they shall not seek indemnification hereunder from the
Selling Stockholders unless the Underwriters shall first have sought indemnity
from the Company and the Company has not satisfied such request for
indemnification in full within 60 days; PROVIDED, HOWEVER, that the Underwriters
shall not be required to effect such initial demand upon the Company and wait
such 60-day period if it would prejudice their right to indemnification from the
Selling Stockholders
<PAGE>
hereunder. This indemnity agreement will be in addition to any liability
which the Company or any Selling Stockholder may otherwise have.
(ii) Notwithstanding anything else herein, each Selling
Stockholder who is not a Principal Stockholder shall only be liable under this
Section 8(a) with respect to (A) information pertaining to such Selling
Stockholder furnished by or on behalf of such Selling Stockholder expressly for
use in the Registration Statement or the Prospectus, or any amendments or
supplements thereto, or (B) facts that would constitute a breach of any
representation or warranty of such Selling Stockholder set forth in Section 1(b)
of this Agreement. In addition, in no event, shall the liability of any Selling
Stockholder (including any Principal Stockholder) for indemnification under this
Section 8(a) exceed the proceeds received by such Selling Stockholder from the
Underwriters in the offering.
(b) Each Underwriter severally and not jointly will indemnify and
hold harmless the Company, each of its directors, each of its officers who have
signed the Registration Statement, the Selling Stockholders and each person, if
any, who controls the Company or the Selling Stockholders within the meaning of
the Act, against any losses, claims, damages or liabilities to which the Company
or any such director, officer, Selling Stockholder, or controlling person may
become subject under the Act or otherwise, insofar as such losses, claims,
damages or liabilities (or actions or proceedings in respect thereof) arise out
of or are based upon (i) any untrue statement or alleged untrue statement of
any material fact contained in the Registration Statement, any Preliminary
Prospectus, the Prospectus or any amendment or supplement thereto, or (ii) the
omission or the alleged omission to state therein a material fact required to be
stated therein or necessary to make the statements therein not misleading in the
light of the circumstances under which they were made; and will reimburse any
legal or other expenses reasonably incurred by the Company or any such director,
officer, Selling Stockholder, or controlling person in connection with
investigating or defending any such loss, claim, damage, liability, action or
proceeding; provided, however, that each Underwriter will be liable in each case
to the extent, but only to the extent, that such untrue statement or alleged
untrue statement or omission or alleged omission has been made in the
Registration Statement, any Preliminary Prospectus, the Prospectus or such
amendment or supplement, in reliance upon and in conformity with written
information furnished to the Company by or through the Representatives
specifically for use in the preparation thereof. This indemnity agreement will
be in addition to any liability which such Underwriter may otherwise have.
(c) In case any proceeding (including any governmental investigation)
shall be instituted involving any person in respect of which indemnity may be
sought pursuant to this Section 8, such person (the "indemnified party") shall
promptly notify the person against whom such indemnity may be sought (the
"indemnifying party") in writing. No indemnification provided for in Section
8(a) or (b) shall be available to any party who shall fail to give notice as
provided in this Section 8(c) if the party to whom notice was not given was
unaware of the proceeding to which such notice would have related and was
materially prejudiced by the failure to give such notice, but the failure to
give such notice shall not relieve the indemnifying party or parties from any
liability which it or they may
<PAGE>
have to the indemnified party for contribution or otherwise than on account
of the provisions of Section 8(a) or (b). In case any such proceeding shall
be brought against any indemnified party and it shall notify the indemnifying
party of the commencement thereof, the indemnifying party shall be entitled
to participate therein and, to the extent that it shall wish, jointly with
any other indemnifying party similarly notified, to assume the defense
thereof, with counsel satisfactory to such indemnified party and shall pay as
incurred the fees and disbursements of such counsel related to such
proceeding. In any such proceeding, any indemnified party shall have the
right to retain its own counsel at its own expense. Notwithstanding the
foregoing, the indemnifying party shall pay as incurred (or within 30 days of
presentation) the fees and expenses of the counsel retained by the
indemnified party in the event (i) the indemnifying party and the
indemnified party shall have mutually agreed to the retention of such
counsel, (ii) the named parties to any such proceeding (including any
impleaded parties) include both the indemnifying party and the indemnified
party and representation of both parties by the same counsel would be
inappropriate due to actual or potential differing interests between them or
(iii) the indemnifying party shall have failed to assume the defense and
employ counsel acceptable to the indemnified party within a reasonable period
of time after notice of commencement of the action. It is understood that
the indemnifying party shall not, in connection with any proceeding or
related proceedings in the same jurisdiction, be liable for the reasonable
fees and expenses of more than one separate firm for all such indemnified
parties. Such firm shall be designated in writing by you in the case of
parties indemnified pursuant to Section 8(a) and by the Company in the case
of parties indemnified pursuant to Section 8(b). The indemnifying party
shall not be liable for any settlement of any proceeding effected without its
written consent but if settled with such consent or if there be a final
judgment for the plaintiff, the indemnifying party agrees to indemnify the
indemnified party from and against any loss or liability by reason of such
settlement or judgment. In addition, the indemnifying party will not,
without the prior written consent of the indemnified party, settle or
compromise or consent to the entry of any judgment in any pending or
threatened claim, action or proceeding of which indemnification may be sought
hereunder (whether or not any indemnified party is an actual or potential
party to such claim, action or proceeding) unless such settlement, compromise
or consent includes an unconditional release of each indemnified party from
all liability arising out of such claim, action or proceeding.
(d) If the indemnification provided for in this Section 8 is
unavailable to or insufficient to hold harmless an indemnified party under
Section 8(a) or (b) above in respect of any losses, claims, damages or
liabilities (or actions or proceedings in respect thereof) referred to therein,
then each indemnifying party shall contribute to the amount paid or payable by
such indemnified party as a result of such losses, claims, damages or
liabilities (or actions or proceedings in respect thereof) in such proportion as
is appropriate to reflect the relative benefits received by the Company and the
Selling Stockholders on the one hand and the Underwriters on the other from the
offering of the Shares. If, however, the allocation provided by the immediately
preceding sentence is not permitted by applicable law, then each indemnifying
party shall contribute to such amount paid or payable by such indemnified party
in such proportion as is appropriate to reflect not only such relative benefits
but also the relative fault of the Company and the Selling
<PAGE>
Stockholders on the one hand and the Underwriters on the other in connection
with the statements or omissions which resulted in such losses, claims,
damages or liabilities, (or actions or proceedings in respect thereof), as
well as any other relevant equitable considerations. The relative benefits
received by the Company and the Selling Stockholders on the one hand and the
Underwriters on the other shall be deemed to be in the same proportion as the
total net proceeds from the offering (before deducting expenses) received by
the Company and the Selling Stockholders bear to the total underwriting
discounts received by the Underwriters, in each case as set forth in the
table on the cover page of the Prospectus. The relative fault shall be
determined by reference to, among other things, whether the untrue or alleged
untrue statement of a material fact or the omission or alleged omission to
state a material fact relates to information supplied by the Company and the
Selling Stockholders on the one hand or the Underwriters on the other and the
parties' relative intent, knowledge, access to information and opportunity to
correct or prevent such statement or omission.
The Company, the Selling Stockholders and the Underwriters agree that
it would not be just and equitable if contributions pursuant to this Section
8(d) were determined by pro rata allocation (even if the Underwriters were
treated as one entity for such purpose) or by any other method of allocation
which does not take account of the equitable considerations referred to above in
this Section 8(d). The amount paid or payable by an indemnified party as a
result of the losses, claims, damages or liabilities (or actions or proceedings
in respect thereof) referred to above in this Section 8(d) shall be deemed to
include any legal or other expenses reasonably incurred by such indemnified
party in connection with investigating or defending any such action or claim.
Notwithstanding the provisions of this subsection (d), (i) no Underwriter shall
be required to contribute any amount in excess of the underwriting discounts and
commissions applicable to the Shares purchased by such Underwriter, and (ii) no
person guilty of fraudulent misrepresentation (within the meaning of Section
11(f) of the Act) shall be entitled to contribution from any person who was not
guilty of such fraudulent misrepresentation and (iii) no Selling Stockholder
shall be required to contribute any amount in excess of the proceeds received by
such Selling Stockholder from the Underwriters in the Offering. The
Underwriters' obligations in this Section 8(d) to contribute are several in
proportion to their respective underwriting obligations and not joint.
(e) In any proceeding relating to the Registration Statement, any
Preliminary Prospectus, the Prospectus or any supplement or amendment thereto,
each party against whom contribution may be sought under this Section 8 hereby
consents to the jurisdiction of any court having jurisdiction over any other
contributing party, agrees that process issuing from such court may be served
upon him or it by any other contributing party and consents to the service of
such process and agrees that any other contributing party may join him or it as
an additional defendant in any such proceeding in which such other contributing
party is a party.
(f) Any losses, claims, damages, liabilities or expenses for which an
indemnified party is entitled to indemnification or contribution under this
Section 8 shall be
<PAGE>
paid by the indemnifying party to the indemnified party as such losses,
claims, damages, liabilities or expenses are incurred. The indemnity and
contribution agreements contained in this Section 8 and the representations
and warranties of the Company set forth in this Agreement shall remain
operative and in full force and effect, regardless of (i) any investigation
made by or on behalf of any Underwriter or any person controlling any
Underwriter, the Company, its directors or officers or any persons
controlling the Company, (ii) acceptance of any Shares and payment therefor
hereunder, and (iii) any termination of this Agreement. A successor to any
Underwriter, or to the Company, its directors or officers, or any person
controlling the Company, shall be entitled to the benefits of the indemnity,
contribution and reimbursement agreements contained in this Section 8.
9. DEFAULT BY UNDERWRITERS.
If on the Closing Date or the Option Closing Date, as the case may be,
any Underwriter shall fail to purchase and pay for the portion of the Shares
which such Underwriter has agreed to purchase and pay for on such date
(otherwise than by reason of any default on the part of the Company or the
Selling Stockholders), you, as Representatives of the Underwriters, shall use
your reasonable efforts to procure within 36 hours thereafter one or more of the
other Underwriters, or any others, to purchase from the Company and the Selling
Stockholders such amounts as may be agreed upon and upon the terms set forth
herein, the Firm Shares or Option Shares, as the case may be, which the
defaulting Underwriter or Underwriters failed to purchase. If during such 36
hours you, as such Representatives, shall not have procured such other
Underwriters, or any others, to purchase the Firm Shares or Option Shares, as
the case may be, agreed to be purchased by the defaulting Underwriter or
Underwriters, then (a) if the aggregate number of shares with respect to which
such default shall occur does not exceed 10% of the Firm Shares or Option
Shares, as the case may be, covered hereby, the other Underwriters shall be
obligated, severally, in proportion to the respective numbers of Firm Shares or
Option Shares, as the case may be, which they are obligated to purchase
hereunder, to purchase the Firm Shares or Option Shares, as the case may be,
which such defaulting Underwriter or Underwriters failed to purchase, or (b) if
the aggregate number of shares of Firm Shares or Option Shares, as the case may
be, with respect to which such default shall occur exceeds 10% of the Firm
Shares or Option Shares, as the case may be, covered hereby, the Company and the
Selling Stockholders, on the one hand, or you on the other as the
Representatives of the Underwriters, will have the right, by written notice
given within the next 36-hour period to the parties to this Agreement, to
terminate this Agreement without liability on the part of the non-defaulting
parties except to the extent provided in Section 8 hereof. In the event of a
default by any Underwriter or Underwriters, as set forth in this Section 9, the
Closing Date or Option Closing Date, as the case may be, may be postponed for
such period, not exceeding seven days, as you, as Representatives, may determine
in order that the required changes in the Registration Statement or in the
Prospectus or in any other documents or arrangements may be effected. The term
"Underwriter" includes any person substituted for a defaulting Underwriter. Any
action taken under this Section 9 shall not relieve any defaulting Underwriter
from liability in respect of any default of such Underwriter under this
Agreement.
<PAGE>
10. NOTICES.
All communications hereunder shall be in writing and, except as
otherwise provided herein, will be mailed, delivered, telecopied or telegraphed
and confirmed as follows: if to the Underwriters, to BT Alex. Brown
Incorporated, 1 South Street, Baltimore, Maryland 21202, Attention: Dan
McIntyre; with a copy to BT Alex. Brown Incorporated, One Bankers Trust Plaza,
130 Liberty Street, New York, New York 10006, Attention: General Counsel; if to
the Company, to
Joel A. Ronning
Chief Executive Officer
Digital River, Inc.
5198 West 76th Street
Edina, Minnesota 55439
and, if to the Selling Stockholders, to
Robert E. Strawman
Chief Financial Officer
Digital River, Inc.
5198 West 76th Street
Edina, Minnesota 55439
11. TERMINATION.
This Agreement may be terminated by you by notice to the Company and
the Selling Stockholders as follows:
(a) at any time prior to the earlier of (i) the time the Shares are
released by you for sale by notice to the Underwriters, or (ii) 11:30 a.m. on
the first business day following the date of this Agreement;
(b) at any time prior to the Closing Date if any of the following has
occurred: (i) since the respective dates as of which information is given in the
Registration Statement and the Prospectus, any material adverse change or any
development involving a prospective material adverse change in or affecting the
condition, financial or otherwise, of the Company and its Subsidiaries taken as
a whole or the earnings, business, management, properties, assets, rights,
operations, condition (financial or otherwise) or prospects of the Company,
whether or not arising in the ordinary course of business, (ii) any outbreak or
escalation of hostilities or declaration of war or national emergency or other
national or international calamity or crisis or change in economic or political
conditions if the effect of such outbreak, escalation, declaration, emergency,
calamity, crisis or change on the financial markets of the United States would,
in your reasonable judgment, make it impracticable to market the Shares or to
enforce contracts for the sale of the Shares, or (iii) suspension of trading in
securities generally on the New York Stock
<PAGE>
Exchange or the American Stock Exchange or limitation on prices (other than
limitations on hours or numbers of days of trading) for securities on either
such Exchange, (iv) the enactment, publication, decree or other promulgation
of any statute, regulation, rule or order of any court or other governmental
authority which in your opinion materially and adversely affects or may
materially and adversely affect the business or operations of the Company,
(v) declaration of a banking moratorium by United States or New York State
authorities, (vi) the suspension of trading of the Company's Common Stock on
the Nasdaq National Market or (viii) the taking of any action by any
governmental body or agency in respect of its monetary or fiscal affairs
which in your reasonable opinion has a material adverse effect on the
securities markets in the United States; or
(c) as provided in Sections 6 and 9 of this Agreement.
12. FAILURE OF THE SELLING STOCKHOLDERS TO SELL AND DELIVER.
If one or more of the Selling Stockholders shall fail to sell and
deliver to the Underwriters the Shares to be sold and delivered by such Selling
Stockholders at the Closing Date or Option Closing Date under the terms of this
Agreement, then the Underwriters may at their option, by written notice from you
to the Company and the Selling Stockholders, purchase the Shares which the other
Selling Stockholders have agreed to sell and deliver in accordance with the
terms hereof. In the event of a failure by one or more of the Selling
Stockholders to sell and deliver as referred to in this Section 12, either you
or the Company shall have the right to postpone the Closing Date or the Option
Closing Date, as the case may be, for a period not exceeding seven business days
in order that the necessary changes in the Registration Statement, Prospectus
and any other documents, as well as any other arrangements, may be effected.
13. SUCCESSORS.
This Agreement has been and is made solely for the benefit of the
Underwriters, the Company and the Selling Stockholders and their respective
successors, executors, administrators, heirs and assigns, the officers,
directors and controlling persons referred to herein, and no other person will
have any right or obligation hereunder. No purchaser of any of the Shares from
any Underwriter shall be deemed a successor or assign merely because of such
purchase.
14. INFORMATION PROVIDED BY UNDERWRITERS.
The Company, the Selling Stockholders and the Underwriters acknowledge
and agree that the only information furnished or to be furnished by any
Underwriter to the Company for inclusion in any Prospectus or the Registration
Statement consists of the information set forth in the last paragraph on the
front cover page (insofar as such information relates to the Underwriters),
legends required by Item 502(d) of Regulation S-K under the Act and the
information under the caption "Underwriting" in the Prospectus.
<PAGE>
15. MISCELLANEOUS.
The reimbursement, indemnification and contribution agreements
contained in this Agreement and the representations, warranties and covenants in
this Agreement shall remain in full force and effect regardless of (a) any
termination of this Agreement, (b) any investigation made by or on behalf of
any Underwriter or controlling person thereof, or on behalf of the Company or
its directors or officers and (c) delivery of and payment for the Shares under
this Agreement.
This Agreement may be executed in two or more counterparts, each of
which shall be deemed an original, but all of which together shall constitute
one and the same instrument.
This Agreement shall be governed by, and construed in accordance with,
the laws of the State of Maryland.
<PAGE>
If the foregoing letter is in accordance with your understanding of our
agreement, please sign and return to us the enclosed duplicates hereof,
whereupon it will become a binding agreement among the Company and the several
Underwriters in accordance with its terms.
Very truly yours,
DIGITAL RIVER, INC.
By
------------------------------------------
Joel A. Ronning
Chief Executive Officer
SELLING STOCKHOLDERS
By
------------------------------------------
Attorney-in-fact
The foregoing Underwriting Agreement
is hereby confirmed and accepted as
of the date first above written.
BT ALEX. BROWN INCORPORATED
BANCBOSTON ROBERTSON STEPHENS INC.
BEAR, STEARNS & CO. INC.
As Representatives of the several
Underwriters listed on Schedule I
By: BT Alex. Brown Incorporated
By:
-----------------------------------
Authorized Officer
[**Signature Page to Underwriting Agreement**]
<PAGE>
SCHEDULE I
SCHEDULE OF UNDERWRITERS
<TABLE>
<CAPTION>
Underwriter Number of Firm
Shares to be
Purchased
----------- ----------------
<S> <C>
BT Alex. Brown Incorporated
BancBoston Robertson Stephens Inc.
Bear, Stearns & Co. Inc.
Total
</TABLE>
<PAGE>
SCHEDULE II
SCHEDULE OF SELLING STOCKHOLDERS
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------
MAXIMUM NUMBER
MAXIMUM NUMBER OF OPTION PERCENTAGE OF
OF FIRM SHARES SHARES TO BE TOTAL NUMBER OF
TO BE SOLD SOLD OPTION SHARES
NAME OF SELLER
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C>
- --------------------------------------------------------------------------------------------
TOTAL SELLING STOCKHOLDER SHARES
- --------------------------------------------------------------------------------------------
TOTAL COMPANY SHARES
- --------------------------------------------------------------------------------------------
TOTAL SHARES
- --------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
EXHIBIT A
LIST OF SUBSIDIARIES
1. Digital River, Inc., a Minnesota corporation
2. Digital River Limited
<PAGE>
[COOLEY GODWARD LLP LETTERHEAD]
November 30, 1998
Digital River, Inc.
9625 W. 76th Street
Suite 150
Eden Prairie, MN 55344
Ladies and Gentlemen:
You have requested our opinion with respect to certain matters in connection
with the filing by Digital River, Inc. (the "Company") of a Registration
Statement on Form S-1 (the "Registration Statement") with the Securities and
Exchange Commission (the "Commission") covering the underwritten public offering
of up to 3,450,000 shares of common stock, including 1,750,000 shares to be sold
by the Company (the "Company Shares"), 450,000 shares for which the Underwriters
have been granted an over-allotment option, and 1,250,000 shares to be sold be
certain selling stockholders (the "Selling Stockholder Shares") (collectively,
the "Common Stock").
In connection with this opinion, we have (i) examined and relied upon the
Registration Statement and related Prospectus, the Company's Amended and
Restated Certificate of Incorporation and Amended and Restated Bylaws and the
originals or copies certified to our satisfaction of such records, documents,
certificates, memoranda and other instruments as in our judgment are necessary
or appropriate to enable us to render the opinion expressed below, and (ii)
assumed that the shares of the Common Stock will be sold by the Underwriters at
a price established by the Pricing Committee of the Company's Board of
Directors.
On the basis of the foregoing, and in reliance thereon, we are of the
opinion that the Selling Stockholder Shares are, and the Company Shares, when
sold and issued in accordance with the Registration Statement and related
Prospectus, will be, validly issued, fully paid and nonassessable.
We consent to the reference to our firm under the caption "Legal Matters" in
the Prospectus included in the Registration Statement and to the filing of this
opinion as an exhibit to the Registration Statement.
Very truly yours,
COOLEY GODWARD LLP
By: /s/ MICHAEL J. SULLIVAN
--------------------------------------------
Michael J. Sullivan
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our
report and to all references to our Firm included in or made a part of this
registration statement.
/s/ ARTHUR ANDERSEN LLP
------------------------------------------
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota
November 30, 1998
