<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 11, 1998
REGISTRATION NO. 333-56787
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------
AMENDMENT NO. 4
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>
5198 WEST 76TH STREET
EDINA, MINNESOTA 55439
(612) 830-9042
(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.
5198 WEST 76TH STREET
EDINA, MINNESOTA 55439
(612) 830-9042
(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.
LANA K. HAWKINS, 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. / /
--------------------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
PROPOSED MAXIMUM PROPOSED MAXIMUM AMOUNT OF
TITLE OF EACH CLASS OF AMOUNT TO OFFERING PRICE AGGREGATE REGISTRATION
SECURITIES TO BE REGISTERED BE REGISTERED(1) PER SHARE(2) OFFERING PRICE(2) FEE(3)
<S> <C> <C> <C> <C>
Common Stock, $0.01 par value......... 3,450,000 $9.00 $31,050,000 $9,160
</TABLE>
(1) Includes 450,000 shares which the Underwriters have the option to purchase
to cover over-allotments, if any.
(2) Estimated solely for the purpose of computing the amount of the registration
fee pursuant to Rule 457(a) of the Securities Act of 1933, as amended.
(3) A registration fee in the amount of $13,028 was previously paid.
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.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
SUBJECT TO COMPLETION
AUGUST 11, 1998
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
<PAGE>
3,000,000 SHARES
[LOGO]
COMMON STOCK
---------
All of the 3,000,000 shares of Common Stock offered hereby are being sold by
Digital River, Inc. ("Digital River" or the "Company"). Prior to this offering,
there has been no public market for the Common Stock. For factors considered in
determining the initial public offering price, see "Underwriting." It is
currently estimated that the initial public offering price of the Common Stock
will be between $8.50 and $9.00 per share. The Common Stock has been approved
for quotation on the Nasdaq National Market under the symbol "DRIV."
----------------
THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" BEGINNING ON PAGE 6.
-------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
PRICE UNDERWRITING PROCEEDS
TO DISCOUNTS AND TO
PUBLIC COMMISSIONS(1) COMPANY(2)
<S> <C> <C> <C>
Per Share.............................................. $ $ $
Total (3).............................................. $ $ $
</TABLE>
(1) See "Underwriting" for information relating to indemnification of the
Underwriters.
(2) Before deducting expenses of the offering estimated at $700,000.
(3) The Company has granted the Underwriters a 30-day option to purchase up to
450,000 additional shares of Common Stock solely to cover over-allotments,
if any. To the extent that the option is exercised, the Underwriters will
offer the additional shares at the Price to Public shown above. If the
option is exercised in full, the total Price to Public, Underwriting
Discounts and Commissions and Proceeds to Company will be $ , $
and $ , respectively. See "Underwriting."
----------------
The shares of Common Stock are offered by the several Underwriters, subject
to prior sale, when, as and if delivered to and accepted by them, and subject to
the right of the Underwriters to reject any order in whole or in part. It is
expected that delivery of the shares of Common Stock will be made at the offices
of BT Alex. Brown Incorporated, Baltimore, Maryland, on or about ,
1998.
BT ALEX. BROWN BANCAMERICA ROBERTSON STEPHENS
BEAR, STEARNS & CO. INC.
THE DATE OF THIS PROSPECTUS IS , 1998
<PAGE>
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.
[ILLUSTRATIONS]
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK IN
CONNECTION WITH THE OFFERING, INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT
COVERING TRANSACTIONS IN SUCH SECURITIES AND THE IMPOSITION OF PENALTY BIDS. FOR
A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
----------------
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
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION AND CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO APPEARING
ELSEWHERE IN THIS PROSPECTUS. THIS PROSPECTUS CONTAINS CERTAIN STATEMENTS OF A
FORWARD-LOOKING NATURE RELATING TO FUTURE EVENTS OR THE FUTURE FINANCIAL
PERFORMANCE OF THE COMPANY. 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.
THE COMPANY
Digital River, Inc. ("Digital River" or the "Company") 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 electronic software
delivery ("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 June 30,
1998, the Company had contracts with 1,122 software publisher clients and 346
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 123,000
software products from its various software publisher clients, including more
than 18,000 software titles and more than 105,000 digital images, such as
photography and clip art, and type fonts. Through June 30, 1998, the Company had
completed more than 172,000 transactions for more than 124,000 unique end-users.
Digital River's proprietary commerce network server ("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 123,000 software products. Using its CNS platform, the
Company creates Web stores for its clients that replicate the look and feel of
such clients' own Web sites. End-users can 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.
Digital River believes that the market for software sales online will
continue to grow rapidly. Jupiter Communications, LLC, estimates that the market
for software sold online will increase from an estimated $69 million in 1997 to
an estimated $2.3 billion by 2002. 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 delivery of software
applications exceeding 10 megabytes can be impractical at slower modem speeds.
The Company believes that as Internet bandwidth increases, ESD will become
increasingly attractive even for large 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. 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 through
3
<PAGE>
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.
The Company provides a number of advantages to software publishers, online
retailers and end-users. By entering into a relationship with the Company,
software publishers can avoid the up-front and ongoing cost and complexity of
operating an electronic commerce infrastructure, offer a full library of their
software products, avoid shipping and packaging costs, and offer software
products through their own Web store or the Company's network of online retailer
clients. The Company also provides software publishers with valuable end-user
information and data mining capabilities that can facilitate targeted marketing,
upgrade notification and sophisticated merchandising. Digital River offers
online retailers the ability to access the software products of most of the
Company's software publisher clients without having to negotiate agreements and
arrange the relationship with individual software publishers and without the
cost and risk associated with carrying inventory. End-users who purchase
products over the Company's network benefit from value-added services including
credit card security and upgrade notifications, as well as the protection of the
Company's archiving service through which the Company guarantees replacement of
software products in the event of accidental loss or damage.
Digital River was incorporated in Minnesota in February 1994 and
reincorporated into Delaware in December 1997. Unless the context requires
otherwise, references in this Prospectus to "Digital River" and the "Company"
refer to Digital River, Inc. a Delaware corporation and its subsidiaries. The
Company's executive offices are located at 5198 West 76th Street, Edina,
Minnesota 55439, and its telephone number is (612) 830-9042.
4
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common Stock offered by the Company.......... 3,000,000 shares
Common Stock to be outstanding after the 16,734,047 shares (1)
offering.....................................
Use of proceeds.............................. For general corporate purposes, including
continued investment in product development,
expansion of sales and marketing activities
and working capital.
Proposed Nasdaq National Market symbol....... DRIV
</TABLE>
SUMMARY CONSOLIDATED FINANCIAL INFORMATION
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 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 $ 461 $ 5,746
Gross profit................................................. -- 16 420 82 955
Loss from operations......................................... (165) (697) (3,538) (1,195) (5,502)
Net loss..................................................... (143) (689) (3,485) (1,176) (5,352)
Basic and diluted net loss per share (2)..................... $ (0.03) $ (0.13) $ (0.46) $ (0.18) $ (0.47)
Shares used in per share computation (2)..................... 5,333 5,333 7,514 6,438 11,279
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, 1998
--------------------------
ACTUAL AS ADJUSTED(3)
---------- --------------
(IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents........................................................... $ 4,755 $ 27,770
Short-term investments.............................................................. 4,934 4,934
Working capital..................................................................... 7,852 30,867
Total assets........................................................................ 12,697 35,712
Accumulated deficit................................................................. (9,677) (9,677)
Total stockholders' equity.......................................................... 10,283 33,298
</TABLE>
- --------------------------
(1) Based on shares outstanding as of August 6, 1998. Excludes (i) 2,291,755
shares of Common Stock issuable upon exercise of options outstanding as of
August 6, 1998 at a weighted average exercise price of $4.31 per share, (ii)
803,008 shares of Common Stock issuable upon exercise of warrants
outstanding as of August 6, 1998 at a weighted average exercise price of
$2.52 per share, and (iii) 530,853 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 method employed to determine the number of shares used to compute per
share amounts.
(3) Adjusted to reflect the sale by the Company of 3,000,000 shares of Common
Stock offered hereby at an assumed initial public offering price of $8.50
per share and the application of the estimated net proceeds therefrom. See
"Use of Proceeds."
EXCEPT AS OTHERWISE SPECIFIED, ALL INFORMATION IN THIS PROSPECTUS (I)
ASSUMES NO EXERCISE OF THE UNDERWRITERS' OVERALLOTMENT OPTION, (II) REFLECTS A 2
FOR 3 REVERSE SPLIT OF THE COMPANY'S COMMON STOCK TO BE EFFECTED PRIOR TO THE
CONSUMMATION OF THIS OFFERING AND (III) REFLECTS THE AUTOMATIC CONVERSION OF ALL
OUTSTANDING SHARES OF SERIES A PREFERRED STOCK INTO COMMON STOCK UPON THE
COMPLETION OF THIS OFFERING.
5
<PAGE>
RISK FACTORS
IN ADDITION TO THE OTHER INFORMATION IN THIS PROSPECTUS, THE FOLLOWING
FACTORS SHOULD BE CONSIDERED CAREFULLY IN EVALUATING AN INVESTMENT IN THE SHARES
OF COMMON STOCK OFFERED BY THIS PROSPECTUS. THIS PROSPECTUS CONTAINS CERTAIN
STATEMENTS OF A FORWARD-LOOKING NATURE RELATING TO FUTURE EVENTS OR THE FUTURE
FINANCIAL PERFORMANCE OF THE COMPANY. 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 BELOW, WHICH
COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE INDICATED BY SUCH
FORWARD-LOOKING STATEMENTS.
LIMITED OPERATING HISTORY; ACCUMULATED DEFICIT; EXPECTATION OF FUTURE
LOSSES. 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 client's Web store in August 1996 and is still in the
early stages of development. Accordingly, 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 June 30, 1998,
had an accumulated deficit of approximately $9.7 million. The Company intends to
expend significant financial and management resources on the development of
additional services, sales and marketing, technology and operations to support
larger-scale operations and greater service offerings. 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 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 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 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 have an
immediate adverse effect on 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.
POTENTIAL FLUCTUATIONS IN OPERATING RESULTS. 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 level of use of the Internet and
consumer acceptance of the Internet for the purchase of consumer products such
as those offered by the Company; (v) the Company's ability to upgrade and
develop its systems and
6
<PAGE>
infrastructure, in particular its CNS; (vi) the termination of any strategic
accounts such as Corel Corporation, from which the Company derives 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 mix of sales generated through software publisher client Web stores
compared to online retailer Web stores; (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; (xi) the amount and timing of operating costs and
capital expenditures relating to expansion of the Company's business, operations
and infrastructure; (xii) certain U.S. and foreign government regulations; and
(xiii) the failure of the Internet to continue to develop as a viable commercial
marketplace. The Company also may, as inducement to obtain certain strategic
contracts, offer certain economic terms to software publishers and online
retailers which will 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.
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% and 34% of the Company's sales in 1997 and the six months
ended June 30, 1998, respectively. The Company expects that a small percentage
of clients will continue to account for a substantial portion of the Company's
sales for the foreseeable future. Contracts with these clients are generally
short term in nature. In the event that any one of these contracts is not
renewed or is otherwise terminated, the Company's business, financial condition
and results of operations could be materially adversely affected.
The Company markets its services directly to software publishers and online
retailers. The Company's Strategic Sales Group focuses on larger software
publishers and online retailers with significant online revenue potential. These
sales are typically complex in nature and involve a lengthy sales cycle. Due to
operating procedures in many large organizations, an extended time period may
elapse after key decision makers have selected the Company's electronic commerce
outsourcing solutions and before a contract with the Company can be signed. As a
result, the period between the initial sales call until a contract with a
software publisher or online retailer with significant sales potential is
consummated 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 have a material adverse
effect on the Company's business, financial condition and results of operations.
RISKS ASSOCIATED WITH ESD; MARKET ACCEPTANCE OF ESD. The Company's success
will depend in large part on end-user acceptance of ESD as a method of
distributing software. ESD is a relatively new method of distributing software
products and the 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 network bandwidth to enable
purchasers to rapidly download software, the impact of time-based Internet
access fees, the number of software products that are available for purchase
through ESD as compared to those available through physical delivery, the level
of end-user comfort with the process of downloading software via the Internet
and the relative ease of such process and concerns about transaction security.
If ESD does not achieve widespread market acceptance, the Company's business,
financial condition and results of operations would be materially adversely
affected. Even if ESD achieves widespread acceptance, there can be no assurance
that the Company will overcome the substantial existing and future technical
challenges associated with electronically delivering software reliably and
consistently on a long-term basis. The failure by the Company to do so would
materially and adversely affect the Company's business, financial condition and
results of operations.
DEPENDENCE ON THE INTERNET, GROWTH IN ELECTRONIC COMMERCE AND INTERNET
INFRASTRUCTURE DEVELOPMENT. Sales of software products using the Internet do not
currently represent a significant portion of overall
7
<PAGE>
software sales. The Company's future sales and any future profits are
substantially dependent upon the widespread acceptance and use 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 and
there can be no assurance that acceptance and use 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. The Company relies
on end-users who have historically used traditional means of commerce to
purchase software products. For the Company to be successful, these end-users
must accept and utilize new ways of conducting business and exchanging
information.
In addition, the Internet may not be accepted as a viable 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. To the extent that the
Internet continues to experience significant growth in the number of users,
their frequency of use or an increase in their bandwidth resources, there can be
no assurance that the infrastructure for the Internet will be able to support
the demands placed upon them. In addition, the Internet could lose its viability
due to delays in the development or adoption of new standards and protocols
required to handle increased levels of Internet activity, or due to increased
governmental regulation. Changes in or insufficient availability of
communications services to support the Internet also could result in slower
response times and adversely affect usage of the Internet. If use of the
Internet does not continue to grow or grows more slowly than expected, if the
infrastructure for the Internet does not effectively support growth that may
occur, or if the Internet does not become a viable commercial marketplace, the
Company's business, financial condition and results of operations would be
materially adversely affected.
DEPENDENCE ON SOFTWARE PUBLISHERS. The Company is entirely dependent upon
the software publishers that supply it with software, and the availability of
such software is unpredictable. The Company's contracts with its software
publisher clients are generally one year in duration, with an automatic renewal
provision for additional one-year periods, unless the Company is provided with a
written notice at least 90 days prior to the termination of the contract. As is
common in the industry, the Company has no long-term or exclusive contracts or
arrangements with any software publisher that guarantees the availability of
software products. There can be no assurance that the software publishers that
currently supply software to the Company will continue to do so or that the
Company will be able to establish new relationships with software publishers. If
the Company is unable to develop and maintain satisfactory relationships with
software publishers on acceptable commercial terms, if the Company is unable to
obtain sufficient quantities of software, if the quality of service provided by
such software publishers falls below a satisfactory standard or if the Company's
level of returns exceeds its clients' expectations, the Company's business,
financial condition and results of operations could be materially adversely
affected.
DEPENDENCE ON ONLINE RETAILERS. The Company's strategy is dependent upon
increasing its sales of software products through online retailers. The Company
has historically generated substantially all of its sales from the sale of
software to end-users that were initiated through its software publisher
clients' Web stores. In 1997 and the six months ended June 30, 1998, less than
6% of the Company's sales were generated through online retailer clients' Web
stores. While the Company plans to increase its sales and marketing efforts over
time in an effort to generate increased sales from online retailer clients,
there can be no assurance that the Company will be successful in entering into
contractual relationships with additional online retailers or that its current
contractual relationships will be renewed. The Company's failure to enter into
contractual relationships with major online retailers or a substantial number of
smaller online retailers or the failure to renew its existing online retailer
contracts could have a material adverse impact upon the Company's business,
financial condition and results of operations.
RISK OF CAPACITY CONSTRAINTS; LIMITED REDUNDANT SYSTEMS; SYSTEM DEVELOPMENT
RISKS. The Company provides commerce, marketing and delivery services to
software publishers, retailers and end-users through its CNS
transaction-processing and client management systems, including electronic
inventory of products and consumer marketing information. The satisfactory
performance, reliability and availability of
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the CNS and the underlying network infrastructure are critical to the Company's
operating results, as well as to its reputation and its ability to attract and
retain clients and maintain adequate customer service levels. The Company's
systems and operations are vulnerable to damage or interruption from fire,
flood, other natural disasters, power loss, telecommunications failure,
break-ins and similar events. The Company presently has limited redundant
systems, no back-up facilities and carries limited business interruption
insurance to compensate it for losses that may occur. Despite the implementation
of network security measures by the Company, its 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 interruptions that result in
reduced order fulfillment performance would reduce the online volume of goods
sold and the attractiveness of the Company's product and service offerings to
software publishers, retailers and end-users, which would have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company has experienced periodic interruptions, affecting all or a
portion of its systems, which it believes will continue to occur from time to
time. The Company periodically enhances and expands its technology and
transaction-processing systems, and network infrastructure and other
technologies to accommodate increases in the volume of traffic on the CNS. There
can be no assurance that the Company will be successful in its efforts to
improve and increase the capacity of its network infrastructure, or that the
Company will be able to accurately project the rate or timing of increases, if
any, in the use of its CNS or expand and upgrade its systems and infrastructure
in a timely manner to accommodate such increases. The Company's inability to add
software and hardware or to develop and upgrade further its existing technology,
transaction-processing systems or network infrastructure to accommodate
increased traffic on its CNS may cause unanticipated system disruptions, slower
response times, degradation in levels of customer service and impaired quality
and speed of order fulfillment, any of 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 additional network capacity will be
available from third-party suppliers when it is needed by the Company. There can
be no assurance that the Company's or its suppliers' network will be able to
achieve or maintain in a timely manner a sufficiently high capacity of data
transmission, especially if demands on the CNS increase. The Company's failure
to achieve or maintain high capacity data transmission could significantly
reduce demand for its services, which would have a material adverse effect on
its business, financial condition and results of operations.
ELECTRONIC COMMERCE SECURITY RISKS. The secure transmission of confidential
information over public networks is critical to the acceptance of electronic
commerce. 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. There can be no assurance
that advances in computer capabilities, new discoveries in the field of
cryptography, or other events or developments will not result in a compromise or
breach of the algorithms used by the Company to protect end-user transaction
data. If any such compromise were to occur, it could have a material adverse
effect on the Company's business, financial condition and results of operations.
A party who is able to circumvent the Company's security measures could
misappropriate proprietary information or cause disruptions in the Company's
operations. The Company may be required to expend significant capital and other
resources to protect against such security breaches or to alleviate problems
caused by such breaches. Concerns over the security of transactions conducted on
the Internet and the privacy of users may also inhibit the growth of the
Internet generally, and electronic commerce in particular. To the extent that
activities of the Company involve the storage and transmission of proprietary
information, such as credit card numbers and end-user profile information,
security breaches could damage the Company's reputation and expose the Company
to a risk of loss or litigation and possible liability. There can be no
assurance that the Company's security measures will prevent security breaches or
that a failure to prevent such security breaches will not have a material
adverse effect on the Company's business, financial condition and results of
operations.
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
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and distribution of software products. The Company currently competes directly
with other providers of electronic commerce solutions, including CyberSource
Corporation, Preview Software Corporation, 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 also competes with companies that sell and distribute
software products via the Internet, including online retailers such as CNET,
Inc., Ingram Micro Inc. and software.net Corporation, as well as companies such
as AltaVista (a subsidiary of Digital Equipment 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 product offerings, software publisher and online retailer
relationships, brand recognition, system capacity, reliability, price,
selection, speed and accessibility, customer service, quality of site content,
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.
RAPID TECHNOLOGICAL CHANGE. 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
electronic 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
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
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is unable, for technical, 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.
MANAGEMENT OF POTENTIAL GROWTH; NEW MANAGEMENT TEAM; LIMITED EXECUTIVE
OFFICER RESOURCES. The Company has rapidly and significantly expanded its
operations and anticipates that further significant expansion will be required
to address potential growth in its client base and market opportunities. From
January 1, 1997 to June 30, 1998, the Company has increased its number of
employees from 11 to 76. This expansion has placed, and is expected to continue
to place, a significant strain on the Company's managerial, operational and
financial resources. The majority of the Company's existing senior management
personnel joined the Company within the last 14 months, including the President,
who joined the Company in July 1998, the Vice President of Marketing, who joined
the Company in August 1998 and the Chief Financial Officer, who joined the
Company in April 1998. Joel A. Ronning, the Company's Chief Executive Officer
also serves as the Chairman of the Board of Tech Squared, Inc. ("Tech Squared"),
a principal stockholder of the Company. The Company's new employees include a
number of key managerial, technical and operations personnel who have not yet
been fully integrated into the Company, and the Company expects to add
additional key personnel in the near future, including direct sales and
marketing personnel. To manage the expected growth of its operations and
personnel, the Company will be required to improve existing and implement new
operational, financial and management controls, reporting systems and
procedures, to install new management information and control systems and to
train, motivate and manage its employees. There can be no assurance that the
Company will install such management information and control systems in an
efficient and timely manner, or that the Company's current or planned personnel,
systems, procedures and controls will be adequate to support the Company's
future operations. In addition, there can be no assurance that management will
be able to hire, train, retain, motivate and manage required personnel or that
the Company's management will be able to successfully identify, manage and
exploit existing and potential market opportunities. If the Company is unable to
manage growth effectively, its business, financial condition and results of
operations would be materially adversely affected.
DEPENDENCE ON KEY PERSONNEL; NEED FOR ADDITIONAL PERSONNEL. The Company's
performance is substantially dependent on the continued services and on the
performance of its senior management, particularly Joel A. Ronning, the
Company's Chief Executive Officer and Kelly J. Wical, the Company's Chief
Technology Officer. The Company's performance also depends on its ability to
retain and motivate its other executive officers and key employees. The loss of
the services of any of its executive officers or other key employees could have
a material adverse effect on the Company's business, financial condition and
results of operations. The Company has long-term employment agreements only with
Mr. Ronning and Perry W. Steiner, the Company's President. See
"Management--Employment Agreements." Also, the Company only maintains a "key
person" life insurance policy on Mr. Ronning. The Company's future success also
depends on its 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 there can be no assurance that the Company will be able to
successfully attract, assimilate or retain sufficiently qualified personnel. The
failure to retain and attract the necessary technical, managerial,
merchandising, sales and marketing and customer service personnel 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 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
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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.
LIABILITY FOR SOFTWARE PRODUCTS CONTENT. Claims may be made against the
Company 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 the Company
carries general liability insurance, the Company's 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 the Company 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 have a material adverse
effect on the Company's business, financial condition and results of operations.
FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING. The Company
requires substantial working capital to fund its business. The Company has
experienced negative cash flow from operations since inception and expects to
continue to experience significant negative cash flow from operations for the
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foreseeable future. The Company expects to use the net proceeds of this offering
primarily to fund continued operations, to expand sales and marketing activities
and for the continued investment in product development. The Company believes
that such proceeds, together with its existing capital resources, will be
sufficient to meet the Company's capital requirements for at least the next
twenty-four months. However, the Company's capital requirements depend on
several factors, including the rate of market acceptance, the ability to expand
the Company's client base, the level of expansion of sales and marketing and
other factors. If capital requirements vary materially from those currently
planned, the Company 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. There can be no assurance that additional financing will
be available when needed on terms favorable to the Company or at all. If
adequate funds are not available or are not available on acceptable terms, the
Company may be unable to develop or enhance its services, take advantage of
future opportunities or respond to competitive pressures, which could have a
material adverse effect on the Company's business, financial condition or
operating results.
GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES. The Company is 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, 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 certain
additional laws or regulations may decrease the growth of the Internet or other
online services, which could, in turn, decrease the demand for the Company's
products and services and increase the Company's cost of doing business, or
otherwise have an adverse effect on the Company's business, financial condition
and results of operations.
Applicability to the Internet 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 is uncertain. The vast majority of such laws were adopted prior to the
advent of the Internet and related technologies and, as a result, 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 which could reduce demand for the services of the Company or
increase the cost of doing business as a result of costs of litigation or
increased service delivery costs, or could in some other manner have a material
adverse effect on the Company's business, financial condition and results of
operations.
In addition, as the Company's services are available over the Internet in
multiple states and foreign countries, such jurisdictions may claim that the
Company is required to qualify to do business as a foreign corporation in each
such state or foreign country. The Company is qualified to do business only in
Minnesota, Iowa and Washington, and failure by the Company to qualify as a
foreign corporation in a jurisdiction where it is required to do so could
subject the Company to taxes and penalties for the failure to qualify and could
result in the inability of the Company to enforce contracts in such
jurisdictions. Any such new legislation or regulation, the application of laws
and regulations from jurisdictions whose laws do not currently apply to the
Company's business, or the application of existing laws and regulations to the
Internet and other electronic services could have a material adverse effect on
the Company's business, financial condition and results of operations.
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RISK OF INTERNATIONAL SALES. Although the Company sells software products
to end-users outside the United States, there can be no assurance that the
Company will be able to expand its 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, the export of certain software from the United States
is subject to export restrictions as a result of the encryption technology in
such software and may give rise to liability to the extent the Company violates
such restrictions. There can be no assurance that the Company will be able to
successfully market, sell and distribute its products in local markets or that
one or more of such factors will not have a material adverse effect on the
Company's future international operations, and consequently, on the Company's
business, financial condition and results of operations.
SALES AND OTHER TAXES. The Company does 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 the Company, which engage in electronic commerce. In
addition, any new operation in states outside 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 the
Company should collect sales, use or other taxes on the sale of merchandise
could have a material adverse effect on the Company's business, financial
condition and results of operations.
CONTROL BY EXISTING STOCKHOLDERS. Upon completion of this offering, the
Company's executive officers, directors and principal stockholders and their
respective affiliates will beneficially own in the aggregate approximately
8,758,944, or 49.37% of the outstanding shares of Common Stock (48.15% if the
Underwriters' overallotment option is exercised in full). As a result, such
persons may have the ability to effectively control the Company and direct its
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 the
Company, and making certain transactions more difficult or impossible absent the
support of such stockholders, including proxy contests, mergers involving the
Company, tender offers, open-market purchase programs or other purchases of
Common Stock that could give stockholders of the Company the opportunity to
realize a premium over the then prevailing market price for shares of Common
Stock.
ABSENCE OF PRIOR PUBLIC MARKET; POSSIBLE VOLATILITY OF STOCK PRICE. Prior
to this offering there has been no public market for the Company's Common Stock,
and there can be no assurance that an active market will develop or be
maintained. The initial public offering price was negotiated between the Company
and the Representatives of the Underwriters and may not be indicative of future
market prices. The trading price of the Common Stock is likely 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 by the
Company or its 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 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 the Company's 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 reflect price
earnings ratios substantially above historical levels. There can be no assurance
that these trading prices and price earnings ratios will be sustained. These
broad market and industry factors may materially and adversely affect the market
price of the Common Stock, regardless of the Company's 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 costs and a
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diversion of management's attention and resources, which would have a material
adverse effect on the Company's business, financial condition and results of
operations.
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 and adversely affect the
market price of the Common Stock or the future ability of the Company to raise
capital through an offering of its equity securities. Upon the completion of
this offering, the Company will have outstanding 16,734,047 shares of Common
Stock, based on the number of shares of Common Stock outstanding as of August 6,
1998, assuming (i) the issuance by the Company of shares of Common Stock offered
hereby, (ii) the automatic conversion of all outstanding shares of Series A
Preferred Stock into Common Stock upon the completion of this offering, (iii) no
exercise of options, warrants or other obligations to issue shares after August
6, 1998 and (iv) no exercise of the Underwriters' over-allotment option to
purchase 450,000 shares of Common Stock, except as otherwise noted. Of these
shares, the 3,000,000 shares sold in this offering will be freely tradable
without restriction under the Securities Act. The remaining 13,734,047 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 12,466,456 shares of the Company's Common Stock
and an additional 1,282,675 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 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: (i) 693,454 shares of Common Stock currently outstanding will be
available for sale into the public market following the effectiveness of this
Registration Statement (ii) 146,666 shares of Common Stock currently outstanding
and 19,342 shares of Common Stock issuable upon exercise of currently
outstanding options will be eligible for sale 90 days after the date of this
Prospectus, (iii) 8,415,048 restricted securities will be eligible for sale 180
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. After this offering,
the holders of approximately 8,081,506 shares of Common Stock and options and
warrants to purchase 1,034,416 shares of Common Stock will be entitled to
certain demand and piggyback registration rights with respect to registration of
such shares under the Securities Act. If such holders, by exercising their
demand or piggyback 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 the Company's Common Stock. If the Company were
to include in a Company initiated registration shares held by such holders
pursuant to the exercise of their piggyback registration rights, such sales may
have an adverse effect on the Company's ability to raise needed capital. In
addition, after the date of this Prospectus, the Company intends to file a Form
S-8 registration statement under the Securities Act to register all shares of
Common Stock issuable under the Company's 1998 Stock Plan. Such registration
statement is expected to become effective not earlier than 180 days after the
effective date of this offering. Shares covered by such registration statement
will thereupon be eligible for sale in the public markets, subject to Rule 144
limitations applicable to affiliates.
ANTI-TAKEOVER EFFECT OF CERTAIN CHARTER PROVISIONS. Upon completion of this
offering, the Company's Board of Directors will have the authority to issue up
to 5,000,000 shares of Preferred Stock and to
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determine the price, rights, preferences and privileges of those shares without
any further vote or action by the Company's stockholders. The rights of the
holders of Common Stock will be subject to, and may be adversely affected by,
the rights of the holders of any Preferred Stock that may be issued in the
future. While the Company has no present intention to issue Preferred Stock, any
such issuance, while providing desirable flexibility in connection with possible
acquisitions and other corporate purposes, could have the effect of making it
more difficult for a third party to acquire a majority of the outstanding voting
stock of the Company and may discourage bids for the Common Stock at a premium
over the market price of the Common Stock and may affect adversely the market
price of and the voting and other rights of the holders of the Common Stock. In
addition, the Company is subject to the anti-takeover provisions of Section 203
of the Delaware General Corporation Law, which prohibits the Company 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. The application of Section 203 could have the effect of
delaying or preventing a change of control of the Company. The Company's Amended
and Restated Certificate of Incorporation ("Restated Certificate of
Incorporation") also provides for staggered three-year terms for the members of
the Board of Directors. 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. These
provisions, and other provisions of the Restated Certificate of Incorporation,
the Company's Bylaws and Delaware corporate law, may have the effect of
deterring hostile takeovers or delaying or preventing changes in control or
management of the Company, including transactions in which stockholders might
otherwise receive a premium for their shares over then current market prices.
NO SPECIFIC PLAN FOR SIGNIFICANT PORTION OF PROCEEDS. The Company currently
has no specific plans for a significant portion of the net proceeds of the
offering. As a consequence, the Company's 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, and there can be no assurance that these
proceeds can or will be invested 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 initial public offering price will be
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 $6.52 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. The Company has never declared or paid any cash dividends
and does not anticipate paying cash dividends in the foreseeable future. The
Company's loan and security agreement and capital equipment leases prohibit the
payment of dividends without the consent of the respective lenders.
YEAR 2000 COMPLIANCE. The Company uses a significant number of computer
software programs and operating systems in its internal operations. The use of
computer programs that rely on two-digit date programs to perform computations
and decision-making functions may cause computer systems to malfunction in the
year 2000 and lead to significant business delays and disruptions. While the
Company believes that the software applications that it uses or has developed
are year 2000 compliant, to the extent that any of these software applications
contain source code that is unable to appropriately interpret the upcoming
calendar year 2000, some level of modification or possible replacement of such
source code or applications will be necessary. The Company has analyzed the
software applications that it uses or has developed and, as a result, the
Company at this time does not anticipate any significant expense in ensuring
that they are year 2000 compliant. However, until the year 2000 arrives, the
Company cannot be absolutely certain that its analysis is correct. The Company
is currently unable to predict the extent to which the year 2000 issue will
affect its clients or suppliers, or the extent to which it would be vulnerable
to any failure by the clients or suppliers to remediate any year 2000 issues on
a timely basis. The failure of a client or a major supplier subject to the year
2000 to convert its systems on a timely basis or a conversion that is
incompatible with the Company's systems could have a material adverse effect on
the Company's business, financial condition and results of operations. In
addition the Company's business, financial condition and results of operations
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.
16
<PAGE>
USE OF PROCEEDS
The net proceeds from the sale of the 3,000,000 shares of Common Stock
offered hereby, at an assumed initial public offering price of $8.50 per share,
are estimated to be approximately $23,015,000 ($26,572,250 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 continued investment in 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. See "Risk Factors--No Specific
Plans for Significant Portion of Proceeds."
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.
17
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of the Company as of June
30, 1998 (i) on an actual basis and (ii) as adjusted to reflect the automatic
conversion of all outstanding shares of Series A Preferred Stock into Common
Stock upon the completion of this offering and the sale of 3,000,000 shares of
Common Stock offered by the Company hereby at an assumed initial public offering
price of $8.50 per share and after deducting underwriting discounts and
commissions and estimated offering expenses payable by the Company and the
application of the estimated net proceeds therefrom. See "Use of Proceeds."
<TABLE>
<CAPTION>
JUNE 30, 1998
----------------------
ACTUAL AS ADJUSTED
--------- -----------
(IN THOUSANDS)
<S> <C> <C>
Stockholders' equity (1):
Preferred Stock; $0.01 par value; 1,500,000 shares authorized, 1,500,000 shares of
Series A Preferred Stock issued and outstanding, actual; 5,000,000 shares authorized,
no shares issued and outstanding, as adjusted......................................... $ 15 $ --
Common Stock; $0.01 par value; 66,666,667 shares authorized, 12,713,715 shares issued
and outstanding, actual; 45,000,000 shares authorized, 16,713,715 shares issued and
outstanding, as adjusted.............................................................. 127 167
Additional paid-in-capital.............................................................. 21,728 44,718
Deferred compensation................................................................... (1,910) (1,910)
Accumulated deficit..................................................................... (9,677) (9,677)
--------- -----------
Total stockholders' equity............................................................ 10,283 33,298
--------- -----------
Total capitalization................................................................ $ 10,283 $ 33,298
--------- -----------
--------- -----------
</TABLE>
- ------------------------
(1) Excludes (i) 1,532,087 shares of Common Stock issuable upon exercise of
options outstanding as of June 30, 1998, at a weighted average exercise
price of $2.16 per share, (ii) 803,008 shares of Common Stock issuable upon
exercise of warrants outstanding as of June 30, 1998, at a weighted average
exercise price of $2.52 per share, and (iii) 801,246 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.
18
<PAGE>
DILUTION
The pro forma net tangible book value of the Company at June 30, 1998 was
$10,120,237 or $0.74 per share after giving effect to the conversion of
outstanding Series A Preferred Stock into 1,000,000 shares of Common Stock. Pro
forma 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 on a pro forma basis 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 pro forma 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 3,000,000 shares of Common Stock offered
hereby at an assumed initial public offering price of $8.50 per share, after
deducting estimated underwriting discounts and commissions and offering
expenses, the pro forma net tangible book value of the Company as of June 30,
1998 would have been $33,135,237, or $1.98 per share. This represents an
immediate increase in pro forma net tangible book value of $1.24 per share to
existing stockholders and an immediate dilution in pro forma net tangible book
value of $6.52 per share to new investors purchasing shares at the assumed
initial public offering price. The following table illustrates this per share
dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share............................. $ 8.50
---------
Pro forma net tangible book value per share at June 30, 1998.............. $ .74
Increase per share attributable to new investors.......................... 1.24
---------
Pro forma net tangible book value per share after the offering.............. 1.98
---------
Net tangible book value dilution per share to new investors................. $ 6.52
---------
---------
</TABLE>
The following table sets forth on a pro forma basis as of June 30, 1998
after giving effort to the automatic conversion of all outstanding shares of
Series A Preferred Stock into Common Stock upon the closing of this offering,
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 an assumed initial public
offering price of $8.50 per share for shares purchased in this offering, before
deducting estimated underwriting discounts and commissions and offering
expenses:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
------------------------ ------------------------ AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
------------- --------- ------------- --------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders......................... 13,713,715 82% $ 20,520,651 45% $ 1.50
New investors................................. 3,000,000 18% 25,500,000 55% 8.50
------------- --------- ------------- ---------
Total....................................... 16,713,715 100.0% $ 46,020,651 100.0%
------------- --------- ------------- ---------
------------- --------- ------------- ---------
</TABLE>
The foregoing tables assume no exercise of outstanding stock options or
warrants and as of June 30, 1998, excludes (i) options to purchase 1,532,087
shares of Common Stock at a weighted average exercise price of $2.16 per share,
(ii) warrants to purchase 803,008 shares of Common Stock at a weighted average
exercise price of $2.52 per share and (iii) 801,246 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.
19
<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 and contain all
adjustments, consisting of normal recurring adjustments, necessary for a fair
presentation of the financial position and results of operations for such
periods. The statement of operations data for the six months ended June 30, 1997
and 1998 and the balance sheet data as of June 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
(FEBRUARY 9, SIX MONTHS ENDED
1994) TO YEAR ENDED DECEMBER 31, JUNE 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 $ 461 $ 5,746
Cost of sales........................................ -- -- 95 2,052 379 4,791
------ --------- --------- --------- --------- ---------
Gross profit....................................... -- -- 16 420 82 955
Operating expenses:
Sales and marketing................................ -- 3 68 1,501 629 3,433
Product development and operations................. -- 130 230 1,528 415 1,611
General and administrative......................... 13 32 415 929 233 1,413
------ --------- --------- --------- --------- ---------
Total operating expenses......................... 13 165 713 3,958 1,277 6,457
------ --------- --------- --------- --------- ---------
Loss from operations................................. (13) (165) (697) (3,538) (1,195) (5,502)
Interest income, net............................... 5 22 8 53 19 150
------ --------- --------- --------- --------- ---------
Net loss............................................. $ (8) $ (143) $ (689) $ (3,485) $ (1,176) $ (5,352)
------ --------- --------- --------- --------- ---------
------ --------- --------- --------- --------- ---------
Basic and diluted net loss per share (1)............. $ (0.00) $ (0.03) $ (0.13) $ (0.46) $ (0.18) $ (0.47)
------ --------- --------- --------- --------- ---------
------ --------- --------- --------- --------- ---------
Shares used in per share computation (1)............. 5,333 5,333 5,333 7,514 6,438 11,279
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------ JUNE 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 $ 4,755
Short-term investments............................................... -- -- -- -- 4,934
Working capital (deficit)............................................ 667 478 (451) 1,244 7,852
Total assets......................................................... 783 635 1,202 3,405 12,697
Accumulated deficit.................................................. (8) (152) (840) (4,325) (9,677)
Total stockholders' equity (deficit)................................. 770 627 (58) 2,329 10,283
</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.
20
<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 THE COMPANY.
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
The Company 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 1,122 software publishers as of December
31, 1997 and June 30, 1998, respectively. In 1997, the Company began to develop
distribution relationships and had contracts with a total of 105 and 346 online
retailers as of December 31, 1997 and June 30, 1998, respectively. During the
six months ended June 30, 1998, the Company completed transactions for 787
software publishers and 112 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 June 30, 1998, the Company's reserve balance for
charge-backs totalled $82,000. Sales of software products that are delivered
through ESD accounted for 72% of sales for the six months ended June 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 June 30, 1998, had an accumulated deficit of
approximately $9.7 million. The Company intends to expend significant financial
and management resources on the development of additional services, sales and
marketing, technology and operations to support larger-scale operations and
greater service offerings. 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 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 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
21
<PAGE>
have a material adverse effect on the Company's business, financial condition
and results of operations. The Company's current 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 have an immediate adverse effect on 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.
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 SIX MONTHS ENDED
31, JUNE 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 83.4
--------- --------- --------- ---------
Gross profit........................................................... 14.4 17.0 17.8 16.6
Operating expenses:
Sales and marketing.................................................... 61.2 60.7 136.5 59.8
Product development and operations..................................... 207.2 61.8 90.0 28.0
General and administrative............................................. 373.9 37.6 50.5 24.6
--------- --------- --------- ---------
Total operating expenses............................................. 642.3 160.1 277.0 112.4
--------- --------- --------- ---------
Loss from operations..................................................... (627.9) (143.1) (259.2) (95.8)
Interest income, net................................................... 7.2 2.1 4.1 2.6
--------- --------- --------- ---------
Net loss................................................................. (620.7)% (141.0)% (255.1)% (93.2)%
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
SIX MONTHS ENDED JUNE 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
$461,000 for the six months ended June 30, 1997 to $5.7 million for the six
months ended June 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 33% of sales for the six months ended June 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 $379,000 in the six months ended June 30, 1997 to $4.8
million in the six months ended June 30, 1998, reflecting the Company's growth
in sales. The Company's gross profit margin decreased from 17.8% in the six
months ended June 30, 1997 to 16.6% in the six months ended June 30, 1998, as a
result of the addition of certain lower margin software publisher clients during
the second half of 1997. The Company has historically generated higher gross
margins on sales through online retailer client Web stores compared to sales
through software publisher client Web
22
<PAGE>
stores. There can be no assurance, however, that the Company will continue to
generate higher gross margins on sales through online retailer client Web
stores. In each of the six months ended June 30, 1997 and 1998, less than 6% 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 $629,000 in the six months ended June 30, 1997 to $3.4 million in the six
months ended June 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 were an increase in advertising and marketing expenditures of $1.4
million and an increase in wages and benefits of $576,000. As a percentage of
sales, sales and marketing expense decreased from 136.5% in the six months ended
June 30, 1997 to 59.8% in the six months ended June 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 $415,000 in the six months ended June 30, 1997 to $1.6 million in the six
months ended June 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 were an increase in wages and benefits of $604,000 and an increase in
consulting costs of $139,000. As a percentage of sales, product development and
operations expense decreased from 90.0% in the six months ended June 30, 1997 to
28.0% in the six months ended June 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. As a percentage of sales, these
expenses are expected to decrease as sales increase.
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 $233,000
in the six months ended June 30, 1997 to $1.4 million in the six months ended
June 30, 1998. The increase was due to increased personnel and related expenses
and increased professional fees. The primary components of this increase were an
increase in deferred compensation expense of $689,000 and an increase in wages
and benefits of $237,000. As a percentage of sales, general and administrative
expense decreased from 50.5% in the three months ended June 30, 1997 to 24.6% in
the six months ended June 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 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 $19,000 in the six months ended June 30, 1997 to
$150,000 in six months ended June 30, 1998. The increase was attributable
23
<PAGE>
to interest received on higher average cash and cash equivalent balances. The
Company expects interest income to increase as a result of the net proceeds from
this offering.
INCOME TAXES. The Company paid no income taxes in the six months ended June
30, 1997 or the six months ended June 30, 1998. The Company has incurred a net
loss for each period since inception. As of June 30, 1998, the Company had
approximately $8.7 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.
24
<PAGE>
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth certain unaudited consolidated quarterly
statement of operations data for the eight quarters ended June 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
----------------------------------------------------------------------------------------------
SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31,
1996 1996 1997 1997 1997 1997 1998
------------- ------------ --------- -------- ------------- ------------ ---------
(IN THOUSANDS, UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
Sales............................ $ 25 $ 86 $ 179 $ 282 $ 683 $ 1,328 $ 2,270
Cost of sales.................... 21 74 147 232 561 1,112 1,896
----- ----- --------- -------- ------------- ------------ ---------
Gross profit................... 4 12 32 50 122 216 374
Operating expenses:
Sales and marketing............ 25 38 270 359 246 626 1,060
Product development and
operations................... 55 118 169 246 530 583 703
General and administrative..... 112 241 81 152 294 402 208
----- ----- --------- -------- ------------- ------------ ---------
Total operating expenses..... 192 397 520 757 1,070 1,611 1,971
----- ----- --------- -------- ------------- ------------ ---------
Loss from operations............. (188) (385) (488) (707) (948) (1,395) (1,597)
Interest income, net........... 3 1 8 11 26 8 42
----- ----- --------- -------- ------------- ------------ ---------
Net loss......................... $(185) $(384) $(480) $(696) $ (922) $(1,387) $(1,555)
----- ----- --------- -------- ------------- ------------ ---------
----- ----- --------- -------- ------------- ------------ ---------
<CAPTION>
JUNE 30,
1998
---------
<S> <C>
Sales............................ $ 3,476
Cost of sales.................... 2,895
---------
Gross profit................... 581
Operating expenses:
Sales and marketing............ 2,373
Product development and
operations................... 908
General and administrative..... 1,205
---------
Total operating expenses..... 4,486
---------
Loss from operations............. (3,905)
Interest income, net........... 108
---------
Net loss......................... $(3,797)
---------
---------
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
----------------------------------------------------------------------------------------------
SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31,
1996 1996 1997 1997 1997 1997 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.................... 84.0 86.0 82.1 82.3 82.1 83.7 83.5
------------- ------------ --------- -------- ------------- ------------ ---------
Gross profit................... 16.0 14.0 17.9 17.7 17.9 16.3 16.5
Operating expenses:
Sales and marketing............ 100.0 44.2 150.8 127.3 36.0 47.1 46.7
Product development and
operations................... 220.0 137.2 94.4 87.2 77.7 43.9 31.0
General and administrative..... 448.0 280.2 45.3 53.9 43.0 30.3 9.2
------------- ------------ --------- -------- ------------- ------------ ---------
Total operating expenses..... 768.0 461.6 290.5 268.4 156.7 121.3 86.9
------------- ------------ --------- -------- ------------- ------------ ---------
Loss from operations............. (752.0) (447.6) (272.6) (250.7) (138.8) (105.0) (70.4)
Interest income, net........... 12.0 1.1 4.4 3.9 3.8 0.6 1.9
------------- ------------ --------- -------- ------------- ------------ ---------
Net loss......................... (740.0)% (446.5)% (268.2)% (246.8)% (135.0)% (104.4)% (68.5)%
------------- ------------ --------- -------- ------------- ------------ ---------
------------- ------------ --------- -------- ------------- ------------ ---------
<CAPTION>
JUNE 30,
1998
---------
<S> <C>
Sales............................ 100.0%
Cost of sales.................... 83.3
---------
Gross profit................... 16.7
Operating expenses:
Sales and marketing............ 68.2
Product development and
operations................... 26.1
General and administrative..... 34.7
---------
Total operating expenses..... 129.0
---------
Loss from operations............. (112.3)
Interest income, net........... 3.1
---------
Net loss......................... (109.2)%
---------
---------
</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 margin for the three months
ended December 31, 1997, March 31, 1998 and June 30, 1998 were lower than gross
margins in the first nine months of 1997 primarily as a result of the addition
of certain lower margin software publisher clients. 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 expenses have
varied widely in the periods indicated due to the timing and amounts of
professional fees, transactions costs and deferred compensation expense.
25
<PAGE>
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 level
of use of the Internet and consumer acceptance of the Internet for the purchase
of consumer products such as those offered by the Company; (v) the Company's
ability to upgrade and develop its systems and infrastructure, in particular its
CNS; (vi) the termination of any strategic accounts such as Corel Corporation,
from which the Company derives 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 mix of sales
generated through software publisher client Web stores compared to online
retailer Web stores; (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; (xi) the amount and timing of operating costs and capital
expenditures relating to expansion of the Company's business, operations and
infrastructure; (xii) certain U.S. and foreign government regulations; and
(xiii) economic conditions specific to the Internet and electronic commerce that
would result in the Internet not becoming a viable commercial marketplace. The
Company also may, as inducement to obtain certain strategic contracts, offer
favorable pricing terms to software publishers and online retailers which will
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
Since inception, the Company has financed its operations primarily through
the private placement of equity securities, which yielded an aggregate of $19.3
million of net proceeds through June 30, 1998.
Net cash used in operating activities in the years ended December 31, 1995,
1996 and 1997 and in the six months ended June 30, 1998 was $142,000, $409,000,
$2.6 million and $3.4 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 six months ended June 30, 1998 was $50,000, $133,000,
$984,000 and $6.5 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 six months ended June 30, 1998 was $0, $855,000,
$4.9 million and $12.6 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 in the first six months of 1998 and the sale of
the Company's Series A Preferred Stock in April 1998.
As of June 30, 1998 the Company had approximately $4.8 million of cash and
cash equivalents and $4.9 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 resources, deploy additional commerce servers
worldwide, and relocate its primary office facility during the
26
<PAGE>
next twelve months. The Company further anticipates that it will expend
approximately $6.0 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 and cash equivalents will be sufficient to meet its anticipated
cash needs for working capital and capital expenditures for at least the next
twenty-four 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
The Company uses a significant number of computer software programs and
operating systems in its internal operations. The use of computer programs that
rely on two-digit date programs to perform computations and decision-making
functions may cause computer systems to malfunction in the year 2000 and lead to
significant business delays and disruptions. While the Company believes that the
software applications that it uses or has developed are year 2000 compliant, to
the extent that any of these software applications contain source code that is
unable to appropriately interpret the upcoming calendar year 2000, some level of
modification or possible replacement of such source code or applications will be
necessary. The Company has analyzed the software applications that it uses or
has developed and, as a result, the Company at this time does not anticipate any
significant expense in ensuring that they are year 2000 compliant. However,
until the year 2000 arrives, the Company cannot be absolutely certain that its
analysis is correct. The Company is currently unable to predict the extent to
which the year 2000 issue will affect its clients or suppliers, or the extent to
which it would be vulnerable to any failure by clients or suppliers to remediate
any year 2000 issues on a timely basis. The failure of a major client or
supplier subject to the year 2000 to convert its systems on a timely basis or a
conversion that is incompatible with the Company's systems could have a material
adverse effect on the Company's business, financial condition and results of
operations. In addition the Company's business, financial condition and results
of operations may be materially adversely affected to the extent its end-users
are unable to use their credit cards due to year 2000 issues that are not
rectified by their credit card vendors.
27
<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 June 30,
1998, the Company had contracts with 1,122 software publisher clients and 346
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 123,000
software products from its various software publisher clients, including more
than 18,000 software titles and more than 105,000 digital images and fonts.
Through June 30, 1998, the Company had completed more than 172,000 transactions
for more than 124,000 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 123,000
software products. Using its CNS platform, the Company creates Web stores for
its clients that replicate the look and feel of such clients' own Web sites.
End-users can 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.
28
<PAGE>
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. Jupiter Communications, LLC estimates that the market for software
sales online will increase from an estimated $69 million in 1997 to an estimated
$2.3 billion by 2002. 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.
29
<PAGE>
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.
30
<PAGE>
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 123,000 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 123,000 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 June 30, 1998, the
Company had signed contracts with 1,122 software publishers, representing more
than 123,000 software products and 870 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.
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
31
<PAGE>
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 346 online
retailers as of June 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 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
32
<PAGE>
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 SERVICES. 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 SERVICES. 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 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 ESD services, which provide them with online
distribution 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
33
<PAGE>
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 June 30, 1998, the Company had 1,122 contracts with software
publishers and 346 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 June 30, 1998, the Company had 920 software publishers
and 239 online retailers connected to its CNS. During the six-month period ended
June 30, 1998, the Company completed transactions for 787 software publishers
and 112 online retailers. The Company's clients include:
<TABLE>
<CAPTION>
SOFTWARE PUBLISHERS ONLINE RETAILERS
- ------------------------------------------------ ---------------------------
<S> <C>
WEB HOSTING AND ESD SERVICES Babbage's, Etc. LLC
Corel Corporation BuySafe, Inc.
Dragon Systems, Inc. Channel MarketMakers
Extensis Corporation Cyberian Outpost, Inc.
JASC, Inc. Damark International, Inc.
Ulead Systems, Inc. Micro Warehouse, Inc.
Shopping.com
ESD SERVICES ONLY Software Warehouse plc
Cendant Corporation Planet Direct
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 15% of the Company's sales for the year ended December 31,
1997 and the six months ended June 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 10% of the Company's
sales for the six months ended June 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 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
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<PAGE>
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. As of June 30, 1998, the
Company had 28 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.
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 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
35
<PAGE>
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 four 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 in Edina, Minnesota. The data center currently incorporates
redundant systems consisting of additional servers and arrays. The Company
currently has no automatic switchover, although it has plans to implement
further redundancy in the future. See "Risk Factors--Risk of Capacity
Constraints; Limited Redundant Systems; 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, recoverable downloading,
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
$1.6 million in 1995, 1996, 1997 and the first six months of 1998, respectively.
As of June 30, 1998, the Company employed 21 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, 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
Software Corporation, 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
36
<PAGE>
and enablers and indirect competition with other providers of electronic
commerce software and systems, the Company also competes with companies that
sell and distribute software products via the Internet, including online
retailers such as CNET, Inc., Ingram Micro Inc. and software.net Corporation, as
well as companies such as AltaVista (a subsidiary of Digital Equipment
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 product offerings, software publisher and online retailer
relationships, brand recognition, system capacity, reliability, price,
selection, speed and accessibility, customer service, quality of site content,
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 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,
37
<PAGE>
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 June 30, 1998, the Company employed 76 people, including 8 in
administration, 40 in product development and operations and 28 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 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 leases approximately 6,400 and 7,000 square feet of
office and warehouse space, respectively from Tech Squared 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.
The Company has also entered into a sublease agreement, effective July 15, 1998,
for approximately 32,900 square feet of office and warehouse space in Eden
Prairie, Minnesota. This sublease agreement expires on July 31, 2003. 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.
38
<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 August 6, 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................. 38 Chief Financial Officer and Treasurer
Kelly J. Wical..................... 41 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
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. 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.
Mr. Steiner joined the Company in July 1998 as President and has served as a
director of the Company since April 1998. Since January 1997 Mr. Steiner has
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.
Subsequent to accepting employment with the Company, Mr. Steiner has submitted
his resignation to Wasserstein Perella & Co., Inc. and Wasserstein Perella
Ventures, Inc. 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. 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
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.
40
<PAGE>
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
and Sharples 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 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. The Company may compensate non-employee
directors in the future for their attendance at Board and Committee meetings.
41
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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 $50,000 or 10% of any such
officer's salary and bonus disclosed in this table.
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth information regarding stock options granted
by the Company during the fiscal year ended December 31, 1997 to each of the
Named Executive Officers:
<TABLE>
<CAPTION>
POTENTIAL
REALIZABLE VALUE
AT ASSUMED
INDIVIDUAL GRANTS ANNUAL RATES OF
-------------------------------------------------------------- STOCK PRICE
NUMBER OF PERCENTAGE OF APPRECIATION FOR
SECURITIES TOTAL OPTIONS OPTION
UNDERLYING GRANTED IN EXERCISE TERM($)(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 $ 1,018,000 $ 1,670,800
267 .1 1.69 6/26/07 3,248 5,427
</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.
42
<PAGE>
(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 by assuming
that the assumed initial public offering price of $8.50 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 equal to the lesser
of $11.00 per share or the initial public offering price. With the exception of
the grant to Mr. Ronning which becomes exercisable at a rate of 25% on the date
of grant and 18.75% annually thereafter, all grants made to the above executive
officers become exercisable at a rate of 25% on the first anniversary of the
vesting commencement date and 25% annually thereafter. In July 1998, the Company
granted options to purchase 550,000 shares of Common Stock to Mr. Steiner. See
"--Employment Agreements."
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND 1997 YEAR-END OPTION VALUES
The following table sets forth for each of the Named Executive Officers the
number and value of securities underlying unexercised options held by the Named
Executive Officers at December 31, 1997:
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED OPTIONS IN-THE- MONEY OPTIONS AT
SHARES AT DECEMBER 31, 1997 DECEMBER 31, 1997(1)
ACQUIRED ON VALUE ------------------------------ --------------------------
NAME EXERCISE(#) REALIZED($) EXERCISABLE(#) UNEXERCISABLE($) EXERCISABLE($) UNEXERCISABLE($)
- --------------------- ------------- ----------- ------------- --------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Joel A. Ronning...... -- -- 160,000 53,333 $1,300,000 $ 433,331
Draper M. Jaffray.... -- -- 20,000 60,267 147,500 444,319
</TABLE>
- ------------------------
(1) Value of unexercised in-the-money options are based on a value of $8.50 per
share, the assumed initial 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 $140,000 per year, with an increase to not less than $225,000
upon the successful completion of the Company's initial public offering. In
addition, in 1998, Mr. Ronning will receive a bonus consisting of (i) 50% of his
base salary upon the successful completion of the Company's initial public
offering and
43
<PAGE>
(ii) 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 the lesser of $11.00 per share or the
initial public offering price of the Company's Common Stock. 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 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
44
<PAGE>
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.
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 August 6, 1998, 13,666 shares of Common Stock had been issued upon the
exercise of options granted under the Option Plan, options to purchase 1,788,814
shares of Common Stock were outstanding and 530,853 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 502,941 shares of Common Stock and as of August 6, 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
45
<PAGE>
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 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.
46
<PAGE>
CERTAIN TRANSACTIONS
TRANSACTIONS WITH TECH SQUARED, INC.
Joel A. Ronning is currently the Chairman of the Board of Directors of Tech
Squared, Inc. and owns approximately 49% of Tech Squared's outstanding Common
Stock as of June 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
19.12% 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.
Tech Squared currently provides 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 $171,000
for fiscal 1997 and the six months ended June 30, 1998, respectively.
TRANSACTIONS WITH FUJITSU LIMITED
Fujitsu Limited ("Fujitsu"), which will own approximately 13.11% of the
outstanding capital stock of the Company after the completion of this offering,
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."
47
<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. Mr. Sharples will own
approximately 7.93% of the outstanding capital stock of the Company after the
completion of this offering. In addition, in February 1998, Mr. Sharples and
another stockholder (the "Sharples Team") have 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 will convert into 1,000,000 shares of Common
Stock upon consummation of this 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 is exercisable, at any time after the date of the
Company's initial public offering and on or before the fifth anniversary of the
initial public offering. If the Company consummates its initial public offering
on or prior to December 31, 1998, the Conditional Warrant will represent the
right to purchase 100,000 shares of Common Stock at $3.00 per share. If the
Company consummates its initial public offering after December 31, 1998 but on
or prior to March 31, 1999 at a price per share greater than $22.50, then the
Conditional Warrant will represent the right to purchase 33,333 Shares of Common
Stock at $3.00 per share.
Each of the above warrants contain provisions for the adjustment of the
exercise price and the aggregate number of shares issuable upon the exercise of
the warrant under certain circumstances including stock dividends, stock splits,
reorganizations, reclassifications and consolidations. Wasserstein is also
entitled to certain rights with respect to the registration of such shares
underlying the warrants under the Securities Act.
Since January 1997, Mr. Steiner, the President and a director of the
Company, has served as Vice President of Wasserstein Perella & Co., Inc. and
Wasserstein Perella Ventures, Inc., the general partner of Wasserstein.
Subsequent to accepting employment with the Company in July 1998, Mr. Steiner
has submitted his resignation to Wasserstein Perella & Co., Inc. and Wasserstein
Perella Ventures, Inc.
48
<PAGE>
OTHER TRANSACTIONS
Listed below are the directors, executive officers and five percent
stockholders who have acquired shares of the Company's Common Stock or Series A
Preferred Stock:
<TABLE>
<CAPTION>
SHARES OF
SHARES OF SERIES A
COMMON PREFERRED AGGREGATE
STOCK STOCK CONSIDERATION($)
------------ ---------- ---------------
<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............................... 2,400 6,840
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 will convert into 1,000,000 shares of Common Stock upon
consummation of the 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.
The holder of the Company's Series A Preferred Stock and 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 intends to enter 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.
49
<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.
50
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information with respect to the
beneficial ownership of the Company's Common Stock as of August 6, 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 holder of more than 5% of the Company's Common Stock and
(iv) all current directors and executive officers as a group.
<TABLE>
<CAPTION>
PERCENTAGE OF SHARES
BENEFICIALLY OWNED(1)
SHARES ------------------------
BENEFICIALLY PRIOR TO AFTER
BENEFICIAL OWNERS OWNED(1) OFFERING OFFERING
- ---------------------------------------------------------------------------- ------------- ----------- -----------
<S> <C> <C> <C>
Joel A. Ronning (2) (3) .................................................... 3,591,841 25.55% 21.06%
c/o Digital River, Inc.
5198 West 76th Street
Edina, Minnesota 55439
Tech Squared, Inc. (3) ..................................................... 3,200,000 23.30 19.12
5198 West 76th Street, Suite 220
Edina, Minnesota 55439
Fujitsu Limited ............................................................ 2,193,333 15.97 13.11
1-1 Kamikodanaka 4-Chome
Nakahara-Ku
Kawasaki 211 Japan
Christopher J. Sharples (4) ................................................ 1,334,666 9.65 7.93
GNI Ltd.
25 Dowgate Hill
London EC4R 2GN
United Kingdom
Wasserstein Adelson Ventures, L.P. (5) ..................................... 1,150,000 8.28 6.81
31 West 52nd Street
New York New York 10019
Draper M. Jaffray (6) ...................................................... 21,732 * *
Timothy C. Choate (7) ...................................................... 5,000 * *
Thomas F. Madison (8) ...................................................... 88,533 * *
Charles E. Reese, Jr. (9) .................................................. 13,800 * *
Perry W. Steiner (10) ...................................................... 275,000 1.96 1.62
J. Paul Thorin (11) ........................................................ 13,800 * *
All directors and executive officers as a group (13 persons) (12) .......... 5,415,611 37.11 30.79
</TABLE>
- ------------------------
* 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 August 6, 1998. Percentage of
beneficial ownership is based on 13,734,047 shares of Common Stock
outstanding as of August 6, 1998 and 16,734,047 shares of Common Stock
outstanding after the completion of this offering.
51
<PAGE>
(2) Includes 321,666 shares Mr. Ronning has the right to acquire pursuant to
options exercisable within 60 days of August 6, 1998.
(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. 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 August 6, 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
is exercisable upon the completion of the Company's initial public
offering.
(6) Includes 20,066 shares issuable upon exercise of options exercisable within
60 days of August 6, 1998.
(7) Includes 5,000 shares issuable upon exercise of options exercisable within
60 days of August 6, 1998.
(8) Includes 55,200 shares issuable upon exercise of options exercisable within
60 days of August 6, 1998.
(9) Includes 13,800 shares issuable upon exercise of options exercisable within
60 days of August 6, 1998.
(10) Includes 137,500 shares issuable upon exercise of options exercisable
within 60 days of August 6, 1998 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 has
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.
(11) Includes 13,800 shares issuable upon exercise of options exercisable
within 60 days of August 6, 1998.
(12) Includes 757,531 shares issuable upon exercise of options exercisable
within 60 days of August 6, 1998 and 100,000 shares subject to warrants.
52
<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 August 6, 1998, there were 13,734,047 shares of Common Stock
outstanding held of record by approximately 122 stockholders (which includes
shares of Preferred Stock that will be converted into Common Stock upon
completion of this offering).
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
Upon the closing of this offering, the Board of Directors will have 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.
Upon the completion of this offering, there will be no shares of Preferred Stock
outstanding and the Company has no current plans to issue any of the Preferred
Stock.
WARRANTS
As of August 6, 1998, the Company had outstanding warrants to purchase an
aggregate of 803,008 shares of the Company's Common Stock. 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, except for one warrant to purchase 100,000 shares, which
only becomes exercisable upon the completion of the Company's initial public
offering.
53
<PAGE>
REGISTRATION RIGHTS
Pursuant to agreements between the Company and the holders (or their
permitted transferees) ("Holders") of approximately 8,081,506 shares of Common
Stock (assuming the conversion of all outstanding Preferred Stock upon the
completion of this offering) and options and warrants to purchase 1,034,416
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, 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. The Holders do not have registration rights with
respect to this offering. 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 six months after the completion of this
offering. 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. has been appointed as the transfer agent and
registrar for the Company's Common Stock.
54
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon the completion of this offering, the Company will have outstanding
16,734,047 shares of Common Stock, based on the number of shares of Common Stock
outstanding as of August 6, 1998, assuming (i) the issuance by the Company of
shares of Common Stock offered hereby, (ii) the automatic conversion of all
outstanding shares of series A Preferred Stock into Common Stock upon the
completion of this offering, (iii) no exercise of options, warrants or other
obligations to issue shares after August 6, 1998 and (iv) no exercise of the
Underwriters' over-allotment option to purchase 450,000 shares of Common Stock,
except as otherwise noted. Of these shares, the 3,000,000 shares sold in this
offering will be freely tradable without restriction under the Securities Act.
The remaining 13,734,047 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 12,466,456
shares of the Company's Common Stock and an additional 1,282,675 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 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: (i) 693,454 shares of
Common Stock currently outstanding will be available for sale into the public
market following the effectiveness of this Registration Statement, (ii) 146,666
shares of Common Stock currently outstanding and 19,342 shares of Common Stock
issuable upon exercise of currently outstanding options will be eligible for
sale 90 days after the date of this Prospectus, (iii) 8,415,048 restricted
securities will be eligible for sale 180 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 167,340 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 Company. The
foregoing is a summary of Rule 144 and is not intended to be a complete
description of that rule.
55
<PAGE>
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 this
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 this 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 this Prospectus (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 intends to file 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." Such registration statement is expected to be filed and become
effective not earlier than 180 days after the effective date of this offering.
Accordingly, shares registered under such registration statement will, subject
to rule 144 volume limitations applicable to affiliates of the Company, be
available for sale in the open market, unless such shares are subject to vesting
restrictions with the Company. As of August 6, 1998, options to purchase
2,291,755 shares of Common Stock were issued and outstanding. See
"Management--Employee Benefit Plans."
Prior to this offering, there has been no public market for the Company's
Common Stock, and there can be no assurance that an active public market for the
Common Stock will develop or will continue after this offering or that the
market price of the Common Stock will not decline below the initial 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.
56
<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, BancAmerica Robertson
Stephens 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 initial public offering price less the underwriting
discounts and commissions set forth on the cover page of this Prospectus.
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
----------
<S> <C>
BT Alex. Brown Incorporated......................................................
BancAmerica Robertson Stephens...................................................
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.
The Company has been advised by the Representatives that the Underwriters
propose to offer the shares of Common Stock to the public at the initial 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 initial 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 initial 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 has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as amended.
Each of the officers and directors and certain stockholders of the Company,
holding in the aggregate 12,466,456 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 180 days after
the date of this Prospectus, 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.
57
<PAGE>
Prior to this offering, there has been no public market for the Common Stock
of the Company. Consequently, the initial public offering price for the Common
Stock has been determined by negotiation among the Company and the
Representatives. Among the factors considered in such negotiations were
prevailing market conditions, the results of operations of the Company in recent
periods, the market capitalizations and stages of development of other companies
which the Company and the Representatives believe to be comparable to the
Company, estimates of the business potential of the Company, the present stage
of the Company's development and other factors deemed relevant.
In order to facilitate the offering of the Common Stock, the Underwriters
may engage in transactions that stabilize, maintain or otherwise affect the
market price of the Common Stock. Specifically, the Underwriters may over-allot
shares of the Common Stock in connection with this offering, thereby creating a
short position in the Underwriters' syndicate account. Additionally, to cover
such over-allotments or to stabilize the market price of the Common Stock, the
Underwriters may bid for, and purchase, shares of the Common Stock in the open
market. Any of these activities may maintain the market price of the Common
Stock at a level above that which might otherwise prevail in the open market.
The Underwriters are not required to engage in these activities, and, if
commenced, any such activities may be discontinued at any time. The
Representatives, on behalf of the Underwriters, also may reclaim selling
concessions allowed to an Underwriter or dealer, if the syndicate repurchases
shares distributed by that Underwriter or dealer.
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed upon for the
Company by Cooley Godward LLP, Palo Alto and San Francisco, 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.
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
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.
58
<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 June 30, 1998 (unaudited).................... F-3
Consolidated Statements of Operations for the years ended December 31, 1995, 1996, 1997 and for the six
months ended June 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 six months ended June 30, 1998 (unaudited)................................................... F-5
Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1996, 1997 and for the six
months ended June 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,
--------------------
1996 1997
--------- --------- JUNE 30, PRO FORMA
1998 STOCKHOLDERS'
----------- EQUITY AT
(UNAUDITED) JUNE 30, 1998
(NOTE 3)
-------------
(UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents....................................... $ 800 $ 2,126 $ 4,755
Short-term investments.......................................... -- -- 4,934
Accounts receivable, net allowance of $0, $20 and $82........... 4 94 196
Prepaid expenses and other...................................... 5 100 381
--------- --------- -----------
Total current assets.......................................... 809 2,320 10,266
--------- --------- -----------
Property and equipment:
Property and equipment.......................................... 115 1,035 2,553
Accumulated depreciation........................................ (8) (132) (284)
--------- --------- -----------
Net property and equipment.................................... 107 903 2,269
Other assets...................................................... 286 182 162
--------- --------- -----------
Total assets.................................................. $ 1,202 $ 3,405 $ 12,697
--------- --------- -----------
--------- --------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Convertible debentures.......................................... $ 998 $ -- $ --
Accounts payable................................................ 112 720 1,844
Accrued payroll................................................. 30 197 467
Due to related party............................................ 67 46 55
Other accrued liabilities....................................... 53 113 48
--------- --------- -----------
Total current liabilities..................................... 1,260 1,076 2,414
--------- --------- -----------
Commitments and contingencies (Note 6)
Stockholders' equity (deficit):
Preferred stock, $.01 par value; 1,500,000 shares authorized;
1,500,000 shares of Series A preferred stock issued and
outstanding................................................... -- -- 15 $ --
Common stock, $.01 par value; 66,666,667 shares authorized;
5,333,333, 9,241,881, 12,713,715 and 13,713,715 shares issued
and outstanding............................................... 53 92 127 137
Additional paid-in capital...................................... 729 6,562 21,728 21,733
Deferred compensation........................................... -- -- (1,910) (1,910)
Accumulated deficit............................................. (840) (4,325) (9,677) (9,677)
--------- --------- ----------- -------------
Total stockholders' equity (deficit).......................... (58) 2,329 10,283 $ 10,283
--------- --------- ----------- -------------
-------------
Total liabilities and stockholders' equity (deficit)........ $ 1,202 $ 3,405 $ 12,697
--------- --------- -----------
--------- --------- -----------
</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 SIX MONTHS ENDED
JUNE 30,
------------------------------- ------------------------
1995 1996 1997 1997 1998
--------- --------- --------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Sales......................................... $ -- $ 111 $ 2,472 $ 461 $ 5,746
Cost of sales................................. -- 95 2,052 379 4,791
--------- --------- --------- ----------- -----------
Gross profit................................ -- 16 420 82 955
Operating expenses:
Sales and marketing......................... 3 68 1,501 629 3,433
Product development and operations.......... 130 230 1,528 415 1,611
General and administrative.................. 32 415 929 233 1,413
--------- --------- --------- ----------- -----------
Total operating expenses.................. 165 713 3,958 1,277 6,457
--------- --------- --------- ----------- -----------
Loss from operations.......................... (165) (697) (3,538) (1,195) (5,502)
Interest income, net...................... 22 8 53 19 150
--------- --------- --------- ----------- -----------
Net loss...................................... $ (143) $ (689) $ (3,485) $ (1,176) $ (5,352)
--------- --------- --------- ----------- -----------
--------- --------- --------- ----------- -----------
Basic and diluted net loss per share.......... $ (0.03) $ (0.13) $ (0.46) $ (0.18) $ (0.47)
--------- --------- --------- ----------- -----------
--------- --------- --------- ----------- -----------
Basic and diluted weighted average common
shares outstanding.......................... 5,333 5,333 7,514 6,438 11,279
--------- --------- --------- ----------- -----------
--------- --------- --------- ----------- -----------
</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).................... -- -- 3,472 35 9,757 -- -- 9,792
Sales of preferred stock
(unaudited).................... 1,500 15 -- -- 2,810 -- -- 2,825
Deferred compensation related to
stock options and warrants
(unaudited).................... -- -- -- -- 2,599 (2,599) -- --
Deferred compensation expense
(unaudited).................... -- -- -- -- -- 689 -- 689
Net loss (unaudited)............. -- -- -- -- -- -- (5,352) (5,352)
--------- ------ ----------- ------ ------- ------------ ----------- -------------
Balance, June 30, 1998
(unaudited)...................... 1,500 $ 15 12,714 $127 $21,728 $(1,910) $(9,677) $10,283
--------- ------ ----------- ------ ------- ------------ ----------- -------------
--------- ------ ----------- ------ ------- ------------ ----------- -------------
</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 SIX MONTHS ENDED
JUNE 30,
------------------------------- ------------------------
1995 1996 1997 1997 1998
--------- --------- --------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Operating activities:
Net loss............................................ $ (143) $ (689) $ (3,485) $ (1,176) $ (5,352)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization..................... 5 35 195 59 259
Deferred compensation expense..................... -- -- -- -- 689
Common stock granted to Fujitsu................... -- -- 101 -- --
Change in operating assets and liabilities;
Accounts receivable and prepaid expenses........ 1 (9) (184) (35) (383)
Accounts payable................................ (9) 108 607 50 1,124
Accrued payroll and other accrued liabilities... 4 79 227 74 205
Due to related party............................ -- 67 (21) (39) 9
--------- --------- --------- ----------- -----------
Net cash used in operating activities......... (142) (409) (2,560) (1,067) (3,449)
--------- --------- --------- ----------- -----------
Investing activities:
Purchases of short-term investments................. -- -- -- -- (4,894)
Purchases of equipment.............................. (9) (105) (920) (324) (1,578)
Patent acquisition costs............................ (41) (28) (64) (42) (23)
--------- --------- --------- ----------- -----------
Net cash used in investing activities......... (50) (133) (984) (366) (6,495)
--------- --------- --------- ----------- -----------
Financing activities:
Sales of preferred and common stock................. -- -- 4,774 1,776 12,617
Proceeds from convertible debentures................ -- 998 147 -- --
Payment of debt issuance costs and other............ -- (143) (51) -- (44)
--------- --------- --------- ----------- -----------
Net cash provided by financing activities..... -- 855 4,870 1,776 12,573
--------- --------- --------- ----------- -----------
Net increase (decrease) in cash and cash
equivalents......................................... (192) 313 1,326 343 2,629
Cash and cash equivalents,
beginning of period................................. 679 487 800 800 2,126
--------- --------- --------- ----------- -----------
Cash and cash equivalents, end of period.............. $ 487 $ 800 $ 2,126 $ 1,143 $ 4,755
--------- --------- --------- ----------- -----------
--------- --------- --------- ----------- -----------
Noncash investing and financing activities:
Convertible debentures exchanged for common stock,
net of direct costs............................... $ -- $ -- $ 998 $ 998 $ --
--------- --------- --------- ----------- -----------
--------- --------- --------- ----------- -----------
</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 June 30, 1998 and the related
consolidated statements of operations and cash flows for the six months ended
June 30, 1997 and 1998, and the consolidated statement of stockholders' equity
(deficit) for the six months ended June 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 six months ended June 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
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 June 30, 1998, short-term investments represent U.S. government treasury
bills maturing in less than one year and classified as available-for-sale. At
June 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 $138,000 as of December 31, 1996, 1997 and June 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 33% for
each of the six months ended June 30, 1997 and 1998. One client accounted for
18%
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)
of sales for the year ended December 31, 1997. For the six months ended June 30,
1998 there were two significant clients which comprised 15% and 10% 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 $167,000 and $1,109,000 for
the six months ended June 30, 1997 and 1998.
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 $368,000 and $946,000 for the
six months ended June 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 six
months ended June 30, 1997 and 1998. Options, warrants and the Series A
Preferred Stock totalling 0, 344,210, 1,056,642, 712,480 and 3,335,095 for the
three years ended December 31, 1995, 1996 and 1997 and the six months ended June
30, 1997 and 1998, respectively, were excluded from the computation of earnings
per share as their effect is antidilutive.
Pro forma net loss per share, assuming the conversion of all shares of
Series A preferred stock, issued in April 1998, into common stock upon the
consummation of the initial public offering, was $(0.46) for the six months
ended June 30, 1998.
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.
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)
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 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.
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 material 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.
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>
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)
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:
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. All common share, per share and
weighted average share information has been restated to reflect the splits.
SERIES A PREFERRED STOCK
Series A preferred stock is convertible into common stock on a 2-for-3 basis
at the option of the holder. Upon the consummation of the Company's first
underwritten stock offering, the Series A preferred stock will be automatically
converted to common stock. Unaudited pro forma stockholders' equity reflects the
assumed conversion of the preferred stock into common stock as of June 30, 1998.
Each share of Series A preferred stock has voting rights equivalent to
common shares. The Series A preferred stock also has a liquidation preference at
a fixed amount over common shares. Dividends are payable only to the extent that
dividends are declared on the Company's common stock.
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.
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 June 30, 1998.
In connection with certain advisory services provided by the preferred
stockholder to the Company, the Company issued a conditional warrant (the
"Conditional Warrant") that is exercisable, at any time after the date of the
Company's initial public offering and on or before the fifth anniversary of the
initial public offering. If the Company consummates its initial public offering
on or prior to December 31, 1998, the Conditional Warrant will represent the
right to purchase 100,000 shares of Common Stock at $3.00 per share. If the
Company consummates its initial public offering after December 31, 1998 but on
or prior to March 31, 1999 at a price per share greater than $22.50, then the
Conditional Warrant will represent the right to purchase 33,333 Shares of Common
Stock at $3.00 per share. The conditional warrant has been included in the
outstanding warrants as of June 30, 1998.
F-11
<PAGE>
DIGITAL RIVER, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1997
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(CONTINUED)
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.
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).................................................. 768,611 3.18
Cancelled (unaudited)............................................... (29,334) 2.64
----------- -----
Balance, June 30, 1998 (unaudited).................................... 1,532,087 $ 2.16
----------- -----
----------- -----
</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.
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)
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 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 June 30, 1998, the Company's President 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 President. 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 $48,000 and $124,000 for the six months ended
June 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 six months ended June 30, 1997 and 1998, the Company was
billed $0 and $47,000 for such services.
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,
F-13
<PAGE>
DIGITAL RIVER, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1997
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(CONTINUED)
5. RELATED-PARTY TRANSACTIONS: (CONTINUED)
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.
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 June 30, 1998, Fujitsu held 16% 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.
YEAR 2000 COMPLIANCE. The Company uses a significant number of computer
software programs and operating systems in its internal operations. The use of
computer programs that rely on two-digit date programs to perform computations
and decision-making functions may cause computer systems to malfunction in the
year 2000 and lead to significant business delays and disruptions. While the
Company believes that the software applications that it uses or has developed
are year 2000 compliant, to the extent that any of these software applications
contain source code that is unable to appropriately interpret the upcoming
calendar year 2000, some level of modification or possible replacement of such
source code or applications will be necessary. The Company has analyzed the
software applications that it uses or has developed and, as a result, the
Company at this time does not anticipate any significant expense in ensuring
that they are year 2000 compliant. However, until the year 2000 arrives, the
Company cannot be absolutely certain that its analysis is correct. The Company
is currently unable to predict the extent to which the year 2000 issue will
affect its clients or suppliers, or the extent to which it would be vulnerable
to any failure by the clients or suppliers to remediate any year 2000 issues on
a timely basis. The failure of a client or a major supplier subject to the year
2000 to convert its systems on a timely basis or a conversion that is
incompatible with the Company's systems could have a material adverse effect on
the Company's business, financial condition and results of operations. In
addition the Company's business, financial condition and results of operations
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.
F-14
<PAGE>
DIGITAL RIVER, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1997
(INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS)
(CONTINUED)
7. SUBSEQUENT EVENT (UNAUDITED):
The Company has filed with the Securities and Exchange Commission a Form S-1
Registration Statement for the sale of 3,000,000 shares of common stock
(excluding the underwriter's overallotment option to purchase an additional
450,000 shares of common stock). 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.
F-15
<PAGE>
[Illustrations]
PICTORIAL DEPICTION OF THE DIGITAL RIVER CLIENT
NETWORK, DEPICTING HOW END-USERS ARE CONNECTED TO
DIGITAL RIVER'S CNS THROUGH EITHER SOFTWARE
PUBLISHER OR ONLINE RETAILER CLIENTS.
<PAGE>
- -------------------------------------------
-------------------------------------------
- -------------------------------------------
-------------------------------------------
NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS,
AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED
UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY OF THE UNDERWRITERS. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER OF ANY SECURITIES OTHER THAN THOSE TO
WHICH IT RELATES OR AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, TO
ANY PERSON IN ANY JURISDICTION WHERE SUCH AN OFFER OR SOLICITATION WOULD BE
UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER
SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION
CONTAINED HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF.
--------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Prospectus Summary............................. 3
Risk Factors................................... 6
Use of Proceeds................................ 17
Dividend Policy................................ 17
Capitalization................................. 18
Dilution....................................... 19
Selected Consolidated Financial Data........... 20
Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................... 21
Business....................................... 28
Management..................................... 39
Certain Transactions........................... 47
Principal Stockholders......................... 51
Description of Capital Stock................... 53
Shares Eligible for Future Sale................ 55
Underwriting................................... 57
Legal Matters.................................. 58
Experts........................................ 58
Additional Information......................... 58
Index to Consolidated Financial Statements..... F-1
</TABLE>
--------------
UNTIL , 1998 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK OFFERED HEREBY, WHETHER OR
NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS
WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
3,000,000 SHARES
[LOGO]
COMMON STOCK
----------------
P R O S P E C T U S
----------------
BT ALEX. BROWN
BANCAMERICA 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.................................................. $ 13,028
NASD filing fee................................................... 4,916
Nasdaq National Market listing fee................................ 95,000
Blue sky qualification fee and expenses........................... 5,000
Printing and engraving expenses................................... 115,000
Legal fees and expenses........................................... 350,000
Accounting fees and expenses...................................... 100,000
Transfer agent and registrar fees................................. 10,000
Miscellaneous..................................................... 7,056
---------
Total......................................................... $ 700,000
---------
---------
</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 August 6, 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 August 6, 1998, the Company granted stock
options to employees, directors and consultants covering an aggregate of
2,305,421 shares of the Company's Common Stock (net of cancellations), at
exercise prices varying from $0.38 to $8.50. To date there have been no
exercise of any options.
(3) From February 9, 1994 to August 6, 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 will convert into 1,000,000 shares of Common
Stock upon consummation of this 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 Certificate of Incorporation of the Registrant, as currently in effect.
**3.2 Certificate of Amendment of Certificate of Incorporation of the
Registrant, as currently in effect.
**3.3 Bylaws of the Registrant, as currently in effect.
**3.4 Form of Amended and Restated Certificate of Incorporation of the
Registrant to be filed upon completion of this offering.
**3.5 Form of Amended and Restated Bylaws of the Registrant to be filed upon
completion of this offering.
**3.6 Form of Certificate of Amendment of Certificate of Incorporation of the
Registrant, to be filed prior to completion of this offering.
**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.
</TABLE>
II-2
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------ --------------------------------------------------------------------------
<C> <S>
**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>
- ------------------------
* To be filed by amendment.
+ Confidential treatment requested for portions of these exhibits. Omitted
portions have been filed separately with the Securities and Exchange
Commission.
** Previously filed as an Exhibit to the Registration Statement.
(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.
II-3
<PAGE>
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 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. 4 to Registration Statement to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of Edina, State of Minnesota, on the 11th day of August 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. 4 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 August 11, 1998
Joel A. Ronning Executive Officer)
Chief Financial Officer
/s/ ROBERT E. STRAWMAN and Treasurer (Principal
- ------------------------------ Financial and Accounting August 11, 1998
Robert E. Strawman Officer)
*PERRY W. STEINER
- ------------------------------ President and Director August 11, 1998
Perry W. Steiner
*THOMAS F. MADISON
- ------------------------------ Director August 11, 1998
Thomas F. Madison
*CHARLES E. REESE, JR.
- ------------------------------ Director August 11, 1998
Charles E. Reese, Jr.
*CHRISTOPHER J. SHARPLES
- ------------------------------ Director August 11, 1998
Christopher J. Sharples
*J. PAUL THORIN
- ------------------------------ Director August 11, 1998
J. Paul Thorin
*TIMOTHY C. CHOATE
- ------------------------------ Director August 11, 1998
Timothy C. Choate
<TABLE>
<S> <C> <C> <C>
*By: /s/ ROBERT E. STRAWMAN
-------------------------
Robert E. Strawman
(ATTORNEY-IN-FACT)
</TABLE>
II-5
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ---------- ------------------------------------------------------------------------------------------------------
<C> <S>
**1.1 Form of Underwriting Agreement.
**3.1 Certificate of Incorporation of the Registrant, as currently in effect.
**3.2 Certificate of Amendment of Certificate of Incorporation of the Registrant, as currently in effect.
**3.3 Bylaws of the Registrant, as currently in effect.
**3.4 Form of Amended and Restated Certificate of Incorporation of the Registrant to be filed upon
completion of this offering.
**3.5 Form of Amended and Restated Bylaws of the Registrant to be filed upon completion of this offering.
**3.6 Form of Certificate of Amendment of Certificate of Incorporation of the Registrant, to be filed prior
to completion of this offering.
**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.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ---------- ------------------------------------------------------------------------------------------------------
<C> <S>
**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>
- ------------------------
* To be filed by amendment.
+ Confidential treatment requested for portions of these exhibits. Omitted
portions have been filed separately with the Securities and Exchange
Commission.
** Previously filed as an Exhibit to the Registration Statement.
(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>
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
August 11, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> 12-MOS 6-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1998
<PERIOD-START> JAN-01-1997 JAN-01-1998
<PERIOD-END> DEC-31-1997 JUN-30-1998
<CASH> 2,126 4,755
<SECURITIES> 0 4,934
<RECEIVABLES> 114 278
<ALLOWANCES> 20 82
<INVENTORY> 0 0
<CURRENT-ASSETS> 2,320 10,266
<PP&E> 1,035 2,553
<DEPRECIATION> 132 284
<TOTAL-ASSETS> 3,405 12,697
<CURRENT-LIABILITIES> 1,076 2,414
<BONDS> 0 0
0 0
0 15
<COMMON> 92 127
<OTHER-SE> 2,237 10,141
<TOTAL-LIABILITY-AND-EQUITY> 3,405 12,697
<SALES> 2,472 5,746
<TOTAL-REVENUES> 2,472 5,746
<CGS> 2,052 4,791
<TOTAL-COSTS> 2,052 4,791
<OTHER-EXPENSES> 3,938 7,114
<LOSS-PROVISION> 20 62
<INTEREST-EXPENSE> 0 0
<INCOME-PRETAX> (3,485) (5,352)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (3,485) (5,352)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (3,485) (5,352)
<EPS-PRIMARY> (.46) (.47)
<EPS-DILUTED> (.46) (.47)
</TABLE>
