<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
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/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____ TO _____
Commission file number 000-24643
DIGITAL RIVER, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 41-1901640
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
9625 WEST 76TH STREET, SUITE 150
EDEN PRAIRIE, MINNESOTA 55344
(Address of principal executive offices)
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(952) 253-1234
(Registrant's telephone number, including area code)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
COMMON STOCK, $0.01 PAR VALUE 22,851,381 SHARES
------------------------------- ----------------------------------
(Class) Outstanding as of November 10, 2000
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<PAGE>
DIGITAL RIVER, INC.
Form 10-Q
Index
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE
----
<S> <C> <C>
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
at September 30, 2000 and December 31, 1999................................................ 3
Condensed Consolidated Statements of Operations
for the three and nine months ended September 30, 2000 and 1999............................ 4
Condensed Consolidated Statements of Cash Flows
for the nine months ended September 30, 2000 and 1999...................................... 5
Notes to Condensed Consolidated Financial Statements....................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...... 9
Item 3. Qualitative and Quantitative Disclosure about Market Risk.................................. 13
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders........................................ 13
Item 6. Exhibits and Reports on Form 8-K........................................................... 14
SIGNATURES ........................................................................................... 15
Exhibit Index ........................................................................................... 16
</TABLE>
2.
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DIGITAL RIVER, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
-------------- ------------
(unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 15,554 $ 15,120
Short-term investments 16,986 24,387
Accounts receivable, net 4,220 2,455
Prepaid expenses and other 1,140 880
-------------- ------------
Total current assets 37,900 42,842
PROPERTY AND EQUIPMENT, NET 13,443 7,279
LONG-TERM INVESTMENTS -- 14,832
GOODWILL, NET AND OTHER ASSETS 20,988 22,189
-------------- ------------
$ 72,331 $ 87,142
============== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 12,449 $ 11,020
Accrued payroll 2,215 1,909
Deferred revenue 2,210 152
Other current liabilities 1,901 984
-------------- ------------
Total current liabilities 18,775 14,065
-------------- ------------
STOCKHOLDERS' EQUITY:
Preferred Stock, $.01 par value; 5,000,000 shares
authorized; no shares issued and outstanding -- --
Common Stock, $.01 par value; 60,000,000 shares authorized;
22,161,123 and 20,699,244 shares issued and outstanding 222 207
Additional paid-in capital 132,105 119,445
Deferred compensation (295) (637)
Accumulated deficit (78,474) (45,938)
-------------- ------------
Total stockholders' equity 53,556 73,077
-------------- ------------
$ 72,331 $ 87,142
============== ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3.
<PAGE>
DIGITAL RIVER, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Data; Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2000 1999 2000 1999
-------- -------- ------- --------
<S> C> <C> <C> <C>
REVENUE $ 7,607 $ 4,017 $ 21,125 $ 8,985
COSTS AND EXPENSES:
Direct cost of services 421 264 991 546
Network and infrastructure 1,888 940 5,636 2,723
Sales and marketing 6,247 4,760 19,690 12,601
Product research and development 2,857 2,686 10,949 7,483
General and administrative 1,151 1,041 3,608 2,958
Depreciation and amortization 896 490 2,239 1,238
Amortization of goodwill and other acquisition related costs 2,603 3,275 12,331 4,577
-------- -------- ------- --------
Total costs and expenses 16,063 13,456 55,444 32,126
-------- -------- ------- --------
LOSS FROM OPERATIONS (8,456) (9,439) (34,319) (23,141)
INTEREST INCOME 382 751 1,621 2,430
-------- -------- ------- --------
Net loss $ (8,074) $ (8,688) $ (32,698) $ (20,711)
======== ======== ======= ========
Basic and diluted net loss per share $ (0.37) $ (0.42) $ (1.55) $ (1.03)
======== ======== ======= ========
Basic and diluted weighted average common shares outstanding 21,598 20,604 21,164 20,137
======== ======== ======= ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4.
<PAGE>
DIGITAL RIVER, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands; Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
----------------------
2000 1999
--------- ---------
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss $ (32,698) $ (20,711)
Adjustments to reconcile net loss to net cash used in operating activities:
Amortization of goodwill and acquisition related costs 10,301 4,296
Depreciation and amortization 2,239 1,238
Deferred compensation expense 342 672
Changes in assets and liabilities:
Accounts receivable and prepaid expense (2,025) (628)
Accounts payable 1,429 3,392
Other current liabilities and deferred revenue 3,281 925
--------- ---------
Net cash used in operating activities (17,131) (10,816)
--------- ---------
INVESTING ACTIVITIES:
Purchases of investments (14,021) (94,643)
Proceeds from sales of investments 36,416 58,000
Purchases of equipment (8,335) (2,526)
Acquisitions, net of cash received (50) (3,320)
Patent acquisition costs (27) (209)
--------- ---------
Net cash provided by (used in) investing activities 13,983 (42,698)
--------- ---------
FINANCING ACTIVITIES:
Sales of Common Stock 3,582 1,137
Payment of deferred costs and other -- (396)
--------- ---------
Net cash provided by financing activities 3,582 741
--------- ---------
Net increase (decrease) in cash and cash equivalents 434 (52,773)
CASH AND CASH EQUIVALENTS, beginning of period 15,120 63,503
--------- ---------
CASH AND CASH EQUIVALENTS, end of period $ 15,554 $ 10,730
========= =========
SUPPLEMENTAL CASH FLOW DISCLOSURE:
Issuance of Common Stock in connection with acquisitions
and related earn-out payments $ 9,093 $ 19,759
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5.
<PAGE>
DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION:
The unaudited condensed consolidated financial statements included herein
reflect all adjustments, consisting only of normal recurring adjustments, which
in the opinion of management are necessary to fairly state the Company's
consolidated financial position, results of operations and cash flows for the
periods presented. These condensed consolidated financial statements should be
read in conjunction with the Company's audited consolidated financial statements
included in the Company's Form 10-K for the year ended December 31, 1999 as
filed with the Securities and Exchange Commission. The results of operations for
the period ended September 30, 2000 are not necessarily indicative of the
results to be expected for any subsequent quarter or for the entire fiscal year
ending December 31, 2000. The December 31, 1999 balance sheet was derived from
audited financial statements, but does not include all disclosures required by
generally accepted accounting principles.
2. PRINCIPLES OF CONSOLIDATION:
The condensed consolidated financial statements include the accounts of
Digital River, Inc. and its wholly owned subsidiaries. All intercompany balances
and transactions have been eliminated.
3. RECENT ACCOUNTING PRONOUNCEMENTS:
Reclassifications:
As of the quarter ended September 30, 2000, the Company has commenced
reporting its company wide revenues on a net basis and has reclassified all
historical information presented herein to conform to this presentation. This
change is based upon the consensus reached in Issue 99-19: "Reporting Revenue
Gross as a Principal versus Net as an Agent" by the Emerging Issues Task Force
(EITF) of the Financial Accounting Standards Board which revised accounting
standards regarding net versus gross revenue recognition. Previously,
substantially all revenue generated through the Company's Software Services
division was recognized on a gross basis. Revenue generated through the
E-Business Services division has historically been reported on a net basis.
This change reflects a new reporting presentation only and will not alter the
Company's net income, either historically or in the future.
The Company has also adopted the provisions of the Securities and
Exchange Commission's (SEC) Staff Accounting Bulletin (SAB) 101, "Revenue
Recognition in Financial Statements" in the quarter ended September 30, 2000.
SAB 101 provides the SEC staff's views in applying generally accepted
accounting principles to selected revenue recognition issues. It also
provides guidance on recording revenue gross as a principal versus net as an
agent consistent with EITF Issue 99-19. Other than the reclassification of
revenues to a net basis, the adoption of SAB 101 did not have any impact to
the Company.
The Company has also made certain other reclassifications to its 1999
financial statements to conform to the 2000 presentation.
Web Site Costs:
In March 2000, the EITF also published its consensus on
EITF 00-2, "Accounting for Web Site Development Costs." EITF 00-2 is
effective for fiscal quarters beginning after June 30, 2000. The Company has
adopted EITF 00-2 and has had no impact to date from the adoption.
4. NET LOSS PER SHARE:
Basic loss per share is computed using the weighted-average number of
common shares outstanding excluding contingently issuable or returnable shares,
and diluted loss per share is computed using the weighted-average number of
common shares outstanding and dilutive potential common shares outstanding. As a
result of the losses incurred by the Company for the three months ended
September 30, 2000 and 1999, respectively, all potential common shares were
anti-dilutive and were excluded from the diluted net loss per share
calculations.
The following table summarizes securities outstanding as of each period end
which were not included in the calculation of diluted net loss per share since
their inclusion would be anti-dilutive:
6.
<PAGE>
<TABLE>
<CAPTION>
September 30, September 30,
2000 1999
------------ -------------
<S> <C> <C>
Common Stock warrants 356,087 371,086
Common Stock options 5,212,357 3,460,985
</TABLE>
5. ACQUISITIONS AND EARN-OUT ARRANGEMENTS:
In August 2000, the Company purchased certain assets, consisting
principally of customer lists, of the software services business of NetSales,
Inc. in exchange for 1,000,000 shares of Common Stock valued at $6.00 per
share at the closing of such transaction, with a contingent earnout for up to
an additional 350,000 shares of Common Stock based on performance over the
subsequent 180 days. The transaction has been accounted for using the
purchase method and the resulting goodwill and other intangibles will be
amortized over two years.
The former owners of Maagnum Internet Group, Inc., a company purchased by
the Company in April 1999, received earn-out payments of 124,349 shares of
Common Stock valued at $3,093,000 in March 2000. The Company charged such amount
to compensation expense and this is included as amortization of goodwill and
acquisition related costs in the accompanying Condensed Consolidated Statements
of Operations. This amount would have increased general and administrative
expense had it been reported outside of that caption.
The Company acquired a total of four companies in 1999 and one company
in 2000 that were accounted for under the purchase method. The following
unaudited pro forma condensed results of operations for the nine months ended
September 30, 2000 and 1999 has been prepared as if each of the acquisitions
had occurred on January 1, 1999:
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
---------------------------------------
2000 1999
-------------------- ----------------
(In Thousands)
<S> <C> <C>
Revenue $ 22,750 $ 10,844
Loss from operations (42,459) (30,702)
Net loss (40,838) (28,373)
Basic and diluted loss per share $ (1.87) $ (1.32)
</TABLE>
This financial information does not purport to represent results that would
actually have been obtained if the transactions had been in effect on January 1,
1999 or any future results that may in fact be realized.
6. SEGMENT INFORMATION:
The Company has two operating segments under the guidelines of SFAS No.
131, Software and Digital Commerce Services and E-Business Services, which have
been identified as components of the Company that are reviewed regularly by
management to determine resource allocation and assess performance. No
disclosure of segments for 1999 has been presented as Software and Digital
Commerce Services represented substantially all operations in 1999. Unallocated
corporate items consist of
7.
<PAGE>
depreciation, goodwill amortization, acquisition-related costs and interest
income for operational results and consist of certain cash, investments and
goodwill for total assets. Segment information is as follows:
<TABLE>
<CAPTION>
Software and Digital E-Business Unallocated
THREE MONTHS ENDED Commerce Services Services Corporate
SEPTEMBER 30, 2000: Division Division Items Consolidated
---------------------- ----------------- ----------------- -----------------
(in thousands)
<S> <C> <C> <C> <C>
Revenue $ 5,880 $ 1,727 $ -- $ 7,607
Gross profit 4,168 1,130 -- 5,298
Loss from operations (1,533) (3,424) (3,499) (8,456)
Net loss (1,533) (3,424) (3,117) (8,074)
Total assets 16,216 6,845 49,270 72,331
</TABLE>
<TABLE>
<CAPTION>
Software and Digital E-Business Unallocated
NINE MONTHS ENDED Commerce Services Services Corporate
SEPTEMBER 30, 2000: Division Division Items Consolidated
---------------------- ----------------- ----------------- -----------------
(in thousands)
<S> <C> <C> <C> <C>
Revenue $ 17,488 $ 3,637 $ -- $ 21,125
Gross profit 12,364 2,134 -- 14,498
Loss from operations (5,840) (13,909) (14,570) (34,319)
Net loss (5,840) (13,909) (12,949) (32,698)
</TABLE>
7. STOCKHOLDERS' EQUITY:
In June 2000, the Company's Board of Directors approved amending the 1999
Non-Officer Stock Option Plan to increase the number of shares of Common Stock
available for grants under the plan to 3,950,000 shares from 2,250,000 shares.
8.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE COMPANY NOTES THAT, EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED
HEREIN, THE MATTERS DISCUSSED BELOW CONTAIN FORWARD-LOOKING STATEMENTS WHICH
INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS WHICH MAY CAUSE
THE ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS OF THE COMPANY, OR INDUSTRY
RESULTS, TO BE MATERIALLY DIFFERENT FROM ANY FUTURE RESULTS, PERFORMANCE OR
ACHIEVEMENTS EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS. THE
COMPANY EXPRESSLY DISCLAIMS ANY OBLIGATION TO UPDATE THIS INFORMATION OR
PUBLICLY RELEASE ANY REVISION OR REFLECT EVENTS OR CIRCUMSTANCES AFTER THE DATE
OF THIS REPORT. SUCH FACTORS INCLUDE, AMONG OTHERS: THE COMPANY'S LIMITED
OPERATING HISTORY AND VARIABILITY OF OPERATING RESULTS, EXPECTATION OF FUTURE
LOSSES, RISKS ASSOCIATED WITH ELECTRONIC SOFTWARE DELIVERY, DEPENDENCE ON THE
INTERNET AND GROWTH IN ELECTRONIC COMMERCE AND INTERNET INFRASTRUCTURE
DEVELOPMENT, DEPENDENCE ON SOFTWARE PUBLISHERS, DEPENDENCE ON ONLINE RETAILERS,
SYSTEM DEVELOPMENT AND ELECTRONIC COMMERCE SECURITY RISKS, RAPID TECHNOLOGICAL
CHANGES, COMPETITION IN THE ELECTRONIC COMMERCE INDUSTRY, THE IMPORTANCE OF
ATTRACTING AND RETAINING PERSONNEL, MANAGEMENT OF THE COMPANY'S GROWTH,
INTEGRATION OF ACQUIRED COMPANIES, DEPENDENCE ON KEY EMPLOYEES AND OTHER RISK
FACTORS REFERENCED IN THE COMPANY'S FORM 10-K FOR THE YEAR ENDED DECEMBER 31,
1999.
OVERVIEW
The Company is a leading provider of comprehensive electronic commerce
outsourcing solutions. 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 Commerce Network Server
("CNS") technology related to electronic commerce. In 1996, the Company began to
focus its business development efforts on the software industry, building its
inventory of software products through contracts with software publishers. In
1997, the Company began to develop software distribution relationships through
contracts with online retailers. As of September 30, 2000, the Company had
approximately 8,000 software publisher clients and online retailer clients that
are served by the Software and Digital Commerce Services Division. In late 1998,
the Company began to offer its comprehensive electronic commerce outsourcing
services in the form of a transaction fee-based e-commerce service to clients
outside of the software industry. As of September 30, 2000, the Company had 49
client contracts under its E-Business Services Division.
The Company derives its revenue primarily from transaction and service fees
associated with the e-commerce services that the Company provides to its
clients. These services include Web commerce hosting, transaction processing,
digital and physical fulfillment services, fraud screening, customer service and
merchandising and analytical marketing services. The Company acts as the
merchant of record on the majority of the transactions processed and has
contractual relationships with its clients, primarily software publishers and
online retailers, which obligate the Company to pay to the client a specified
percentage of each sale. The Company retains its transaction fee and also
charges for various service fees. The Company also derives revenue from
licensing, integration, development and consulting services provided to its
clients. This revenue is recognized as services are performed, except for
licensing and certain integration and development fees which are recognized
evenly over the term of the contract.
The Company has a limited operating history upon which investors may
evaluate its business and prospects. Since inception, the Company has incurred
significant losses, and as of September 30, 2000,
9.
<PAGE>
had an accumulated deficit of approximately $78.5 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, particularly with respect
to the E-Business Services division. As a result, the Company expects to incur
additional losses and continued negative cash flow from operations for the
foreseeable future. There can be no assurance that the Company's revenue 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, online retailers and E-Business Services clients, 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
revenue. Revenue 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 revenue 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 revenue 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.
10.
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth certain items from the Company's
consolidated condensed statements of operations as a percentage of total
revenues for the periods indicated.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -----------------------
2000 1999 2000 1999
------------ ---------- ---------- ------------
<S> <C> <C> <C> <C>
Revenue 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Direct cost of services 5.6 6.6 4.7 6.1
Network and infrastructure 24.8 23.4 26.7 30.3
Sales and marketing 82.1 118.5 93.2 140.2
Product research and development 37.6 66.9 51.8 83.3
General and administrative 15.1 25.9 17.1 32.9
Depreciation 11.8 12.2 10.6 13.8
Amortization of goodwill and other acquisition related
costs 34.2 81.5 58.4 50.9
------------ ---------- ---------- ------------
Total operating expenses 211.2 335.0 262.5 357.5
------------ ---------- ---------- ------------
Loss from operations (111.2) (235.0) (162.5) (257.5)
------------ ---------- ---------- ------------
Interest income, net 5.1 18.7 7.7 27.0
------------ ---------- ---------- ------------
Net loss (106.1)% (216.3)% (154.8)% (230.5)%
============ ========== ========== ============
</TABLE>
REVENUE
Revenue increased to $7.6 million for the quarter ended September 30,
2000 from $4.0 million for the quarter ended September 30, 1999 and increased
to $21.1 million for the nine months ended September 30, 2000, up from $9.0
million for the same period of 1999. As of the quarter ending September 30,
2000, the Company commenced reporting its company wide revenues on a net
basis and reclassified all historical information presented herein to conform
to this presentation, which is further described in "Recent Accounting
Pronouncements." Sales for the Software and Digital Commerce Services segment
increased to $5.9 million for the quarter ended September 30, 2000 from $4.0
million for the quarter ended September 30, 1999 and increased to $17.5
million for the nine months ended September 30, 2000, up from $9.0 million
for the same period of 1999. The increases were primarily 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 electronic
software delivery. Sales for the E-Business Services segment were $1.7
million for the quarter ended September 30, 2000 and were $3.6 million for
the nine months ended September 30, 2000. These sales resulted from new
clients contracted. International sales represented approximately 24% and 22%
of sales for the nine months ended September 30, 2000 and 1999, respectively.
GROSS PROFIT
Cost of revenue, which consists of direct cost of services and network
and infrastructure, increased to $2.3 million in the quarter ended
September 30, 2000 from $1.2 million in the quarter ended September 30, 1999
and increased to $6.6 million for the nine months ended September 30, 2000
from $3.3 million for the same period of 1999. The Company's gross profit margin
11.
<PAGE>
was consistent in the quarter ended September 30, 2000 with that of 1999. The
gross profit margin for the Software and Digital Commerce Services segment was
also consistent in the quarter ended September 30, 2000 with that of 1999. The
gross profit margin for the E-Business Services segment was 65.4% in the quarter
ended September 30, 2000 and is a function of margins earned on licensing,
transaction fees and other services. 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 could reduce gross margins.
SALES AND MARKETING
Sales and marketing expense increased to $6.2 million in the quarter ended
September 30, 2000 from $4.8 million in the quarter ended September 30, 1999 and
increased to $19.7 million for the nine months ended September 30, 1999 from
$12.6 million for the same period of 1999. The increases resulted from expanding
the E-Business sales, client services and marketing infrastructure and variable
expenses that increase in relation to sales. The primary components of the
increase for the comparable quarters ended September 30 were an increase in
wages and benefits of $1.1 million and an increase in credit card fees and
chargeback costs of $547,000 which were partially offset by a decrease in
advertising and marketing expense of $529,000. As a percentage of revenue, sales
and marketing expense decreased to 82.1% in the quarter ended September 30, 2000
from 118.5% in the quarter ended September 30, 1999, primarily reflecting the
Company's increased revenue volume. 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 develop marketing programs.
PRODUCT RESEARCH AND DEVELOPMENT
Product research and development expense increased to $2.9 million in
the quarter ended September 30, 2000 from $2.7 million in the quarter ended
September 30, 1999 and increased to $10.9 million for the nine months ended
September 30, 2000 from $7.5 million for the same period of 1999. These
increases were primarily related to increased personnel and consulting costs
related to developing and enhancing the Company's CNS. For the comparable
quarters ended September 30, the primary components of the increase were an
increase in wages and benefits of $383,000 that were partially offset by
lower consulting fee expenses. As a percentage of revenue, product research
and development expense decreased to 37.6% in the quarter ended September 30,
2000 from 66.9% in the quarter ended September 30, 1999, primarily reflecting
the Company's increased revenue volume. The Company believes that continued
investment in product research and development is critical to attaining its
strategic objectives and, and as a result, expects product research and
development expenses will continue to increase in absolute dollars. As a
percentage of revenue, these expenses are expected to decrease as revenue
increases.
GENERAL AND ADMINISTRATIVE
General and administrative expense increased to $1.2 million in the quarter
ended September 30, 2000 from $1.0 million in the quarter ended September 30,
1999 and increased to $3.6 million for the nine months ended September 30, 2000
from $3.0 million for the same period of 1999. The increases were primarily due
to increased personnel and related expenses and legal expenses. As a percentage
of sales, general and administrative expense decreased to 15.1% in the quarter
ended September 30, 2000 from 25.9% in the quarter ended September 30, 1999,
primarily reflecting the Company's revenue growth. The Company expects general
and administrative 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
revenue, these expenses are expected to decrease as revenue increases.
12.
<PAGE>
AMORTIZATION OF GOODWILL AND OTHER ACQUISITION RELATED COSTS
Amortization of goodwill and other acquisition-related costs decreased
in the quarter ended September 30, 2000 from the quarter ended September 30,
1999 primarily due to an earn-out payment of approximately $1.0 million that
occurred in 1999 which was partially offset by additional amortization of
goodwill from two acquisitions. Amortization of goodwill and other
acquisition related costs increased for the nine months ended September 30,
2000 from the same period of 1999 primarily due to two earn-out payments
totalling $5.1 million made in the first half of 2000.
INTEREST INCOME
Interest income consists of earnings on the Company's cash, cash
equivalents and investments. The decrease from the prior period was attributable
to lower cash and investment balances in 2000. The Company expects interest
income to decrease in the future as cash is used to fund operations and is used
for investments in infrastructure.
INCOME TAXES
The Company paid no income taxes in any reported period. The Company has
incurred a net loss for each period since inception. As of September 30, 2000,
the Company had approximately $79 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 that resulted from the
sales of Common and Preferred Stock will limit the future annual realization of
the tax net operating loss carryforwards to a specified percentage under Section
382 of the Internal Revenue Code.
LIQUIDITY AND CAPITAL RESOURCES
In the first nine months of 2000, the Company used $17.1 million of cash to
fund operations and made additions of equipment and software totaling $8.3
million. The Company sold $36.4 million in investments that were partially
offset by $14.0 million in purchases of investments. In addition, the Company
received $3.6 million from stock sales, all of which were through stock option
and warrant exercises. In the same period for 1999, the Company used $10.8
million of cash to fund operations, $3.3 million for acquisitions, $2.5 million
for addition of equipment and software and $94.6 million to purchase short-term
investments which was partially offset by $58.0 million in sales of investments
As of September 30, 2000, the Company had $15.5 million of cash and cash
equivalents and $17.0 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 continued capital expenditures consistent with its anticipated
growth in operations, infrastructure and personnel. The Company anticipates that
it will expend approximately $13.0 million over the next 15 months on capital
expenditures based on the Company's current anticipated growth rate. The Company
further anticipates that it will expend approximately $12.5 million over the
next 15 months on product development based on the Company's current anticipated
growth rate in operations. 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 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 existing sources of liquidity will provide adequate cash to fund its
operations for at least the next 15 months.
RECENT ACCOUNTING PRONOUNCEMENTS
As of the quarter ended September 30, 2000, the Company has commenced
reporting its company wide revenues on a net basis and has reclassified all
historical information presented herein to conform to this presentation. This
change is based upon the consensus reached in Issue 99-19: "Reporting Revenue
Gross as a Principal versus Net as an Agent" by the Emerging Issues Task Force
(EITF) of the Financial Accounting Standards Board which revised accounting
standards regarding net versus gross revenue recognition. Previously,
substantially all revenue generated through the Company's Software Services
division was recognized on a gross basis. Revenue generated through the
E-Business Services division has historically been reported on a net basis.
This change reflects a new reporting presentation only and will not alter the
Company's net income, either historically or in the future.
The Company has also adopted the provisions of the Securities and
Exchange Commission's (SEC) Staff Accounting Bulletin (SAB) 101, "Revenue
Recognition in Financial Statements" in the quarter ended September 30, 2000.
SAB 101 provides the SEC staff's views in applying generally accepted
accounting principles to selected revenue recognition issues. It also
provides guidance on recording revenue gross as a principal versus net as an
agent consistent with EITF Issue 99-19. Other than the reclassification of
revenues to a net basis, the adoption of SAB 101 did not have any impact to
the Company.
In March 2000, the EITF also published its consensus on EITF 00-2,
"Accounting for Web Site Development Costs." EITF 00-2 is effective for
fiscal quarters beginning after June 30, 2000. The Company has adopted EITF
00-2 and has had no impact to date from the adoption.
13.
<PAGE>
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
The Company does not enter into financial instruments for trading or
speculative purposes and does not currently utilize derivative financial
instruments. The operations of the Company are conducted primarily in the United
States and as such are not subject to material foreign currency exchange rate
risk. The Company has no long-term debt.
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) On August 24, 2000, pursuant to an Asset Purchase Agreement dated as of
August 24, 2000 (the "Purchase Agreement") by and between the Company and
NetSales, Inc. ("NetSales"), in exchange for 1,000,000 shares of Common Stock of
the Company, the Company purchased those assets and assumed those liabilities of
NetSales related to NetSales' software services business. The Purchase Agreement
includes a contingent earnout whereby NetSales can receive up to an additional
350,000 shares of Common Stock of the Company based on performance over the 180
day period following August 24, 2000.
The issuance and sale of the Common Stock was intended to be exempt
from registration and prospectus delivery requirements under the Securities Act
of 1933, as amended (the "Securities Act"), by virtue of Section 4(2) thereof
due to, among other things, (i) the limited number of persons to whom the Common
Stock was issued, (ii) the distribution of disclosure documents to the investor,
(iii) the fact that such person represented and warranted to the Company, among
other things, that such person was acquiring the Common Stock for investment
only and not with a view to the resale or distribution thereof, and (iv) the
fact that a certificate representing the Common Stock was issued with a legend
to the effect that such Common Stock had not been registered under the
Securities Act or any state securities laws and could not be sold or transferred
in the absence of such registration or an exemption therefrom.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENTS
-------- ------------------------
<S> <C>
3.1(1) Amended and Restated Certificate of Incorporation
3.2(1) Bylaws of the Registrant
4.1(1) Specimen Common Stock Certificate
11.1(2) Statement of Computation of Per Share Earnings
27.1 Financial Data Schedule
</TABLE>
14.
<PAGE>
(1) Filed as an exhibit to the Company's Registration Statement on
Form S-1, File No. 333-56787, declared effective on August 11,
1998, incorporated herein by reference.
(2) See Note 4 to Condensed Consolidated Financial Statements.
(B) REPORTS ON FORM 8-K
The Company filed one current report on Form 8-K during the quarter
ended September 30, 2000. The report was filed on September 8, 2000 and amended
by Form 8-K/A filed on November 7, 2000. It reported the Company's acquisition
on August 24, 2000 of the assets and liabilities of NetSales related to
NetSales' software services business and included audited financial statements
of NetSales as of December 31, 1999 as well as unaudited pro forma condensed
consolidated financial statements as of June 30, 2000 that give effect to such
acquisition.
15.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 13, 2000 DIGITAL RIVER, INC.
By: /s/ Robert E. Strawman
-----------------------------
Robert E. Strawman
Chief Financial Officer
(Principal Financial and Accounting
Officer)
16.
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENTS
------- ------------------------
<S> <C>
3.1(1) Amended and Restated Certificate of Incorporation
3.2(1) Bylaws of the Registrant
4.1(1) Specimen Common Stock Certificate
11.1(2) Statement of Computation of Per Share Earnings
27.1 Financial Data Schedule
</TABLE>
(1) Filed as an exhibit to the Company's Registration Statement on
Form S-1, File No. 333-56787, declared effective on August 11,
1998, incorporated herein by reference.
(2) See Note 4 to Condensed Consolidated Financial Statements.
17.
