##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 FORM 10-Q
 
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR
15(d) OF THESECURITIES EXCHANGE ACT OF 1934
 FOR THE QUARTERLY PERIOD ENDED March 31, 2006
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THESECURITIES EXCHANGE ACT OF 1934
 FOR THE TRANSITION PERIOD FROM            TO
 Commission file number 000-24643
 DIGITAL RIVER, INC.
  DELAWARE
(State or other jurisdiction of
incorporation or organization)
    
    41-1901640
(I.R.S. Employer
Identification Number)
 9625 WEST 76TH STREET
EDEN PRAIRIE, MINNESOTA 55344
  (952) 253-1234
  
 þ o
 þ  ̈  ̈
 o þ




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##### 



PART I.
    
    FINANCIAL INFORMATIONItem 1.
    
    Financial StatementsCondensed Consolidated Balance Sheets as of March 31, 2006 and December 31, 2005Condensed Consolidated Statements of Operations for the three months ended March 31,
2006 and 2005Condensed Consolidated Statements of Cash Flows for the three months ended March 31,
2006 and 2005Notes to Condensed Consolidated Financial StatementsItem 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 3.
    
    Qualitative and Quantitative Disclosure about Market RiskItem 4.
    
    Controls and ProceduresPART II.
    
    OTHER INFORMATIONItem 1.
    
    Legal ProceedingsItem 1A.
    
    Risk FactorsItem 2.
    
    Unregistered Sales of Equity Securities and Use of ProceedsItem 6.
    
    ExhibitsSIGNATURESEXHIBIT INDEXComputation of Ratio of Earnings to Fixed ChargesCertification Pursuant to Section 302Certification Pursuant to Section 302Certification Pursuant to Section 906Certification Pursuant to Section 906
  
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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 
 DIGITAL RIVER, INC.
 (Unaudited)March 31,
    
    
    December 31,2006
    
    
    2005ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    317,795
    
    
    $
    131,770Short-term investments
    
    
    235,442
    
    
    
    220,569Accounts receivable, net of allowance of $758 and $1,023
    
    
    29,979
    
    
    
    34,883Deferred income taxes
    
    
    24,835
    
    
    
    22,251Prepaid expenses and other
    
    
    3,627
    
    
    
    3,741Total current assets
    
    
    611,678
    
    
    
    413,214Property and equipment, net
    
    
    20,236
    
    
    
    17,955Goodwill
    
    
    216,402
    
    
    
    195,299Intangible assets, net of accumulated amortization of $39,843 and $36,798
    
    
    22,592
    
    
    
    20,054Deferred income taxes
    
    
    1,900
    
    
    
    10,444Other assets
    
    
    12,121
    
    
    
    12,174TOTAL ASSETS
    
    $
    884,929
    
    
    $
    669,140LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIES:Accounts payable
    
    $
    134,862
    
    
    $
    127,846Accrued payroll
    
    
    6,644
    
    
    
    8,866Deferred revenue
    
    
    6,072
    
    
    
    5,403Accrued acquisition costs
    
    
    8,699
    
    
    
    5,651Other accrued liabilities
    
    
    23,819
    
    
    
    21,210Total current liabilities
    
    
    180,096
    
    
    
    168,976NON-CURRENT LIABILITIES:Convertible senior notes
    
    
    195,000
    
    
    
    195,000Deferred income taxes
    
    
    
    
    
    
    22Total non-current liabilities
    
    
    195,000
    
    
    
    195,022TOTAL LIABILITIES
    
    
    375,096
    
    
    
    363,998COMMITMENTS AND CONTINGENCIESSTOCKHOLDERS EQUITY:Preferred Stock, $.01 par value; 5,000,000 shares authorized; no
shares issued or outstanding
    
    
    
    
    
    
    Common Stock, $.01 par value; 60,000,000 shares authorized;
39,492,865 and 35,033,741 shares issued and outstanding
    
    
    395
    
    
    
    350Additional paid-in capital
    
    
    499,040
    
    
    
    315,489Deferred compensation
    
    
    
    
    
    
    (1,942
    )Retained earnings/(accumulated deficit)
    
    
    10,053
    
    
    
    (6,324
    )Accumulated other comprehensive income (loss)
    
    
    345
    
    
    
    (2,431
    )Total stockholders equity
    
    
    509,833
    
    
    
    305,142TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    884,929
    
    
    $
    669,140
  3




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DIGITAL RIVER, INC.
 Three Months EndedMarch 31,2006
    
    
    2005Revenue
    
    $
    78,014
    
    
    $
    54,529Costs and expenses:Direct cost of services
    
    
    1,863
    
    
    
    1,301Network and infrastructure
    
    
    7,443
    
    
    
    4,479Sales and marketing
    
    
    26,939
    
    
    
    16,376Product research and development
    
    
    7,602
    
    
    
    4,458General and administrative
    
    
    8,250
    
    
    
    5,615Depreciation and amortization
    
    
    2,253
    
    
    
    2,122Amortization of acquisition-related intangibles
    
    
    2,840
    
    
    
    2,396Total costs and expenses
    
    
    57,190
    
    
    
    36,747Income from operations
    
    
    20,824
    
    
    
    17,782Other income, net
    
    
    2,935
    
    
    
    1,155Income before income tax expense
    
    
    23,759
    
    
    
    18,937Income tax expense
    
    
    7,382
    
    
    
    4,900Net income
    
    $
    16,377
    
    
    $
    14,037Net income per share  basic
    
    $
    0.46
    
    
    $
    0.41Net income per share  diluted
    
    $
    0.41
    
    
    $
    0.35Shares used in per-share calculation  basic
    
    
    35,301
    
    
    
    33,932Shares used in per-share calculation  diluted
    
    
    41,154
    
    
    
    41,454
  4




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DIGITAL RIVER, INC.
 Three Months EndedMarch 31,2006
    
    
    2005OPERATING
ACTIVITIES:Net income
    
    $
    16,377
    
    
    $
    14,037Adjustments to reconcile net income to net cash provided by
operating activities:Amortization of acquisition-related intangibles
    
    
    2,840
    
    
    
    2,396Change in accounts receivable allowance, net of acquisitions
    
    
    94
    
    
    
    6Depreciation and amortization
    
    
    2,253
    
    
    
    2,122Stock-based compensation expense related to stock options and
employee stock purchase plans
    
    
    3,413
    
    
    
    Tax benefit of stock-based compensation
    
    
    
    
    
    
    2,600Excess tax benefits from stock-based compensation
    
    
    (1,488
    )
    
    
    Deferred and other income taxes
    
    
    6,377
    
    
    
    Litigation and other charges
    
    
    (15
    )
    
    
    (620
    )Change in operating assets and liabilities (net of acquisitions):Accounts receivable
    
    
    6,172
    
    
    
    831Prepaid and other assets
    
    
    94
    
    
    
    (4,408
    )Accounts payable
    
    
    5,184
    
    
    
    4,086Deferred revenue
    
    
    344
    
    
    
    851Income tax payable
    
    
    898
    
    
    
    (632
    )Accrued payroll and other accrued liabilities
    
    
    (2,011
    )
    
    
    5,992Net cash provided by operating activities
    
    
    40,532
    
    
    
    27,261INVESTING ACTIVITIES:Purchases of investments
    
    
    (66,310
    )
    
    
    (36,485
    )Sales of investments
    
    
    51,263
    
    
    
    27,277Cash paid for acquisitions, net of cash received
    
    
    (16,470
    )
    
    
    (7,306
    )Purchases of equipment and capitalized software
    
    
    (4,002
    )
    
    
    (3,680
    )Net cash used in investing activities
    
    
    (35,519
    )
    
    
    (20,194
    )FINANCING ACTIVITIES:Proceeds from sales of common stock
    
    
    172,700
    
    
    
    Exercise of stock options
    
    
    6,117
    
    
    
    8,801Sales of common stock under employee stock purchase plan
    
    
    
    
    
    
    771Excess tax benefits from stock-based compensation
    
    
    1,488
    
    
    
    Net cash provided by financing activities
    
    
    180,305
    
    
    
    9,572EFFECT OF EXCHANGE RATE CHANGES ON CASH
    
    
    707
    
    
    
    (1,587
    )NET INCREASE IN CASH AND CASH EQUIVALENTS
    
    
    186,025
    
    
    
    15,052CASH AND CASH EQUIVALENTS, beginning of period
    
    
    131,770
    
    
    
    127,734CASH AND CASH EQUIVALENTS, end of period
    
    $
    317,795
    
    
    $
    142,786SUPPLEMENTAL DISCLOSURES:Cash paid for interest on Convertible Senior Notes
    
    $
    1,219
    
    
    $
    1,401Cash paid for income taxes
    
    $
    155
    
    
    $
    Noncash investing and financing activities:Common stock issued in acquisitions and earn-outs
    
    $
    684
    
    
    $
    
  5




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DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 1. BASIS OF PRESENTATION
  Summary of Significant Accounting Policies
  Foreign Currency Translation
  Research and Development and Software Development
  Stock-Based Compensation Expense
    6




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DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
    2. NET INCOME PER SHARE
   7




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DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
  Three Months EndedMarch 31,2006
    
    
    2005Earnings per share  basicNet income  basic
    
    $
    16,377
    
    
    $
    14,037Weighted average shares outstanding  basic
    
    
    35,301
    
    
    
    33,932Earnings per share  basic
    
    $
    0.46
    
    
    $
    0.41Earnings per share  dilutedNet income  basic
    
    
    16,377
    
    
    
    14,037Exclude: Interest expense and amortized
financing cost of convertible senior notes,
net of tax benefit
    
    
    435
    
    
    
    511Net income  diluted
    
    $
    16,812
    
    
    $
    14,548Weighted average shares outstanding  basic
    
    
    35,301
    
    
    
    33,932Dilutive impact of non-vested stock and options outstanding
    
    
    1,428
    
    
    
    3,097Dilutive impact of convertible senior notes
    
    
    4,425
    
    
    
    4,425Weighted average shares outstanding  diluted
    
    
    41,154
    
    
    
    41,454Net income per share  diluted
    
    $
    0.41
    
    
    $
    0.35
  3. BUSINESS COMBINATIONS, GOODWILL AND INTANGIBLE ASSETS
     8




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DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
   Accrual
    
    
    
    
    
    
    
    
    
    
    Accrual
    
    
    
    
    
    
    
    
    
    
    Accrual
    
    
    
    
    
    
    AccrualApril 16,
    
    
    Net
    
    
    
    
    
    
    December 31,
    
    
    
    
    
    
    
    
    
    
    December 31,
    
    
    
    
    
    
    March 31,2004
    
    
    Additions
    
    
    Charges
    
    
    2004
    
    
    Adjustments
    
    
    Charges
    
    
    2005
    
    
    Charges
    
    
    2006Shareholder escrow
    
    $
    
    
    
    $
    2,500
    
    
    $
    
    
    
    $
    2,500
    
    
    $
    
    
    
    $
    (1,250
    )
    
    $
    1,250
    
    
    $
    (1,250
    )
    
    $
    Employee severance costs
    
    
    700
    
    
    
    2,100
    
    
    
    (400
    )
    
    
    2,400
    
    
    
    (200
    )
    
    
    (1,250
    )
    
    
    950
    
    
    
    (200
    )
    
    
    750Facilities consolidation
    
    
    200
    
    
    
    100
    
    
    
    (300
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    900
    
    
    $
    4,700
    
    
    $
    (700
    )
    
    $
    4,900
    
    
    $
    (200
    )
    
    $
    (2,500
    )
    
    $
    2,200
    
    
    $
    (1,450
    )
    
    $
    750
   Three Months EndedMarch 31,2006
    
    
    2005Revenue
    
    $
    78,433
    
    
    $
    58,508Income from operations
    
    
    20,751
    
    
    
    16,837Net income
    
    
    16,300
    
    
    
    13,701Basic net income per share
    
    $
    0.46
    
    
    $
    0.40Diluted net income per share
    
    $
    0.41
    
    
    $
    0.34
  Goodwill and Other Intangible Assets
   9




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DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
  As of March 31, 2006Carrying Amount
    
    
    Accumulated
    
    
    Carrying AmountGross
    
    
    Amortization
    
    
    NetCustomer relationships
    
    $
    38,091
    
    
    $
    22,891
    
    
    $
    15,200Non-compete agreements
    
    
    5,141
    
    
    
    4,486
    
    
    
    655Technology/tradename
    
    
    19,203
    
    
    
    12,466
    
    
    
    6,737Total
    
    $
    62,435
    
    
    $
    39,843
    
    
    $
    22,592
 As of December 31, 2005Carrying Amount
    
    
    Accumulated
    
    
    Carrying AmountGross
    
    
    Amortization
    
    
    NetCustomer relationships
    
    $
    34,666
    
    
    $
    21,103
    
    
    $
    13,563Non-compete agreements
    
    
    5,121
    
    
    
    4,300
    
    
    
    821Technology/tradename
    
    
    17,065
    
    
    
    11,395
    
    
    
    5,670Total
    
    $
    56,852
    
    
    $
    36,798
    
    
    $
    20,054
  Year2006
    
    
    8,4502007
    
    
    6,3722008
    
    
    4,0702009
    
    
    3,5962010
    
    
    104Total
    
    $
    22,592
 4. STOCK-BASED COMPENSATION
    10




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DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
  Options
    
    
    Options PriceOutstanding
    
    
    Per ShareBalance, December 31, 2005
    
    
    4,523,385
    
    
    
    2.59 - 31.13Grants
    
    
    270,500
    
    
    
    29.75 - 38.17Exercised
    
    
    (371,200
    )
    
    
    2.59 - 30.69Cancelled
    
    
    (27,557
    )
    
    
    2.59 - 27.40Balance, March 31, 2006
    
    
    4,395,128
    
    
    $
    2.59 - $38.17
  Three Months EndedMarch 31,2006
    
    
    2005Costs and expensesDirect cost of services
    
    $
    214
    
    
    $
    Network and infrastructure
    
    
    86
    
    
    
    Sales and marketing
    
    
    1,289
    
    
    
    Product research and development
    
    
    585
    
    
    
    General and administrative
    
    
    1,239
    
    
    
    Stock-based compensation included in
costs and expenses
    
    
    3,413
    
    
    
    Tax benefit
    
    
    (1,270
    )
    
    
    Stock-based compensation expense, net of tax
    
    $
    2,143
    
    
    $
    
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DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
  Three Months EndedMarch 31,2006
    
    
    2005Net income, as reported for prior periods (1)
    
    
    N/A
    
    
    $
    14,037Stock-based compensation expense
    
    $
    (3,413
    )
    
    
    (3,234
    )Tax benefit (2)
    
    
    1,270
    
    
    
    Stock-based compensation expense, net of tax (3)
    
    
    (2,143
    )
    
    
    (3,234
    )Net income, including the effect of stock-based compensation
expense (4)
    
    $
    16,377
    
    
    
    10,803Basic net income per share  as reported for prior periods (1)
    
    
    N/A
    
    
    $
    0.41Diluted net income per share  as reported for prior periods (1)
    
    
    N/A
    
    
    $
    0.35Basic net income per share, including the effect of stock-based
compensation expense (4)
    
    $
    0.46
    
    
    $
    0.32Diluted net income per share, including the effect of
stock-based compensation expense (4)
    
    $
    0.41
    
    
    $
    0.27
 
 (1)
    
    Net income and net income per share prior to 2006 did not include stock-based compensation expense
under SFAS 123 because we did not adopt the recognition provisions of SFAS 123.(2)
    
    No tax benefit was recorded prior to the removal of the valuation allowance on our deferred taxes in
the fourth quarter of 2005.(3)
    
    Stock-based compensation expense prior to 2006 is calculated based on the pro forma application of
SFAS 123.(4)
    
    Net income and net income per share prior to 2006 represents pro forma information based on SFAS 123.  Three Months EndedMarch 31,2006
    
    
    2005Risk-free interest rate
    
    
    4.6
    %
    
    
    4.0
    %Expected life (years)
    
    
    3.14
    
    
    
    4Volatility factor
    
    
    0.61
    
    
    
    0.93Expected dividends
    
    
    
    
    
    
    
    12




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DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 5. INCOME TAXES
       6. LONG-TERM DEBT
   13




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DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
   14




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 The discussion in this Quarterly Report contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ materially from those discussed below. Additional
factors that could cause or contribute to such differences include, but are not limited to, those
identified below, and those discussed in the section entitled Risk Factors, included in Item 1A
of Part II of this Quarterly Report. When used in this document, the words believes, expects,
anticipates, intends, plans, and similar expressions, are intended to identify certain of
these forward-looking statements. However, these words are not the exclusive means of identifying
such statements. In addition, any statements that refer to expectations, projections or other
characterizations of future events or circumstances are forward-looking statements. The cautionary
statements made in this document should be read as being applicable to all related forward-looking
statements wherever they appear in this document.
 Overview
      Critical Accounting Policies
  15




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Results of Operations
  Three Months EndedMarch 31,2006
    
    
    2005Revenue
    
    
    100.0
    %
    
    
    100.0
    %Cost of Revenue (exclusive of depreciation
and amortization expense shown separately
below):Direct cost of services
    
    
    2.4
    
    
    
    2.4Network and infrastructure
    
    
    9.6
    
    
    
    8.2Sales and marketing
    
    
    34.5
    
    
    
    30.0Product research and development
    
    
    9.7
    
    
    
    8.2General and administrative
    
    
    10.6
    
    
    
    10.3Depreciation and amortization
    
    
    2.9
    
    
    
    3.9Amortization of acquisition related costs
    
    
    3.6
    
    
    
    4.4Total costs and expenses
    
    
    73.3
    
    
    
    67.4Income from operations
    
    
    26.7
    
    
    
    32.6Other income/(expense), net
    
    
    3.8
    
    
    
    2.1Income before income tax expense
    
    
    30.5
    
    
    
    34.7Income tax expense
    
    
    9.5
    
    
    
    9.0Net income
    
    
    21.0
    %
    
    
    25.7
    %
  16




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REVENUE.
  DIRECT COST OF SERVICES.
 NETWORK AND INFRASTRUCTURE.
 SALES AND MARKETING.
 17




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PRODUCT RESEARCH AND DEVELOPMENT.
 GENERAL AND ADMINISTRATIVE.
 AMORTIZATION OF ACQUISITION-RELATED INTANGIBLES.
 OTHER INCOME, NET.
 INCOME TAXES.
   18




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Off Balance Sheet Arrangements
  19




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Liquidity and Capital Resources
      Payment due by period (in thousands)Total Amount
    
    
    Apr-Dec
    
    
    
    
    
    
    
    
    
    
    2011 andContractual Obligations
    
    Committed
    
    
    2006
    
    
    2007-2008
    
    
    2009-2010
    
    
    ThereafterOperating Lease Obligations
    
    $
    7,046
    
    
    $
    2,214
    
    
    $
    3,999
    
    
    $
    833
    
    
    $
    0Convertible Senior Notes
    
    $
    238,875
    
    
    $
    2,438
    
    
    $
    4,875
    
    
    $
    4,875
    
    
    $
    226,687Total
    
    $
    245,921
    
    
    $
    4,652
    
    
    $
    8,874
    
    
    $
    5,708
    
    
    $
    226,687
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Item 3. Qualitative and Quantitative Disclosure About Market Risk
 Interest Rate Risk
   Foreign Currency Risk
  Transaction Exposure
  Translation Exposure
  22




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Item 4. Controls and Procedures
 (a)
    
    Our management, under the supervision and with the participation of our Chief Executive
Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of the
design and operation of our disclosure controls and procedures as of March 31, 2006. Based
upon this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded
that our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e)
promulgated under the Securities Exchange Act of 1934) were effective in providing reasonable
assurance that material information required to be disclosed by us in this Form 10-Q was
recorded, processed, summarized and reported in a timely manner.
 (b)
    
    During the quarter ended March 31, 2006, there was no change in our internal control over
financial reporting that materially affected, or is reasonably likely to materially affect,
our internal control over financial reporting.
 Limitations on the Effectiveness of Controls
  23




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PART II. OTHER INFORMATION
 
 Item 1. Legal Proceedings
    
 Item 1A. Risk Factors
 The risks described below are not the only ones facing our company. Additional risks not presently
known to us or that we currently deem immaterial also may impair our business operations. Our business,
financial condition or results of operations could be materially adversely affected by any of these risks and
the value of our common stock could decline due to any of these risks. This quarterly report also contains
forward-looking statements that involve risks and uncertainties. Our actual results could differ materially
from those anticipated in these forward-looking statements as a result of certain factors,
including the risks faced by us described below and elsewhere in this report.
 A loss of any client that accounts for a large portion of our revenue would cause our revenue to
decline.
  24




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We have a limited profitable operating history.
  Failure to properly manage and sustain our expansion efforts could
strain our management and other resources.
  We intend to continue to expand our international operations and these efforts may not be
successful in generating additional revenue.
 
 
    
    Changes in regulatory requirements and tariffs;
    
    Uncertainty of application of local commercial, tax, privacy and other laws and regulations;
    
    Reduced protection of intellectual property rights;
    
    Difficulties in physical distribution for international sales;
    
    Higher incidences of credit card fraud and difficulties in accounts receivable collection;
    
    The burden and cost of complying with a variety of foreign laws;
    
    The possibility of unionization of our workforce outside the United States, particularly inEurope; and
    
    Political or economic constraints on international trade or instability.
   Our operating results are subject to fluctuations in demand for products and services offered by us
or our clients.
  25




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New obligations to collect or pay transaction taxes could substantially increase the cost to us of
doing business.
  We could be liable for fraudulent, improper or illegal uses of our platforms.
  Loss of our credit card acceptance privileges would seriously hamper our ability to process the
sale of merchandise.
  26




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Our failure to attract and retain software and digital products publishers, manufacturers, online
retailers
and online channel partners as clients would cause our revenue and operating profits to decline.
  Implementing our acquisition strategy could result in dilution and operating difficulties leading
to a decline in revenue and operating profit.
  We may need to raise additional capital to achieve our business objectives, which could result in
dilution to existing investors or increase our debt obligations.
  27




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Our operating results have fluctuated in the past and are likely to continue to do so, which could
cause the price of our common stock to be volatile.
  
    
    The addition of new clients or loss of current clients;
    
    The introduction by us of new websites, web stores or services that may require a substantial
investment of our resources;
    
    The introduction by others of competitive websites, web stores or services or products;
    
    Our ability to continue to upgrade and develop our systems and infrastructure to meet emerging
market needs and remain competitive in our service offerings;
    
    Economic conditions, particularly those affecting e-commerce;
    
    Client decisions to delay new product launches or to invest in e-commerce initiatives;
    
    The performance of our newly acquired assets or companies;
    
    Slower than anticipated growth of the online market as a vehicle for the purchase of software
products;
    
    The cost of compliance with U.S. and foreign regulations relating to our business; and
    
    Our ability to retain and attract personnel commensurate with our business needs.
   Security breaches could hinder our ability to securely transmit confidential information.
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Claims of infringement of other parties intellectual property rights could require us to expend
significant resources, enter into unfavorable licenses or require us to change our business plans.
  Claims against us related to the software products that we deliver electronically and the tangible
goods that we deliver physically could require us to expend significant resources.
  The growth of the market for our services depends on the development and maintenance of the
Internet infrastructure.
  Because the e-commerce industry is highly competitive and has low barriers to entry, we may be
unable to compete effectively.
  
    
    In-house development of e-commerce capabilities using tools or applications from companies, such
as Art Technology Group, Inc. and IBM Corporation;
    
    E-Commerce capabilities custom-developed by companies, such as IBM Global Services and
Accenture, Inc.;
    
    Other providers of outsourced e-commerce solutions, such as GSI Commerce, Inc., Macrovision
Corporation, asknet Inc. and eSellerate, Inc.;
    
    Companies that provide technologies, services or products that support a portion of the e-commerce
process, such as payment processing, including CyberSource Corporation and PayPal Corp.;
    
    Companies that offer various online marketing services, technologies and products, including
ValueClick, Inc. and aQuantive, Inc.;
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##### Table of Contents




    
    High-traffic, branded websites that generate a substantial portion of their revenue from e-commerce
and may offer or provide to others the means to offer their products for sale, such as Amazon.com,
Inc.; and
    
    Web hosting, web services and infrastructure companies that offer portions of our solution and are
seeking to expand the range of their offering, such as Network
Solutions, LLC, Akamai Technologies, Inc., Yahoo! Inc., eBay Inc. and Hostopia.com Inc.
   Changes in government regulation could limit our Internet activities or result in additional costs
of doing business over the Internet.
  
    
    User privacy with respect to adults and minors;
    
    Our ability to collect and/or share necessary information that allows us to conduct business on the
Internet;
    
    Export compliance;
    
    Pricing and taxation;
    
    Fraud;
    
    Advertising;
    
    Intellectual property rights;
    
    Information security; and
    
    Quality of products and services.
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Failure to develop our technology to accommodate increased traffic could reduce demand for our
services
and impair the growth of our business.
   System failures could reduce the attractiveness of our service offerings.
  
 
    
    Fire, flood and other natural disasters;
    
    Operator negligence, improper operation by, or supervision of, employees, physical and electronic
break-ins, misappropriation, computer viruses and similar events; and
    
    Power loss, computer systems failures, and Internet and telecommunications failure.
  We may become liable to clients who are dissatisfied with our services.
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We depend on key personnel.
   Protecting our intellectual property is critical to our success.
   Our clients sales cycles are lengthy, which may cause us to incur substantial expenses and expend
management time without generating corresponding consumer revenue, which would impair our cash
flow.
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The listing of our network addresses on anti-SPAM lists could harm our ability to service our
clients and deliver goods over the Internet.
  We are subject to regulations relating to consumer privacy.
    Compliance with future laws imposed on e-commerce may substantially increase our costs of doing
business or otherwise adversely affect our ability to offer our services.
  33




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##### Table of Contents



We are exposed to foreign currency exchange risk.
  Developments in accounting standards may cause us to increase our recorded expenses, which in turn
would jeopardize our ability to demonstrate sustained profitability.
  Compliance with changing regulation of corporate governance and public disclosure may result in
additional expenses.
  34




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##### Table of Contents



Internet-related stock prices are especially volatile and this volatility may depress our stock
price or cause it to fluctuate significantly.
  
    
    Actual or anticipated variations in quarterly operating results;
    
    Announcements of technological innovations;
    
    The ability to sign new clients and the retention of existing clients;
    
    New products or services that we offer;
    
    Competitive developments, including new products or services, or new relationships by our
competitors;
    
    Changes that affect our clients or the viability of their product lines;
    
    Changes in financial estimates by securities analysts;
    
    Conditions or trends in the Internet and online commerce industries;
    
    Global unrest and terrorist activities;
    
    Changes in the economic performance and/or market valuations of other Internet or online
e-commerce companies;
    
    Required changes in generally accepted accounting principles and disclosures;
    
    Our announcement of significant acquisitions, strategic partnerships, joint ventures or capital
commitments or results of operations or other developments related to those acquisitions;
    
    Additions or departures of key personnel; and
    
    Sales or other transactions involving our common stock or our convertible notes.
  Provisions of our charter documents, other agreements and Delaware
law may inhibit potential acquisition bids for us.
  35




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##### Table of Contents



Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
   Approximate dollarTotal number of
    
    
    value of sharesTotal number
    
    
    Average
    
    
    shares purchased as
    
    
    that may yet beshares of
    
    
    price paid
    
    
    part of publicly
    
    
    purchased under thePeriod
    
    purchased
    
    
    per share
    
    
    announced plan
    
    
    plan (in millions)January 1, 2006 - January 31, 2006
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    36.6February 1, 2006 - February 28, 2006
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    36.6March 1, 2006 - March 31, 2006
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    36.6Total
    
    
    
    
    
    
    
    
    
    
    
 36




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##### Table of Contents



Item 6. Exhibits
  EXHIBITNUMBER
    
    DESCRIPTION OF DOCUMENTS3.1
    
    (1)
    
    Amended and Restated Certificate of Incorporation, as amended, as currently in effect.3.2
    
    (2)
    
    Amended and Restated Bylaws, as currently in effect.4.1
    
    (3)
    
    Specimen of Common Stock Certificate.4.2
    
    (1)
    
    Form of Senior Debt Indenture.4.3
    
    (1)
    
    Form of Subordinated Debt Indenture.4.4
    
    
    
    References are made to Exhibits 3.1 and 3.2.4.5
    
    (4)
    
    Indenture dated as of June 1, 2004 between Digital River, Inc. and Wells Fargo Bank, N.A.
as trustee, including therein the form of the Note.10.26
    
    (5)
    
    Summary of Compensation Programs for Non-Employee Directors and Executive Officers.12.1
    
    
    
    Computation of Ratio of Earnings to Fixed Charges.31.1
    
    
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    
    
    Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    
    
    Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 (1)
    
    Filed as exhibits 3.1 and 3.3 and exhibits 4.5 and 4.6 to our Registration
Statement on Form S-3, File No. 333-81626, filed on January 29, 2002, declared
effective on February 12, 2002, and incorporated herein by reference.(2)
    
    Filed as an exhibit to our Annual Report on Form 10-K for the year ended
December 31, 2000, filed on March 27, 2001, and incorporated herein by reference.(3)
    
    Filed as an exhibit to our Registration Statement on Form S-1, File No.
333-56787, declared effective on August 11, 1998, and incorporated herein by
reference.(4)
    
    Filed as exhibit 99.1 to our Current Report on Form 8-K, filed on July 13, 2004
and incorporated herein by reference.(5)
    
    Filed as exhibit 99.1 to our Current Report on Form 8-K filed on February 16, 2006. 37




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##### Table of Contents



Date: May 10, 2006
    DIGITAL RIVER, INC.By:
    /s/ THOMAS M. DONNELLYThomas M. DonnellyChief Financial Officer
(Principal Financial and Accounting Officer) 38




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##### Table of Contents



EXHIBITNUMBER
    
    DESCRIPTION OF DOCUMENTS3.1
    
    (1)
    
    Amended and Restated Certificate of Incorporation, as amended, as currently in effect.3.2
    
    (2)
    
    Amended and Restated Bylaws, as currently in effect.4.1
    
    (3)
    
    Specimen of Common Stock Certificate.4.2
    
    (1)
    
    Form of Senior Debt Indenture.4.3
    
    (1)
    
    Form of Subordinated Debt Indenture.4.4
    
    
    
    References are made to Exhibits 3.1 and 3.2.4.5
    
    (4)
    
    Indenture dated as of June 1, 2004 between Digital River, Inc. and Wells Fargo Bank, N.A.
as trustee, including therein the form of the Note.10.26
    
    (5)
    
    Summary of Compensation Programs for Non-Employee Directors and Executive Officers.12.1
    
    
    
    Computation of Ratio of Earnings to Fixed Charges.31.1
    
    
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    
    
    Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    
    
    Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 (1)
    
    Filed as Exhibits 3.1 and 3.3 and Exhibits 4.5 and 4.6 to our Registration
Statement on Form S-3, File No. 333-81626, filed on January 29, 2002, declared
effective on February 12, 2002, and incorporated herein by reference.(2)
    
    Filed as an exhibit to our Annual Report on Form 10-K for the year ended
December 31, 2000, filed on March 27, 2001, and incorporated herein by reference.(3)
    
    Filed as an exhibit to our Registration Statement on Form S-1, File No.
333-56787, declared effective on August 11, 1998, and incorporated herein by
reference.(4)
    
    Filed as exhibit 99.1 to our Current Report on Form 8-K, filed on July 13, 2004
and incorporated herein by reference.(5)
    
    Filed as exhibit 99.1 to our Current Report on Form 8-K filed on February 16, 2006. 39