**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-Q**

 

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| **ý**                                                                                                                    | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**  |
|-------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------|
|                                                                                                                          |                                                                                                     |
| **FOR THE QUARTERLY PERIOD ENDED June 30, 2005**                                                                         |
|                                                                                                                          |                                                                                                     |
| **OR**                                                                                                                        |
|                                                                                                                          |                                                                                                     |
| **o**                                                                                                                         | **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  incorporation or organization)    |   | (I.R.S.  Employer  Identification Number) |
|                                                                |   |   |
| **9625 WEST 76TH STREET, SUITE 150  EDEN PRAIRIE, MINNESOTA 55344** |
| (Address of  principal executive offices)                           |
|                                                                |   |   |
| **(952) 253-1234**                                                  |
| (Registrant’s  telephone number, including area code)          |

 

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Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.   Yes ý No o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Exchange Act Rule 12b-2) Yes ý No o

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practical date.

 
| **COMMON STOCK, $0.01 PAR VALUE** | ** ** | **34,301,597 SHARES**                 |
|-----------------------------------|------------|---------------------------------------|
| (Class)                           |       | Outstanding  as of July 29, 2005 |

 

 

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DIGITAL RIVER, INC.

Form 10-Q

Index

 
| PART I.       | FINANCIAL INFORMATION                                                                                           |   |
|--------------------|-----------------------------------------------------------------------------------------------------------------|--------|
|               |                                                                                                            |   |
| Item  1.           | Financial Statements                                                                                            |   |
|               |                                                                                                            |   |
|               | Condensed Consolidated Balance Sheets as of June 30,  2005 and December 31, 2004                      |   |
|               |                                                                                                            |   |
|               | Condensed Consolidated Statements of Operations for  the three and six months ended June 30, 2005 and 2004 |   |
|               |                                                                                                            |   |
|               | Condensed Consolidated Statements of Cash Flows for  the six months ended June 30, 2005 and 2004           |   |
|               |                                                                                                            |   |
|               | Notes to Condensed Consolidated Financial Statements                                                            |   |
|               |                                                                                                            |   |
| Item  2.           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                     |   |
|               |                                                                                                            |   |
| Item  3.           | Qualitative and  Quantitative Disclosure about Market Risk                                                      |   |
|               |                                                                                                            |   |
| Item  4.           | Controls and Procedures                                                                                         |   |
|               |                                                                                                            |   |
| PART II.      | OTHER INFORMATION                                                                                               |   |
|               |                                                                                                            |   |
| Item 1.            | Legal Proceedings                                                                                               |   |
|               |                                                                                                            |   |
| Item 2.            | Unregistered  Sales of Equity Securities and Use of Proceeds                                                    |   |
|               |                                                                                                            |   |
| Item 4.            | Submission of  Matters to a Vote of Security Holders                                                            |   |
|               |                                                                                                            |   |
| Item 5.            | Other Information                                                                                               |   |
|               |                                                                                                            |   |
| Item 6.            | Exhibits                                                                                                        |   |
|               |                                                                                                            |   |
| SIGNATURES         |                                                                                                            |
|               |                                                                                                            |   |
| EXHIBIT INDEX |                                                                                                            |

 

2

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**PART I.  FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

**DIGITALRIVER, INC.**

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except sharedata)

 
| ** **                                                                                                            | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                            |       |                    |       |                        |       |
| CURRENT  ASSETS:                                                                                                      |       |                    |       |                        |       |
| Cash and  cash equivalents                                                                                            |       | $                       | 142,221    |                        | $          | 127,734 |   |
| Short-term  investments                                                                                               |       | 179,824                 |       | 164,402                     |       |
| Accounts  receivable, net of allowance of $653 and $1,146                                                             |       | 21,903                  |       | 21,520                      |       |
| Other  current assets                                                                                                 |       | 3,109                   |       | 3,317                       |       |
| Total  current assets                                                                                                 |       | 347,057                 |       | 316,973                     |       |
|                                                                                                                  |       |                    |       |                        |       |
| PROPERTY AND  EQUIPMENT, NET                                                                                          |       | 19,314                  |       | 17,367                      |       |
| GOODWILL                                                                                                              |       | 156,279                 |       | 148,086                     |       |
| INTANGIBLE  ASSETS, net of accumulated amortization of $32,758 and $28,245                                            |       | 15,194                  |       | 17,297                      |       |
| OTHER ASSETS                                                                                                          |       | 9,566                   |       | 10,113                      |       |
| TOTAL ASSETS                                                                                                          |       | $                       | 547,410    |                        | $          | 509,836 |   |
|                                                                                                                  |       |                    |       |                        |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                        |       |                    |       |                        |       |
| CURRENT  LIABILITIES:                                                                                                 |       |                    |       |                        |       |
| Accounts  payable                                                                                                     |       | $                       | 84,879     |                        | $          | 88,052 |   |
| Accrued  payroll                                                                                                      |       | 4,254                   |       | 5,332                       |       |
| Deferred  revenue                                                                                                     |       | 4,419                   |       | 3,901                       |       |
| Accrued  acquisitions expenses                                                                                        |       | 6,588                   |       | 6,720                       |       |
| Other  accrued liabilities                                                                                            |       | 16,987                  |       | 14,221                      |       |
| Total  current liabilities                                                                                            |       | 117,127                 |       | 118,226                     |       |
|                                                                                                                  |       |                    |       |                        |       |
| NON-CURRENT  LIABILITIES:                                                                                             |       |                    |       |                        |       |
| Convertible  senior notes                                                                                             |       | 195,000                 |       | 195,000                     |       |
| Deferred tax  liability                                                                                               |       | 3,245                   |       | 3,841                       |       |
| Total non  current liabilities                                                                                        |       | 198,245                 |       | 198,841                     |       |
| Total  liabilities                                                                                                    |       | 315,372                 |       | 317,067                     |       |
|                                                                                                                  |       |                    |       |                        |       |
| COMMITMENTS  AND CONTINGENCIES                                                                                        |       |                    |       |                        |       |
|                                                                                                                  |       |                    |       |                        |       |
| STOCKHOLDERS’  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; 34,208,165 and 33,652,149  shares issued and outstanding |       | 342                     |       | 337                         |       |
| Additional  paid-in capital                                                                                           |       | 261,103                 |       | 243,926                     |       |
| Accumulated  deficit                                                                                                  |       | (29,079                 | )          | (51,164                     | )          |
| Accumulated  other comprehensive loss                                                                                 |       | (328                    | )          | (330                        | )          |
| Total  stockholders’ equity                                                                                      |       | 232,038                 |       | 192,769                     |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                      |       | $                       | 547,410    |                        | $          | 509,836 |   |

 

See accompanying notes tocondensed consolidated financial statements.

 

3

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**DIGITALRIVER, INC.**

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per sharedata; unaudited)

 
| ** **                                                                                       | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                       | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                             |       |                                  |       |                                |       |   |   |   |   |
| REVENUE                                                                                          |       | $                                     | 51,143     |                                | $          | 34,877 |   | $ | 105,672 |   | $ | 66,732 |   |
| COSTS AND  EXPENSES (exclusive of depreciation and amortization expense shown separately  below) |       |                                  |       |                                |       |   |   |   |   |
| Direct cost  of services                                                                         |       | 1,187                                 |       | 1,449                               |       | 2,488 |   | 2,067 |   |
| Network and  infrastructure                                                                      |       | 4,738                                 |       | 3,506                               |       | 9,216 |   | 6,806 |   |
| Sales and  marketing                                                                             |       | 15,740                                |       | 11,407                              |       | 32,116 |   | 22,875 |   |
| Product  research and development                                                                |       | 5,127                                 |       | 3,645                               |       | 9,585 |   | 6,569 |   |
| General and  administrative                                                                      |       | 5,301                                 |       | 3,856                               |       | 10,917 |   | 6,693 |   |
| Depreciation  and amortization                                                                   |       | 2,375                                 |       | 1,859                               |       | 4,497 |   | 3,470 |   |
| Amortization  of acquisition related intangibles                                                 |       | 2,110                                 |       | 2,267                               |       | 4,506 |   | 3,846 |   |
| Total costs  and expenses                                                                        |       | 36,578                                |       | 27,989                              |       | 73,325 |   | 52,326 |   |
|                                                                                             |       |                                  |       |                                |       |   |   |   |   |
| INCOME FROM  OPERATIONS                                                                          |       | 14,565                                |       | 6,888                               |       | 32,347 |   | 14,406 |   |
| OTHER  INCOME/(EXPENSE), NET                                                                     |       | 891                                   |       | (132                                | )          | 2,046 |   | (35 | ) |
| INCOME  BEFORE INCOME TAX EXPENSE                                                                |       | $                                     | 15,456     |                                | $          | 6,756 |   | $ | 34,393 |   | $ | 14,371 |   |
| Income tax expense                                                                               |       | 5,230                                 |       | —                              |       | 10,130 |   | — |   |
| NET INCOME                                                                                       |       | $                                     | 10,226     |                                | $          | 6,756 |   | $ | 24,263 |   | $ | 14,371 |   |
|                                                                                             |       |                                  |       |                                |       |   |   |   |   |
| NET INCOME  PER SHARE:                                                                           |       |                                  |       |                                |       |   |   |   |   |
| BASIC                                                                                            |       | $                                     | 0.30       |                                | $          | 0.21 |   | $ | 0.71 |   | $ | 0.45 |   |
| DILUTED                                                                                          |       | $                                     | 0.26       |                                | $          | 0.19 |   | $ | 0.61 |   | $ | 0.40 |   |
|                                                                                             |       |                                  |       |                                |       |   |   |   |   |
| WEIGHTED  AVERAGE COMMON SHARES OUTSTANDING:                                                     |       |                                  |       |                                |       |   |   |   |   |
| BASIC                                                                                            |       | 34,176                                |       | 32,064                              |       | 34,097 |   | 31,842 |   |
| DILUTED                                                                                          |       | 41,154                                |       | 37,440                              |       | 41,347 |   | 36,244 |   |

 

See accompanying notes tocondensed consolidated financial statements.

 

4

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**DIGITALRIVER, INC.**

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands; unaudited)

 
| ** **                                                                         | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                         | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| OPERATING  ACTIVITES:                                                              |       |                                |       |   |   |
| Net income                                                                         |       | $                                   | 24,263     |   | $ | 14,371 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                                |       |   |   |
| Amortization  of acquisition related costs                                         |       | 4,506                               |       | 3,846 |   |
| Change in  accounts receivable allowance                                           |       | (390                                | )          | 175 |   |
| Depreciation  and amortization                                                     |       | 4,497                               |       | 3,453 |   |
| Tax benefit  of stock based compensation                                           |       | 6,269                               |       | — |   |
| Deferred and  other income taxes                                                   |       | 3,870                               |       | — |   |
| Change in  operating assets and liabilities:                                       |       |                                |       |   |   |
| Accounts  receivable                                                               |       | 1,392                               |       | (1,026 | ) |
| Prepaid and  other assets                                                          |       | (475                                | )          | 587 |   |
| Accounts  payable                                                                  |       | (6,705                              | )          | 4,934 |   |
| Deferred  revenue                                                                  |       | 633                                 |       | 41 |   |
| Accrued  payroll and other accrued liabilities                                     |       | 595                                 |       | (1,423 | ) |
| Net cash  provided by operating activities                                         |       | 38,455                              |       | 24,958 |   |
|                                                                               |       |                                |       |   |   |
| INVESTING  ACTIVITIES:                                                             |       |                                |       |   |   |
| Purchases of  investments                                                          |       | (69,089                             | )          | (44,207 | ) |
| Sales of  investments                                                              |       | 53,227                              |       | 44,982 |   |
| Cash paid  for acquisitions, net of cash received                                  |       | (7,825                              | )          | (124,714 | ) |
| Purchases of  property, equipment and capitalized software                         |       | (6,021                              | )          | (4,409 | ) |
| Net cash  used in investing activities                                             |       | (29,708                             | )          | (128,348 | ) |
|                                                                               |       |                                |       |   |   |
| FINANCING  ACTIVITIES:                                                             |       |                                |       |   |   |
| Principal  amount on line of credit                                                |       | —                              |       | 45,000 |   |
| Repayment of  principal on line of credit                                          |       | —                              |       | (45,000 | ) |
| Net proceeds  on issuance of 1.25% convertible senior notes due 1/1/2024           |       | —                              |       | 169,201 |   |
| Exercise of  stock options                                                         |       | 10,453                              |       | 8,007 |   |
| Sales of  common stock under employee stock purchase plan                          |       | 1,488                               |       | 427 |   |
| Repurchase  of common stock                                                        |       | (3,205                              | )          | — |   |
| Net cash  provided by financing activities                                         |       | 8,736                               |       | 177,635 |   |
| EFFECT OF  EXCHANGE RATE CHANGES ON CASH                                           |       | (2,996                              | )          | 57 |   |
| NET INCREASE  IN CASH AND CASH EQUIVALENTS                                         |       | 14,487                              |       | 74,302 |   |
| CASH AND  CASH EQUIVALENTS, beginning of period                                    |       | 127,734                             |       | 101,878 |   |
| CASH AND  CASH EQUIVALENTS, end of period                                          |       | $                                   | 142,221    |   | $ | 176,180 |   |
| SUPPLEMENTAL  DISCLOSURES:                                                         |       |                                |       |   |   |
| Cash paid  for interest on Convertible Senior Notes                                |       | $                                   | 1,422      |   | $ | — |   |

 

See accompanying notes tocondensed consolidated financial statements.

 

5

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**DIGITALRIVER, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

(Unaudited)

 

**1. BASIS OF PRESENTATION**

 

The unaudited condensed consolidated financial statements includedherein reflect all adjustments, including normal recurring adjustments, whichin our opinion are necessary to fairly state our consolidated financialposition, results of operations and cash flows for the periods presented. These condensed consolidated financial statements should be read in conjunctionwith our audited consolidated financial statements included in our Form 10-Kfor the year ended December 31, 2004 as filed with the Securities andExchange Commission. The results of operations for the three and six monthsended June 30, 2005 are not necessarily indicative of the results to beexpected for any subsequent quarter or for the entire fiscal year ending December 31,2005. The December 31, 2004 balance sheet was derived from auditedfinancial statements, but does not include all disclosures required byaccounting principles generally accepted in the United States.

 

***Summary ofSignificant Accounting Policies***

 

A detailed description of our significant accounting policies can befound in our most recent Annual Report filed on Form 10-K for the fiscalyear ended December 31, 2004.

 

***Foreign CurrencyTranslation***

 

Foreign currency denominated revenue and expense transactions areremeasured to our functional currency using average exchange rates for thefiscal period.  Foreign currencydenominated assets and liabilities are remeasured to our functional currencyusing the exchange rate in effect at the respective balance sheet dates.  Any gains or losses are included in theconsolidated statement of operations within “other income (expense), net.”  The financial position and results ofoperations of our foreign subsidiaries are measured using local currency as thefunctional currency.  Assets andliabilities are translated to their U.S. dollar equivalents at rates in effectat the respective balance sheet dates and statements of operations and cashflows are translated using average exchange rates for the fiscal period.  The resulting translation adjustments arerecorded as a component of stockholders’ equity.

 

***Research andDevelopment and Software Development***

 

Research and development expenses consist primarily of developmentpersonnel and external contractor costs related to the development of newproducts and services, enhancement of existing products and services, qualityassurance and testing.  We follow AICPAStatement of Position No. 98-1, “Accounting for the Costs of ComputerSoftware Developed or Obtained for Internal Use,” in accounting for internallydeveloped software.  Consistentwith SOP 98-1, we capitalized approximately, $0 million and $0.4 million ofsoftware development costs related to those efforts for the three and sixmonths ended June 30, 2005, respectively. We did not capitalize any costsrelated to software development during the three months ended June 30,2005 and do not expect to capitalize any such costs for the balance of2005.  These capitalized costs areincluded in purchases of equipment within investing activities on ourConsolidated Statement of Cash Flows.

 

**2.NET INCOME PER SHARE**

 

The table below sets forth the computation of basic and diluted netincome per share (in thousands, except per share amounts):

 

6

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| ** **                                                                                               | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                               | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| EARNINGS PER  SHARE - BASIC                                                                              |       |                                  |       |                                |       |   |   |   |   |
| Net income -  basic                                                                                      |       | $                                     | 10,226     |                                | $          | 6,756 |   | $ | 24,263 |   | $ | 14,371 |   |
| Weighted  average shares outstanding - basic                                                             |       | 34,176                                |       | 32,064                              |       | 34,097 |   | 31,842 |   |
| Earning per  share - basic                                                                               |       | $                                     | 0.30       |                                | $          | 0.21 |   | 0.71 |   | 0.45 |   |
|                                                                                                     |       |                                  |       |                                |       |   |   |   |   |
| EARNINGS PER  SHARE - DILUTED                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Net income -  basic                                                                                      |       | 10,226                                |       | 6,756                               |       | 24,263 |   | 14,371 |   |
| Exclude:  Interest expense and amortized financing cost of convertible senior notes,  net of tax benefit |       | 457                                   |       | 236                                 |       | 969 |   | 236 |   |
| Net income -  diluted                                                                                    |       | $                                     | 10,683     |                                | $          | 6,992 |   | 25,232 |   | 14,607 |   |
| Weighted  average shares outstanding - basic                                                             |       | 34,176                                |       | 32,064                              |       | 34,097 |   | 31,842 |   |
| Dilutive  impact of options outstanding                                                                  |       | 2,553                                 |       | 3,917                               |       | 2,825 |   | 3,673 |   |
| Dilutive  impact of convertible senior notes                                                             |       | 4,425                                 |       | 1,459                               |       | 4,425 |   | 729 |   |
| Diluted —  weighted average shares outstanding                                                      |       | 41,154                                |       | 37,440                              |       | 41,347 |   | 36,244 |   |
| Diluted —  net income per share                                                                     |       | $                                     | 0.26       |                                | $          | 0.19 |   | $ | 0.61 |   | $ | 0.40 |   |

 

Subsequentto our issuance of 1.25% convertible senior notes on June 1, 2004, theEmerging Issues Task Force (EITF), Issue No. 04-08, proposed that theunissued shares underlying contingent convertible notes be treated as if suchshares were issued and outstanding for the purposes of calculating GAAP dilutedearnings per share.  The notes arecontingently convertible into approximately 4.4 million shares of common stockat an initial conversion price of $44.063 per share, which have been includedin our weighted average shares outstanding calculation since the date ofissuance.

 

**3. GOODWILL AND INTANGIBLE ASSETS**

 

We account for our goodwill in accordance with SFAS No. 142, “Goodwilland Other Intangible Asset.”  SFAS No. 142precludes the amortization of goodwill and intangible assets with indefinitelives, but these assets are reviewed annually (or more frequently if impairmentindicators arise) for impairment.

 

We complete our annual impairment test in the fourth quarter of eachfiscal year, and reassess any intangible assets, including goodwill, recordedin connection with earlier acquisitions. There was no impairment of goodwill in the three and six months ended June 30,2005 and 2004.

 

Information regarding our other intangible assets is as follows (inthousands):

 

7

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| ** **              | ** ** | **As of June 30, 2005** | ** ** |
|-------------------------|------------|------------------------------|------------|
| ** **              | ** ** | **Carrying Amount  Gross**   | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
|                    |       |                         |       |   |   |   |   |
| Customer  relationships |       | $                            | 27,217     |   | $ | 19,001 |   | $ | 8,216 |   |
| Non-compete  agreements |       | 5,141                        |       | 3,933 |   | 1,208 |   |
| Technology/tradename    |       | 15,594                       |       | 9,824 |   | 5,770 |   |
| Total                   |       | $                            | 47,952     |   | $ | 32,758 |   | $ | 15,194 |   |

 
| ** **              | ** ** | **As of December 31, 2004** | ** ** |
|-------------------------|------------|----------------------------------|------------|
| ** **              | ** ** | **Carrying Amount  Gross**       | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
|                    |       |                             |       |   |   |   |   |
| Customer  relationships |       | $                                | 25,406     |   | $ | 14,784 |   | $ | 10,622 |   |
| Non-compete  agreements |       | 5,134                            |       | 3,549 |   | 1,585 |   |
| Technology/tradename    |       | 15,002                           |       | 9,912 |   | 5,090 |   |
| Total                   |       | $                                | 45,542     |   | $ | 28,245 |   | $ | 17,297 |   |

 

Amortization expense for the three months ended June 30, 2005 and2004 was $2.1 million and $2.3 million, respectively and $4.5 million and $3.8million for the six months ended June 30, 2005 and 2004respectively.  Estimated amortization expense for the remaining life ofthe intangible assets, based on intangible assets as of June 30, 2005, isas follows (in thousands):

 
| **Year** | ** ** | **As of June 30, 2005** | ** ** |
|----------|------------|------------------------------|------------|
| 2005     |       | 4,160                        |       |
| 2006     |       | 7,667                        |       |
| 2007     |       | 2,770                        |       |
| 2008     |       | 491                          |       |
| 2009     |       | 102                          |       |
| 2010     |       | 4                            |       |
| Total    |       | $                            | 15,194     |   |
|          |            |                              |            |  |

 

**4. STOCK BASED COMPENSATION**

 

Prior to the annual stockholders’ meeting held in May 2005, we hadtwo stock-based employee compensation plans, which are described more fully inNote 11 of our 2004 Annual Report on Form 10-K.  At the annual stockholders’ meeting held in May 2005,stockholders approved an amendment and restatement of our 1998 Stock OptionPlan that combined the 1998 plan with our 1999 Stock Option Plan and gave usthe flexibility to grant restricted stock awards, restricted stock unit awardsand performance shares, in addition to incentive and nonstatutory stockoptions, to our directors, employees, and consultants under the combined plan.We account for these plans under the recognition and measurement principles ofAccounting Principles Board (APB) Opinion No. 25, “Accounting for StockIssued to Employees,” and related interpretations.  No stock-based employee compensation cost isreflected in net income, as all options granted under these plans had anexercise price equal to the market value of the underlying common stock on thedate of the grant.

 

We have elected to apply the disclosure-only provisions of SFAS No. 123,“Accounting for Stock-Based Compensation” as amended by SFAS No. 148.Accordingly, we account for stock-based compensation using the intrinsic valuemethod prescribed in APB Opinion No. 25, “Accounting for Stock Issued toEmployees,” and related interpretations. Compensation cost for stock options ismeasured as the excess, if any, of the fair value of our common stock at thedate of grant over the stock option exercise price.

 

8

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The following table illustrates the effect on net income and net incomeper share if we had applied the fair value recognition provision of FinancialAccounting Standards Board Statement No. 123, “Accounting for Stock-BasedCompensation,” to stock-based employee compensation (in thousands, except pershare amounts):

 
| ** **                                                                                       | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                       | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income,  as reported                                                                         |       | $                                     | 10,226     |                                | $          | 6,756 |   | $ | 24,263 |   | $ | 14,371 |   |
| Deduct:  Total stock-based compensation determined under fair value based method for  all awards |       | (3,347                                | )          | (7,511                              | )          | (6,581 | ) | # | (13,540 | ) |
| Adjusted net  income, fair value method for all stock-based awards                               |       | $                                     | 6,879      |                                | $          | (755 | ) | $ | 17,682 |   | $ | 831 |   |
|                                                                                             |       |                                  |       |                                |       |   |   |   |   |
| Basic income  per share — as reported                                                       |       | $                                     | 0.30       |                                | $          | 0.21 |   | $ | 0.71 |   | $ | 0.45 |   |
| Diluted  income per share — as reported                                                     |       | $                                     | 0.26       |                                | $          | 0.19 |   | $ | 0.61 |   | $ | 0.40 |   |
| Basic income  per share – SFAS No. 123 adjusted                                        |       | $                                     | 0.20       |                                | $          | (0.02 | ) | $ | 0.52 |   | $ | 0.03 |   |
| Diluted  income per share – SFAS No. 123 adjusted                                      |       | $                                     | 0.18       |                                | $          | (0.02 | ) | $ | 0.45 |   | $ | 0.02 |   |

 

The fair value of each option grant is estimated on the date of grantusing the Black-Scholes option pricing model using the following weightedaverage assumptions:

 
| ** **               | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------|------------|------------------------------------|------------|
| ** **               | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| Risk-free  interest rate |       | 4                                  | %          | 4 | % |
| Expected  life (years)   |       | 4                                  |       | 1–3 |   |
| Volatility  factor       |       | 0.93                               |       | 1.3 |   |
| Expected  dividends      |       | —                             |       | — |   |

 

In December 2004, the Financial Accounting Standards Board issuedSFAS 123 (R), “Share-Based Payment.” This Statement is a revision to SFAS 123, “Accounting for Stock-BasedCompensation,” and supersedes APB Opinion No. 25, “Accounting for StockIssued to Employees.”  SFAS 123(R)requires the measurement of the cost of employee services received in exchangefor an award of equity instruments based on the grant-date fair value of theaward.  No compensation cost isrecognized for equity instruments for which employees do not render service.  We expect to adopt SFAS 123(R) effective on January 1,2006, requiring compensation cost to be recognized as expense for the portionof outstanding unvested awards, and any new awards made thereafter, based onthe grant-date fair value of those awards.

 

**5. ACQUISITIONS AND EARN-OUT ARRANGEMENTS**

 

In March 2005, we acquired certain assets and assumed certainliabilities, vendor contracts and intellectual property of SWReg, an operatingbusiness of Atlantic Coast plc, a private limited UK company for $8.8 millionin cash. SWReg is a provider of e-commerce services for software authors.Goodwill of $8.8 million was recorded as a result of this acquisition.  We are amortizing other intangibles assetsacquired as follows; technology over three years, tradename over five years,and customer relationships over a four-year period.  We may also make additional earn-out paymentsin cash based on achieving specific revenue and development goals over thefirst 12 months following the closing of the acquisition.  Such earn-out amounts, if paid, will berecorded as goodwill as they are considered incremental to the purchase price.

 

In November 2004, we acquired all of the outstanding capital stockof BlueHornet Networks, Inc. BlueHornet is a leading provider of e-mail marketing campaign managementservices and related customer relationship management (CRM) tools.  As consideration for the acquisition, weissued a total of 160 thousand shares of our common stock to the BlueHornetstockholders, valued at approximately $5.3 million, paid off $0.7 million ofBlueHornet debt obligations at

 

9

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closing and agreed to pay an additional $0.5 million in cash to theformer BlueHornet stockholders following the transition of certain BlueHornetassets to our facilities in Eden Prairie, Minnesota.  Goodwill of $4.8 million was recorded as aresult of this acquisition. We are amortizing other intangible assets acquired,consisting of technology/tradename, customer relationships and non-competeagreements, over a three-year period.  Inaddition, the former BlueHornet stockholders may receive additional earn-outpayments in cash or our common stock, at our discretion, based on BlueHornet’soperating performance over the first 36 months following the closing of theacquisition.  These earn-out amounts, ifpaid, will be recorded as goodwill as they are considered incremental to thepurchase price.

 

In June 2004, we acquired substantially all of the assets andassumed certain liabilities of Fireclick, Inc., a leading provider ofWeb-analysis solutions for online retailers, providing web site owners with thetools necessary to measure campaign ROI, track user path analysis and enhanceweb site user experience.  Under theterms of the agreement, we paid $7.5 million in cash and an additional $0.3million in cash upon the completion of certain integration milestones.  Goodwill of $7.5 million has been recorded asa result of this acquisition. We are amortizing other intangible assetsacquired, consisting of non-compete agreements and technology/tradename, over athree-year period. The agreement also provides Fireclick the opportunity for anearn-out based on our achieving certain revenue and profitability targetsattributable to Fireclick over the first 36 months following the closing of theacquisition.  These earn-out amounts, ifpaid, will be recorded as goodwill as they are considered incremental to thepurchase price.

 

In April 2004, we acquired element 5 AG, a privately held companybased in Germany and a leading European e-commerce solution provider forsoftware publishers.  Under the terms ofthe acquisition, we paid $120 million in cash to acquire all of the outstandingshares of capital stock of element 5.  Wealso agreed to pay up to an additional $2.5 million in cash based on element 5’soperating performance over the first 24 months following the closing of theacquisition. Goodwill of $110.8 million was recorded as a result of thisacquisition. We are amortizing other intangible assets acquired, consisting oftechnology/tradename, customer relationships and non-compete agreements, over athree-year period.

 

On January 18, 2005, we entered into an agreement with senioremployees of element 5 AG, pursuant to which these employees agreed to ceaseproviding services to element 5 sixty days after the date of the agreement. Wealso agreed to resolve a $12 million escrow associated with our acquisition ofelement 5 by distributing $10 million to the former element 5 shareholders, and$2 million to us.  Certain adjustments were also made to our earn-outobligations under the April 2004 acquisition agreement.  Under therestructured earn-out, the former element 5 shareholders were paid $1.25million on March 1, 2005 and will be paid an additional $1.25 million on March 1,2006.  These earn-out amounts have beenrecorded as additional goodwill as they were incremental to the purchase price.

 

As of June 30, 2005, our accrued acquisition cost related to theelement 5 restructuring plan was $2.9 million. The following table provides detail on the activity and our remaining accrualbalance as of June 30, 2005 (in thousands):

 
| ** **                | ** ** | **Accrual  March 31, 2004** | ** ** | **Net Additions** | ** ** | **Payments** | ** ** | **Accrual  June 30, 2005** | ** ** |
|---------------------------|------------|----------------------------------|------------|-------------------|------------|--------------|------------|---------------------------------|------------|
| Employee  severance costs |       | $                                | 3,300      |              | $          | 0            |       | $                               | (400       | ) | $ | 2,900 |   |
| Total                     |       | $                                | 3,300      |              | $          | 0            |       | $                               | (400       | ) | $ | 2,900 |   |

 

As of June 30, 2005, we believe that the maximum potential forfuture earn-out payments for all prior acquisitions is approximately $2.8million.  This amount has not yet beenrecorded as goodwill.

 

10

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The Condensed Consolidated Financial Statements include the operatingresults of each business from the date of acquisition.  The following unaudited pro forma condensedresults of operations for the three and six months ended June 30, 2005 and2004 have been prepared as if each of the acquisitions had occurred on January 1,2004 (in thousands, except per share amounts):

 
| ** **                    | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                    | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|                          |       |                                  |       |                                |       |   |   |   |   |
| Revenue                       |       | $                                     | 51,143     |                                | $          | 37,684 |   | $ | 106,273 |   | 77,582 |   |
| Income from  operations       |       | 14,565                                |       | 6,520                               |       | 32,641 |   | 13,023 |   |
| Net income                    |       | 10,226                                |       | 6,444                               |       | 24,621 |   | 12,836 |   |
|                          |       |                                  |       |                                |       |   |   |   |   |
| Basic net  income per share   |       | $                                     | 0.30       |                                | $          | 0.20 |   | $ | 0.72 |   | $ | 0.40 |   |
| Diluted net  income per share |       | $                                     | 0.26       |                                | $          | 0.18 |   | $ | 0.62 |   | $ | 0.36 |   |

 

This financial information does not purport to represent results thatwould actually have been obtained if the transactions had been completed on January 1,2004 or any future results that may be realized.

 

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**6. LONG-TERM DEBT**

 

OnJune 1, 2004 we sold and issued $175 million in aggregate principal amountof 1.25% convertible senior notes due January 1, 2024, in a private,unregistered offering. The notes were sold at 100% of their principalamount.  The initial purchasers exercisedin full their option to purchase up to an additional $20 million in aggregateprincipal amount of the notes on June 30, 2004, which purchase transactionclosed on July 6, 2004.

 

Weare required to pay interest on the notes on January 1 and July 1.  The notes bear interest at a rate of 1.25%and, if specified conditions are met, are convertible into our common stock ata conversion price of $44.063 per share. The notes may be surrendered for conversion under certaincircumstances, including the satisfaction of a market price condition, suchthat the price of our common stock reaches a specified threshold; thesatisfaction of a trading price condition, such that the trading price of thenotes falls below a specified level; the redemption of the notes by us, theoccurrence of specified corporate transactions, as defined in the relatedindenture; and the occurrence of a fundamental change, as defined in therelated indenture. The initialconversion price is equivalent to a conversion rate of approximately 22.6948shares per $1,000 of principal amount of the notes.  We will adjust the conversion price ifcertain events occur, as specified in the related indenture, such as theissuance of our common stock as a dividend or distribution or the occurrence ofa stock subdivision or combination. If a fundamental change, such as a changein our control, as defined in the related indenture, occurs on or before January 1,2009, we may also be required to purchase the notes for cash and pay anadditional make whole premium payable in our common stock upon the repurchaseor conversion of the notes in connection with the fundamental change. Holders of the notes have the right to requireus to repurchase their notes prior to maturity on January 1, 2009, 2014and 2019. We have the right to redeem the notes, under certain circumstances,on or after July 1, 2007 and prior to January 1, 2009, and we mayredeem the notes at anytime on or after January 1, 2009.

 

Aportion of the net proceeds of the offering was used to repay our seniorsecured revolving credit facility with Harris Trust and Savings Bank.  The balance will be used for generalcorporate purposes, including working capital, capital expenditures, potentialfuture acquisitions, investments, and the potential repurchase of shares of ourcommon stock.

 

Inthe second quarter of 2005 and 2004, we incurred interest expense of $0.6million and $0.2 million, respectively, on the convertible senior notes andmade no interest payments.  Interestexpense on the convertible senior notes for six months ended June 30, 2005and June 30, 2004 was $1.2 million and $0.2 million, respectively.

 

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**Item 2.  Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

*We note that, except for the historicalinformation contained herein, the matters discussed below containforward-looking statements that involve known and unknown risks, uncertaintiesand other factors that may cause our actual results, performance orachievements, or industry results, to be materially different from any futureresults, performance or achievements expressed or implied by suchforward-looking statements.  We expressly disclaim any obligation toupdate this information or publicly release any revision or reflect events orcircumstances after the date of this report.  Such factors include, amongothers: our limited operating history and variability of operatingresults, possibility of future losses, risks associated with electronic softwaredelivery, dependence on the Internet and growth in electronic commerce andInternet infrastructure development, dependence on software publishers,dependence on online retailers, system development and electronic commercesecurity risks, rapid technological changes, competition in the electroniccommerce industry, the importance of attracting and retaining personnel,management of our growth, integration of acquired companies, dependence on keyemployees and other risk factors referenced in our Form 10-K for the yearended December 31, 2004.*

 

**Overview**

 

We are a provider of comprehensive e-commerce outsourcing solutions. Wewere incorporated in February 1994 and commenced offering products forsale through our clients’ e-commerce stores in August 1996. From inceptionthrough August 1996, we had no sales, and our activities related primarilyto the development of our proprietary technology platform.  In 1996, we began to focus our businessdevelopment efforts on the software industry, building our catalog of softwareproducts through contracts with software publishers.  In 1997, we began to develop softwaredistribution relationships through contracts with online retailers. In late1998, we began to offer our comprehensive e-commerce outsourcing services inthe form of a transaction fee-based e-commerce service to clients outside ofthe software industry.  As of June 30**,**2005, we were providing e-commerceservices for more than 40,000 software and digital products publishers,manufacturers, online retailers and online channel partners.

 

Prior to January 1, 2004, we managed our physical goods clientsthrough a division (formerly our E-Business Services Division) that wasseparate from our Software and Digital Commerce Services Division.  Beginning January 1, 2004, thisdivisional structure was consolidated, and we announced that we will no longerreport our activities as separate business segments.  Nonetheless, we remain committed to servingexisting and new physical goods clients.

 

We have approximately nine years of operating history upon whichinvestors may evaluate our business and prospects. Until 2003, we incurredsignificant operating losses, and as of June 30, 2005, we had anaccumulated deficit of $29.1 million. We intend to expend financial and managementresources on the development of additional services, sales and marketing,technology and operations to support larger-scale operations and greaterservice offerings. Although we expect to generate positive cash flow fromoperations in 2005, there can be no assurance that our revenue will increase oreven continue at its current level or that we will maintain profitability orgenerate cash from operations in future periods.

 

Our prospects must be considered in light of the risks, expenses anddifficulties frequently encountered by companies in new and rapidly evolvingmarkets such as e-commerce. To address these risks, we must, among otherthings, attract and retain software publishers and online retailers as clients,attract and retain physical goods clients, introduce new Web sites, onlinestores or services, continue to upgrade and develop our systems andinfrastructure to meet emerging market needs and remain competitive in ourservice offerings, and retain and attract personnel commensurate with ourbusiness needs. There can be no assurance that we will be successful inaddressing these risks, and any failure to do so could have a material adverseeffect on our business, financial condition and results of operations.

 

Our current and future expense levels are based largely on our plannedoperations and estimates of future revenue. Revenue and operating resultsgenerally depend on the volume and timing of orders received, which aredifficult to forecast. We may be unable to adjust spending in a timely mannerto compensate for any unexpected revenue shortfall.  Accordingly, any significant shortfall inrevenue could have an immediate adverse effect on our business, financialcondition and results of operations. Our quarterly and annual operating resultsare subject to fluctuations in demand for the products or services offered byus or our clients, such as anti-virus software and tax preparation software,among others.  In particular, sales ofanti-virus software represented a significant portion of our revenues in recentyears, and continue to be very important to our business.  To the extent that our competitorssuccessfully introduce products or services not sold through our platform thatare competitive with products and services sold by current Digital Riverclients (including anti-virus products and services), our revenues will beadversely affected.

 

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We are also likely to continue to see revenue fluctuate on a seasonalbasis, which is typical for the software publishing market in general and forour existing physical goods clients. We believe that our first and fourthquarters tend to be seasonally stronger than our second and third quarters dueto the timing of demand for tax preparation software and the holiday seasonselling period. In addition, we believe that software publishers avoid newproduct releases in the summer months. In view of the rapidly evolving natureof our business, we are unable to accurately forecast our revenue and believe thatperiod-to-period comparisons of our operating results are not necessarilymeaningful and should not be relied upon as an indication of futureperformance.

 

**Results of Operations**

 

The following table sets forth certain items from our condensedconsolidated statements of operations as a percentage of total revenue for theperiods indicated.

 
| ** **                                                                                          | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                          | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenue                                                                                             |       | 100.0                                 | %          | 100.0                               | %          | 100.0 | % | 100.0 | % |
| Cost of  Revenue (exclusive of depreciation and amortization expense shown  separately below): |       |                                  |       |                                |       |   |   |   |   |
| Direct cost  of services                                                                            |       | 2.3                                   |       | 4.1                                 |       | 2.3 |   | 3.1 |   |
| Network and  infrastructure                                                                         |       | 9.3                                   |       | 10.1                                |       | 8.7 |   | 10.2 |   |
| Sales and  marketing                                                                                |       | 30.8                                  |       | 32.7                                |       | 30.4 |   | 34.3 |   |
| Product  research and development                                                                   |       | 10.0                                  |       | 10.5                                |       | 9.1 |   | 9.8 |   |
| General and  administrative                                                                         |       | 10.4                                  |       | 11.0                                |       | 10.3 |   | 10.0 |   |
| Depreciation  and amortization                                                                      |       | 4.6                                   |       | 5.3                                 |       | 4.3 |   | 5.2 |   |
| Amortization  of acquisition related costs                                                          |       | 4.1                                   |       | 6.5                                 |       | 4.3 |   | 5.8 |   |
| Total costs  and expenses                                                                           |       | 71.5                                  |       | 80.2                                |       | 69.4 |   | 78.4 |   |
| Income from  operations                                                                             |       | 28.5                                  |       | 19.8                                |       | 30.6 |   | 21.6 |   |
| Other  income/(expense), net                                                                        |       | 1.7                                   |       | (0.4                                | )          | 1.9 |   | — |   |
| Income  before income tax expense                                                                   |       | 30.2                                  |       | 19.4                                |       | 32.5 |   | 21.6 |   |
| Income tax  expense                                                                                 |       | (10.2                                 | )          | —                              |       | (9.6 | ) | — |   |
| Net income                                                                                          |       | 20.0                                  | %          | 19.4                                | %          | 22.9 | % | 21.6 | % |

 

We acquired element 5 AG in April 2004, Fireclick, Inc. in June 2004,BlueHornet Networks, Inc. in November 2004 and SWReg in March 2005.  Accordingly, our operations in the secondquarter of 2005 include the revenue and expenses of these acquired operations,with no corresponding expenses in the second quarter of 2004.  As a result, while absolute dollars haveincreased in the second quarter of 2005 compared to 2004, our total costs andexpenses declined as a percent of revenue from 80.2% for the three months endedJune 30, 2004 to 71.5% for the three months ended June 30, 2005 andfrom 78.4% for the six months ended June 30, 2004 to 69.4% for the sixmonths ended June 30, 2005.

 

***REVENUE.***Revenue increased to $51.1 million for the three months ended June 30,2005 from $34.9 million for the same period in the prior year, an increase of$16.3, million or 46.6%. For the six months ended June 30, 2005, revenuetotaled $105.7 million, an increase of $38.9 million, or 58.4%, from revenue of$66.7 million in the same period of the prior year. The increase was primarilyattributable to higher online activity across our client base and growth in thenumber of software publishers, online retailers and international sites.

 

International sales represented approximately 39% and 31% of totalrevenue in the three month period ended June 30, 2005 and 2004,respectively, and approximately 38% and 29% of total revenue for the six monthperiod ended June 30, 2005 and 2004, respectively.  We expect that this percentage will continueto increase on a year over year basis.

 

***GROSS MARGIN (Exclusive of depreciation andamortization, consistent with our Condensed Consolidated Statement ofOperations.)*** Cost of revenue consists of direct cost of services and network andinfrastructure costs

 

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and is composed of direct labor costs related to revenue and the coststo operate and maintain our technology platform, as well as customer service,site design, customer specific development and operations functions.  Such amounts are shown exclusive of anyrelated depreciation and amortization expenses. Gross margin was $45.2 million and $94.0 million for the three and sixmonths ended June 30, 2005, up from $29.9 and $57.9 million for the sameperiods in the prior year.  Gross profitmargins were 88.4% and 88.9% for the three and six months ended June 30,2005 versus 85.8% and 86.7% for the same periods in the prior year due togreater leveraging of our infrastructure over more revenue and clients.  We continue to believe that e-commerce andrelated services may become more competitive in the future.  Accordingly, we may have to reduce ourpricing or alter our pricing structure and policies in the future and any suchchange could negatively impact gross margins. We expect direct cost of services and network and infrastructure toincrease in absolute dollars and remain relatively flat as a percent ofrevenue.

 

***GROSS MARGIN (Inclusive of depreciation andamortization, an alternative to our Condensed Consolidated Statement ofOperations.)*** Gross margin, inclusive of depreciation and amortization, was $42.8million and $89.5 million for the three and six months ended June 30,2005, up from $28.1 and $54.4 million for the same periods in the prioryear.  Gross profit margins, inclusive ofdepreciation and amortization, were 83.8% and 84.7% for the three and sixmonths ended June 30, 2005 and 80.5% and 81.5% for the same periods ofprior year.  This inclusive presentationis an allocation of depreciation and amortization costs from that line item inour Consolidated Statement of Operations. This inclusive allocation presentation impacts neither net income, nornet income per share as reported.

 

***SALES AND MARKETING.***Sales and marketing expense consists primarily ofpersonnel and related expenses, advertising and promotional expenses, creditcard chargebacks and bad debt expense, and credit card transaction and otherpayment processing fees.  Sales and marketing expense increased to $15.7million and $32.1 million, respectively, for the three and six months ended June 30,2005 from $11.4 million and $22.9 million for the same periods in the prioryear, an increase of $4.3 million, or 38.0%, and $9.2 million, or 40.4%,respectively. The increase primarily resulted from credit card fees directlyassociated with the increase in revenue and additional sales and marketingpersonnel and related expenses, partially offset by lower bad debt expense andlower advertising expenses.  As a percentage of revenue, sales andmarketing expense was 30.8% and 30.4%, respectively, in the three and sixmonths ended June 30, 2005, compared to 32.7% and 34.3%, respectively, forthe same periods in the prior year, primarily reflecting our increasedrevenue.  We expect sales and marketing expenses to increase in absolutedollars and decline slightly as a percentage of revenue over time.

 

***PRODUCT RESEARCH ANDDEVELOPMENT.*** Product research anddevelopment expense consists primarily of personnel and related expenses andconsulting costs associated with developing and enhancing our technologyplatform and related internal systems. Product research and development expense increased to $5.1 million and$9.6 million, respectively, for the three and six months ended June 30,2005 from $3.6 million and $6.6 million for the same periods in the prior year,an increase of $1.5 million, or 40.7%, and $3.0 million, or 45.9%,respectively.   The increase wasprimarily driven by increases in personnel-related expenses and outsideconsulting fees.  During the secondquarter of 2005, we continued to advance our new self-service, remote-controltechnology, as well as the international and e-marketing capabilities on ournext-generation e-commerce platform.  Wecapitalized approximately $0.0 million and $0.4 million of software developmentcosts related to these efforts in the three and six months ended June 30,2005, respectively.  We did notcapitalize any costs related to software development during the three monthsended June 30, 2005 and do not expect to capitalize any such costs for thebalance of 2005.  As a percentage ofrevenue, product research and development expense was 10.0% and 9.1% in thethree and six months ended June 30, 2005, compared to 10.5% and 9.8% forthe same periods in the prior year.  We expect product research anddevelopment costs to increase in absolute dollars and remain relatively flat ona percentage basis as revenues increase.

 

***GENERAL ANDADMINISTRATIVE.***General and administrative expenseconsists primarily of executive, accounting and administrative personnel andrelated expenses, including professional fees and investor relationsexpenses.  General and administrative expenses increased to $5.3 millionand $10.9 million, respectively, for the three and six months ended June 30,2005 from $3.9 million and $6.7 million for the same periods in the prior year,an increase of $1.4 million, or 37.5%, and $4.2 million, or 63.1%,respectively.  The increase resultedprimarily from wages and professional service expenses.  As a percentageof revenue, general and administrative expense was 10.4% and 10.3% for thethree and six months ended June 30, 2005, compared to 11.0% and 10.0% forthe same periods in the prior year.  We expect general and administrativeexpense will increase in absolute dollars over time as we continue to buildinfrastructure to support our business and comply with new governmentalregulations.  As a percentage of revenue,general and administrative expense is expected to decline slightly over time.

 

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***AMORTIZATION OFACQUISITION-RELATED INTANGIBLES.***Amortization ofacquisition related intangibles consists of amortization of other intangibleassets recorded from our acquisitions over the last three years.  Amortization of intangible assets was $2.1million and $4.5 million, respectively, for the three and six months ended June 30,2005 compared to $2.3 million and $3.8 million for the same periods in theprior year. The increase was due to additional amortizable assets acquiredthroughout 2004 and the first quarter of 2005.

 

***OTHERINCOME/(EXPENSE), NET.***  Other income/(expense), net consists ofinterest income on our cash and cash equivalents and short-term investments,interest expense on debt financing obligations, currency gain or loss fromremeasured foreign transactions or assets from their native currency to theirfunctional currency, as well as gain or loss on the sale of investments.  Interest income was $2.3 million and $4.1million, respectively, for the three and six months ended June 30, 2005compared to $0.4 million and $0.8 million for the same periods in the prioryear. Interest expense on long term debt and other interest expense was $0.6million and $1.2 million, respectively, for the three and six months ended June 30,2005 compared to $0.3 million and $0.3 million for the same periods in theprior year.  Losses from currencyremeasurement were $0.7 million and $0.8 million, respectively, for the threeand six months ended June 30, 2005. Gains and losses were $0.1 million and$0.5 million for the same periods in the prior year. Gains or losses from thesale of investments were immaterial.

 

***INCOME TAXES.***** **For the three months ended June 30,2005, we had tax expense of $5.2 million of which $4.3 million related todomestic operations and $0.9 million to foreign operations.  The effective tax rate for the three monthsended June 30, 2005 was 34%.  Theincrease in the tax rate from the first quarter rate of 26% is because the netoperating loss arising from continuing operations was fully utilized in thefirst quarter.  Subsequent net operatingloss utilization is attributable to deductions arising from disqualifyingnon-qualifying stock option dispositions that do not affect tax rate.  We anticipate an annual effective rate of 34%for the remainder of the year.

 

As of June 30, 2005, we had net U.S. operating loss carryforwardsof approximately $84.6 million resulting from disqualifying dispositions ofstock options and foreign tax loss carryforwards of $8.4 million related topre-acquisition losses.  When thesedisqualifying disposition deductions and pre-acquisition loss deductions arerealized for financial statement purposes, they will not result in a reductionin income tax expense, rather the benefit will be recorded as additionalpaid-in-capital or a reduction of goodwill. The U.S. income tax net operatingloss carryforwards expire beginning in the year 2012. Additionally, we havemade a Section 338 election allowing us to deduct the step up basis in acquisitionsof approximately $100 million over 15 years from 2005 to 2019.

 

No income tax expense was recorded for the three month period ended June 30,2004, as we utilized prior operating loss carryforwards and related valuationallowance resulting in a full offset of income tax expense for thequarter.  Deductions from disqualifyingdispositions of stock options are included in net operating loss carryforwardswith a corresponding valuation allowance.

 

Because of the uncertainty of future realization, a valuation allowanceequal to the net deferred tax asset has been recorded.  Ownership changes resulting from the issuanceof additional equity may limit future annual realization of the tax netoperating loss carryforwards to a specified percentage of our value under Section 382of the Internal Revenue Code.

 

**Off Balance Sheet Arrangements**

* *

None.

 

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**Liquidity and Capital Resources**

 

As of June 30, 2005, we had $142.2 million of cash and cashequivalents, $179.8 million of short-term investments and working capital ofapproximately $229.9 million. Significant components of our workingcapital are cash and cash equivalents, short term investments and short termreceivables net of client and merchant payables. Our primary source of internalliquidity is our operating activities. During the six months ended June 30, 2005, our operations generated$38.5 million of cash compared to $25.0 million for the same period of theprior year.  The improvement was mainly due to an increase in net incomeand non-cash tax expense offset by a decrease in accounts payable.  Netcash used in investing activities during the six months ended June 30,2005 totaled $29.7 million.  This was comprised of cash paid foracquisitions, net of cash received of $7.8 million, net purchases ofinvestments of $15.9 million and investments in property, equipment andcapitalized software of $6.0 million.  InMarch 2005, we acquired SWReg, an operating business of Atlantic Coastplc, a private limited UK company, for $8.8 million in cash.  Net cash provided by financing activitiesduring the six months ended June 30, 2005 totaled $8.7 million.  This was comprised of the sale of stockthrough the exercise of stock options and purchases through the employee stockpurchase plan totaling $11.9 million offset by $3.2 million repurchases ofcommon stock.

 

Our principal commitments consist of interest and principal on ourconvertible senior notes and long-term obligations outstanding under operatingleases.  Although we have no materialcommitments for capital expenditures, we anticipate continued capitalexpenditures consistent with our anticipated growth in operations,infrastructure, and personnel.  We further anticipate that ourexpenditures on product development will be consistent with our anticipatedgrowth in operations. We also anticipate that we will continue to experiencegrowth in our operating expenses for the foreseeable future and that ouroperating expenses will be a material use of our cash resources.

 

**Contractual Commitments**

 
| ** **                   | ** ** | **Payment due by period (in  thousands)** | ** ** |
|------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligations**  | ** ** | **Total Amount  Committed**               | ** ** | **Jul-Dec  2005** | ** ** | **2006-2007** | ** ** | **2008-2009** | ** ** | **2010 and  Thereafter** | ** ** |
| Operating  Lease Obligations |       | $                                         | 7,225      |   | $ | 1,082 |   | $ | 3,916 |   | $ | 2,006 |   | $ | 221 |   |
| Convertible  Senior Notes    |       | $                                         | 240,094    |   | $ | 1,219 |   | $ | 4,875 |   | $ | 4,875 |   | $ | 229,125 |   |
| Total                        |       | $                                         | 247,319    |   | $ | 2,301 |   | $ | 8,791 |   | $ | 6,881 |   | $ | 229,346 |   |

 

We expect to continue to evaluate and consider a wide array ofpotential strategic transactions, including business combinations andacquisitions of businesses, products, services and other assets as well aslicenses of technology related to our current business.  At any given time, we may be engaged indiscussions or negotiations with respect to one or more such transactions.  Any such transactions could have a materialimpact on our financial position, results of operations, or cash flows.  There is no assurance that any such discussionsor negotiations will result in the consummation of any transaction.  The process of integrating any acquisitionmay create unforeseen challenges for our operational, financial and managementinformation systems, as well as unforeseen expenditures and other risks,including diversion of management’s attention from other business concerns, thepotential loss of key customers, employees and business partners, difficultiesin managing facilities and employees in different geographic areas, anddifficulties in entering markets in which we have no or limited direct priorexperience and where competitors in such markets have stronger marketpositions.  In addition, an acquisitionmay cause us to assume liabilities or become subject to litigation.  Further, there can be no assurance that wewill realize a positive return on any acquisition or that future acquisitionswill not be dilutive to our current shareholders’ percentage ownership or toearnings.  We have allocated significantvaluation in the form of goodwill and intangibles for the companies we acquiredin the past, which is subject to impairment testing on a regular basis.  If the individual businesses do not performas expected at the acquisition dates, we may incur impairment charges forgoodwill, accelerated amortization of definite-lived intangible assets due toshortened expected lives of those assets, immediate write-offs andrestructuring or other related expenses.

 

Withrespect to our convertible senior notes, we are required to pay interest on thenotes on January 1 and July 1 of each year.  On January 3, 2005 we paid $1.4 millionin interest for the period June 1 through December 31, 2004.  The notes bear interest at a rate of 1.25%and, if specified conditions are met, are convertible into our common stock ata conversion price of $44.063 per share. The notes may be surrendered for conversion under certaincircumstances, including the satisfaction of a market price condition, suchthat the price of our common stock reaches a specified threshold; thesatisfaction of a trading price condition, such that the trading price of thenotes falls below a specified level; the redemption of the notes by us, theoccurrence of specified corporate transactions, as defined in the relatedindenture; and the occurrence of a fundamental change, as defined in therelated indenture.

 

17

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Theinitial conversion price is equivalent to a conversion rate of approximately22.6948 shares per $1,000 of principal amount of the notes.  We will adjust the conversion price ifcertain events occur, as specified in the related indenture, such as theissuance of our common stock as a dividend or distribution or the occurrence ofa stock subdivision or combination. In addition, contingent interest isrequired to be paid to holders if certain conditions are met. If a fundamentalchange, such as a change in our control, as defined in the related indenture,occurs on or before January 1, 2009, we may also be required to purchasethe notes for cash and pay an additional make whole premium payable in ourcommon stock upon the repurchase or conversion of the notes in connection withthe fundamental change. Holdersof the notes have the right to require us to repurchase their notes prior tomaturity on January 1, 2009, 2014 and 2019. We have the right to redeemthe notes, under certain circumstances, on or after July 1, 2007 and priorto January 1, 2009, and we may redeem the notes at anytime on or after January 1,2009.

 

We believe that existing sources of liquidity and the results of ouroperations will provide adequate cash to fund our operations, although we mayseek to raise additional capital. In January 2002, we filed a universalshelf registration statement with the SEC pursuant to which we could issue upto $100 million in common stock, preferred stock, debt securities and/orwarrants.   Of this amount, approximately$45 million was utilized to issue common stock in our July 2003 publicoffering, leaving approximately $55 million available for future use.   In January 2005, we filed aregistration statement to increase our available shelf registration amount fromapproximately $55 million to $255 million. In addition, we filed an acquisition shelf registration statement for upto approximately 1.5 million shares. Both registration statements were declaredeffective by the SEC in April 2005. These filings were made to provide future flexibility for acquisitionand financing purposes.  The sale ofadditional equity or convertible debt securities could result in additionaldilution to our stockholders. There can be no assurances that financing will beavailable in amounts or on terms acceptable to us, if at all.

 

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**Item 3.  Qualitative and QuantitativeDisclosure About Market Risk**

 

**Interest Rate Risk**

 

We maintain our portfolio of cash equivalents and short-terminvestments in a variety of securities, including government obligations and money market funds. Investments areclassified as available-for-sale securities and carried at their market valuewith cumulative unrealized gains or losses recorded as a component ofaccumulated other comprehensive income/(loss) within stockholders’ equity.  As of June 30, 2005, all securities heldhad maturities of less than three years. A sharp rise in interest rates could have an adverse impact on themarket value of certain securities in our portfolio.  We do not currently hedge our interest rateexposure and do not enter into financial instruments for trading or speculativepurposes or utilize derivative financial instruments.  There have been no significant changes to ourinvestment portfolio that would alter our interest rate risk for the threemonths ended June 30, 2005.

 

**Foreign Currency Risk**

 

Our operations have historically been conducted primarily in the UnitedStates currency and as such have not been subject to material foreign currencyexchange rate risk.   However, the growthin our international operations is increasing our exposure to foreign currencyfluctuations as well as other risks typical of international operations, including,but not limited to differing economic conditions, changes in political climate,differing tax structures and other regulations and restrictions. Accordingly,our future results could be materially adversely impacted by changes in theseor other factors.  For example,approximately half of our subsidiary element 5’s revenue is denominated ineuros or currencies other than the U.S. dollar. As a result, a greater proportion of our revenues and earnings are nowsubject to currency fluctuations.  We translatestatement of operations amounts that are denominated in foreign currency intoU.S. dollars at the average exchange rates in each applicable period. To theextent the U.S. dollar weakens against foreign currencies, the translation ofthese foreign currency denominated transactions results in increased netrevenues, operating expenses and net income. Conversely, our net revenues,operating expenses and net income will decrease when the U.S. dollarstrengthens against foreign currencies. We do not currently have a currencyhedging program to mitigate the effect of fluctuations of currency prices onour financial results.

 

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**Item 4.  Controls and Procedures**

 

(a)                      Based ontheir evaluation of our disclosure controls and procedures conducted as of June 30,2005, our Chief Executive Officer and Chief Financial Officer have concludedthat our disclosure controls and procedures (as defined in Rules 13a-15(e) or15d-15(e) promulgated under the Securities Exchange Act of 1934) areeffective at the reasonable assurance level.

 

(b)                     Thisevaluation did not identify any change in our internal control over financialreporting that occurred during the quarter ended June 30, 2005 that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

**Limitations on the Effectiveness of Controls**

 

Our management, including the Chief Executive Officer and ChiefFinancial Officer, does not expect that our disclosure controls and proceduresor our internal control will prevent all error and fraud. A control system, nomatter how well conceived and operated, can provide only reasonable, notabsolute, assurance that the objectives of the control system are met. Further,the design of a control system must reflect the fact that there are resourceconstraints, and the benefits of controls must be considered relative to theircosts. Because of the inherent limitations in all control systems, noevaluation of controls can provide absolute assurance that all control issuesand instances of fraud, if any, within our company have been detected. Theseinherent limitations include the realities that judgments in decision-makingcan be faulty, and that breakdowns can occur because of simple error ormistake. Additionally, controls can be circumvented by the individual acts ofsome persons, by collusion of two or more people, or by management override ofthe control. The design of any system of controls also is based in part uponcertain assumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions; over time, control may become inadequate becauseof changes in conditions, or the degree of compliance with the policies orprocedures may deteriorate.  Because of the inherent limitations in acost-effective control system, misstatements due to error or fraud may occurand not be detected.

 

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**PART II.  OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

Beginning in August 2001, we and certain of our officers anddirectors were named as defendants in several class action shareholdercomplaints filed in the United States District Court for the Southern Districtof New York, now consolidated as *In re Digital River, Inc.Initial Public Offering Securities Litigation,* Case No. 01-CV-7355.  Similar complaints, referred to here as theIPO Lawsuits, were filed in the same court against hundreds of other publiccompanies, referred to here as the Issuers. In the consolidated amended complaint against us, the plaintiffs allegethat we, certain of our officers and directors and the underwriters of ourinitial public offering, or IPO, violated Section 11 of the Securities Actof 1933 based on allegations that our IPO registration statement and prospectusfailed to disclose material facts regarding the compensation to be received by,and the stock allocation practices of, the IPO underwriters.  The complaint also contains a claim forviolation of Section 10(b) of the Securities Exchange Act of 1934based on allegations that this omission constituted a deceit on investors.  The plaintiffs seek unspecified monetarydamages and other relief.

 

In July 2002, we joined in a global motion to dismiss the IPOLawsuits filed by all of the Issuers (among others).  In October 2002,the parties agreed to toll the statute of limitations with respect to certainof the named officers and directors until September 30, 2003 and on thebasis of this agreement, our officers and directors were dismissed fromthe lawsuit without prejudice.  In February 2003, the court issued adecision denying the motion to dismiss the Section 11 claims against usand almost all of the other Issuers and denying the motion to dismiss the Section 10(b) claimsagainst us and many of the Issuers.

 

In June 2003, pursuant to the authorization of a speciallitigation committee of our board of directors, we and a substantialmajority of Issuers entered into a non-binding memorandum of understandingreflecting a tentative settlement of the IPO Lawsuits. The terms of thetentative settlement provide for, among other things, a release of the Issuersand their officers and directors from all further liability resulting fromplaintiffs’ claims, and the assignment to plaintiffs of certain potentialclaims that the Issuers may have against their IPO underwriters. The tentativesettlement also provides that, in the event that plaintiffs ultimately recoverless than a guaranteed sum of $1 billion from the IPO underwriters,plaintiffs would be entitled to payment by each participating Issuer’s insurerof a pro rata share of any shortfall in the plaintiffs’ guaranteedrecovery.  In September 2003, in connection with the tentativesettlement, our officers and directors who had entered tolling agreementswith plaintiffs (described above) agreed to extend those agreements so thatthey would not expire prior to any settlement being finalized. In June 2004,we executed a final settlement agreement with the plaintiffs consistent withthe terms of the memorandum of understanding. On February 15, 2005, the Court issued a decision certifying aclass action for settlement purposes and granting preliminary approval of thesettlement, subject to modification of certain bar orders contemplated by thesettlement.  In addition, the settlementis still subject to statutory notice requirements as well as final judicialapproval. Pending final approval of the settlement, we continue to believethat the claims against us, our officers and directors are without merit andintend to defend against them vigorously.

 

In addition, we are subject to legal proceedings, claims, andlitigation arising in the ordinary course of business.  While the final outcome of these matters iscurrently not determinable, we believe there is no litigation pending againstus that could have, individually or in the aggregate, a material adverse effecton our consolidated financial position, results of operation or cash flows.

 

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**Item 2. Unregistered Sales of EquitySecurities and Use of Proceeds**

 

In April 2005, the Board of Directors authorized a new sharerepurchase program of up to $50.0 million of our outstanding shares of commonstock. This new program superseded and replaced the $5.0 million sharerepurchase program adopted in 2001. In 2001, we spent $267,000 to repurchaseour shares.  Under the new program, theshares may be repurchased in the open market or in privately negotiatedtransactions. Repurchases are at our discretion based on ongoing assessments ofthe capital needs of the business, the market price of our common stock andgeneral market conditions. No time limit was set for the completion of the repurchaseprogram.

 

During the six months ended June 30, 2005, we repurchased a totalof 136,000 shares at a weighted average price per share of $23.57.

 
| **Period**                          | ** ** | **Total number  of shares  purchased** | ** ** | **Average  price paid  per share** | ** ** | **Total number of  shares purchased  as part of publicly  announced plan** | ** ** | **Approximate dollar value  of shares that may yet be  purchased under the plan  (in millions)** | ** ** |
|-------------------------------------|------------|----------------------------------------|------------|------------------------------------|------------|----------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|
| April 1  - April 30, 2005 |       | —                                 |       | —                             |       | —                                                                     |       | $                                                                                                | 50.0       |   |
| May 1 -  May 31, 2005     |       | 136,000                                |       | $                                  | 23.57      |                                                                       | 136,000    |                                                                                             | $          | 46.5 |   |
| June 1  - June 30, 2005   |       | —                                 |       | —                             |       | —                                                                     |       | $                                                                                                | 46.5       |   |
|                                |       |                                   |       |                               |       |                                                                       |       |                                                                                             |       |
| Total                               |       | 136,000                                |       |                               |       | 136,000                                                                    |       |                                                                                             |       |
|                                     |            |                                        |            |                                    |            |                                                                            |            |                                                                                                  |            |  |  |

 

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**Item 4. Submission of Matters to a Vote ofSecurity Holders**

 

Our annual meeting of stockholders was held on May 25, 2005 (the “AnnualMeeting”).  The following matters wereconsidered and voted upon at the Annual Meeting:

 

The first matter related to the election of the director nominee ThomasF. Madison as a director to serve until the 2008 annual meeting of thestockholders.  The votes cast for andagainst such nominee were as follows:

 
| **Name**           | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|--------------------|------------|------------|------------|--------------|------------|
|               |       |       |       |         |       |
| Thomas F.  Madison |       | 27,230,477 |       | 5,042,735    |       |

 

William J. Lansing, Frederick M. Seegal, Joel A. Ronning, Perry W.Steiner and J. Paul Thorin are our directors whose terms of office as directorscontinued after the Annual Meeting

 

The second matter related to an amendment and restatement of our 1998Stock Option Plan that would combine the 1998 Plan with our 1999 Stock OptionPlan and would give us the flexibility to grant restricted stock awards,restricted stock unit awards and performance shares, in addition to incentiveand nonstatutory stock options, to our directors, employees, and consultantsunder the combined plan.  There were17,565,886 votes cast for the approval, and there were 7,898,267 votes castagainst the approval.  There were 58,451abstentions and 6,750,608 broker non-votes.

 

The third matter related to the ratification of the appointment ofErnst & Young, LLP as our independent auditors for the fiscal yearending December 31, 2005.  Therewere 32,103,819 votes cast for approval, and there were 129,670 votes castagainst the approval.  There were 39,723abstentions and no broker non-votes.

 

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**Item 5. Other Information**

 

In August 2005, the Compensation Committee of our Board ofDirectors approved an amendment and restatement of the employment agreement ofour Chief Executive Officer, Joel A. Ronning. A copy of the agreement, as soamended and restated, is attached to this report as an exhibit and isincorporated herein by reference.

 

In addition, an amendment to the option agreements of our directors wasalso approved to allow acceleration of vesting in the event of a change ofcontrol. A form of the amendment is attached hereto as an exhibit and isincorporated herein by reference.

 

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**Item6.  Exhibits**

 

(a) Exhibits

 
| **EXHIBIT  NUMBER** | ** ** |   |   | **DESCRIPTION OF DOCUMENTS**                                                                                                                                                                                                                           |
|---------------------|------------|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |   |   |                                                                                                                                                                                                                                                   |
| 3.1                 |       | (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.                                                                                              |
| *10.18              |       | (5)    |   | Amended and Restated Authorized Symantec  Electronic Reseller for Shop Symantec Agreement by and among Symantec  Corporation, Symantec Limited and Digital River, Inc. dated as of July 1,  2003, including Amendments 2 through 10 thereto. |
| 10.19               |       | (6)    |   | 1998 Equity Incentive Plan (formerly known  as 1998 Stock Option Plan).                                                                                                                                                                                |
| 10.20               |       | (7)    |   | Employment Agreement between Digital River, Inc.  and Carter D. Hicks.                                                                                                                                                                            |
| 10.21               |       | (8)    |   | Employment Offer Letter between Digital  River, Inc. and Thomas M. Donnelly.                                                                                                                                                                      |
| *10.22              |       |   |   | Amendment number 11 to the Amended and  Restated Authorized Symantec Electronic Reseller for Shop Symantec Agreement  by and among Symantec Corporation, Symantec Limited and Digital River, Inc.  dated as of June 15, 2005.                |
| 10.23               |       |   |   | Employment Agreement between Digital River, Inc.  and Joel A. Ronning.                                                                                                                                                                            |
| 10.24               |       |   |   | Form of Amendment to Non-Qualified  Stock Option Agreement.                                                                                                                                                                                       |
| 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.                                                                                                                                                                         |

 

* Confidential treatment has been requested for portions of thisagreement, which portions have been filed separately with the SEC.

 

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| (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 10.18 to our Current  Report on Form 8-K, filed on June 15, 2005 and incorporated herein  by reference.                                                                                                                     |
| (6) |   | Filed as exhibit 99.1 to our Current Report  on Form 8-K, filed on May 31, 2005 and incorporated herein by  reference.                                                                                                                       |
| (7) |   | Filed as exhibit 99.1 to our Current Report  on Form 8-K, filed on July 5, 2005 and incorporated herein by  reference.                                                                                                                       |
| (8) |   | Filed as exhibit 99.1 to our Current Report  on Form 8-K, filed on July 5, 2005 and incorporated herein by  reference.                                                                                                                       |

 

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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 theundersigned thereunto duly authorized.

 
| Date:  | August 9, 2005 |   | DIGITAL RIVER,  INC.                                                    |
|--------|---------------------|--------|-------------------------------------------------------------------------|
|   |                |   |                                                                    |
|   |                | By:    | /s/ THOMAS  M. DONNELLY                                                 |
|   |                |   |                                                                    |
|   |                |   | Thomas M.  Donnelly                                                     |
|   |                |   | *Chief Financial Officer  (Principal Financial and Accounting Officer)* |

 

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EXHIBIT INDEX

 
| **EXHIBIT  NUMBER** | ** ** |   |   | **DESCRIPTION OF DOCUMENTS**                                                                                                                                                                                                                           |
|---------------------|------------|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |   |   |                                                                                                                                                                                                                                                   |
| 3.1                 |       | (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.                                                                                              |
| *10.18              |       | (5)    |   | Amended and Restated Authorized Symantec  Electronic Reseller for Shop Symantec Agreement by and among Symantec  Corporation, Symantec Limited and Digital River, Inc. dated as of July 1,  2003, including Amendments 2 through 10 thereto. |
| 10.19               |       | (6)    |   | 1998 Equity Incentive Plan (formerly known  as 1998 Stock Option Plan).                                                                                                                                                                                |
| 10.20               |       | (7)    |   | Employment Agreement between Digital River, Inc.  and Carter D. Hicks.                                                                                                                                                                            |
| 10.21               |       | (8)    |   | Employment Offer Letter between Digital  River, Inc. and Thomas M. Donnelly.                                                                                                                                                                      |
| *10.22              |       |   |   | Amendment number 11 to the Amended and  Restated Authorized Symantec Electronic Reseller for Shop Symantec Agreement  by and among Symantec Corporation, Symantec Limited and Digital River, Inc.  dated as of June 15, 2005.                |
| 10.23               |       |   |   | Employment Agreement between Digital River, Inc.  and Joel A. Ronning.                                                                                                                                                                            |
| 10.24               |       |   |   | Form of Amendment to Non-Qualified  Stock Option Agreement.                                                                                                                                                                                       |
| 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.                                                                                                                                                                         |

 

* Confidential treatment has been requested for portions of thisagreement, which portions have been filed separately with the SEC.

 

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| (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 10.18 to our Current  Report on Form 8-K, filed on June 15, 2005 and incorporated herein  by reference.                                                                                                                     |
| (6) |   | Filed as exhibit 99.1 to our Current Report  on Form 8-K, filed on May 31, 2005 and incorporated herein by  reference.                                                                                                                       |
| (7) |   | Filed as exhibit 99.1 to our Current Report  on Form 8-K, filed on July 5, 2005 and incorporated herein by  reference.                                                                                                                       |
| (8) |   | Filed as exhibit 99.1 to our Current Report  on Form 8-K, filed on July 5, 2005 and incorporated herein by  reference.                                                                                                                       |

 

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