##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 FORM 10-Q
 
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2007
 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.
  DELAWARE
(State or other jurisdiction of 
incorporation or organization)
    
    41-1901640
(I.R.S. Employer
Identification Number)
 9625 WEST 76TH STREET
EDEN PRAIRIE, MINNESOTA 55344
 (952) 253-1234
 
 þ o
  þ o o
 o þ




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##### 



PART I.
    
    FINANCIAL INFORMATION
    
    
    3Item 1.
    
    Financial Statements
    
    
    3Condensed Consolidated Balance Sheets as of September 30, 2007 and December 31, 2006
    
    
    3Condensed Consolidated Statements of Operations for the three and nine months ended
    September 30, 2007 and 2006
    
    
    4Condensed Consolidated Statements of Cash Flows for the nine months ended September
     30, 2007 and 2006
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    16Item 3.
    
    Qualitative and Quantitative Disclosure about Market Risk
    
    
    23Item 4.
    
    Controls and Procedures
    
    
    24PART II.
    
    OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    25Item 1A.
    
    Risk FactorsItem 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    38Item 6.
    
    Exhibits
    
    
    39SIGNATURES
    
    
    40EXHIBIT INDEX
    
    
    41Computation of Ratio of Earnings to Fixed ChargesCertification Pursuant to Section 302Certification Pursuant to Section 302Certification Pursuant to Section 906Certification Pursuant to Section 906
  2




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 
 DIGITAL RIVER, INC.
 (Unaudited)September 30,
    
    
    December 31,2007
    
    
    2006ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    371,100
    
    
    $
    390,243Short-term investments
    
    
    267,352
    
    
    
    235,699Accounts receivable, net of allowance of $3,180 and $2,339
    
    
    64,549
    
    
    
    52,392Deferred income taxes
    
    
    15,399
    
    
    
    19,687Prepaid expenses and other
    
    
    7,583
    
    
    
    6,025Total current assets
    
    
    725,983
    
    
    
    704,046Property and equipment, net
    
    
    25,497
    
    
    
    24,079Goodwill
    
    
    273,361
    
    
    
    243,799Intangible assets, net of accumulated amortization of $57,263 and $50,092
    
    
    15,992
    
    
    
    21,106Deferred income taxes
    
    
    17,403
    
    
    
    1,276Other assets
    
    
    12,018
    
    
    
    11,957TOTAL ASSETS
    
    $
    1,070,254
    
    
    $
    1,006,263LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIES:Accounts payable
    
    $
    146,770
    
    
    $
    141,386Accrued payroll
    
    
    13,992
    
    
    
    12,097Deferred revenue
    
    
    8,980
    
    
    
    7,040Accrued acquisition costs
    
    
    1,255
    
    
    
    5,654Other accrued liabilities
    
    
    52,605
    
    
    
    39,982Total current liabilities
    
    
    223,602
    
    
    
    206,159NON-CURRENT LIABILITIES:Convertible senior notes
    
    
    195,000
    
    
    
    195,000Other liabilities
    
    
    10,125
    
    
    
    1,345Total non-current liabilities
    
    
    205,125
    
    
    
    196,345TOTAL LIABILITIES
    
    
    428,727
    
    
    
    402,504COMMITMENTS AND CONTINGENCIESSTOCKHOLDERS EQUITY:Preferred Stock, $.01 par value; 5,000,000 shares authorized; no
shares issued or outstanding
    
    
    
    
    
    
    Common Stock, $.01 par value; 120,000,000 shares authorized;
40,328,998 and 40,458,093 shares issued and outstanding
    
    
    403
    
    
    
    404Additional paid-in capital
    
    
    567,837
    
    
    
    546,758Retained earnings
    
    
    48,108
    
    
    
    44,989Accumulated other comprehensive income
    
    
    25,179
    
    
    
    11,608Total stockholders equity
    
    
    641,527
    
    
    
    603,759TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    1,070,254
    
    
    $
    1,006,263
  3




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##### Table of Contents



DIGITAL RIVER, INC.
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Revenue
    
    $
    82,539
    
    
    $
    75,337
    
    
    $
    252,397
    
    
    $
    224,628Costs and expenses:Direct cost of services
    
    
    3,009
    
    
    
    1,912
    
    
    
    7,998
    
    
    
    5,689Network and infrastructure
    
    
    7,983
    
    
    
    7,761
    
    
    
    22,812
    
    
    
    21,502Sales and marketing
    
    
    32,945
    
    
    
    28,451
    
    
    
    99,927
    
    
    
    83,018Product research and development
    
    
    10,170
    
    
    
    8,338
    
    
    
    27,057
    
    
    
    23,428General and administrative
    
    
    9,055
    
    
    
    8,054
    
    
    
    28,711
    
    
    
    24,551Depreciation and amortization
    
    
    3,120
    
    
    
    2,943
    
    
    
    9,269
    
    
    
    7,671Amortization of acquisition-related intangibles
    
    
    1,611
    
    
    
    3,313
    
    
    
    5,964
    
    
    
    9,191Total costs and expenses
    
    
    67,893
    
    
    
    60,772
    
    
    
    201,738
    
    
    
    175,050Income from operations
    
    
    14,646
    
    
    
    14,565
    
    
    
    50,659
    
    
    
    49,578Other income, net
    
    
    7,528
    
    
    
    5,804
    
    
    
    22,528
    
    
    
    15,131Income before income tax expense
    
    
    22,174
    
    
    
    20,369
    
    
    
    73,187
    
    
    
    64,709Income tax expense
    
    
    6,875
    
    
    
    5,581
    
    
    
    22,689
    
    
    
    20,255Net income
    
    $
    15,299
    
    
    $
    14,788
    
    
    $
    50,498
    
    
    $
    44,454Net income per share  basic
    
    $
    0.38
    
    
    $
    0.37
    
    
    $
    1.25
    
    
    $
    1.17Net income per share  diluted
    
    $
    0.35
    
    
    $
    0.33
    
    
    $
    1.12
    
    
    $
    1.04Shares used in per-share calculation  basic
    
    
    40,078
    
    
    
    39,619
    
    
    
    40,555
    
    
    
    38,126Shares used in per-share calculation  diluted
    
    
    45,386
    
    
    
    45,666
    
    
    
    46,099
    
    
    
    44,107
  4




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##### Table of Contents



DIGITAL RIVER, INC.
 Nine Months EndedSeptember 30,2007
    
    
    2006OPERATING
ACTIVITIES:Net income
    
    $
    50,498
    
    
    $
    44,454Adjustments to reconcile net income to net cash provided by
operating activities:Amortization of acquisition-related intangibles
    
    
    5,964
    
    
    
    9,191Change in accounts receivable allowance, net of acquisitions
    
    
    628
    
    
    
    426Depreciation and amortization
    
    
    9,269
    
    
    
    7,671Stock-based compensation expense related to stock-based
compensation plans
    
    
    10,536
    
    
    
    10,388Excess tax benefits from stock-based compensation
    
    
    (11,297
    )
    
    
    (3,032
    )Deferred and other income taxes
    
    
    17,337
    
    
    
    17,676Change in operating assets and liabilities (net of acquisitions):Accounts receivable
    
    
    (8,373
    )
    
    
    (2,351
    )Prepaid and other assets
    
    
    (1,652
    )
    
    
    (291
    )Accounts payable
    
    
    810
    
    
    
    (7,028
    )Deferred revenue
    
    
    1,782
    
    
    
    881Income tax payable
    
    
    3,314
    
    
    
    1,022Other accrued liabilities
    
    
    5,912
    
    
    
    5,680Net cash provided by operating activities
    
    
    84,728
    
    
    
    84,687INVESTING ACTIVITIES:Purchases of investments
    
    
    (228,342
    )
    
    
    (135,911
    )Sales of investments
    
    
    197,645
    
    
    
    116,446Cash paid for acquisitions, net of cash received
    
    
    (30,573
    )
    
    
    (37,998
    )Purchases of equipment and capitalized software
    
    
    (9,752
    )
    
    
    (12,825
    )Net cash used in investing activities
    
    
    (71,022
    )
    
    
    (70,288
    )FINANCING ACTIVITIES:Proceeds from sales of common stock
    
    
    
    
    
    
    172,700Exercise of stock options
    
    
    11,244
    
    
    
    10,579Sales of common stock under employee stock purchase plan
    
    
    1,244
    
    
    
    933Repurchase of common stock
    
    
    (62,968
    )
    
    
    Repurchase
of restricted stock to satisfy tax withholding obligation
    
    
    (382
    )
    
    
    Excess tax benefits from stock-based compensation
    
    
    11,297
    
    
    
    3,032Net cash (used in)/provided by financing activities
    
    
    (39,565
    )
    
    
    187,244EFFECT OF EXCHANGE RATE CHANGES ON CASH
    
    
    6,716
    
    
    
    2,263NET INCREASE IN CASH AND CASH EQUIVALENTS
    
    
    (19,143
    )
    
    
    203,906CASH AND CASH EQUIVALENTS, beginning of period
    
    
    390,243
    
    
    
    131,770CASH AND CASH EQUIVALENTS, end of period
    
    $
    371,100
    
    
    $
    335,676SUPPLEMENTAL DISCLOSURES:Cash paid for interest on Convertible Senior Notes
    
    $
    2,438
    
    
    $
    2,438Cash paid for income taxes
    
    $
    1,819
    
    
    $
    1,424Noncash investing and financing activities:Common stock issued in acquisitions and earn-outs
    
    $
    986
    
    
    $
    1,172
  5




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##### Table of Contents



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




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##### Table of Contents



DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
   Recent Accounting Pronouncements
 
    1A. RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS
   2. NET INCOME PER SHARE
  7




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DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Earnings per share  basicNet income  basic
    
    $
    15,299
    
    
    $
    14,788
    
    
    $
    50,498
    
    
    $
    44,454Weighted average shares outstanding  basic
    
    
    40,078
    
    
    
    39,619
    
    
    
    40,555
    
    
    
    38,126Earnings per share  basic
    
    $
    0.38
    
    
    $
    0.37
    
    
    $
    1.25
    
    
    $
    1.17Earnings per share  dilutedNet income  basic
    
    $
    15,299
    
    
    $
    14,788
    
    
    $
    50,498
    
    
    $
    44,454Exclude: Interest expense and amortized financing cost of
convertible senior notes, net of tax benefit
    
    
    434
    
    
    
    435
    
    
    
    1,304
    
    
    
    1,305Net income  diluted
    
    $
    15,733
    
    
    $
    15,223
    
    
    $
    51,802
    
    
    $
    45,759Weighted average shares outstanding  basic
    
    
    40,078
    
    
    
    39,619
    
    
    
    40,555
    
    
    
    38,126Dilutive impact of non-vested stock and options outstanding
    
    
    883
    
    
    
    1,622
    
    
    
    1,119
    
    
    
    1,556Dilutive impact of convertible senior notes
    
    
    4,425
    
    
    
    4,425
    
    
    
    4,425
    
    
    
    4,425Weighted average shares outstanding  diluted
    
    
    45,386
    
    
    
    45,666
    
    
    
    46,099
    
    
    
    44,107Net income per share  diluted
    
    $
    0.35
    
    
    $
    0.33
    
    
    $
    1.12
    
    
    $
    1.04
 
 3. BUSINESS COMBINATIONS, GOODWILL AND INTANGIBLE ASSETS
 Acquisitions completed in 2007
  Acquisitions completed in 2006
   8




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##### Table of Contents



DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 Future Earn-outs
  Pro Forma Operating Results (Unaudited)
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2007
    
    2006
    
    2007
    
    2006Revenue
    
    $
    84,452
    
    
    $
    77,664
    
    
    $
    260,312
    
    
    $
    235,843Income from operations
    
    
    14,706
    
    
    
    14,635
    
    
    
    51,516
    
    
    
    49,230Net income
    
    
    15,359
    
    
    
    14,858
    
    
    
    51,354
    
    
    
    43,887Basic net income per share
    
    $
    0.38
    
    
    $
    0.38
    
    
    $
    1.27
    
    
    $
    1.15Diluted net income per share
    
    $
    0.35
    
    
    $
    0.33
    
    
    $
    1.14
    
    
    $
    1.02
  Goodwill and Other Intangible Assets
    9




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##### Table of Contents



DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 As of September 30, 2007Carrying Amount
    
    
    Accumulated
    
    
    Carrying AmountGross
    
    
    Amortization
    
    
    NetCustomer relationships
    
    $
    43,729
    
    
    $
    32,382
    
    
    $
    11,347Non-compete agreements
    
    
    5,317
    
    
    
    5,284
    
    
    
    33Technology/tradename
    
    
    24,209
    
    
    
    19,597
    
    
    
    4,612Total
    
    $
    73,255
    
    
    $
    57,263
    
    
    $
    15,992
 As of December 31, 2006Carrying Amount
    
    
    Accumulated
    
    
    Carrying AmountGross
    
    
    Amortization
    
    
    NetCustomer relationships
    
    $
    43,072
    
    
    $
    28,890
    
    
    $
    14,182Non-compete agreements
    
    
    5,251
    
    
    
    5,017
    
    
    
    234Technology/tradename
    
    
    22,875
    
    
    
    16,185
    
    
    
    6,690Total
    
    $
    71,198
    
    
    $
    50,092
    
    
    $
    21,106
  Year2007
    
    
    
    $
    1,2342008
    
    
    
    
    4,4802009
    
    
    
    
    3,5702010
    
    
    
    
    1,8532011
    
    
    
    
    1,2862012
    
    
    
    
    1,236Thereafter
    
    
    
    
    2,333Total
    
    
    
    $
    15,992
 4. STOCKHOLDERS EQUITY
 Option and Restricted Stock Awards
 2007 Plan
  1998 Plan
  General Stock Award Information
  10




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##### Table of Contents



DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
   WeightedShares
    
    
    
    
    
    
    Options
    
    
    AverageAvailable
    
    
    Options
    
    
    Price
    
    
    Pricefor Grant
    
    
    Outstanding
    
    
    Per Share
    
    
    Per ShareBalance, December 31, 2005
    
    
    1,928,584
    
    
    
    4,523,385
    
    
    $
    2.59-$31.13
    
    
    $
    16.69Granted
    
    
    (395,000
    )
    
    
    395,000
    
    
    
    29.75 - 57.36
    
    
    
    38.64Restricted stock effect on
shares available for grant
    
    
    (134,250
    )
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/AExercised
    
    
    
    
    
    
    (1,219,736
    )
    
    
    2.59 - 45.24
    
    
    
    17.31Canceled/expired
    
    
    140,866
    
    
    
    (140,866
    )
    
    
    2.59 - 30.69
    
    
    
    22.57Balance, December 31, 2006
    
    
    1,540,200
    
    
    
    3,557,783
    
    
    $
    2.59-$57.36
    
    
    $
    18.68Granted
    
    
    (535,376
    )
    
    
    535,376
    
    
    
    45.07 - 56.61
    
    
    
    54.52Restricted stock effect on
shares available for grant
    
    
    (220,688
    )
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/AExercised
    
    
    
    
    
    
    (1,089,476
    )
    
    
    2.59 - 45.24
    
    
    
    10.32Canceled/expired
    
    
    127,927
    
    
    
    (127,927
    )
    
    
    4.56 - 55.39
    
    
    
    37.25Additional Shares Reserved
    
    
    2,000,000
    
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/ABalance, September 30, 2007
    
    
    2,912,063
    
    
    
    2,875,756
    
    
    $
    2.59-$57.36
    
    
    $
    27.69
   Options Outstanding
    
    
    Options ExercisableWeighted
    
    
    Weighted
    
    
    Aggregate
    
    
    
    
    
    
    Weighted
    
    
    AggregateNumber
    
    
    Average
    
    
    Average
    
    
    Intrinsic
    
    
    Number
    
    
    Average
    
    
    IntrinsicExercise Price
    
    Outstanding
    
    
    Life Remaining
    
    
    Price
    
    
    Value
    
    
    Exercisable
    
    
    Price
    
    
    Value$2.59 - $3.88
    
    
    19,787
    
    
    3.2 years
    
    $
    2.75
    
    
    $
    831,117
    
    
    
    19,787
    
    
    $
    2.75
    
    
    $
    831,1174.56 - 7.55
    
    
    241,742
    
    
    3.7 years
    
    
    5.52
    
    
    
    9,484,183
    
    
    
    241,742
    
    
    
    5.52
    
    
    
    9,484,1839.12 - 13.92
    
    
    552,854
    
    
    5.0 years
    
    
    11.76
    
    
    
    18,236,377
    
    
    
    464,474
    
    
    
    11.93
    
    
    
    15,244,71416.72 - 22.98
    
    
    502,331
    
    
    6.1 years
    
    
    22.38
    
    
    
    11,236,144
    
    
    
    432,395
    
    
    
    22.64
    
    
    
    9,560,79023.01 - 30.69
    
    
    738,755
    
    
    7.4 years
    
    
    27.87
    
    
    
    12,470,622
    
    
    
    332,479
    
    
    
    27.74
    
    
    
    5,656,67133.58 - 57.36
    
    
    820,287
    
    
    9.1 years
    
    
    48.64
    
    
    
    2,099,364
    
    
    
    152,977
    
    
    
    44.20
    
    
    
    738,731$2.59 - $57.36
    
    
    2,875,756
    
    
    6.8 years
    
    $
    27.69
    
    
    $
    54,357,807
    
    
    
    1,643,854
    
    
    $
    19.89
    
    
    $
    41,516,206
  11




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##### Table of Contents



DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
  WeightedRestricted
    
    
    AverageStock
    
    
    Intrinsic ValueNon-Vested Balance, December 31, 2005
    
    
    
    
    
    $
    Granted
    
    
    89,500
    
    
    
    39.96Vested
    
    
    
    
    
    
    Forfeited
    
    
    
    
    
    
    Non-Vested Balance, December 31, 2006
    
    
    89,500
    
    
    $
    39.96Granted
    
    
    158,389
    
    
    
    55.22Vested
    
    
    (22,713
    )
    
    
    38.68Forfeited
    
    
    (11,264
    )
    
    
    55.39Non-Vested Balance, September 30, 2007
    
    
    213,912
    
    
    $
    50.58
 Employee Stock Purchase Plan
  Inducement Equity Incentive Plan
  Stock Repurchase Activity
  Rule 10b5-1 Trading Plans
  Expense Information under SFAS 123(R)
  12




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##### Table of Contents



DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Costs and expensesDirect cost of services
    
    $
    223
    
    
    $
    197
    
    
    $
    643
    
    
    $
    629Network and infrastructure
    
    
    58
    
    
    
    78
    
    
    
    191
    
    
    
    248Sales and marketing
    
    
    1,230
    
    
    
    1,268
    
    
    
    3,848
    
    
    
    3,880Product research and development
    
    
    391
    
    
    
    556
    
    
    
    1,409
    
    
    
    1,732General and administrative
    
    
    1,509
    
    
    
    1,357
    
    
    
    4,445
    
    
    
    3,899Stock-based compensation
included in costs and expenses
    
    
    3,411
    
    
    
    3,456
    
    
    
    10,536
    
    
    
    10,388Tax benefit
    
    
    (913
    )
    
    
    (1,286
    )
    
    
    (2,953
    )
    
    
    (3,864
    )Stock-based compensation expense,
net of tax
    
    $
    2,498
    
    
    $
    2,170
    
    
    $
    7,583
    
    
    $
    6,524
 Valuation Information under SFAS 123(R)
  Nine Months EndedSeptember 30,2007
    
    2006Risk-free interest rate
    
    
    4.5
    %
    
    
    4.7
    %Expected life (years)
    
    
    3.5
    
    
    
    4.2Volatility factor
    
    
    0.51
    
    
    
    0.60Expected dividends
    
    
    
    
    
    
    
    5. INCOME TAXES
  13




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DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
     6. LONG-TERM DEBT
    7. LITIGATION
  14




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




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##### Table of Contents



Results of Operations
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2007
    
    2006
    
    2007
    
    2006Revenue
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of Revenue (exclusive of depreciation
and amortization expense shown separately
below):Direct cost of services
    
    
    3.6
    
    
    
    2.5
    
    
    
    3.2
    
    
    
    2.5Network and infrastructure
    
    
    9.7
    
    
    
    10.3
    
    
    
    9.0
    
    
    
    9.6Sales and marketing
    
    
    39.9
    
    
    
    37.8
    
    
    
    39.6
    
    
    
    37.0Product research and development
    
    
    12.3
    
    
    
    11.1
    
    
    
    10.7
    
    
    
    10.4General and administrative
    
    
    11.0
    
    
    
    10.7
    
    
    
    11.4
    
    
    
    10.9Depreciation and amortization
    
    
    3.8
    
    
    
    3.9
    
    
    
    3.7
    
    
    
    3.4Amortization of acquisition-related costs
    
    
    2.0
    
    
    
    4.4
    
    
    
    2.3
    
    
    
    4.1Total costs and expenses
    
    
    82.3
    
    
    
    80.7
    
    
    
    79.9
    
    
    
    77.9Income from operations
    
    
    17.7
    
    
    
    19.3
    
    
    
    20.1
    
    
    
    22.1Other income/(expense), net
    
    
    9.1
    
    
    
    7.7
    
    
    
    8.9
    
    
    
    6.7Income before income tax expense
    
    
    26.8
    
    
    
    27.0
    
    
    
    29.0
    
    
    
    28.8Income tax expense
    
    
    8.3
    
    
    
    7.4
    
    
    
    9.0
    
    
    
    9.0Net income
    
    
    18.5
    %
    
    
    19.6
    %
    
    
    20.0
    %
    
    
    19.8
    %
  REVENUE.
 16




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##### Table of Contents



DIRECT COST OF SERVICES.
 NETWORK AND INFRASTRUCTURE.
 SALES AND MARKETING.
 PRODUCT RESEARCH AND DEVELOPMENT.
 17




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##### Table of Contents



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




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Off Balance Sheet Arrangements
  19




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Liquidity and Capital Resources
       Payment due by period (in thousands)Total Amount
    
    Oct-Dec
    
    
    
    
    
    
    
    
    
    2012 andContractual Obligations
    
    Committed
    
    2007
    
    2008-2009
    
    2010-2011
    
    ThereafterOperating Lease Obligations
    
    $
    13,501
    
    
    $
    1,263
    
    
    $
    5,149
    
    
    $
    1,422
    
    
    $
    5,667Convertible Senior Notes
    
    $
    235,219
    
    
    $
    
    
    
    $
    4,875
    
    
    $
    4,875
    
    
    $
    225,469Total
    
    $
    248,720
    
    
    $
    1,263
    
    
    $
    10,024
    
    
    $
    6,297
    
    
    $
    231,136
  20




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21




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Item 3. Qualitative and Quantitative Disclosure About Market Risk
 Interest Rate Risk
   Foreign Currency Risk
   Transaction Exposure
  Translation Exposure
  22




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Item 4. Controls and Procedures
 (a)
    
    We are committed to maintaining disclosure controls and procedures designed to ensure that
information required to be disclosed in our periodic reports filed under the Securities
Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the
time periods specified in the SECs rules and forms, and that such information is accumulated
and communicated to our management, including our Chief Executive Officer and Chief Financial
Officer, as appropriate, to allow for timely decisions regarding required disclosure. Our
management, under the supervision and with the participation of our Chief Executive Officer
and Chief Financial Officer, carried out an evaluation of the effectiveness of the design and
operation of our disclosure controls and procedures as of September 30, 2007. Based upon this
evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our
disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) promulgated
under the Securities Exchange Act of 1934) were effective in providing reasonable assurance
that material information required to be disclosed by us in this Form 10-Q was recorded,
processed, summarized and reported in a timely manner.
 (b)
    
    During the quarter ended September 30, 2007, there was no change in our internal control over
financial reporting that materially affected, or is reasonably likely to materially affect,
our internal control over financial reporting.
 Limitations on the Effectiveness of Controls
  23




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##### Table of Contents



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




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##### Table of Contents



Failure to properly manage and sustain our expansion efforts could strain our management and other
resources.
  We intend to continue to expand our international operations and these efforts may not be
successful in generating additional revenue.
  §
    
    Changes in regulatory requirements and tariffs;§
    
    Uncertainty of application of local commercial, tax, privacy and other laws and
regulations;§
    
    Reduced protection of intellectual property rights;§
    
    Difficulties in physical distribution for international sales;§
    
    Higher incidences of credit card fraud and difficulties in accounts receivable
collection;§
    
    The burden and cost of complying with a variety of foreign laws;§
    
    The possibility of unionization of our workforce outside the United States, particularly
in Europe;§
    
    Political, social and economic instability;§
    
    Import and export license requirements and restrictions of
the United States and every other country in which we operate; and§
    
    Political or economic constraints on international trade or instability.
   25




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##### Table of Contents



Our operating results are subject to fluctuations in demand for products and services offered by us
or our clients.
  New obligations to collect or pay transaction taxes could substantially increase the cost to us of
doing business.
  We could be liable for fraudulent, improper or illegal uses of our platforms.
  Loss of our credit card acceptance privileges would seriously hamper our ability to process the
sale of merchandise.
  26




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##### Table of Contents



Our failure to attract and retain software and digital products publishers, manufacturers, online
retailers and online channel partners as clients would cause our revenue and operating profits to
decline.
  The matters relating to the investigation by the Special Committee of the Board of Directors and
the restatement of our consolidated financial statements may result in additional litigation and
governmental enforcement actions.
  Activities related to our internal review of historical stock option practices have required us to
incur substantial expenses for legal, accounting, tax and other professional services, have
diverted managements attention from our business, and could in the future harm our business,
financial condition, results of operations and cash flows.
   Implementing our acquisition strategy could result in dilution and operating difficulties leading
to a decline in revenue and operating profit.
  27




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We may need to raise additional capital to achieve our business objectives, which could result in
dilution to existing investors or increase our debt obligations.
  28




---



##### Table of Contents



Our operating results have fluctuated in the past and are likely to continue to do so, which could
cause the price of our common stock to be volatile.
  §
    
    The addition of new clients or loss of current clients;§
    
    The introduction by us of new websites, web stores or services that may require a
substantial investment of our resources;§
    
    The introduction by others of competitive websites, web stores or services or products;§
    
    Our ability to continue to upgrade and develop our systems and infrastructure to meet
emerging market needs and remain competitive in our service offerings;§
    
    Economic conditions, particularly those affecting e-commerce;§
    
    Client decisions to delay new product launches or to invest in e-commerce initiatives;§
    
    The performance of our newly acquired assets or companies;§
    
    Slower than anticipated growth of the online market as a vehicle for the purchase of
software products;§
    
    The cost of compliance with U.S. and foreign regulations relating to our business; and§
    
    Our ability to retain and attract personnel commensurate with our business needs.
   Security breaches could hinder our ability to securely transmit confidential information.
   Claims of infringement of other parties intellectual property rights could require us to expend
significant resources, enter into unfavorable licenses or require us to change our business plans.
  29




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##### Table of Contents



Claims against us related to the software products that we deliver electronically and the tangible
goods that we deliver physically could require us to expend significant resources.
  If our internal control over financial reporting or disclosure controls and procedures are not
effective, there may be errors in our financial statements that could require a restatement or our
filings may not be timely and investors may lose confidence in our reported financial information,
which could lead to a decline in our stock price.
    The growth of the market for our services depends on the development and maintenance of the
Internet infrastructure.
  30




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##### Table of Contents



Because the e-commerce industry is highly competitive and has low barriers to entry, we may be
unable to compete effectively.
  §
    
    In-house development of e-commerce capabilities using tools or applications from
companies, such as Art Technology Group, Inc. and IBM Corporation;§
    
    E-Commerce capabilities custom-developed by companies, such as IBM Global Services and
Accenture, Inc.;§
    
    Other providers of outsourced e-commerce solutions, such as GSI Commerce, Inc.,
Macrovision Corporation, and asknet Inc.;§
    
    Companies that provide technologies, services or products that support a portion of the
e-commerce process, such as payment processing, including CyberSource Corporation and
PayPal Corp.;§
    
    Companies that offer various online marketing services, technologies and products,
including ValueClick, Inc. and aQuantive, Inc.;§
    
    High-traffic, branded websites that generate a substantial portion of their revenue from
e-commerce and may offer or provide to others the means to offer their products for sale,
such as Amazon.com, Inc.; and§
    
    Web hosting, web services and infrastructure companies that offer portions of our
solution and are seeking to expand the range of their offering, such as Network Solutions,
LLC, Akamai Technologies, Inc., Yahoo!, Inc., eBay, Inc. and Hostopia.com, Inc.
   Changes in government regulation could limit our Internet activities or result in additional costs
of doing business over the Internet.
  §
    
    User privacy with respect to adults and minors;§
    
    Our ability to collect and/or share necessary information that allows us to conduct
business on the Internet;§
    
    Export compliance;§
    
    Pricing and taxation;§
    
    Fraud;§
    
    Advertising;§
    
    Intellectual property rights;§
    
    Information security; and§
    
    Quality of products and services.
 31




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##### Table of Contents



Failure to develop our technology to accommodate increased traffic could reduce demand for our
services and impair the growth of our business.
   System failures could reduce the attractiveness of our service offerings.
   §
    
    Fire, flood and other natural disasters;§
    
    Operator negligence, improper operation by, or supervision of, employees, physical and
electronic break-ins, misappropriation, computer viruses and similar events; and§
    
    Power loss, computer systems failures, and Internet and telecommunications failure.
  32




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We may become liable to clients who are dissatisfied with our services.
  We depend on key personnel.
     Protecting our intellectual property is critical to our success.
  33




---



##### Table of Contents



Our clients sales cycles are lengthy, which may cause us to incur substantial expenses and expend
management time without generating corresponding consumer revenue, which would impair our cash
flow.
  The listing of our network addresses on anti-SPAM lists could harm our ability to service our
clients and deliver goods over the Internet.
  We are subject to regulations relating to consumer privacy.
    34




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##### Table of Contents



Compliance with future laws imposed on e-commerce may substantially increase our costs of doing
business or otherwise adversely affect our ability to offer our services.
    We are exposed to foreign currency exchange risk.
  Changes in our tax rates could affect our future results.
  Developments in accounting standards may cause us to increase our recorded expenses, which in turn
would jeopardize our ability to demonstrate sustained profitability.
  35




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##### Table of Contents



Compliance with changing regulation of corporate governance and public disclosure may result in
additional expenses.
  Internet-related stock prices are especially volatile and this volatility may depress our stock
price or cause it to fluctuate significantly.
  §
    
    Actual or anticipated variations in quarterly operating results;§
    
    Announcements of technological innovations;§
    
    The ability to sign new clients and the retention of existing clients;§
    
    New products or services that we offer;§
    
    Competitive developments, including new products or services, or new relationships by
our competitors;§
    
    Changes that affect our clients or the viability of their product lines;§
    
    Changes in financial estimates by securities analysts;§
    
    Conditions or trends in the Internet and online commerce industries;§
    
    Global unrest and terrorist activities;§
    
    Changes in the economic performance and/or market valuations of other Internet or online
e-commerce companies;§
    
    Required changes in generally accepted accounting principles and disclosures;§
    
    Our announcement of significant acquisitions, strategic partnerships, joint ventures or
capital commitments or results of operations or other developments related to those
acquisitions;§
    
    Additions or departures of key personnel; and§
    
    Sales or other transactions involving our common stock or our convertible notes.
  Provisions of our charter documents, other agreements and Delaware law may inhibit potential
acquisition bids for us.
  36




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##### Table of Contents



Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    Total number of
    
    
    Approximate dollar valueTotal number
    
    
    Average
    
    
    shares purchased
    
    
    of shares that may yet beof shares
    
    
    price paid
    
    
    as part of publicly
    
    
    purchased under the planPeriod
    
    purchased
    
    
    per share
    
    
    announced plan
    
    
    (in millions)July 1, 2007 - July 31, 2007
    
    
    1,372,185
    
    
    $
    45.89
    
    
    
    1,372,185
    
    
    $
    137.0August 1, 2007 - August 31, 2007
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    137.0September 1, 2007 - September
30, 2007
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    137.0Total
    
    
    1,372,185
    
    
    
    
    
    
    
    1,372,185
 37




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##### Table of Contents



Item 6. Exhibits
  EXHIBITNUMBER
    
    DESCRIPTION OF DOCUMENTS3.1
    
    
    (1
    )
    
    Amended and Restated Certificate of Incorporation, as amended, as currently in effect.3.2
    
    
    (2
    )
    
    Amended and Restated Bylaws, as currently in effect.4.1
    
    
    (3
    )
    
    Specimen of Common Stock Certificate.4.2
    
    
    (1
    )
    
    Form of Senior Debt Indenture.4.3
    
    
    (1
    )
    
    Form of Subordinated Debt Indenture.4.4
    
    
    
    
    
    References are made to Exhibits 3.1 and 3.2.4.5
    
    
    (4
    )
    
    Indenture dated as of June 1, 2004 between Digital River, Inc. and Wells Fargo Bank,
N.A. as trustee, including therein the form of the Note.12.1
    
    
    
    
    
    Computation of Ratio of Earnings to Fixed Charges.31.1
    
    
    
    
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    
    
    
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    
    
    
    
    Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    
    
    
    
    Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 (1)
    
    Filed as exhibits 3.1 and 3.3 and exhibits 4.5 and 4.6 to our
Registration Statement on Form S-3, File No. 333-81626, filed on
January 29, 2002, declared effective on February 12, 2002, and
incorporated herein by reference.(2)
    
    Filed as an exhibit to our Annual Report on Form 10-K for the year
ended December 31, 2000, filed on March 27, 2001, and incorporated
herein by reference.(3)
    
    Filed as an exhibit to our Registration Statement on Form S-1, File
No. 333-56787, declared effective on August 11, 1998, and incorporated
herein by reference.(4)
    
    Filed as exhibit 99.1 to our Current Report on Form 8-K, filed on July
13, 2004 and incorporated herein by reference. 38




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##### Table of Contents



Date:      November 9, 2007
    DIGITAL RIVER, INC.By:
    /s/ THOMAS M. DONNELLYThomas M. DonnellyChief Financial Officer
(Principal Financial and Accounting Officer) 39




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##### Table of Contents



EXHIBITNUMBER
    
    DESCRIPTION OF DOCUMENTS3.1
    
    
    (1
    )
    
    Amended and Restated Certificate of Incorporation, as amended, as currently in effect.3.2
    
    
    (2
    )
    
    Amended and Restated Bylaws, as currently in effect.4.1
    
    
    (3
    )
    
    Specimen of Common Stock Certificate.4.2
    
    
    (1
    )
    
    Form of Senior Debt Indenture.4.3
    
    
    (1
    )
    
    Form of Subordinated Debt Indenture.4.4
    
    
    
    
    
    References are made to Exhibits 3.1 and 3.2.4.5
    
    
    (4
    )
    
    Indenture dated as of June 1, 2004 between Digital River, Inc. and Wells Fargo Bank,
N.A. as trustee, including therein the form of the Note.12.1
    
    
    
    
    
    Computation of Ratio of Earnings to Fixed Charges.31.1
    
    
    
    
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    
    
    
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    
    
    
    
    Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    
    
    
    
    Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 (1)
    
    Filed as Exhibits 3.1 and 3.3 and Exhibits 4.5 and 4.6 to our
Registration Statement on Form S-3, File No. 333-81626, filed on
January 29, 2002, declared effective on February 12, 2002, and
incorporated herein by reference.(2)
    
    Filed as an exhibit to our Annual Report on Form 10-K for the year
ended December 31, 2000, filed on March 27, 2001, and incorporated
herein by reference.(3)
    
    Filed as an exhibit to our Registration Statement on Form S-1, File
No. 333-56787, declared effective on August 11, 1998, and incorporated
herein by reference.(4)
    
    Filed as exhibit 99.1 to our Current Report on Form 8-K, filed on July
13, 2004 and incorporated herein by reference. 40