**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

----

 

**FORM10-Q**

 

----

 
| **ý**                                                                        | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|-----------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------|
|                                                                              |
| **FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003**                                 |
|                                                                              |
| **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**

 

**DIGITALRIVER, INC.**

(Exactname 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)          |

 

----

 

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90days.  Yes ý No o

 

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

 

Indicate the number of sharesoutstanding of each of the issuer’s classes of common stock, as of the latestpractical date.

 

| **COMMON STOCK, $0.01 PAR VALUE** |   | **28,282,528 SHARES**          |
|-----------------------------------|--------|--------------------------------|
| (Class)                           |   | Outstanding  as of May 9, 2003 |

 

 

----

 

DIGITALRIVER, INC.

 Form10-Q

Index

 
| PART I.        | FINANCIAL  INFORMATION                                                                                    |
|----------------|-----------------------------------------------------------------------------------------------------------|
|           |                                                                                                      |
| Item 1.        | Financial Statements                                                                                      |
|           |                                                                                                      |
|           | Condensed  Consolidated Balance Sheets as of March 31, 2003 and December 31, 2002                    |
|           |                                                                                                      |
|           | Condensed  Consolidated Statements of Operations for the three months ended  March 31, 2003 and 2002 |
|           |                                                                                                      |
|           | Condensed  Consolidated Statements of Cash Flows for the three months ended  March 31, 2003 and 2002 |
|           |                                                                                                      |
|           | 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 6.        | Exhibits  and Reports on Form 8-K                                                                         |
|           |
| SIGNATURES     |
|           |
| CERTIFICATIONS |
|           |
| EXHIBIT INDEX  |

 

2

----

 

**PARTI.  FINANCIAL INFORMATION**

 

**Item1.  Financial Statements**

 

**DIGITAL RIVER, INC.**

CONDENSEDCONSOLIDATED BALANCE SHEETS

(inthousands, except share data)

 
|                                                                                                                 |   | **March 31,********2003** |       | **December 31,  2002** |       |
|----------------------------------------------------------------------------------------------------------------------|--------|---------------------------|------------|------------------------|------------|
|                                                                                                                 |   | **(unaudited)**           |       |                   |       |
| **ASSETS**                                                                                                           |   |                      | ** ** |                   | ** ** |
| Current Assets                                                                                                       |   |                      |       |                   |       |
| Cash and cash equivalents                                                                                            |   | $                         | 49,189     |                   | $          | 40,801 |   |
| Accounts receivable, net of allowance of  $1,746 and $839                                                            |   | 10,944                    |       | 10,397                 |       |
| Prepaid expenses and other                                                                                           |   | 1,706                     |       | 1,807                  |       |
|                                                                                                                 |   |                      |       |                   |       |
| Total current assets                                                                                                 |   | 61,839                    |       | 53,005                 |       |
|                                                                                                                 |   |                      |       |                   |       |
| Property and equipment, net                                                                                          |   | 15,154                    |       | 15,637                 |       |
| Goodwill                                                                                                             |   | 20,445                    |       | 18,698                 |       |
| Intangible and other assets                                                                                          |   | 7,800                     |       | 8,353                  |       |
|                                                                                                                 |   | $                         | 105,238    |                   | $          | 95,693 |   |
|                                                                                                                 |   |                      |       |                   |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                        |   |                      |       |                   |       |
| Current liabilities                                                                                                  |   |                      |       |                   |       |
| Accounts payable                                                                                                     |   | $                         | 35,339     |                   | $          | 31,126 |   |
| Accrued payroll                                                                                                      |   | 2,079                     |       | 1,788                  |       |
| Deferred revenue                                                                                                     |   | 1,428                     |       | 1,865                  |       |
| Other accrued liabilities                                                                                            |   | 4,431                     |       | 3,728                  |       |
|                                                                                                                 |   |                      |       |                   |       |
| Total current liabilities                                                                                            |   | 43,277                    |       | 38,507                 |       |
|                                                                                                                 |   |                      |       |                   |       |
| 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; 27,659,032 and 27,537,240 shares issued and outstanding |   | 277                       |       | 275                    |       |
| Additional paid-in capital                                                                                           |   | 161,286                   |       | 160,535                |       |
| Accumulated deficit                                                                                                  |   | (99,602                   | )          | (103,624               | )          |
|                                                                                                                 |   |                      |       |                   |       |
| Total stockholders’ equity                                                                                      |   | 61,961                    |       | 57,186                 |       |
|                                                                                                                 |   |                      |       |                   |       |
|                                                                                                                 |   | $                         | 105,238    |                   | $          | 95,693 |   |

 

Seeaccompanying notes to condensed consolidated financial statements.

 

3

----

 

**DIGITAL RIVER, INC.**

CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS

(inthousands, except per share data; unaudited)

 
|                                                                                             |   | **Three  months ended  March 31,** |   |
|--------------------------------------------------------------------------------------------------|--------|------------------------------------|--------|
|                                                                                             |   | **2003**                           |   | **2002** |   |
|                                                                                             |   |                               |   |   |   |
| Revenue                                                                                          |   | $                                  | 24,600 |   | $ | 18,070 |   |
| Costs and expenses (exclusive of depreciation and amortization  expense shown separately below): |   |                               |   |   |   |
| Direct cost of services                                                                          |   | 942                                |   | 615 |   |
| Network and infrastructure                                                                       |   | 2,946                              |   | 2,712 |   |
| Sales and marketing                                                                              |   | 9,272                              |   | 8,013 |   |
| Product research and development                                                                 |   | 2,388                              |   | 3,274 |   |
| General and administrative                                                                       |   | 2,291                              |   | 1,615 |   |
| Litigation and other charges                                                                     |   | —                             |   | 2,500 |   |
| Depreciation and amortization                                                                    |   | 1,588                              |   | 1,374 |   |
| Amortization of acquisition related costs                                                        |   | 1,221                              |   | 1,549 |   |
|                                                                                             |   |                               |   |   |   |
| Total costs and expenses                                                                         |   | 20,648                             |   | 21,652 |   |
|                                                                                             |   |                               |   |   |   |
| Income (loss) from operations                                                                    |   | 3,952                              |   | (3,582 | ) |
| Interest income - net                                                                            |   | 70                                 |   | 52 |   |
|                                                                                             |   |                               |   |   |   |
| Net income (loss)                                                                                |   | $                                  | 4,022  |   | $ | (3,530 | ) |
|                                                                                             |   |                               |   |   |   |
| Net income (loss) per share                                                                      |   |                               |   |   |   |
| Basic                                                                                            |   | $                                  | 0.15   |   | $ | (0.13 | ) |
| Diluted                                                                                          |   | $                                  | 0.13   |   | $ | (0.13 | ) |
| Weighted average common shares outstanding                                                       |   |                               |   |   |   |
| Basic                                                                                            |   | 27,609                             |   | 26,449 |   |
| Diluted                                                                                          |   | 30,410                             |   | 26,449 |   |

 

Seeaccompanying notes to condensed consolidated financial statements.

 

4

----

 

**DIGITAL RIVER, INC.**

CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS

(inthousands; unaudited)

 
|                                                                                      |   | **Three  months ended  March 31,** |   |
|-------------------------------------------------------------------------------------------|--------|------------------------------------|--------|
|                                                                                      |   | **2003**                           |   | **2002** |   |
|                                                                                      |   |                               |   |   |   |
| Operating activities:                                                                     |   |                               |   |   |   |
| Net income (loss)                                                                         |   | $                                  | 4,022  |   | $ | (3,530 | ) |
| Adjustments to reconcile net income (loss) to net cash provided by  operating activities: |   |                               |   |   |   |
| Amortization of acquisition related costs                                                 |   | 1,221                              |   | 1,549 |   |
| Depreciation and amortization                                                             |   | 1,588                              |   | 1,374 |   |
| Deferred compensation expense                                                             |   | —                             |   | 29 |   |
| Litigation and other charges                                                              |   | —                             |   | 2,500 |   |
| Change in operating assets and liabilities:                                               |   |                               |   |   |   |
| Accounts receivable                                                                       |   | (291                               | )      | (2,231 | ) |
| Other assets                                                                              |   | 101                                |   | 371 |   |
| Accounts payable                                                                          |   | 4,040                              |   | 6,639 |   |
| Other current liabilities                                                                 |   | 797                                |   | (2,306 | ) |
| Deferred revenue                                                                          |   | (473                               | )      | 217 |   |
|                                                                                      |   |                               |   |   |   |
| Net cash provided by operating activities                                                 |   | 11,005                             |   | 4,612 |   |
|                                                                                      |   |                               |   |   |   |
| Investing activities:                                                                     |   |                               |   |   |   |
| Sales of investments, net                                                                 |   | —                             |   | 2,000 |   |
| Cash paid for acquisitions, net of cash received                                          |   | (2,267                             | )      | (2,598 | ) |
| Purchases of equipment                                                                    |   | (1,103                             | )      | (976 | ) |
|                                                                                      |   |                               |   |   |   |
| Net cash used in investing activities                                                     |   | (3,370                             | )      | (1,574 | ) |
|                                                                                      |   |                               |   |   |   |
| Financing activities:                                                                     |   |                               |   |   |   |
| Exercise of stock options and warrants                                                    |   | 359                                |   | 632 |   |
| Sales of Common Stock under employee stock purchase plan                                  |   | 394                                |   | — |   |
| Repayment of notes payable                                                                |   | —                             |   | (2,500 | ) |
|                                                                                      |   |                               |   |   |   |
| Net cash provided by (used in) financing activities                                       |   | 753                                |   | (1,868 | ) |
|                                                                                      |   |                               |   |   |   |
| Net increase in cash and cash equivalents                                                 |   | 8,388                              |   | 1,170 |   |
| Cash and cash equivalents, beginning of period                                            |   | 40,801                             |   | 21,677 |   |
|                                                                                      |   |                               |   |   |   |
| Cash and cash equivalents, end of period                                                  |   | $                                  | 49,189 |   | $ | 22,847 |   |
|                                                                                      |   |                               |   |   |   |
| Supplemental cash flow disclosure:                                                        |   |                               |   |   |   |
| Common Stock issued in acquisitions and earn-outs                                         |   | $                                  | — |   | $ | 2,910 |   |

 

Seeaccompanying notes to condensed consolidated financial statements.

 

5

----

 

**DIGITAL RIVER, INC.**

# **NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

 

**1. BASIS OFPRESENTATION**

 

The unaudited condensed consolidatedfinancial statements included herein reflect all adjustments, consisting ofnormal recurring adjustments, which in the opinion of management are necessaryto fairly state the Company’s consolidated financial position, results of operationsand cash flows for the periods presented.  These condensed consolidatedfinancial statements should be read in conjunction with the Company’s auditedconsolidated financial statements included in the Company’s Form 10-K for theyear ended December 31, 2002 as filed with the Securities and ExchangeCommission.  The results of operations for the three months ended March31, 2003 are not necessarily indicative of the results to be expected for anysubsequent quarter or for the entire fiscal year ending December 31,2003.  The December 31, 2002 balance sheet was derived from auditedfinancial statements, but does not include all disclosures required bygenerally accepted accounting principles.

 

**2. PRINCIPLES OF CONSOLIDATION**

 

The condensed consolidated financialstatements include the accounts of Digital River, Inc. and its whollyowned subsidiaries. All intercompany balances and transactions have beeneliminated in consolidation.

 

**3. NET INCOME (LOSS) PER SHARE**

 

The table below sets forth the computation ofbasic and diluted net income (loss) per share:

 

|                                               |   | **Three  months ended  March 31,** |      |
|----------------------------------------------------|--------|------------------------------------|-----------|
|                                               |   | **2003**                           |      | **2002** |   |
| Numerator:                                         |   |                               |      |   |   |
| Net income (loss)                                  |   | $                                  | 4,022,000 |   | $ | (3,530,000 | ) |
|                                               |   |                               |      |   |   |
| Denominator:                                       |   |                               |      |   |   |
| Basic — weighted average shares outstanding   |   | 27,609,000                         |      | 26,499,000 |   |
| Effect of dilutive securities:                     |   |                               |      |   |   |
| Employee stock options and warrants                |   | 2,801,000                          |      | — |   |
| Diluted — weighted average shares outstanding |   | 30,410,000                         |      | 26,499,000 |   |
|                                               |   |                               |      |   |   |
| Basic — net income (loss) per share           |   | $                                  | 0.15      |   | $ | (0.13 | ) |
|                                               |   |                               |      |   |   |
| Diluted — net income (loss) per share         |   | $                                  | 0.13      |   | $ | (0.13 | ) |

 

Diluted — weighted average shares outstandinghave not been adjusted for employee stock options and warrants where the effectof those securities would have been anti-dilutive.

 

6

----

 

**4. GOODWILLAND INTANGIBLE ASSETS**

 

In July 2001, the FinancialAccounting Standards Board issued Statement of Financial Accounting Standards(SFAS) No. 141, “Business Combinations” and No. 142, “Goodwill and OtherIntangible Assets.” SFAS No. 141 which requires all business combinationsinitiated after June 30, 2001 to be accounted for using the purchasemethod.  Under SFAS No. 142, goodwilland intangible assets with indefinite lives will no longer be amortized but arereviewed annually (or more frequently if impairment indicators arise) forimpairment.  For acquisitionsconsummated by the Company subsequent to July 1, 2001, the Company adopted theprovisions of SFAS No. 141 and 142 effective July 1, 2001.  The Company adopted the full provisions ofSFAS No. 141 and 142 during the first quarter of 2002.

 

The Company has assessed goodwillimpairment using a two-step approach based on reportable segments andreassessed any intangible assets, including goodwill, recorded in connectionwith earlier acquisitions. The Company completed its initial and annualrequired goodwill impairment tests under SFAS No. 142 in the first and fourthquarters of 2002, respectively, which indicated that there was no impairment ofgoodwill or other intangibles.

 

The changes in the carrying amount ofgoodwill for the three months ended March 31, 2003 by operating segment, are asfollows:

 
|                                |   | **Software  and  Digital Commerce  Services Division** |       | **E-Business  Services Division** |   | **Total** |   |
|-------------------------------------|--------|--------------------------------------------------------|------------|-----------------------------------|--------|-----------|--------|
|                                |   |                                                   |       |                              |   |      |   |
| Balance as of December 31, 2002     |   | $                                                      | 11,070,000 |                              | $      | 7,628,000 |   | $ | 18,698,000 |   |
| Goodwill acquired during the period |   | 1,747,000                                              |       | —                            |   | 1,747,000 |   |
| Balance as of March 31, 2003        |   | $                                                      | 12,817,000 |                              | $      | 7,628,000 |   | $ | 20,445,000 |   |

 

Information regarding the Company’s otherintangible assets is as follows:

 
|                   |   | **As of  March 31, 2003**         |       |
|------------------------|--------|-----------------------------------|------------|
|                   |   | **Carrying  amount********Gross** |       | **Accumulated  amortization** |   | **Carrying  amount********Net** |   |
|                   |   |                              |       |   |   |   |   |
| Customer relationships |   | $                                 | 14,117,000 |   | $ | 8,926,000 |   | $ | 5,191,000 |   |
| Non-compete agreements |   | 3,300,000                         |       | 2,528,000 |   | 772,000 |   |
| Technology/tradename   |   | 6,183,000                         |       | 4,363,000 |   | 1,820,000 |   |
| Total                  |   | $                                 | 23,600,000 |   | $ | 15,817,000 |   | $ | 7,783,000 |   |
|                   |   |                              |       |   |   |   |   |
|                   |   | **As of  December 31, 2002**      |       |
|                   |   | **Carrying  amount**              |       | **Accumulated  amortization** |   | **Net** |   |
|                   |   |                              |       |   |   |   |   |
| Customer relationships |   | $                                 | 14,117,000 |   | $ | 8,171,000 |   | $ | 5,946,000 |   |
| Non-compete agreements |   | 3,150,000                         |       | 2,399,000 |   | 751,000 |   |
| Technology/tradename   |   | 5,675,000                         |       | 4,026,000 |   | 1,649,000 |   |
| Total                  |   | $                                 | 22,942,000 |   | $ | 14,596,000 |   | $ | 8,346,000 |   |

 

7

----

 

Amortization expense for the three monthsended March 31, 2003 was $1,221,000.  Estimated amortization expense forthe remaining life of the intangible assets, based on intangible assets as ofMarch 31, 2003, is as follows:

 

| Year ended December 31, |   |      |      |
|-------------------------|--------|-----------|-----------|
| 2003                    |   | $         | 4,930,000 |   |
| 2004                    |   | 3,409,000 |      |
| 2005                    |   | 649,000   |      |
| 2006                    |   | 16,000    |      |
|                         |        |           |           |  |

 

**5.  STOCK BASED COMPENSATION**

 

At March 31,2003, the Company has two stock-based employee compensation plans, which aredescribed more fully in the Company’s 2002 Annual Report Note 7.  The Company accounts for these plans underthe recognition and measurement principles of APB Opinion No. 25, “Accountingfor Stock Issued to Employees,” and related Interpretations.  No stock-based employee compensation cost isreflected in net income (loss), 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.  The following tableillustrates the effect on net income (loss) and net income (loss) per share ifthe Company had applied the fair value recognition provision of FinancialAccounting Standards Board Statement No. 123, “Accounting for Stock-BasedCompensation,” to stock-based employee compensation.

 

The Company has elected to applythe disclosure-only provisions of SFAS No. 123, “Accounting forStock-Based Compensation” as amended by SFAS No. 148. Accordingly, the Companyaccounts for stock-based compensation using the intrinsic value methodprescribed in Accounting Principles Board Opinion (APB) No. 25, “Accountingfor Stock Issued to Employees”, and related interpretations. Compensation costfor stock options is measured as the excess, if any, of the fair value of theCompany’s Common Stock at the date of grant over the stock option exerciseprice. Had compensation costs for these plans been determined consistent withSFAS No. 123, the Company’s net income (loss) would have been adjusted to the following pro formaamounts:

 
|                                                                                            |   | **Three  months ended  March 31,** |      |
|-------------------------------------------------------------------------------------------------|--------|------------------------------------|-----------|
|                                                                                            |   | **2003**                           |      | **2002** |   |
| **Net income (loss), as reported**                                                              |   | $                                  | 4,022,000 |   | $ | (3,530,000 | ) |
| Add: Stock-based compensation, as reported                                                      |   | —                             |      | 29,000 |   |
| Deduct: Total stock-based compensation determined under fair value  based method for all awards |   | (2,762,000                         | )         | (3,035,000 | ) |
| Adjusted net income (loss), fair value method for all stock-based  awards                       |   | $                                  | 1,260,000 |   | $ | (6,536,000 | ) |
|                                                                                            |   |                               |      |   |   |
| Basic income (loss) per share — as reported                                                |   | $                                  | 0.15      |   | $ | (0.13 | ) |
| Basic income (loss) per share — SFAS No. 123 adjusted                                      |   | $                                  | 0.05      |   | $ | (0.25 | ) |
|                                                                                            |   |                               |      |   |   |
| Diluted income (loss) per share — as reported                                              |   | $                                  | 0.13      |   | $ | (0.13 | ) |
| Diluted income (loss) per shares — SFAS No. 123 adjusted                                   |   | $                                  | 0.04      |   | $ | (0.25 | ) |

 

The fair value of each optiongrant is estimated on the date of grant using the Black-Scholes option pricingmodel with the following weighted average assumptions used: risk-free interestrates of 3.0% in 2003 and 2002, no expected dividends; expected lives of fiveyears; and a volatility factor of 1.4 in 2003 and 2002.

 

8

----

 

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

 

In January 2003, the Companyacquired certain assets and assumed certain liabilities of Metatec®International, Inc.’s ("Metatec") electronic software distribution("ESD") business in exchange for approximately $1.2 million.   Goodwill of  $826,000 was recorded as a result of this agreement. The Companywill amortize intangible assets acquired, consisting of a non-compete agreementand technology/tradename, over a three-year period.  The agreement also provides Metatec the opportunity for anadditional earn-out based on the Company achieving certain revenue metricsrelated to the ESD business over the course of the twelve months followingNovember 1, 2002.  Such earn-out amount,if any, will be recorded as additional goodwill.

 

In March 2003, the Companyacquired substantially all of the assets and assumed certain liabilities ofHartsell Holdings, Inc., ("Hartsell") d/b/a Infocon AmericaCorporation in connection with its business of providing web services forbusiness-to-business publishers in exchange for approximately $1.1 million.Goodwill of $921,000 was recorded as a result of this agreement. The Companywill amortize intangible assets acquired, consisting of non-compete agreementsand technology/tradename, over a three-year period. The agreement also providesHartsell the opportunity for additional earn-outs based on the Companyachieving certain gross margin and revenue metrics related to the web servicesfor business-to-business publishers over the course of the twelve months and,at the Company’s sole discretion, the twenty-four months, following the closingof the acquisition. Such earn-out amount, if any, will be recorded asadditional goodwill.

 

During the three months ended March 31, 2002,the Company acquired certain assets and liabilities of Innuity AcquisitionCorp. and Beyond.com Corporation.  Thefollowing unaudited pro forma condensed results of operations for the threemonths ended March 31, 2003 and 2002 have been prepared as if each of the acquisitionsfrom the three months ended March 31, 2002 had occurred on January 1,2002.  The pro forma presentation doesnot include pro forma presentation for the assets acquired in the three monthsended March 31, 2003 as they are not deemed to be significant.

 
|                                |   | **Three  months ended********March 31,** |       |
|-------------------------------------|--------|------------------------------------------|------------|
|                                |   | **2003**                                 |       | **2002** |   |
|                                |   |                                     |       |   |   |
| Revenue                             |   | $                                        | 24,600,000 |   | $ | 20,059,000 |   |
| Income (loss) from operations       |   | 3,952,000                                |       | (6,873,000 | ) |
| Net income (loss)                   |   | 4,022,000                                |       | (6,874,000 | ) |
|                                |   |                                     |       |   |   |
| Basic net income (loss) per share   |   | $                                        | 0.15       |   | $ | (0.26 | ) |
| Diluted net income (loss) per share |   | $                                        | 0.13       |   | $ | (0.26 | ) |

 

This financial information does not purportto represent results that would actually have been obtained if the transactionshad been in effect on January 1, 2002 or any future results that may in fact berealized.

 

9

----

 

**7. SEGMENTINFORMATION**

 

The Company has two operating segments,Software and Digital Commerce Services and E-Business Services, which have beenidentified as components of the Company that are reviewed regularly bymanagement to determine resource allocation and assess performance. Unallocated corporate items consist of pending litigation and other charges,depreciation, amortization of acquisition-related costs, and interest incomefor operational results, and consist of certain cash, investments and goodwilland other intangibles for total assets.  Segment information is asfollows:

 
|                                   |   | **Software  and  Digital Commerce  Services Division** |       | **E-Business  Services Division** |   | **Unallocated  Corporate  Items** |   | **Consolidated** |       |
|----------------------------------------|--------|--------------------------------------------------------|------------|-----------------------------------|--------|-----------------------------------|--------|------------------|------------|
| **Three months  ended March 31, 2003** |   |                                                   |       |                              |   |                              |   |             |       |
| Revenue                                |   | $                                                      | 21,037,000 |                              | $      | 3,563,000                         |   | $                | —     |   | $ | 24,600,000 |   |
| Gross profit                           |   | 18,202,000                                             |       | 2,510,000                         |   | —                            |   | 20,712,000       |       |
| Income (loss) from operations          |   | 7,359,000                                              |       | (598,000                          | )      | (2,809,000                        | )      | 3,952,000        |       |
| Net income (loss)                      |   | 7,359,000                                              |       | (598,000                          | )      | (2,739,000                        | )      | 4,022,000        |       |
| Total assets at March 31, 2003         |   | $                                                      | 50,028,000 |                              | $      | 15,068,000                        |   | $                | 40,142,000 |   | $ | 105,238,000 |   |
|                                   |   |                                                   |       |                              |   |                              |   |             |       |
| **Three  months ended March 31, 2002** |   |                                                   |       |                              |   |                              |   |             |       |
| Revenue                                |   | $                                                      | 14,697,000 |                              | $      | 3,373,000                         |   | $                | —     |   | $ | 18,070,000 |   |
| Gross profit                           |   | 12,382,000                                             |       | 2,361,000                         |   | —                            |   | 14,743,000       |       |
| Income (loss) from operations          |   | 4,375,000                                              |       | (2,534,000                        | )      | (5,423,000                        | )      | (3,582,000       | )          |
| Net income (loss)                      |   | 4,375,000                                              |       | (2,534,000                        | )      | (5,371,000                        | )      | (3,530,000       | )          |
| Total assets at March 31, 2002         |   | $                                                      | 23,364,000 |                              | $      | 14,378,000                        |   | $                | 49,682,000 |   | $ | 87,424,000 |   |

 

**8.SUBSEQUENT EVENTS**

 

In March 2002, pursuant to anAmended and Restated Asset Purchase Agreement (the “Agreement”) between theCompany and Beyond.com Corporation (“Beyond.com”), the Company purchased thoseassets and assumed those liabilities of Beyond.com related to its eStoresbusiness, which manages online stores for clients, in exchange for 179,096shares of the Company’s Common Stock.  Atotal of 70,000 of such shares were placed in escrow (the “Escrow”) to securecertain indemnification obligations of Beyond.com under the Agreement. Thepurchase was approved by the U.S. Bankruptcy Court following Beyond.com’sfiling for Chapter 11 bankruptcy protection. Immediately following the closing of the Agreement, the Company enteredinto a Post-Closing Amendment to the Agreement with Beyond.com (the“Post-Closing Amendment”), pursuant to which, among other things, the Companyagreed to increase the number of shares to be delivered to Beyond.com under theAgreement to 222,842, in exchange for a release of certain claims of Beyond.comagainst the Company.  The Post-ClosingAmendment is subject to approval by the U.S. Bankruptcy Court.  The Official Committee of UnsecuredCreditors (the “Committee”) of Beyond.com’s bankruptcy estate objected to thePost-Closing Amendment, asserting that the increase in shares to be deliveredto Beyond.com under the Post-Closing Amendment was inadequate, and alsoasserting the right to additional shares of the Company’s Common Stock undercertain provisions of the Agreement.

 

On April 11, 2003, Beyond.com,the Committee and Digital River entered into a Settlement Agreement (the“Settlement Agreement”) pursuant to which the Company agreed to transfer anadditional 50,919 shares (in addition to the 222,842 shares previously agreedto) to Beyond.com, in exchange for the release by Beyond.com and the Committeeof their claims against the Company. The parties also agreed to resolve certain claims by the Company againstthe 70,000 shares in the Escrow by transferring 55,123 of such shares toBeyond.com and returning 14,877 of such shares to the Company.

 

A hearing before the BankruptcyCourt is currently set for May 23, 2003 to consider the Post-ClosingAmendment.   Digital River anticipatesthat at this hearing, the Bankruptcy Court will approve the Post-ClosingAmendment and execute an order memorializing its approval, after which thePost-Closing Amendment will be consummated.

 

In April 2003, Beyond.comsought Bankruptcy Court approval of the Settlement Agreement by providingnotice to Beyond.com’s creditors and providing them with an opportunity toobject to the settlement.  The deadlinefor Beyond.com’s creditors to object is May 13, 2003.  If no objections are raised to the Settlement Agreement, theCompany expects that Beyond.com will seek an order from the Bankruptcy Courtapproving the Settlement Agreement, which will be consummated after such orderis granted.

 

10

----

 

**Item2.  Management’s Discussion and Analysis of Financial Condition andResults of Operations**

 

*TheCompany notes that, except for the historical information contained herein, thematters discussed below contain forward-looking statements that involve knownand unknown risks, uncertainties and other factors that may cause the actualresults, performance or achievements of the Company, or industry results, to bematerially different from any future results, performance or achievementsexpressed or implied by such forward-looking statements.  The Companyexpressly disclaims any obligation to update this information or publiclyrelease any revision or reflect events or circumstances after the date of thisreport.  Such factors include, among others:  the Company’s limitedoperating history and variability of operating results, possibility of futurelosses, risks associated with electronic software delivery, dependence on theInternet and growth in electronic commerce and Internet infrastructuredevelopment, dependence on software publishers, dependence on online retailers,system development and electronic commerce security risks, rapid technologicalchanges, competition in the electronic commerce industry, the importance ofattracting and retaining personnel, management of the Company’s growth,integration of acquired companies, dependence on key employees and other riskfactors referenced in the Company’s Form 10-K for the year ended December 31,2002.*

 

**Overview**

 

The Company is a leading providerof comprehensive electronic commerce outsourcing solutions. The Company wasincorporated in February 1994 and commenced offering products for salethrough its clients’ Web stores in August 1996. From inception throughAugust 1996, the Company had no sales, and its activities relatedprimarily to the development of its proprietary technology platform, known asCNS. In 1996, the Company began to focus its business development efforts onthe software industry, building its inventory of software products throughcontracts with software publishers. In 1997, the Company began to developsoftware distribution relationships through contracts with online retailers. Asof March 31**,**2003, the Company hadapproximately 14,000 software publisher clients and online retailer clientsserved by the Software and Digital Commerce Services Division. In late 1998,the Company began to offer its comprehensive electronic commerce outsourcingservices in the form of a transaction fee-based e-commerce service to clientsoutside of the software industry. As of March 31, 2003, the Company wasoperating approximately 20,000 sites under its E-Business Services Division.

 

The Company has approximatelyseven years of operating history upon which investors may evaluate its businessand prospects. Since inception, the Company has incurred significant losses,and as of March 31, 2003, had an accumulated deficit of approximately$100 million. The Company intends to expend financial and managementresources on the development of additional services, sales and marketing, technologyand operations to support larger-scale operations and greater serviceofferings. Although the Company expects to generate positive cash flow fromoperations in 2003, there can be no assurance that the Company’s revenue willincrease or even continue at its current level or that the Company willmaintain profitability or generate cash from operations in future periods.

 

The Company’s prospects must beconsidered in light of the risks, expenses and difficulties frequentlyencountered by companies in new and rapidly evolving markets such as electroniccommerce. To address these risks, the Company must, among other things, attractand retain software publishers and online retailers as clients, attract andretain E-Business clients, introduce new Web sites, Web stores or services,continue to upgrade and develop the Company’s systems and infrastructure tomeet emerging market needs and remain competitive in the Company’s serviceofferings, and retain and attract personnel commensurate with the Company’sbusiness needs. There can be no assurance that the Company will be successfulin addressing these risks, and any failure to do so could have a materialadverse effect on the Company’s business, financial condition and results ofoperations.

 

The Company’s current and futureexpense levels are based largely on its planned operations and estimates offuture revenue. Revenue and operating results generally depend on the volumeand timing of orders received, which are difficult to forecast. The Company maybe unable to adjust spending in a timely manner to compensate for anyunexpected revenue shortfall. Accordingly, any significant shortfall in revenuecould have an immediate adverse effect on the Company’s business, financialcondition and results of operations. The Company is also likely to continue tosee revenue fluctuate on a seasonal basis, which is typical for the softwarepublishing market in general and its current E-Business Service clients. TheCompany believes that its first and fourth quarters tend to be seasonallystronger than its second and third quarters due to the timing of demand for taxpreparation software and the holiday season selling period. In addition, it isthe Company’s belief that software publishers avoid new product releases in thesummer months. In view of the rapidly evolving nature of the Company’sbusiness, the Company is unable to accurately forecast its revenue and believesthat period-to-period comparisons of its operating results are not necessarilymeaningful and should not be relied upon as an indication of futureperformance.

 

11

----

 

**Results ofOperations**

 

The following table sets forth certain itemsfrom the Company’s condensed consolidated statements of operations as a percentageof total revenue for the periods indicated.

 

|                                      |   | **Three  months ended  March 31,** |   |
|-------------------------------------------|--------|------------------------------------|--------|
|                                      |   | **2003**                           |   | **2002** |   |
|                                      |   |                               |   |   |   |
| Revenue                                   |   | 100.0                              | %      | 100.0 | % |
| Operating expenses                        |   |                               |   |   |   |
| Direct cost of services                   |   | 3.8                                |   | 3.4 |   |
| Network and infrastructure                |   | 12.0                               |   | 15.0 |   |
| Sales and marketing                       |   | 37.7                               |   | 44.4 |   |
| Product research and development          |   | 9.7                                |   | 18.1 |   |
| General and administrative                |   | 9.3                                |   | 8.9 |   |
| Litigation and other charges              |   | —                             |   | 13.8 |   |
| Depreciation and amortization             |   | 6.5                                |   | 7.6 |   |
| Amortization of acquisition-related costs |   | 5.0                                |   | 8.6 |   |
| Total operating expenses                  |   | 84.0                               |   | 119.8 |   |
| Income (loss) from operations             |   | 16.0                               |   | (19.8 | ) |
| Interest income, net                      |   | 0.3                                |   | 0.3 |   |
| Net income (loss)                         |   | 16.3                               | %      | (19.5 | )% |

 

***REVENUE.***Revenue increased to $24,600,000 for the three months ended March 31, 2003 from$18,070,000 for the same period in the prior year, an increase of $6,530,000 or36.1%. Revenue for the Software and Digital Commerce Services divisionincreased to $21,037,000 for the three months ended March 31, 2003 from$14,697,000 for the three months ended March 31, 2002.  The increaseprimarily resulted from growth in the number of the Company’s softwarepublisher and online retailer clients, as well as increasing market acceptanceof electronic software delivery.   Revenue for the E-Business Servicesdivision increased to $3,563,000 for the three months ended March 31, 2003 from$3,373,000 for the three months ended March 31, 2002.

 

International sales represented approximately21% and 19% of total revenue in the three-month periods ended March 31, 2003and 2002, respectively.

 

***GROSS PROFIT.***Cost of revenue, which consists of direct cost of services and networkand infrastructure costs (both shown exclusive of depreciation and amortizationexpense), increased to $3,888,000 for the three months ended March 31, 2003from $3,327,000 for the same period in the prior year.  The absolutedollar increase for the three-month period primarily resulted fromvolume-related costs such as bandwidth and customer service associated  directly with the increase in revenues and costsassociated with new products and services introduced by the Company.  The gross profit margin for the Software andDigital Commerce Services division increased in the three months ended March31, 2003 to 86.5% from 84.2% for the same period of the prior year.  Thegross profit margin for the E-Business Services division increased in the threemonths ended March 31, 2003 to 70.5% compared to 70.0% for the same period ofthe prior year.  The increase in margin in both divisions is primarily dueto leveraging the Company’s infrastructure over significantly more revenue andclients.  The Company believes that Internet commerce and related servicescould become more competitive in the future.  In that event, the Companymay reduce its pricing or alter its pricing structure and policies in thefuture and any such change could reduce gross margins.

 

***SALES AND MARKETING.***Sales and marketing expense consists primarily of personnel and relatedexpenses, advertising and promotional expenses, bad debt/chargeback expense andcredit card transaction fees.  Sales and marketing expense increased to$9,272,000 for the three months ended March 31, 2003 from $8,013,000 for thesame period in the prior year, an increase of $1,259,000 or 15.7%.  Theincrease primarily resulted from an increase in credit card fees and chargebackcosts directly associated with the increase in revenue.  Sales andmarketing expense for the Software and Digital Commerce Services divisionincreased to $7,081,000 for the three months ended March 31, 2003 from$5,512,000 for the same period in the prior year.  Sales and marketingexpense for the E-Business Services division was $2,191,000 for the threemonths ended March 31, 2003, compared to $2,501,000 for the same period in theprior year.  The decrease in E-Business sales and marketing expense is aresult of the previously announced

 

12

----

 

consolidation of the teams that supportE-Business and Software Services, which has resulted in increased efficiencies.  As a percentage of revenue, sales andmarketing expense was 37.7% in the three month period ended March 31, 2003,compared to 44.4% for the same period in the prior year, primarily reflectingthe Company’s increased revenue.  The Company expects that sales andmarketing expense will continue to increase in absolute dollars as the Companycontinues to build its sales and marketing infrastructure and developsmarketing programs, and as volume–driven credit card and bad debt/chargebackexpenses increase.  As a percentage of revenue, sales and marketingexpenses are expected to decrease as revenue increases.

 

***PRODUCT RESEARCH AND DEVELOPMENT.*** Product research and developmentexpense consists primarily of personnel and related expenses and consultingcosts associated with developing and enhancing the Company’s CNS and relatedinternal systems.  Product research anddevelopment expense decreased to $2,388,000 for the three months ended March31, 2003 from $3,274,000 for the same period in the prior year, a decrease of$886,000 or 27.1%.   The decrease wasprimarily driven by a reduction in personnel-related expenses and outsideconsulting fees.  Product research anddevelopment expense for the Software and Digital Commerce Services division was$1,055,000 for the three months ended March 31, 2003 compared to $1,406,000 forthe same period of the prior year.  Product research and developmentexpense for the E-Business Services division decreased to $1,333,000 from$1,868,000 in the same period in the prior year.  As a percentage ofrevenue, product research and development expense was 9.7% in the three monthperiod ended March 31, 2003, compared to 18.1% for the same period in the prioryear.  The Company expects that product research and development costswill increase in absolute dollars as the Company continues to develop the CNSand other related internal systems.  TheCompany expects that product research and development expenses will continue todecrease as a percentage of revenue as revenue increases.

 

***GENERAL AND ADMINISTRATIVE.***General and administrative expense consistsprimarily of executive, accounting and administrative personnel and relatedexpenses, including professional fees and investor relations expenses. General and administrative expenses increased to $2,291,000 for the threemonths ended March 31, 2003 from $1,615,000 for the same period in the prioryear, an increase of $676,000 or 41.9%. The increase resulted primarily from personnel-related expenses andprofessional and legal fees associated with compliance with the newSarbanes-Oxley Act and related rules and regulations and foreign governanceissues.  General and administrative expense for the Software and DigitalCommerce Services division increased to $1,963,000 for the three months March31, 2003, from $1,088,000 for the same period in the prior year.  Generaland administrative expense for the E-Business Services division decreased to$328,000 for the three months ended March 31, 2003, from $527,000  for the same period in the prior year. As a percentage of revenue, general and administrative expense was 9.3% for thethree month period ended March 31, 2003, compared to 8.9% for the same periodin the prior year.  The Company expects that general and administrativeexpense will increase in absolute dollars over time as the Company defends itspositions related to legal claims and as it continues to build infrastructureto support its revenue growth and to comply with new governmental regulations.The Company expects that general and administrative expenses will decrease as apercentage of revenue as revenue increases.

 

***LITIGATION AND OTHER CHARGES.***During the three months ended March 31, 2002,the Company recorded a charge for pending litigation of $2,300,000.  Thisreserve was established based upon developments in new and existing litigationfor which management determined, in the first quarter of 2002, that payment wasboth probable and estimable.  Additionally, the Company recorded a chargeof $200,000 during the three months ended March 31, 2002 in connection with itsdecision during the period to consolidate one of its offices.  During the three months ended March 31,2003, no charges were recorded for litigation and other charges.

 

***AMORTIZATION OF INTANGIBLE ASSETS AND ACQUISITION-RELATED COSTS.***Amortization of intangible assets andacquisition-related costs decreased to $1,221,000 for the three months endedMarch 31, 2003 from $1,549,000 for the same period in the prior year due toassets acquired in 1999 becoming fully amortized. The amortization related toassets acquired in the three months ended March 31, 2003 was not significant.

 

***INCOME TAXES.***The Company paid no income taxes in any reported period.  As ofMarch 31, 2003, the Company had approximately $77,678,000 of net operating losscarryforwards for federal income tax purposes, which expire beginning in2009.  Due to the uncertainty of future profitability, a valuationallowance equal to the deferred tax asset has been recorded.  Certainchanges in ownership that resulted from the sales of common and preferred stockwill limit the future annual realization of the tax operating losscarryforwards to a specified percentage under Section 382 of the InternalRevenue Code.

 

13

----

 

**Liquidityand Capital Resources**

 

As of March 31, 2003, the Company had$49,189,000 of cash and cash equivalents and working capital of approximately$18,562,000.  The Company’s principal commitments consisted of obligationsoutstanding under operating leases.  During the three months ended March31, 2003, the Company’s operations generated $11,005,000 of cash compared to$4,612,000 for the same period of the prior year.  The improvement ismainly due to the increase in net income in the current year three-month period. Net cash used in investing activities during the three months ended March 31,2003 totaled $3,370,000.  This was comprised of investments in equipmentof $1,103,000 and investments in acquisitions of $2,267,000.  Net cashused in financing activities during the three months ended March 31, 2003totaled $753,000, comprised of cash received upon the sale of stock through theCompany’s employee stock purchase plan and the exercise of stock options.

 

Although the Company has no materialcommitments for capital expenditures, it anticipates continued capitalexpenditures consistent with its anticipated growth in operations,infrastructure and personnel.  The Company anticipates that it will expendapproximately $16,000,000 over the next 21 months on capital expenditures basedon its current anticipated growth rate.  The Company further anticipatesthat it will expend approximately $18,000,000 over the next 21 months onproduct development based on its current anticipated growth rate in operations. The Company may also use cash to acquire or license technology, products orbusinesses related to the Company’s current business.

 

The Company believes that existing sources ofliquidity and the results of its operations will provide adequate cash to fundits operations for at least the next 21 months, although the Company may seekto raise additional capital during that period.  In January 2002, theCompany filed a universal shelf registration statement with the Securities andExchange Commission pursuant to which the Company may issue up to $100,000,000in common stock, preferred stock, debt securities and/or warrants.  Thesale of additional equity or convertible securities could result in additionaldilution to the Company’s stockholders.  There can be no assurance thatfinancing will be available in amounts or on terms acceptable to the Company,if at all.

 

**Item3.  Qualitative and Quantitative Disclosure About Market Risk**

 

The Company does not enter into financialinstruments for trading or speculative purposes and does not currently utilizederivative financial instruments.  The operations of the Company areconducted primarily in the United States currency and as such are not subjectto material foreign currency exchange rate risk.  The Company has nolong-term debt.

 

**Item4.  Controls and Procedures**

 

(a) Based on their evaluation of theCompany’s disclosure controls and procedures conducted within 90 days of thedate of filing this report on Form 10-Q, the Company’s Chief Executive Officerand Chief Financial Officer have concluded that the Company’s disclosurecontrols and procedures (as defined in Rules 13a-14(c) and 15d-14(c)promulgated under the Securities Exchange Act of 1934) are effective.

 

(b) There have been no significant changes(including corrective actions with regard to significant deficiencies ormaterial weaknesses) in the Company’s internal controls or in other factorsthat could significantly affect these controls subsequent to the date of theevaluation referenced in paragraph (a) above.

 

**Limitationson the Effectiveness of Controls**

 

The Company’s management, including the ChiefExecutive Officer and Chief Financial Officer, does not expect that theCompany’s disclosure controls and procedures or internal controls will preventall error and all fraud. A control system, no matter how well conceived andoperated, can provide only reasonable, not absolute, assurance that theobjectives of the control system are met. Further, the design of a controlsystem must reflect the fact that there are resource constraints, and thebenefits of controls must be considered relative to their costs. Because of theinherent limitations in all control systems, no evaluation of controls canprovide absolute assurance that all control issues and instances of fraud, ifany, within the Company have been detected. These inherent limitations includethe realities that judgments in decision-making can be faulty, and thatbreakdowns can occur because of simple error or mistake. Additionally, controlscan be circumvented by the individual acts of some persons, by collusion of twoor more people, or by management override of the control. The design of anysystem of controls also is based in part upon certain assumptions about thelikelihood of future events, and there can be no assurance that any design willsucceed in achieving its stated goals under all potential future conditions;over time, control may become inadequate because of

 

14

----

 

changes in conditions, or the degree of compliancewith the policies or procedures may deteriorate.  Because of the inherentlimitations in a cost-effective control system, misstatements due to error orfraud may occur and not be detected.

 

15

----

 

**PART II.  OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

Beginning in August 2001, the Company andcertain of the Company’s officers and directors were named as defendants inseveral class action shareholder complaints filed in the United States DistrictCourt for the Southern District of New York, now consolidated as*In re Digital River, Inc. Initial Public OfferingSecurities Litigation,* Case No. 01-CV-7355.  In theconsolidated amended complaint, the plaintiffs allege that the Company, certainof the Company’s officers and directors and the underwriters of the Company’sinitial public offering, or IPO, violated Section 11 of the Securities Act of1933 based on allegations that the Company’s IPO registration statement andprospectus failed to disclose material facts regarding the compensation to bereceived by, and the stock allocation practices of, the IPO underwriters. The complaint also contains a claim for violation of Section 10(b) of theSecurities Exchange Act of 1934 based on allegations that this omissionconstituted a deceit on investors.  The plaintiffs seek unspecifiedmonetary damages and other relief.  Similar complaints, referred to hereas the IPO Lawsuits, were filed in the same court against hundreds of otherpublic companies.

 

On August 8, 2001, the IPO Lawsuits wereconsolidated for pretrial purposes before United States Judge Shira Scheindlinof the Southern District of New York.  Judge Scheindlin held an initialcase management conference on September 7, 2001, at which time she ordered, amongother things, that the time for all defendants in the IPO Lawsuits to respondto any complaint be postponed until further order of the court.  Thus, theCompany has not been required to answer any of the complaints, and no discoveryhas been served on the Company.

 

On July 15, 2002, the Company joined in aglobal motion to dismiss the IPO Lawsuits filed by all of the issuers (amongothers).  On October 9, 2002, the court entered an order dismissing theCompany’s named officers and directors from the IPO Lawsuits without prejudice,pursuant to an agreement tolling the statute of limitations with respect tothese officers and directors until September 30, 2003.  On February 19,2003, the court issued a decision denying the motion to dismiss the Section 11claims against the Company and almost all of the other issuers and denying themotion to dismiss the Section 10(b) claims against the Company and many of theother issuers.

 

On August 21, 2001, the Company, along withother defendants, was named as a defendant in a patent litigation regardingUnited States Patent No. 6,014,651 owned by Christopher M. Crawford ofWashington, D.C.  The case was filed and is pending in the U.S. DistrictCourt in the District of Columbia.  No substantive actions have taken placeas yet in this case.  The court has delayed substantive discovery in thiscase, pending a preliminary determination of the legal scope of Crawford’sclaim.  During this time period, the Company has monitored the case, buthas not taken substantive action.  Oncethe court determines the scope of the claims, the Company may file for adismissal of the case if the court’s decision is consistent with the Company’sand the other defendants’ position regarding the interpretation of this patentclaim.  At this time, Crawford has not made a definitive demand for theresolution of this case.

 

On April 25, 2002, the Company, along withRegSoft.com, Inc., a subsidiary of the Company, and Register Now!, a divisionof the Company, and other various defendants, were named as defendants in apatent litigation regarding United States Patent No. 4,500,919 assigned to theMassachusetts Institute of Technology, or MIT, by the inventor William F.Schreiber of Cambridge, Massachusetts.  MIT licensed the patent to Electronicsfor Imaging, Inc., or EFI, and these parties jointly filed a lawsuit in theU.S. District Court in the Eastern District of Texas.  The suit is stillpending.  The court set the Scheduling Order and the parties haveexchanged documents, argued the claim interpretation of the patent in suit, andare conducting limited discovery on notice and marking issues.  Claim interpretation determines the scope ofthe claims and whether the Company may be liable based on those claims. Upon the determination of the claims’ scope, the Company may file for adismissal of the case if the court construes the patent claims consistentlywith our position.  The Company has sought indemnification from vendorsand has been indemnified for portions of the potential liability, but remainspotentially liable for other portions.

 

In March 2002, pursuant to anAmended and Restated Asset Purchase Agreement (the “Agreement”) between theCompany and Beyond.com Corporation (“Beyond.com”), the Company purchased thoseassets and assumed those liabilities of Beyond.com related to its eStoresbusiness, which manages online stores for clients, in exchange for 179,096shares of the Company’s Common Stock.  Atotal of 70,000 of such shares were placed in escrow (the “Escrow”) to securecertain indemnification obligations of Beyond.com under the Agreement. Thepurchase was approved by the U.S. Bankruptcy Court following Beyond.com’sfiling for Chapter 11 bankruptcy protection. Immediately following the closing of the Agreement, the Company enteredinto a Post-Closing Amendment to the

 

16

----

 

Agreement with Beyond.com (the“Post-Closing Amendment”), pursuant to which, among other things, the Companyagreed to increase the number of shares to be delivered to Beyond.com under theAgreement to 222,842, in exchange for a release of certain claims of Beyond.comagainst the Company.  The Post-ClosingAmendment is subject to approval by the U.S. Bankruptcy Court.  The Official Committee of UnsecuredCreditors (the “Committee”) of Beyond.com’s bankruptcy estate objected to thePost-Closing Amendment, asserting that the increase in shares to be deliveredto Beyond.com under the Post-Closing Amendment was inadequate, and alsoasserting the right to additional shares of the Company’s Common Stock undercertain provisions of the Agreement.

 

On April 11, 2003, Beyond.com,the Committee and Digital River entered into a Settlement Agreement (the“Settlement Agreement”) pursuant to which the Company agreed to transfer anadditional 50,919 shares (in addition to the 222,842 shares previously agreedto) to Beyond.com, in exchange for the release by Beyond.com and the Committeeof their claims against the Company. The parties also agreed to resolve certain claims by the Company againstthe 70,000 shares in the Escrow by transferring 55,123 of such shares toBeyond.com and returning 14,877 of such shares to the Company.

 

A hearing before the BankruptcyCourt is currently set for May 23, 2003 to consider the Post-Closing Amendment.   Digital River anticipates that at thishearing, the Bankruptcy Court will approve the Post-Closing Amendment andexecute an order memorializing its approval, after which the Post-ClosingAmendment will be consummated.

 

In April 2003, Beyond.comsought Bankruptcy Court approval of the Settlement Agreement by providingnotice to Beyond.com’s creditors and providing them with an opportunity toobject to the settlement.  The deadlinefor Beyond.com’s creditors to object is May 13, 2003.  If no objections are raised to the Settlement Agreement, theCompany expects that Beyond.com will seek an order from the Bankruptcy Courtapproving the Settlement Agreement, which will be consummated after such orderis granted.

 

17

----

 

**Item6.  Exhibits and Reports on Form 8-K**

 

(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                                                                                                                                                                 |
| 10.14               |   | Second  Amendment of Lease dated April 22, 2002 to that certain Lease dated April 24,  1996 between CSM Investors, Inc. and Registrant (as assignee of Intranet  Integration Group, Inc., as amended. |
| 10.15               |   | Second  Amendment of Lease dated April 28, 2003 to that certain Lease dated January  18, 2000 between Property Reserve Inc. and Registrant.                                                           |
| 99.1                |   | Certification pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                              |

 

----

| (1) |   | Filed as Exhibits 3.1 and  3.3 to the Company’s 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 the  Company’s 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 the  Company’s Registration Statement on Form S-1, File No. 333-56787, declared  effective on August 11, 1998, and incorporated herein by reference.                                         |

 

(B) Reports on Form 8-K:  No reports were filed on Form8-K during the quarter ended March 31, 2003.

 

18

----

 

SIGNATURES

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 
| Date:  | May 15, 2003 |   | DIGITAL  RIVER, INC.                                                    |   |
|--------|--------------|--------|-------------------------------------------------------------------------|--------|
|   |         |   |                                                                    |   |
|   |         | By:    | /s/  CARTER D. HICKS                                                    |   |
|   |         |   | Carter  D. Hicks                                                        |   |
|   |         |   | *Chief Financial Officer  (Principal Financial and Accounting Officer)* |   |

 

 

CERTIFICATIONS

 

I, Joel A. Ronning, certify that:

 

1. I have reviewed this quarterly report onForm 10-Q of Digital River, Inc.;

 

2. Based on my knowledge, this quarterlyreport does not contain any untrue statement of a material fact or omit tostate a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3. Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periods presentedin this quarterly report;

 

4. The registrant’s other certifying officerand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

 

a) Designed such disclosurecontrols and procedures to ensure that material information relating to theregistrant, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b) Evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c) Presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5. The registrant’s other certifying officerand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

 

a) All significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b) Any fraud, whether or notmaterial, that involves management or other employees who have a significantrole in the registrant’s internal controls; and

 

6. The registrant’s other certifying officerand I have indicated in this quarterly report whether or not there weresignificant changes in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 

19

----

 
| Date:  | May 15, 2003 |   |                      |   |
|--------|--------------|--------|---------------------------|--------|
|   |         |   |                      |   |
|   |         | By:    | /s/  JOEL A. RONNING      |   |
|   |         |   | Joel  A. Ronning          |   |
|   |         |   | *Chief Executive Officer* |   |

 

 

I, Carter D. Hicks, certify that:

 

1. I have reviewed this quarterly report onForm 10-Q of Digital River, Inc.;

 

2. Based on my knowledge, this quarterlyreport does not contain any untrue statement of a material fact or omit tostate a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3. Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

 

4. The registrant’s other certifying officerand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

 

a) Designed such disclosurecontrols and procedures to ensure that material information relating to theregistrant, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b) Evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c) Presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5. The registrant’s other certifying officerand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

 

a) All significantdeficiencies in the design or operation of internal controls which could adverselyaffect the registrant’s ability to record, process, summarize and reportfinancial data and have identified for the registrant’s auditors any materialweaknesses in internal controls; and

 

b) Any fraud, whether or notmaterial, that involves management or other employees who have a significantrole in the registrant’s internal controls; and

 

6. The registrant’s other certifying officerand I have indicated in this quarterly report whether or not there weresignificant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 
| Date:  | May 15, 2003 |   |                      |   |
|--------|--------------|--------|---------------------------|--------|
|   |         |   |                      |   |
|   |         | By:    | /s/  CARTER D. HICKS      |   |
|   |         |   |                      |   |
|   |         |   | Carter  D. Hicks          |   |
|   |         |   | *Chief Financial Officer* |   |

 

20

----

 

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                                                                                                                                                                  |
| 10.14               |   | Second  Amendment of Lease dated April 22, 2002 to that certain Lease dated April 24,  1996 between CSM Investors, Inc. and Registrant (as assignee of Intranet  Integration Group, Inc.), as amended. |
| 10.15               |   | Second  Amendment of Lease dated April 28, 2003 to that certain Lease dated January  18, 2000 between Property Reserve Inc. and Registrant.                                                            |
| 99.1                |   | Certification pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                               |

 

----

| (1) |   | Filed as Exhibits 3.1 and  3.3 to the Company’s 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 the  Company’s 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 the  Company’s Registration Statement on Form S-1, File No. 333-56787, declared  effective on August 11, 1998, and incorporated herein by reference.                                         |

 

(B) Reports on Form 8-K:  No reports were filed on Form8-K during the quarter ended March 31, 2003.

 

21

----