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, 2008
 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
  Large accelerated filer þAccelerated filer oNon-accelerated filer o(Do not check if a smaller reporting company)Smaller reporting company o o þ




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##### 



PART I.
    
    FINANCIAL INFORMATION
    
    
    3Item 1.
    
    Financial Statements
    
    
    3Condensed Consolidated Balance Sheets as of September 30, 2008 and December 31, 2007
    
    
    3Condensed Consolidated Statements of Income for the three and nine months endedSeptember 30, 2008 and 2007
    
    
    4Condensed Consolidated Statements of Cash Flows for the nine months ended September30, 2008 and 2007
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    17Item 3.
    
    Qualitative and Quantitative Disclosure about Market Risk
    
    
    27Item 4.
    
    Controls and Procedures
    
    
    28PART II.
    
    OTHER INFORMATION
    
    
    29Item 1.
    
    Legal Proceedings
    
    
    29Item 1A.
    
    Risk Factors
    
    
    30Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    41Item 6.
    
    Exhibits
    
    
    42SIGNATURES
    
    
    
    
    43EXHIBIT INDEX
    
    
    
    
    44
 2




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##### 



PART I. FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 DIGITAL RIVER, INC.
 
 
 (Unaudited)September 30,
    
    
    December 31,2008
    
    
    2007ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    345,249
    
    
    $
    381,788Short-term investments
    
    
    149,907
    
    
    
    315,636Accounts receivable, net of allowance of $3,004 and $2,489
    
    
    54,699
    
    
    
    64,914Deferred income taxes
    
    
    2,784
    
    
    
    7,899Prepaid expenses and other
    
    
    17,438
    
    
    
    4,577Total current assets
    
    
    570,077
    
    
    
    774,814Property and equipment, net
    
    
    34,235
    
    
    
    31,102Goodwill
    
    
    278,732
    
    
    
    261,885Intangible assets, net of accumulated amortization of $64,859 and $59,493
    
    
    35,454
    
    
    
    32,382Long-term investments
    
    
    109,008
    
    
    
    Deferred income taxes
    
    
    15,606
    
    
    
    15,606Other assets
    
    
    6,631
    
    
    
    11,955TOTAL ASSETS
    
    $
    1,049,743
    
    
    $
    1,127,744LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIES:Convertible senior notes
    
    $
    195,000
    
    
    $
    Accounts payable
    
    
    181,033
    
    
    
    180,386Accrued payroll
    
    
    17,345
    
    
    
    12,704Deferred revenue
    
    
    12,289
    
    
    
    10,384Accrued acquisition costs
    
    
    4,500
    
    
    
    399Other accrued liabilities
    
    
    31,491
    
    
    
    41,229Total current liabilities
    
    
    441,658
    
    
    
    245,102NON-CURRENT LIABILITIES:Convertible senior notes
    
    
    
    
    
    
    195,000Other liabilities
    
    
    11,377
    
    
    
    11,362Total non-current liabilities
    
    
    11,377
    
    
    
    206,362TOTAL LIABILITIES
    
    
    453,035
    
    
    
    451,464COMMITMENTS 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;
43,294,562 and 42,502,019 shares issued
    
    
    433
    
    
    
    425Treasury stock at cost; 6,203,948 and 1,952,884 shares
    
    
    (215,952
    )
    
    
    (77,707
    )Additional paid-in capital
    
    
    617,087
    
    
    
    597,128Retained earnings
    
    
    172,637
    
    
    
    125,501Accumulated other comprehensive income
    
    
    22,503
    
    
    
    30,933Total stockholders equity
    
    
    596,708
    
    
    
    676,280TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    1,049,743
    
    
    $
    1,127,744
  3




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##### 



DIGITAL RIVER, INC.
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Revenue
    
    $
    96,301
    
    
    $
    82,539
    
    
    $
    298,309
    
    
    $
    252,397Costs and expenses:Direct cost of services
    
    
    3,913
    
    
    
    3,009
    
    
    
    12,557
    
    
    
    7,998Network and infrastructure
    
    
    10,552
    
    
    
    7,983
    
    
    
    31,136
    
    
    
    22,812Sales and marketing
    
    
    35,419
    
    
    
    32,945
    
    
    
    114,396
    
    
    
    99,927Product research and development
    
    
    12,993
    
    
    
    10,170
    
    
    
    38,737
    
    
    
    27,057General and administrative
    
    
    9,861
    
    
    
    9,055
    
    
    
    30,939
    
    
    
    28,711Depreciation and amortization
    
    
    4,047
    
    
    
    3,120
    
    
    
    11,838
    
    
    
    9,269Amortization of acquisition-related
intangibles
    
    
    2,001
    
    
    
    1,611
    
    
    
    6,347
    
    
    
    5,964Total costs and expenses
    
    
    78,786
    
    
    
    67,893
    
    
    
    245,950
    
    
    
    201,738Income from operations
    
    
    17,515
    
    
    
    14,646
    
    
    
    52,359
    
    
    
    50,659Interest income
    
    
    4,513
    
    
    
    7,831
    
    
    
    15,057
    
    
    
    23,977Other expense, net
    
    
    (1,387
    )
    
    
    (303
    )
    
    
    (3,789
    )
    
    
    (1,449
    )Income before income tax expense
    
    
    20,641
    
    
    
    22,174
    
    
    
    63,627
    
    
    
    73,187Income tax expense
    
    
    5,007
    
    
    
    6,875
    
    
    
    16,491
    
    
    
    22,689Net income
    
    $
    15,634
    
    
    $
    15,299
    
    
    $
    47,136
    
    
    $
    50,498Net income per share  basic
    
    $
    0.43
    
    
    $
    0.38
    
    
    $
    1.27
    
    
    $
    1.25Net income per share  diluted
    
    $
    0.39
    
    
    $
    0.35
    
    
    $
    1.15
    
    
    $
    1.12Shares used in per-share calculation  basic
    
    
    36,495
    
    
    
    40,078
    
    
    
    37,186
    
    
    
    40,555Shares used in per-share calculation  diluted
    
    
    41,620
    
    
    
    45,386
    
    
    
    42,203
    
    
    
    46,099
  4




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##### 



DIGITAL RIVER, INC.
 Nine Months EndedSeptember 30,2008
    
    
    2007OPERATING ACTIVITIES:Net income
    
    $
    47,136
    
    
    $
    50,498Adjustments to reconcile net income to net cash provided by
operating activitiesAmortization of acquisition-related intangibles
    
    
    6,347
    
    
    
    5,964Change in accounts receivable allowance, net of acquisitions
    
    
    632
    
    
    
    628Depreciation and amortization
    
    
    11,838
    
    
    
    9,269Stock-based compensation expense related to stock-based
compensation plans
    
    
    10,161
    
    
    
    10,536Excess tax benefits from stock-based compensation
    
    
    (1,685
    )
    
    
    (11,297
    )Deferred and other income taxes
    
    
    6,927
    
    
    
    17,337Change in operating assets and liabilitiesAccounts receivable
    
    
    10,204
    
    
    
    (8,373
    )Prepaid and other assets
    
    
    (7,819
    )
    
    
    (1,652
    )Accounts payable
    
    
    1,310
    
    
    
    810Deferred revenue
    
    
    1,789
    
    
    
    1,782Income tax payable
    
    
    (10,289
    )
    
    
    3,314Other accrued liabilities
    
    
    39
    
    
    
    5,912Net cash provided by operating activities
    
    
    76,590
    
    
    
    84,728INVESTING ACTIVITIES:Purchases of investments
    
    
    (460,549
    )
    
    
    (228,342
    )Sales of investments
    
    
    516,108
    
    
    
    197,645Cash paid for acquisitions, net of cash received
    
    
    (22,221
    )
    
    
    (30,573
    )Purchases of equipment and capitalized software
    
    
    (15,169
    )
    
    
    (9,752
    )Net cash provided by/(used for) investing activities
    
    
    18,169
    
    
    
    (71,022
    )FINANCING ACTIVITIES:Exercise of stock options
    
    
    6,841
    
    
    
    11,244Sales of common stock under employee stock purchase plan
    
    
    1,446
    
    
    
    1,244Repurchase of common stock
    
    
    (137,858
    )
    
    
    (62,968
    )Repurchase of restricted stock to satisfy tax withholding obligation
    
    
    (387
    )
    
    
    (382
    )Excess tax benefits from stock-based compensation
    
    
    1,685
    
    
    
    11,297Net cash used for financing activities
    
    
    (128,273
    )
    
    
    (39,565
    )EFFECT OF EXCHANGE RATE CHANGES ON CASH
    
    
    (3,025
    )
    
    
    6,716NET DECREASE IN CASH AND CASH EQUIVALENTS
    
    
    (36,539
    )
    
    
    (19,143
    )CASH AND CASH EQUIVALENTS, beginning of period
    
    
    381,788
    
    
    
    390,243CASH AND CASH EQUIVALENTS, end of period
    
    $
    345,249
    
    
    $
    371,100SUPPLEMENTAL DISCLOSURES:Cash paid for interest on convertible senior notes
    
    $
    2,438
    
    
    $
    2,438Cash paid for income taxes
    
    $
    17,039
    
    
    $
    1,819Noncash investing and financing activities:Common stock issued in acquisitions and earn-outs
    
    $
    
    
    
    $
    986
  5




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##### 



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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##### 



DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 Comprehensive Income
  Recent Accounting Pronouncements
   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 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Earnings per share  basicNet income  basic
    
    $
    15,634
    
    
    $
    15,299
    
    
    $
    47,136
    
    
    $
    50,498Weighted average shares outstanding  basic
    
    
    36,495
    
    
    
    40,078
    
    
    
    37,186
    
    
    
    40,555Earnings per share  basic
    
    $
    0.43
    
    
    $
    0.38
    
    
    $
    1.27
    
    
    $
    1.25Earnings per share  dilutedNet income  basic
    
    $
    15,634
    
    
    $
    15,299
    
    
    $
    47,136
    
    
    $
    50,498Exclude: Interest expense and amortized financing cost of
convertible senior notes, net of tax benefit
    
    
    435
    
    
    
    434
    
    
    
    1,304
    
    
    
    1,304Net income  diluted
    
    $
    16,069
    
    
    $
    15,733
    
    
    $
    48,440
    
    
    $
    51,802Weighted average shares outstanding  basic
    
    
    36,495
    
    
    
    40,078
    
    
    
    37,186
    
    
    
    40,555Dilutive impact of non-vested stock and options outstanding
    
    
    700
    
    
    
    883
    
    
    
    592
    
    
    
    1,119Dilutive impact of convertible senior notes
    
    
    4,425
    
    
    
    4,425
    
    
    
    4,425
    
    
    
    4,425Weighted average shares outstanding  diluted
    
    
    41,620
    
    
    
    45,386
    
    
    
    42,203
    
    
    
    46,099Net income per share  diluted
    
    $
    0.39
    
    
    $
    0.35
    
    
    $
    1.15
    
    
    $
    1.12
  3. BUSINESS COMBINATIONS, GOODWILL AND INTANGIBLE ASSETS
 Acquisitions completed in 2008
    8




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##### 



DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 Acquisitions completed in 2007
  Future Earn-outs
  Pro Forma Operating Results (Unaudited)
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2008
    
    2007
    
    2008
    
    2007Revenue
    
    $
    96,687
    
    
    $
    86,580
    
    
    $
    299,780
    
    
    $
    265,548Income from operations
    
    
    17,101
    
    
    
    14,081
    
    
    
    51,516
    
    
    
    48,226Net income
    
    
    15,220
    
    
    
    14,735
    
    
    
    46,296
    
    
    
    48,068Basic net income per share
    
    $
    0.42
    
    
    $
    0.37
    
    
    $
    1.24
    
    
    $
    1.19Diluted net income per
    
    $
    0.38
    
    
    $
    0.33
    
    
    $
    1.13
    
    
    $
    1.07
  Goodwill and Other Intangible Assets
    9




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##### 



DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 As of September 30, 2008Carrying Amount
    
    
    Accumulated
    
    
    Carrying AmountGross
    
    
    Amortization
    
    
    NetCustomer relationships
    
    $
    63,375
    
    
    $
    37,067
    
    
    $
    26,308Non-compete agreements
    
    
    5,441
    
    
    
    5,319
    
    
    
    122Technology/tradename
    
    
    31,497
    
    
    
    22,473
    
    
    
    9,024Total
    
    $
    100,313
    
    
    $
    64,859
    
    
    $
    35,454
 As of December 31, 2007Carrying Amount
    
    
    Accumulated
    
    
    Carrying AmountGross
    
    
    Amortization
    
    
    NetCustomer relationships
    
    $
    57,327
    
    
    $
    33,761
    
    
    $
    23,566Non-compete agreements
    
    
    5,351
    
    
    
    5,328
    
    
    
    23Technology/tradename
    
    
    29,197
    
    
    
    20,404
    
    
    
    8,793Total
    
    $
    91,875
    
    
    $
    59,493
    
    
    $
    32,382
  Year2008
    
    $
    2,1182009
    
    
    7,6602010
    
    
    6,1322011
    
    
    4,8562012
    
    
    4,5872013
    
    
    2,689Thereafter
    
    
    7,412Total
    
    $
    35,454
 4. STOCKHOLDERS EQUITY
 Option and Restricted Stock Awards
 2007 Plan
  1998 Plan
  General Stock Award Information
  10




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##### 



DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
   WeightedShares
    
    
    
    
    
    
    Options
    
    
    AverageAvailable
    
    
    Options
    
    
    Price
    
    
    Pricefor Grant
    
    
    Outstanding
    
    
    Per Share
    
    
    Per ShareBalance, December 31, 2006
    
    
    1,540,200
    
    
    
    3,557,783
    
    
    $
    2.59 - $57.36
    
    
    $
    18.68Granted
    
    
    (573,376
    )
    
    
    573,376
    
    
    
    45.07 - 56.61
    
    
    
    54.17Restricted stock effect on
shares available for grant
    
    
    (251,426
    )
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/AExercised
    
    
    
    
    
    
    (1,219,519
    )
    
    
    2.59 - 45.24
    
    
    
    11.08Canceled/expired
    
    
    133,330
    
    
    
    (133,330
    )
    
    
    4.56 - 56.61
    
    
    
    38.01Additional Shares Reserved
    
    
    2,000,000
    
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/ABalance, December 31, 2007
    
    
    2,848,728
    
    
    
    2,778,310
    
    
    $
    2.59 - $57.36
    
    
    $
    28.41Granted
    
    
    (707,000
    )
    
    
    707,000
    
    
    
    30.68 - 41.44
    
    
    
    32.26Restricted stock effect on
shares available for grant
    
    
    (527,334
    )
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/AExercised
    
    
    
    
    
    
    (389,564
    )
    
    
    4.56 - 38.17
    
    
    
    17.56Canceled/expired
    
    
    83,660
    
    
    
    (83,660
    )
    
    
    9.13 - 56.61
    
    
    
    44.47Balance, September 30, 2008
    
    
    1,698,054
    
    
    
    3,012,086
    
    
    $
    2.59 - $57.36
    
    
    $
    30.27
   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
    
    
    19,187
    
    
    2.3 years
    
    $
    2.74
    
    
    $
    568,992
    
    
    
    19,187
    
    
    $
    2.74
    
    
    $
    568,9924.56 - 7.55
    
    
    170,323
    
    
    2.8 years
    
    
    5.67
    
    
    
    4,553,188
    
    
    
    170,323
    
    
    
    5.67
    
    
    
    4,553,1889.55 - 13.92
    
    
    357,665
    
    
    4.1 years
    
    
    11.69
    
    
    
    7,405,772
    
    
    
    301,421
    
    
    
    11.84
    
    
    
    6,196,52616.72 - 22.98
    
    
    388,746
    
    
    5.1 years
    
    
    22.39
    
    
    
    3,892,456
    
    
    
    367,317
    
    
    
    22.58
    
    
    
    3,607,45123.01 - 30.69
    
    
    625,603
    
    
    6.5 years
    
    
    28.23
    
    
    
    2,608,876
    
    
    
    426,065
    
    
    
    28.31
    
    
    
    1,741,77531.84 - 57.36
    
    
    1,450,562
    
    
    8.7 years
    
    
    41.09
    
    
    
    286,536
    
    
    
    385,012
    
    
    
    44.57
    
    
    
    28,927$2.59 - $57.36
    
    
    3,012,086
    
    
    6.9 years
    
    $
    30.27
    
    
    $
    19,315,820
    
    
    
    1,669,325
    
    
    $
    25.22
    
    
    $
    16,696,859
   11




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##### 



DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 WeightedRestricted
    
    
    AverageStock
    
    
    Intrinsic ValueNon-Vested Balance, December 31,
2006
    
    
    89,500
    
    
    $
    39.96Granted
    
    
    198,889
    
    
    
    53.75Vested
    
    
    (23,713
    )
    
    
    39.19Forfeited
    
    
    (31,272
    )
    
    
    48.54Non-Vested Balance, December 31,
2007
    
    
    233,404
    
    
    $
    50.64Granted
    
    
    362,300
    
    
    
    32.24Vested
    
    
    (54,885
    )
    
    
    49.66Forfeited
    
    
    (10,744
    )
    
    
    46.62Non-Vested Balance, September 30,
2008
    
    
    530,075
    
    
    $
    38.24
 Inducement Equity Incentive Plan
  Employee Stock Purchase Plan
  Stock Repurchase Activity
    Expense Information under SFAS 123(R)
  12




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##### 



DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Costs and expensesDirect cost of services
    
    $
    220
    
    
    $
    223
    
    
    $
    659
    
    
    $
    643Network and infrastructure
    
    
    60
    
    
    
    58
    
    
    
    123
    
    
    
    191Sales and marketing
    
    
    1,403
    
    
    
    1,230
    
    
    
    3,788
    
    
    
    3,848Product research and development
    
    
    371
    
    
    
    391
    
    
    
    969
    
    
    
    1,409General and administrative
    
    
    1,569
    
    
    
    1,509
    
    
    
    4,622
    
    
    
    4,445Stock-based compensation included in
costs and expenses
    
    
    3,623
    
    
    
    3,411
    
    
    
    10,161
    
    
    
    10,536Tax benefit
    
    
    (712
    )
    
    
    (913
    )
    
    
    (2,082
    )
    
    
    (2,953
    )Stock-based compensation expense, net of tax
    
    $
    2,911
    
    
    $
    2,498
    
    
    $
    8,079
    
    
    $
    7,583
 Valuation Information under SFAS 123(R)
  Nine Months EndedSeptember 30,2008
    
    2007Risk-free interest rate
    
    
    2.0
    %
    
    
    4.5
    %Expected life (years)
    
    
    3.4
    
    
    
    3.5Volatility factor
    
    
    0.45
    
    
    
    0.51Expected dividends
    
    
    
    
    
    
    
    5. INCOME TAXES
  13




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##### 



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




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##### 



DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 7. FAIR VALUE MEASUREMENTS
     Level 3 
    
    Unobservable inputs in which there is little or no market data, which require the
reporting entity to develop its own assumption.
       15




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##### 



DIGITAL RIVER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 FAIR VALUE MEASUREMENTSAS OF SEPTEMBER 30, 2008Total
    
    
    Level 1
    
    
    Level 2
    
    
    Level 3Cash equivalents
    
    $
    345,249
    
    
    $
    345,249
    
    
    $
    
    
    
    $
    Short-term investments
    
    
    149,907
    
    
    
    149,807
    
    
    
    
    
    
    
    100Long-term investments
    
    
    109,008
    
    
    
    
    
    
    
    
    
    
    
    109,008Total assets measured at fair value
    
    $
    604,164
    
    
    $
    495,056
    
    
    $
    
    
    
    $
    109,108
  8. LITIGATION
 
 16




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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
       17




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##### 



Critical Accounting Policies
  Revenue Recognition. (
      Allowance for Doubtful Accounts.
 Credit Card Chargeback Reserve.
 18




---



##### 



Goodwill, Intangibles and Other Long-Lived Assets.
 Income Taxes and Deferred Taxes
 Accounting for Uncertainty in
Income Taxes  an interpretation of FASB Statement No. 109 Accounting for Income Taxes
 Fair Value Measurements
 Stock-Based Compensation Expense
  19




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##### 



Results of Operations
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2008
    
    2007
    
    2008
    
    2007Revenue
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of Revenue (exclusive of depreciation and
amortization expense shown separately below):Direct cost of services
    
    
    4.0
    
    
    
    3.6
    
    
    
    4.2
    
    
    
    3.2Network and infrastructure
    
    
    11.0
    
    
    
    9.7
    
    
    
    10.4
    
    
    
    9.0Sales and marketing
    
    
    36.8
    
    
    
    39.9
    
    
    
    38.3
    
    
    
    39.6Product research and development
    
    
    13.5
    
    
    
    12.3
    
    
    
    13.0
    
    
    
    10.7General and administrative
    
    
    10.2
    
    
    
    11.0
    
    
    
    10.4
    
    
    
    11.4Depreciation and amortization
    
    
    4.2
    
    
    
    3.8
    
    
    
    4.0
    
    
    
    3.7Amortization of acquisition-related intangibles
    
    
    2.1
    
    
    
    2.0
    
    
    
    2.1
    
    
    
    2.3Total costs and expenses
    
    
    81.8
    
    
    
    82.3
    
    
    
    82.4
    
    
    
    79.9Income from operations
    
    
    18.2
    
    
    
    17.7
    
    
    
    17.6
    
    
    
    20.1Interest Income
    
    
    4.7
    
    
    
    9.5
    
    
    
    5.0
    
    
    
    9.5Other expense, net
    
    
    (1.5
    )
    
    
    (0.4
    )
    
    
    (1.3
    )
    
    
    (0.6
    )Income before income tax expense
    
    
    21.4
    
    
    
    26.8
    
    
    
    21.3
    
    
    
    29.0Income tax expense
    
    
    5.2
    
    
    
    8.3
    
    
    
    5.5
    
    
    
    9.0Net income
    
    
    16.2
    %
    
    
    18.5
    %
    
    
    15.8
    %
    
    
    20.0
    %
  REVENUE.
  DIRECT COST OF SERVICES.
 20




---



##### 



NETWORK AND INFRASTRUCTURE.
   SALES AND MARKETING.
   PRODUCT RESEARCH AND DEVELOPMENT.
 21




---



##### 



GENERAL AND ADMINISTRATIVE.
   DEPRECIATION AND AMORTIZATION.
  AMORTIZATION OF ACQUISITION-RELATED INTANGIBLES.
 22




---



##### 



INTEREST INCOME.
 OTHER EXPENSE, NET.
 INCOME TAXES.
    Off Balance Sheet Arrangements
  23




---



##### 



Liquidity and Capital Resources
          24




---



##### 



Payment due by period (in thousands)Total Amount
    
    Oct-Dec
    
    
    
    
    
    
    
    
    
    2013 andContractual Obligations
    
    Committed
    
    2008
    
    2009-2010
    
    2011-2012
    
    ThereafterOperating Lease Obligations
    
    $
    18,589
    
    
    $
    1,458
    
    
    $
    8,472
    
    
    $
    2,866
    
    
    $
    5,793Convertible Senior Notes
    
    $
    232,781
    
    
    $
    
    
    
    $
    4,875
    
    
    $
    4,875
    
    
    $
    223,031Total
    
    $
    251,370
    
    
    $
    1,458
    
    
    $
    13,347
    
    
    $
    7,741
    
    
    $
    228,824
     25




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##### 



26




---



##### 



Item 3. Qualitative and Quantitative Disclosure about Market Risk
 Interest Rate Risk
   Foreign Currency Risk
   Transaction Exposure
  Translation Exposure
  Other Market Risks
 Investments in auction-rate securities
  27




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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, 2008. 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, 2008, 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
  28




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##### 



PART II. OTHER INFORMATION
 
 Item 1. Legal Proceedings
      29




---



##### 



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 and
profit to decline.
  Our future success cannot be predicted based upon our operating history.
  Failure to properly manage and sustain our expansion efforts could strain our management and other
resources.
  We intend to continue to expand our international operations and these efforts may not be
successful in generating additional revenue.
  
    
    Changes in regulatory requirements and tariffs;
    
    Uncertainty of application of local commercial, tax, privacy and other laws and
regulations;
    
    Reduced protection of intellectual property rights;
    
    Difficulties in physical distribution for international sales;
    
    Higher incidences of credit card and other payment-related fraud and difficulties in
accounts receivable
 30




---



##### 



collection;
 
    
    The burden and cost of complying with a variety of foreign laws, rules and regulations;
    
    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.
   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.
  31




---



##### 



Loss of our credit card acceptance privileges would seriously hamper our ability to process the
sale of merchandise.
  Our failure to attract and retain software and digital products publishers, manufacturers, online
retailers and online channel partners as clients would cause our revenue and operating profits to
decline.
  Implementing our acquisition strategy could result in dilution and operating difficulties leading
to a decline in revenue and operating profit.
   32




---



##### 



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.
  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;
 33




---



##### 




    
    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; and
    
    Acquisitions.
   Security breaches could hinder our ability to securely transmit confidential information and could
materially affect our reputation, business operations, operating results and financial condition.
   Claims of infringement of other parties intellectual property rights could require us to expend
significant resources, enter into unfavorable licenses or require us to change our business plans.
  Claims against us related to the software products and services, and/or tangible goods, which we
resell and/or deliver could require us to expend significant resources.
 34




---



##### 



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.
    Political and economic conditions, and current turmoil in United States and global markets, may
adversely affect our revenue and results of operations.
   35




---



##### 



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. 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., aQuantive, Inc. and Omniture, 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, taxation, and regulatory fees;
    
    Fraud;
    
    Advertising;
    
    Intellectual property rights;
    
    Information security;
    
    Quality of products and services;
 36




---



##### 




    
    Security breaches;
    
    Processing of credit card information;
    
    Taxes; and
    
    Recycling of consumer products.
  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;
 37




---



##### 




    
    Operator negligence, improper operation by, or supervision of, employees, physical and
electronic break-ins, misappropriation, computer viruses and similar events;
    
    Power loss, computer systems failures, and Internet and telecommunications failure; and
    
    Other events beyond our control.
  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.
   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.
 38




---



##### 



The listing of our network addresses on anti-spam lists could harm our ability to service our
clients and deliver goods over the Internet.
  We are subject to regulations relating to consumer privacy.
    Compliance with foreign laws and export/import control laws may substantially increase our costs of
doing business or otherwise adversely affect our ability to offer our services.
   39




---



##### 



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.
  Internet-related stock prices are especially volatile and this volatility may cause our stock price
to fluctuate significantly.
  40




---



##### 




    
    Actual or anticipated variations in quarterly operating results;
    
    Announcements of technological innovations;
    
    The ability to sign new clients and the retention of existing clients;
    
    Loss of key 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;
    
    Continued uncertainty in the U.S. and global economy and markets;
    
    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.
  The investment of our substantial cash balance and our investments in marketable debt securities
are subject to risks which may cause losses and affect the liquidity of these investments.
     
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 None
 41




---



##### 



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. 42




---



##### 



Date: November 4, 2008
    DIGITAL RIVER, INC.By:
    /s/ THOMAS M. DONNELLYThomas M. DonnellyChief Financial Officer
(Principal Financial and Accounting Officer) 43




---



##### 



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. 44